In a crisis, cash is king. It underpins the fiscal health of every business and the economic fallout from the COVID-19 pandemic is no exception. Demand has been intense enough to include physical cash with The New York Times reporting that some bank branches in Manhattan temporarily ran out of $100 bills as customers withdrew tens of thousands of dollars at a time.
But first and foremost, the unprecedented public health challenge presented by COVID-19 is both a national and a global emergency. It has forced governments everywhere to protect life by implementing measures that affect every citizen: severely limiting social engagement and routine human contact.
Their near impossible task involves facilitating a sharp reduction in economic activity, closing borders and putting countries in some form of lockdown, without causing long-term damage. As supply chains fragment, market volatility has returned to a level not seen since the Global Financial Crisis (GFC). Simultaneously, deal-making has come to a juddering halt as M&A, divestitures and strategic alliances dry up, capital markets grind to a halt, bond issuance shrinks and IPOs are shelved.
Whatever their crisis management plans may have anticipated, no law firm was fully prepared for this eventuality – although some were better prepared than others. The transportation of entire firms from office-based working to home-working appears to have been successfully achieved by many firms, allowing most work to continue. But dealing with financial gridlock as swaths of clients choose to delay payment of their bills has been far more problematic, exposing fissures in even the best-laid plans.
Last November, no firm could have foreseen the scope or scale of the crisis about to unfold. But one man who fully appreciated that many law firms were already in a precarious financial position was Giles Murphy, Head of Professional Practices at Smith & Williamson (S&W). In interviewing him for Global Legal Chronicle, he clearly sounded the alarm bell on LLP accounts filed by the UK’s top 50 law firms.
In his view, the current cash flow problems facing law firms were as predictable and perhaps as preventable as COVID-19 has been disruptive and devastating. ‘From their latest accounts,’ noted Murphy, ‘there is roughly £450m of net cash on the balance sheets at year end. Compare that with their monthly wage bill of around £600m and they have about three weeks of wages they can afford to pay.’
Murphy’s warning was clear: ‘It shows how thinly capitalised law firms are and how reliant they are on clients continuing to pay bills on time. In a stable environment the model works quite well. But we’re not in a stable environment. If you are a £50m turnover law firm and your clients, on average, decide to defer payment for a week that will cost you £1m of cash.’
Unlike banks and insurers, law firms are not required to hold minimum levels of capital.
Four months on and Murphy’s words seem remarkably prescient. He was speaking then of potential disruption to cash flows caused by Brexit. But the impact of COVID-19 has been immeasurably greater than Brexit could ever be, as evidenced by the wholesale delay in clients’ payment of bills.
The equally dramatic response by law firms in preserving cash and bolstering their balance sheets is just as plain to see. Take Linklaters. It has suspended partner profit distributions that were due in June, deferred 50% of its next bonus round pay-out, pushed back salary reviews by six months and introduced a complete hiring freeze. Of course, this merely follows what others have already done.
Slaughter and May has suspended partner pay for an unspecified period following a similar move by Freshfields Bruckhaus Deringer to suspend its latest quarterly partner distribution. Both firms have stopped recruitment. The first of the magic circle to take action, Allen & Overy, announced a cash call at the end of March, requesting partners to contribute capital to the business.
Taking a long view, Clifford Chance cancelled its partner conference in Berlin that was due to be held at the end of June. Details of its cash preservation measures have not yet been made public. Elsewhere, a similar picture emerges. As examples, Herbert Smith Freehills is reducing partner profit distributions although bonuses for the 2019/20 financial year will be paid – 50% in July and 50% by the end of the year. Meanwhile Norton Rose Fulbright staff have seen their working week reduce by 20% and their pay cut to 80% of base salary.
The bottom line is that partners everywhere are temporarily going without pay or bonuses, allowing cash to be retained in the business. To make predictions of how things may look in three, six, or twelve months from now is brave; some might say foolish. But that is the job of economists. Although banks like J.P. Morgan and Goldman Sachs predict a strong economic recovery in the second half of 2020, others are more bearish.
A consensus exists that as GDP in the major economies declines by staggering amounts in the first half of 2020, insolvencies and unemployment will rise sharply in the second half. The only question is by how much. An extraordinary 16 million Americans have already filed for unemployment. A doubling of the UK unemployment total towards the 8% mark is widely predicted.
But some economists are making stark predictions that the figure will be even higher. At least six million people (18%) could find themselves unemployed in Britain – more than during the Great Depression of 1929-32 – according to economist David Blanchflower, a former senior Bank of England official during the GFC.
What then are the Cassandras saying about law firms? So far, the response has been muted. Despite the hiring freezes, cash calls and widespread furloughing of non-fee earners, no big law firms have axed any lawyers. At least not yet. A wait-and-see attitude prevails. Commentators are therefore holding fire until concrete evidence emerges to suggest that the impact is more than temporary.
One man who has put his head above the parapet is Tony Williams, principal of Jomati Consultants and former managing partner of both Andersen Legal and Clifford Chance. He argues that the impact of COVID-19 on law firms will be very different when compared to the GFC. ‘There is no shortage of liquidity with the risk of the whole economy grinding to a halt. A lot of transactional work will, of course, be on hold, but legal practice on this occasion is significantly better off than other parts of the economy,’ he said in a recent interview. ‘Work is still taking place and lawyers are working from home reasonably well. Once there is a floor to the market, you get the sense that hedge funds and country funds will see a buying opportunity and corporate deals will start up again.’
For UK firms which are nearing their financial year-ends, he argues, the timing could be a lot worse. ‘They might not end with a flourish, but I don’t think it will have a major impact on revenue – a few percentage points, not 20%. So they have a bit of breathing space as they should be fairly cash rich. That may not be the case for the US firms, which have calendar year-ends.’
Williams is therefore as sanguine about the outlook for law firms as Blanchflower is despondent about the impact on wider employment. Which of them is proved right remains to be seen.
Dominic Carman, journalist, writer and legal commentator. www.dominiccarman.com