For an industry so reliant on cash flow and unlikely to keep most of it on hand, the coronavirus' economic impact has sent many firms scrambling for ways to preserve their access to cash.

Many of those efforts have gone public, including layoffs, furloughs, compensation reductions and more. Others are happening behind the scenes as firms renegotiate with their banks.

Joseph Mendola of Wells Fargo's Private Bank Legal Specialty Group said the bank's credit underwriters are busier than they have ever been as law firm clients seek access to more cash.

"We, and [other] banks, have been overwhelmed with requests for line of credit increases and extensions of existing lines," Mendola said, noting law firms are conservative and busy mapping out how many weeks of operating expenses they can cover with existing cash and credit lines. He said most don't expect to use the lines right now but are mainly accessing for precautionary reasons.

The process has proven relatively painless so far in terms of the financial health of the industry, banks' willingness to lend and law firms' access to alternatives, such as litigation funders buying up receivables. The question is how many months firms can withstand a significant dip in collections, How far will they be able to ride on their existing lines of credit, withholding distributions from Q1 and the other cash-preserving measures they have taken?

Most firms would be coming out of their lines of credit around this time, having used the last of it to pay out distributions so partners could pay taxes by the typical April 15 deadline in the United States. But with the deadline pushed back to July 15, most firms have held onto that cash. And a strong Q4 of 2019, coupled with good inventory coming into the year, has provided some additional cushion. Many firm leaders report demand was up in March and collections started to slow only slightly by month's end. They are preparing for a different story in April and May.

Jeff Grossman of Citi Private Bank's Law Firm Specialty Group said firms are well capitalized and, from a debt point of view, most law firms have moderate to little debt. But when you look at the amount of cash they have on hand, the story changes.

"The strongest firms have a few months of operating cash on top of their capital," Grossman said. "And they will be better off. The firms that are still very well capitalized in normal times but lest capitalized because they pay out distributions every year and don't have significant cash, they are less well positioned."

Profitability is also a factor, he notes.

"The firms with a higher net income margin are also better able to weather the storm because they have levers they can pull to prevent release of cash. Less profitable firms have less levers to pull," Grossman said.

The message Citi is sending to its clients is for them to build up as much cash as possible. Hence many of the measures the bank's clients and other law firms are taking, such as furloughs, compensation reductions and more.

Partners Up First

Partners are clearly feeling more of an impact this economic downturn than in previous ones as distributions are being withheld and compensation cut. The question is whether they will have to put even more skin in the game through increased capital contributions or recourse loans in their name.

"One question I have is whether banks will ask partners to personally guarantee [loans] and then will drop them again once things are normal," said Dan DiPietro, a consultant who spent 30 years with Citi Private Bank's law firm group. "Personal liability of partners is now the exception, whereas it used to be the norm. There may be a need to look at that, depending on how" individual firms are positioned.

It does come down to how much in profits they hold back as a matter of firm culture and financial philosophy as well as how much cash they have on hand in the early months of the year.

Giles Murphy of professional consulting firm Smith & Williamson in London said "firms are currently stress-testing around [cash]," with a focus in the U.K. on the period through July 31, when LLPs must make tax payments in the country.

"Most firms are in decent shape profitability-wise," he says, "but less so cash flow-wise." They are "thinly capitalized" and only tend to "keep a minimum level of cash in the business."

Due to law firms being considered a good credit risk, law firm consultant Tony Williams believes firms will "generally be OK to negotiate headroom," adding that "there is not a liquidity crisis in the market like 2008. There is cash."

The caveat, however, is that that banks "will be considering the ability of firms to repay debt" generated during the pandemic, Murphy said.

"There is a limit on how much a bank is prepared to lend a firm," Murphy said. "Many banks are happy to lend, but, this time, with personal guarantees."

He says some firms have already started negotiating extended facilities where equity partners are having to decide whether they want to enter into a personal guarantee.

A senior analyst at a leading U.K. investment advisory firm said "personal guarantees are proliferating," with partners "putting their own personal finances on the line." However, he adds that he is yet to come across a scenario where "a firm has advocated personal guarantees to the point that a partner could lose their personal assets."

"It has happened previously. But for a top firm to ask their partners to expose all they've got, everything they've earned, seems to me unlikely. There will be personal guarantees, but these themselves will be limited."

Bankers in the U.S were less convinced that personal guarantees would be commonplace in this downturn.

The good news for firms is there have been a lot of lessons learned from the Great Recession and many differences in what caused this current downturn. Unlike in 2008, banks have the money to lend. And since 2008, most firms have moved to committed lines of credit with their banks, meaning the banks almost have to lend, barring any breach of covenants, Mendola said.

Not Just a Banker's Game

Litigation funders, many of whom were born out of the last recession, also say the calls are coming in fast and furious, both from law departments and law firms. Law departments are asking about getting paid out now on litigation winnings they are waiting to collect on. And law firms are using litigation funding to help offer true alternative fee arrangements to clients who can't afford to handle the proactive litigation they need to initiate.

Jonathan Molot, co-founder of Burford Capital, said firms are starting to have trouble keeping some midlevel associates busy. Litigation funding that allows clients to act on litigation they otherwise can't afford, serves the dual benefit of helping the law firm keep its lawyers busy and paid, he said.

Another option for law firms to access cash faster started happening before the COVID-19 pandemic hit and could accelerate in the current climate. That option is the sale of law firm receivables.

Well before COVID-19, law firms had started to turn to funders to sell off quality, new receivables of somewhere between 30-90 days old. They'd take a haircut on the returns in exchange for getting a known amount of cash in at a set time. This was often done to help boost realization rates at the end of the year, Molot said. That may be more attractive in the current economic climate as clients slow to pay, he said.

Another trend that could accelerate in this market is offering funders an equity stake in the portion of a firm that isn't providing legal services, Molot said. The concept isn't new to the market, with UnitedLex doing similar deals with LeClairRyan or Polsinelli.

Molot said Burford is seeing an increased interest in the model now.

"The problem with capital by banks is you have to repay with interest," Molot said, noting "for equity, you never have to pay it back."

How Bad Will It Be?

While everyone agrees it's anyone's guess as to how long and how badly the industry will feel the impacts of COVID-19, Grossman said he is hearing from firms that they are expecting receipts to be down anywhere from 5-10% and as high as 25-35%, with the second quarter being hardest hit.

"But we believe that with all the preemptive actions that are being taken, most law firms will be in a reasonably strong position," Grossman said, adding, however, that some would be impacted "severely." How well firms fare will be due not just to cash on hand but also to practice mix, he and others said.

The recovery won't be immediate, but Grossman said law firms may likely be a leading indicator as they face the unusual circumstance of both corporate and litigation spiking at the same time. That is due in large part to the same reasons banks are ready and able to lend—there is no fundamental problem with the economy.