What successes or challenges can we expect for law firms in 2014? Writers like Dimitra Kessenides and Jennifer Smith recently have written that 2014 may be a challenging year for law firms. But as reported just this week, including by Jennifer Smith, the 2014 Outlook from Citi Private Bank and Hildebrandt Consulting projects law firm profits to go up by five percent.
While decidedly different prognostications, neither may be wrong. Some firms likely will enjoy an upward tick, while others will continue to struggle through transition. For most law firms facing transition in 2014, resolution of any challenge will not be a life or death matter. But for some, the tests they face could cause a default in their bank financing. For such a firm, its troubled law firm loan will require a workout, a circumstance it probably never anticipated facing.
From the bank’s perspective, getting the workout right can save a valuable business relationship or reduce the risk of loss. Getting it wrong, and the bank can find itself a party in a Dewey like world-a place few bankers want to visit. The increased risk profile spawned by a law firm’s setbacks demands careful attention by the bank and compels it to understand the ins and outs of working out a troubled law firm loan.
Law Firm Loan Basics-Good Times. Law firms can be great customers for banks. A law firm’s needs can be many: working capital loans, equipment financing, depository services, trust department services, and capital loans for partners. The relationship that evolves from these needs can spawn further relationships – introduction to attorneys and staff who have personal banking needs; introduction to law firm clients that have business banking needs. As long as the bank/law firm relationship is a smooth one, it can prove to be a long lasting and lucrative partnership.
Law Firm Loan Basics-Not So Good Times. When a law firm’s loan with the bank exhibits signs of tension or trouble, it is imperative that the bank gives the matter its immediate attention. Indeed, because a law firm’s asset value is in its attorneys that can resign at any time, a loan workout with a law firm is challenging. For most banks, the fundamental objective of getting paid is coupled with a desire to see the law firm smooth out its bumps in the road so that the law firm remains a good customer going forward. In other cases however, the circumstances may have advanced to where there is little hope that the relationship will continue, and the focus of the bank is directed solely to getting paid. Whatever point on the workout continuum the law firm falls, there are certain basic steps the bank should take when facing a law firm loan workout. These steps work regardless of the severity of the situation, and position the bank so it can obtain the best result possible.
Getting a Sense of the Situation. As is the case in any workout, take a snapshot of the situation from 50,000 feet so that you get a sense of the overall situation. You’ll dig into the details later, but you will want to start your preparations by viewing the entire landscape, especially since law firms can be fragile institutions. Determining the situational overview allows you to know if the problem is manageable, and whether it is a problem for others. No doubt it is a problem for your law firm borrower, but there can be others, whether contractually bound or not, that may have an interest in seeing the loan workout succeed. You’ll want to know the identity of those parties and understand their motivations. Performing this preliminary assessment will provide needed context as you go forward.
Understanding The Sources of Recovery-Obligors. No workout should go long without determining all available sources of recovery. Obviously, the law firm borrower is a source, but you may have guarantees from various partners or affiliates. Few law firms are general partnerships anymore, but look at the nature of the business organization to see if additional parties may be liable as a matter of law.
Understanding the Sources of Recovery-Collateral. What collateral do you hold? Is there collateral from the other parties that are liable, whether they be guarantors or otherwise? Do your collateral documents give you a security interest in the borrower’s “unfinished business”-the underlying profit in the client work in process?
Enlisting Professional Help. Your preliminary steps will guide you in the wisdom of bringing in outside professional help. In performing the preliminary steps, you already may have enlisted the assistance of outside advisors such as attorneys, financial advisors and accountants. If not, however, unless the situation with the law firm is completely benign, a call to your outside advisors is warranted. With their assistance, the bank should decide on its ultimate objective. Once the objective is established, your team can work together to develop a comprehensive plan designed to achieve the bank’s objective, including alternative paths to implementation depending on the array of responses from the law firm.
What steps do you think are most critical in getting a good start on a troubled law firm loan workout?
Next week we’ll cover Part Two of this three part series on The Bank Workout of the Troubled Law Firm Loan.