Like a lot of things, the workout of a troubled law firm loan is neither mechanical nor predictable. Facts unique to the situation guide a bank’s approach, and finding the correct strategy is as much art as it is science. But because the problem loan is not likely to resolve itself, the smart banker seizes the initiative and acts promptly.
As noted in Part One-Fundamentals and Preliminary Steps. it is imperative that a bank initiate steps designed to get a sense of its challenge. Generally understanding the task at hand prior to getting too deep into the workout is always a smart move. Indeed, having done so, the banker can then move on to assessing the level of risk and, on the basis of the risk recognized, creating a plan.
ASSESSING THE RISK
Documentation. Now is the time to review all the basic documents. Loan agreements (and any ancillary documents such as account control agreements), correspondence and the law firm constituent documents must be carefully reviewed. Does the law firm’s documentation waive and release an attorney’s unfinished business? What is the law firm’s current cash situation, future cash needs and the quality of any offset rights held by the bank.
Collateral Quality. You have already determined the extent of your collateral, but in this stage it is imperative to research whether others have competing liens, whether you are perfected in your collateral and the quality of the collateral that you hold. If you have a lien on accounts receivable, but they are over 180 days old, you may be less secure than you would desire.
Financial Statements. Your review should also include examining the most recent financial statements or other financial reporting from the law firm. If others are liable, review any financials in the file that they have provided. If you have the right to ask for updated financials, be prepared to make that request. Does the law firm appear solvent?
Relationship Quality. Assess the bank’s relationship with the borrower and anyone else that may be liable to the bank. Is the law firm’s management trustworthy? Does the law firm appear to trust the bank? Has the relationship become strained and if so, what are the reasons? Are there steps that can diffuse the strained relations? Is the management team long-standing or new? Is it experienced and capable? Is it willing to listen and will it work with you? Even if you have a favorable impression of the management team, is it distracted by something, and if so what distracts it?
Recent Operations. A closer look at recent history is vital. Is the firm’s current situation the result of turnover, in particular the loss of attorneys with the most client relationships? Have there been recent client departures? Is the law firm facing an onslaught of litigation and if so, is it covered by errors and omissions policies? Is the insurance adequate to cover the potential exposure? What recent distributions have been made to the law firm’s owners (and others) and are the distributions consistent with the law firm’s constituent documents and past practices?
Timing. Are you dealing with any timing constraints? Having to respond to an emergency compels a completely different tact than when ample time exists to develop a plan that contemplates a law firm repositioning.
Options. On the basis of this investigation and understanding of key facts, your action plan will probably fall within one of four options. Hopefully, the situation allows for you to continue the relationship but simply be more attentive in the future. Even if that is not the case, your second option may permit you to reach a consensual resolution with the law firm in which the bank shores up any substantive deficiencies and additional covenants are imposed in a loan modification agreement. If the foregoing two options are not realistically available to the bank, requesting the law firm borrower to move the loan to another lending institution may make sense. No doubt that risks the continuation of tangential banking activity that currently exists, but losing the ability to provide those services may be a small price to pay in order to assure payment of the outstanding loan(s). Finally, if those options do not fit your situation, you may be left to exercising your remedies against the law firm.
In past workouts, did you use additional ways to assess the risk and develop a plan? Were there some approaches that you did not use but wish you had?