A recession hedge for law firms
The world economy appears headed into a downturn, and—assuming that high inflation rates persist in a recession—may even face the first stagflation environment since the 1970s. As companies come under pressure to manage expenses and maintain cashflows, an inevitable cooling in client demand for transactional work from law firms will follow. This is cause for concern, as law firms are experiencing a reduction in corporate and deal work as well as increased costs, leading to a reduction in profits at many of the largest international law firms, according to research from the Thomson Reuters Institute. While billable hours declined by less than one percent in the last quarter, payroll expenses rose by almost 11% and overheads by almost 13%. Demand for M&A work for law firms fell almost 14% between July 2022 and September 2022 compared to the same period in 2021. And industry experts are already observing that 2023 demand is “concerningly weak.” The consequences are already evident in layoffs by leading firms.
We’ve seen this before: In the wake of the 2008 global financial crisis, many firms sought to bring expenses under control by cutting headcount. But there are arguably better ways to offset the loss of transactional work.
Litigation practices as a recession hedge for law firms
In a downturn, law firms look to their litigation practices as a hedge. In essence, the countercyclical nature of disputes means there will be no shortage of commercial claims. And there is a further opportunity for firms that want to enhance existing litigation practices.
The opportunity is most obvious for firms that have both a litigation practice and specialty practices that they haven’t historically leveraged in their litigation practice. For example, intellectual property specialists could work with established litigators to build a patent litigation team, or corporate associates could be deployed to undertake the forensic work of any ongoing securities litigation.
Rather than being laid off, underutilized lawyers could be deployed towards affirmative litigation, of which there will be no short supply—quite the opposite.
Sharing risk with clients on their affirmative claims
In a recession, clients find that legal claims they could once gloss over need to be pursued aggressively, as they represent a newly important path to recover money to the business. But as companies struggle to manage soaring inflation and increased capital costs, law firms are likely to be pressured to provide discounts and alternative billing arrangements. Meanwhile, clients want risk-sharing options from their firms: In a recent survey of GCs, six in ten said their panel firms either talked to them about cost or risk sharing options or that their doing so would have aided company success (and, presumably, reflected well on the firms).
In recent years some big law firm players have sought to meet the demand for cost-sharing. In 2019, Kirkland & Ellis, the largest “big law” firm in the United States by revenue, made the well-publicized announcement that they would be taking on plaintiff matters and self-funding them through contingency arrangements. This announcement was a striking example of an historically hourly fee defense firm adapting to meet client needs.
Law firms that already have risk-based practices for particular groups now have an opportunity to expand those practices, given rising demand.
Sharing risk with legal finance providers
While work pursuing or defending commercial claims can provide a welcome hedge for law firms, unless they have a risk-sharing partner of their own, they can face significant challenges to cash flow when that work comes with demands for large discounts, partial contingencies or other reduced- or deferred-fee arrangements. Taking on more contingent work creates an extraordinary risk of outright capital loss to a law firm whose clients have claims that, however meritorious, may well lose.
As law firms seek to arm themselves for a recessionary environment, legal finance will be an even more important weapon in their arsenals—and one that will help them manage the financial risk that comes with representing clients on a contingent basis. Legal finance in the form of a capital facility tied to a pool of existing or future matters enables law firms to take on a significantly greater number of contingent cases without increasing risk to the firm. Law firms that do not have a legal finance partner in place will be more limited, especially in a downturn, in their ability to compete for profitable new business and hedge against the client budget cuts to come.
In addition to using legal finance to share the risk of the costs of representing clients on a contingent basis, firms that have contingent matters in their books of business can work with a legal finance provider to accelerate or “monetize” an expected entitlement to the firm, providing immediate liquidity.
Serving clients with fee fatigue—without interruption
Not all law firms are set up to or want to share contingent litigation risk with their clients. Hourly billing firms are home to some of the best litigation talent and may lack the appetite or the experience, even if they are financially able, to underwrite and then carry the litigation risk clients ask them to share.
Legal finance can also help these law firms serve their clients uninterrupted. In the event that clients become unable or unwilling to pay hourly fees, legal finance can provide law firms with the ability to continue working on meritorious claims. Burford’s first matter following its 2009 founding, in the wake of the global financial crisis, involved a large New York law firm with an hourly billing model that introduced Burford to a client that used legal finance capital to continue retaining and using the firm on an important affirmative claim when its capacity to pay became constrained.
By providing a solution to clients to finance the fees and expenses of ongoing litigation, legal finance allows law firms to continue to represent clients with strong claims when they experience fee fatigue.
Preparing for the future
The key lesson from past recessions is that far from having just one tool—layoffs—law firms have options. They can and should look to their litigation practices as recession hedges as transactional and M&A work abates. Legal finance—which has enjoyed most of its historical growth since the 2008 recession—can powerfully enhance the countercyclical effect of the litigation practice for law firms, while at the same time benefiting their clients.
This article was originally published on New York Law Journal and can be found here.
Reprinted with permission from the February 10, 2023 issue of the New York Law Journal. © 2023 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
