Younger lawyers need to ask tough questions before taking partnership, warns CMS's Rita Lowe

When a business enters a formal insolvency procedure, creditors and employees lose out, as well as the owners of the business who lose their equity investment. When a law firm enters an insolvency process, however, there is another class of stakeholder with plenty to lose: junior partners, who fall between the stones of employee and owner.  

New partners can be some of the most vulnerable stakeholders in law firms suffering financial difficulties.  As a result, it is not surprising when new partners at insolvent law firms are the first to criticise their management, nor that they are the most frustrated when an insolvency practitioner approaches them for repayment of drawings. This may be broadly equivalent to salary without any sizeable participation in distributions before insolvency.  

New partners will have invested some of their hardest working years to be accepted into the partnership, and perhaps have also taken out a large loan to make a capital contribution. As they build their business, their reputations are always on the line, and their judgement is constantly scrutinised by clients and peers. All of this makes it even more difficult, and painful, for new partners to move on after insolvency.

So how do you avoid becoming a new partner in an insolvent law firm? Here are some warning signs of a firm that may be at risk. These signs are neither exhaustive nor conclusive, but they may help a prospective or new partner to ask the right questions. 

Hidden financials

A successful firm should be prepared to disclose and discuss its finances, especially to anyone knocking on the door of partnership. A struggling firm, however, is often paranoid about whistleblowers who ask tough questions. When numbers are concealed by management, or brushed over with vague answers, it may be time to probe deeper.  

Of course, commercially sensitive data must be protected. A strong firm will not fear disclosing bad results that are symptomatic of prevailing market conditions (rather than the firm's failure). Openly acknowledging poor results may also give the board the leverage that it needs to make unpopular, though necessary, changes.

Autocratic role

An unfortunate pattern among insolvent law firms is autocratic leadership. A charismatic leader may find it difficult to admit failure, and hold the ship together long after it should have been scrapped.  

As discussed by Clare Boardman in her article in Legal Week in May on underperforming law firms, there are solutions and these solutions are more effective the earlier they are implemented. 

However, partners may find it difficult to get the information they need from a charismatic leader, and to persuade that leader to implement change. A sizeable law firm driven by one personality, who is largely unchallenged and unaccountable, is a risk to all employees and stakeholders.

Flashing the cash

While firms need to spend in order to grow, expenditure must be targeted and provide value for money. A firm in financial difficulties may be tempted to 'bet the farm' on a speculative investment or on expensive corporate hospitality and perks. 

It is also another sign of grandiose management. Flash expenditure is a bold statement of success, and some firms may believe that the impression of success will foster success, but such belief is misconceived. Taking on expensive premises and uncontrolled marketing expenditure has caused difficulties for more than one firm in this recession.  

Fading stars

Big hitters often receive big salaries, reflecting the years of graft and dedication required to stay ahead of the competition. Yet when those big hitters stop bringing in work, law firms are slow to reduce their drawings. This may be through fear that those partners will leave, taking flagship clients with them; or it may be through loyally supporting colleagues in good times and in bad. 

Either way, law firms, like all businesses, need to be fast on their feet to adapt to change and take sensible steps to stay profitable.  

Guaranteed drawings are a dangerous strategy for law firms. Lateral hires are often not successful and guaranteed drawings leave little or no room to rectify mistakes. Likewise, salary rises in difficult times send out the wrong signal. A prospective partner will need to review utilisation across the firm and decide whether the business is sustainable, both in the short and medium terms.

Partner exodus

Partner departures, promotions and lateral hires are all normal parts of a firm's life cycle, but partners should look out for unusual trends, and a prospective partner may be wise to find out why partners are leaving if that is the case. Astute partners should recognise when a firm is struggling, and will seek to remedy the situation where possible or protect their own positions by moving on where it is not, while bearing in mind duties to stakeholders.  

It is widely reported in the legal press that there are currently law firms in the UK that are in serious financial difficulty. We have certainly not seen the last law firm to go under in this recession. 

In a progressive and successful firm, it should be possible for any partner to challenge financial data, firm strategy and assumptions by management of future success. No partners should take their eyes off the sky in case it is about to rain.

Rita Lowe is a partner and head of the banking and finance team at CMS Cameron McKenna.