When corporate and transactional work ebbs for law firms, financed litigation can be a welcome recession hedge and a better alternative to firm layoffs.
Law firm leaders are watching economic trends with some trepidation these days—particularly those whose businesses are heavily reliant on transactional work, which has slowed precipitously in the last year. According to a recent Thomson Reuters study, in the fourth quarter of 2022, demand for M&A work was down by nearly 17%.1 And the picture for big law firms does not appear to be improving any time soon, with industry experts already observing that 2023 demand is “concerningly weak”.2
As companies come under increasing pressure to manage expenses and maintain cashflows, their appetite to take on new business ventures and hire lawyers understandably lessens. Research by Thomson Reuters connects the slowdown in transactional work on law firms to a steep decline in firm profitability.
The consequences of these trends are already evident in the layoffs that several leading firms, including within the Am Law 100, have already made and the move by some firms to delay new associate classes.3,4 This is not a new strategy: In the wake of the 2008 global financial crisis, many firms sought to lower expenses and preserve profit margins by reducing headcount. But there are arguably better ways to offset the loss of transactional work as the economy slows.
Litigation practices can help recession-proof firms
While corporate and deal work almost always declines in uncertain times, the countercyclical nature of disputes means there will be no shortage of commercial claims impacting clients—and thus law firms can augment their litigation practices to offset other deficits. In times of economic strain, litigation increases as fraudulent activity is revealed and deals turn sour. Clients find that legal claims they could once gloss over need to be pursued aggressively, as they become newly urgent about the need to recover money for the business.
Even before the increased economic uncertainty of the last year, we have seen a trend toward large companies affirmatively pursuing claims that represent significant recoverable value to their businesses. As one assistant general counsel of litigation at a health insurance company told a researcher:5 “Every legal department should have an affirmative recovery practice.”
Clients want more risk-sharing solutions
Even as companies become more likely to pursue valuable claims, with companies struggling to manage soaring inflation and increased capital costs, it is likely they will expect more risk-sharing solutions from their panel law firms. Anecdotally, law firms have already noted a rise in demand for law firm price reductions or discounts. As Tamara Box, Europe and Middle East managing partner of Reed Smith, recently told the Financial Times: “We had a number of clients who said, ‘I’m not going to pay you all that now, I’ll do it over a different timeframe.”6
Clients are already increasingly asking for price flexibility: In a recent survey of GCs, six in ten said their outside counsel 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).7 Further, according to a recent study by the Association of Corporate Counsel, over half (53%) of chief legal officers believe the use of alternative fee arrangements will become more prominent over the next five years.8
However, law firms navigating tough market conditions may find an increase in alternative fee arrangements difficult to rationalize. While pursuing commercial claims can provide guaranteed work for law firms even in a down economy, unless they have a risk-sharing partner of their own, they can face significant cash flow challenges when that work comes with demands for large discounts, contingencies or other reduced- or deferred-fee arrangements. While contingency cases present the opportunity for significant upside upon their successful resolution, they present a big risk of expense and cash loss to the firm if matters lose.
This challenge is even more acute in a downturn. Firms with fewer hours billed on transactional and other work will inevitably face challenges paying lawyers assigned to contingency cases who are not currently generating revenue—even though in a couple of years their work may produce a windfall for the firm—without reducing partner distributions to others still working on an hourly basis. Even firms with established plaintiff practices often need a risk-sharing partner to weather the ups and downs of commercial disputes that may take years to resolve.
Law firms can share risk through portfolio finance structures
Legal finance helps law firms 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. It also solves the partner compensation problem for partners working on contingency by paying a portion of lawyers’ hourly rates on contingency matters in real-time and as billed, thus creating a pool of capital from which to pay partners while contingent matters are being litigated.
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 any client budget cuts that arise.
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. Already this year Burford has received increasing interest from AmLaw 50 law firms that traditionally operate on a hourly fee basis looking to share risk with Burford while expanding their contingency fee practices.
Legal finance helps law firms serve clients with fee fatigue
Not all law firms are set up to or want to share contingent litigation risk with their clients. Some of the best litigation talent can be found at traditional hourly-fee firms that may lack the appetite or experience to underwrite and carry the litigation risk clients are asking them to share.
Even in these circumstances, legal finance can help law firms serve their clients uninterrupted. When clients become unable or unwilling to pay hourly fees, legal finance can provide law firms with the ability to continue working on meritorious claims. In the wake of the global financial crisis, Burford’s first matter following its 2009 founding involved a large New York law firm with an hourly billing model. The firm 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 clients with strong claims to continue to work with their chosen counsel even when hourly fee rates become harder to meet.
A better solution in the long-run than lay-offs
As demand wanes for lucrative business transactions, law firms may be tempted to cut headcount as in previous recessions. However, there are other options available to law firms that do not carry the same reputational and long-term financial implications that lay-offs do. Eventually, when business booms, those law firms will inevitably have to incur additional costs to rehire and retrain staff.
Instead, law firms should look to their litigation practices as potential recession hedges as transactional and M&A work abates. And legal finance can powerfully enhance the countercyclical effect of the litigation practice for law firms, while at the same time allowing them to better serve their clients.
1 Karen Sloan, “Law firms’ demand slump deepened at the end of 2022. Is a rebound coming?”, Reuters, February 14, 2023, available at: https://www.reuters.com/legal/legalindustry/law-firms-demand-slump-deepened-end-2022-is-rebound-coming-2023-02-14/
3 Kathryn Rubino, “Top 50 Biglaw Firm Announces Layoffs: The layoff trend continues in Biglaw,” Above the Law, February 27, 2023, available at: https://abovethelaw.com/2023/02/perkins-coie-staff-layoffs/
5 Burford Capital, 2022 Affirmative Recovery Programs Report, available at: https://www.burfordcapital.com/insights/insights-container/2022-affirmative-recovery-programs-report/
6 Katie Beioley, “Law firms warn of tougher fee negotiations and payment delays,” Financial Times, March 1 2023, available at: https://www.ft.com/content/a31bc6a3-f7b7-4c6e-8e51-61e5229ab552
7 Burford Capital, 2022 GC Survey, available at: https://www.burfordcapital.com/insights/insights-container/2022-research-gc-survey-on-legal-finance/
8 Association of Corporate Counsel, 2022 Chief Legal Officers Survey, available at: https://www.acc.com/clo2022