Boom time for law firms?

Boom time for law firms?

The past year has been unprecedented and extraordinary, as commentators keep reminding us – just in case we hadn’t noticed. That the global pandemic and the ensuing economic downturn have presented a huge array of challenges for businesses everywhere is self-evident. For most companies in most sectors, there is a long road back to achieving anything like normality.

But for the legal market, words like unprecedented and extraordinary may, for once, be something of an understatement. Like nearly every other business, law firms experienced significant disruption in their operations because the response to Covid-19 caused such havoc.

They had to adapt fast, and it appears that most of them have done so with a level of success which is quite remarkable – a tribute to the innovation and resilience of law firms and those who lead and manage them.

In its Report on the State of the Legal Market 2021, recently published by the Georgetown University Law Center and Thomson Reuters, figures are given for the performance of the AM Law100 – the 100 largest US law firms – as well as for mid-size law firms. The published data is based on reported results from 162 US-based law firms, including 45 Am Law 100 firms, 56 Am Law Second 100 firms, and 61 additional midsize firms.

The report suggests that among all US law firms, there was an aggregate demand drop of 2.9% last year. However, fee income had returned to pre-pandemic levels across the board by November. In the context of most sectors, these are impressive results, demonstrating that the level of demand was not hugely impacted.  

With the exception of bankruptcy and reorganization, which saw a 3.2% increase, the report shows that nearly every practice area experienced some fall in demand. The areas that experienced the biggest falls include: Real Estate (-4.4%), Tax (-4.2%), and Litigation (-4%). But in the context of Covid, falls of this magnitude are very small when compared with many other sectors where big double-digit declines have been the norm.  

Notably, the overall drop in demand was not shared by law firm clients. In an Acritas survey of US senior in-house counsel, the vast majority reported a surge in workload resulting from the pandemic. Much of this involved novel issues that had to be handled in-house since they required an in-depth knowledge of the businesses and a very quick turnaround. By contrast, many transactions and litigation matters, which would have involved external law firms, had to be put on hold. This contributed to the drop in demand for their services.

But what is truly remarkable is what happened to their profitability. Among all the firms surveyed by Thomson Reuters, profits per equity partner (PEP) increased by 18%, while for the AM Law 100 firms, they soared by 22%. Compared with their historic performance, this would represent the best year ever for big law firms in terms of profit growth.

So how have they managed to achieve such an impressive performance? Since the global financial crisis (GFC) of 2008-9, law firms have successfully re-engineered their business model: fairly aggressively increasing rates, increasing leverage by shrinking the ranks of equity partners while growing other categories of fee earners, and aggressively controlling costs.

Where possible, firms have shifted work over the past year from associates and non-lawyers to partners, enabling them to charge significantly higher rates. But the real answer as to how they have ridden out the Covid-19 pandemic so successfully lies in aggressive cost control, which anticipated that the reduction in demand would be much worse than it ultimately turned out to be.

The Thomson Reuters report states that 81% of firms implemented cost-cutting measures, stopping or significantly reducing all discretionary spending. In addition, big cuts occurred in marketing and business development (-44%) and recruitment (-40%). It also highlights the following:

• 46 % of firms reduced partner draws

• 40 % reduced the salaries of fee earners

• 34% furloughed support staff

• 32% reduced the salaries of support staff

• 36% made support staff redundant

• 11 percent discharged fee earners

In addition to these cost cutting measures, a majority of law firms also received government assistance: 59% of firms (79% of small firms and 48% of large firms) applied for and received government financial support during 2020, mostly in the form of Payroll Protection Program loans from the US Small Business Administration.

The actions taken by firms last year, combined with the significant reductions in expenses, explain the very strong growth in PEP even during a very turbulent year. Indeed, every segment of the US legal market in 2020 showed significant improvement in PEP over the previous year.

Despite recent progress in the development and rollout of vaccines, uncertainty remains as to the duration of pandemic-related disruption and how many months it will be before law firms can return to normal operations. There is also considerable speculation as to what normal will mean in a post-pandemic world.

Taking a bullish view, a sharp bounce back in economic activity will create a surge of work for law firms as M&A, capital raising and investment activities resume. This needs to be weighed against aggregate debt, both at a sovereign and corporate level, which will remain at a much higher level for years to come. This will continue to be an economic drag for many countries, particularly those most affected by the pandemic, which includes the US, the UK and the EU.  

Since the GFC, the legal services market has evolved toward a different delivery model. Evidence of that evolution can be seen in the expectations of clients, the pricing of law firm services, the growth of competition, particularly from non-traditional law firms, and dramatic changes in technology. Combined, these trends have made the delivery of legal services more efficient, more predictable, and more cost effective.

Arguably, the pandemic has exacerbated and accelerated the pace of change in each trend, potentially adding some new ones. Trying to predict the economic and legal future is always an impossible task. Although an even greater use of technology, and a proliferation of more lawyers working from home more of the time, now appear to be baked into the law firm model going forward, other issues seem far less certain.

On the profitability front, it is highly unlikely that the law firm sector will ever repeat its aggregate performance of last year, as outlined in the Thomson Reuters report. Indeed, 2021 may be considerably tougher as much of the law firm discretionary spending will have to resume and competition becomes ever more intense in what will be a very challenging economic environment across multiple sectors and jurisdictions.

The likelihood that profit stagnation or decline may yet be a defining characteristic of law firms is very real, although perhaps too early to predict with any certainty. What a post-Covid world will look like and exactly how things operate by the end of 2021 is equally impossible to forecast. 

At the beginning of 2020, the world was anxious about Trump, the EU was anxious about Brexit, and each country was anxious about its own domestic concerns. Law firms in 2021 will have an entirely new set of challenges to those which they faced just 12 months ago. How they manage them remains to be seen. 

Dominic Carman

Written by:

Dominic Carman, journalist, writer and legal commentator. www.dominiccarman.com

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Author: Dominic Carman