Some of the U.K.'s top 50 law firms face a real risk of collapse amid the financial hardships brought on by the pandemic, according to an analysis of their accounts by auditor Smith & Williamson.

For the financial year to April 2019, 36 of the 50 firms did not have enough cash to cover three months' lawyer and staff salary costs, the research found. In addition, 37 firms had bank loans and overdrafts, totalling more than £800 million.

At the same time firms have failed to improve either their profit margin, which remains at about 31%, or the amount of time it takes for them to get paid, which remains at 119 days, down from 121 the previous year.

On average revenues rose by more than 7%, compared with 8% in the previous year, "which in most industries would be considered to be quite a positive sign", said Giles Murphy, head of professional practices at Smith & Williamson. However, he added that "beneath some of those numbers the scenario is perhaps not quite as rosy as some of those headline numbers might suggest".

"One has to question whether the productivity drives that firms have essentially failed to achieve and the failures to bring down their lockup will come back to haunt them"

In a podcast interview with Legal Week, the U.K. arm of Law.com International, he pointed out that even prior to the pandemic, Brexit uncertainty had been affecting transaction levels and that the U.K. general election had also had an effect.

"I do wonder whether the period to April 2019 will be seen as the last of the really benign trading positions that law firms have operated through.

"The concern is that for the period, probably for three, four, five years up to the year end in 2019 were, when we look back, actually very benign trading periods, and one has to question whether the productivity drives that firms have essentially failed to achieve and the failures to bring down their lockup will come back to haunt them.

"We'll obviously see as results come out but with the triple whammy of Brexit, General Election and the pandemic it is hard to see that there is going to be a firm out there that has not been affected in some way and clearly there are some who are more precarious than others."

"We have concerns about January 31, 2021 and the period up to that, as to whether that's the period when firms will realise that actually they simply do not have enough cash to survive"

Murphy said the prospect of law firm conversations about keeping themselves afloat were "not just theoretical".

He said a number of firms had experienced a "tail-off of chargeable time over last six to eight weeks as the pandemic hit and that is reducing the amount they can bill and at the same time they have cost bases to service".

He added: "At the moment with government support schemes in place most are in a position whereby they can keep going for a good few months or so. The concern is that a number of government support schemes, particularly in relation to taxation, are deferrals and therefore those liabilities have to be settled at some point."

Murphy suggests that January next year will be a key period as that is when firms typically hit their lowest cash position as they make partner tax payments.

"We have concerns about January 31, 2021 and the period up to that, as to whether that's the period when firms will realise that actually they simply do not have enough cash to survive that period."

In addition, Murphy said there was a chance some firms may collapse due to a succession of partner departures.

"Those more precarious firms do run the risk that a number of partners might decide that now is the time to make the jump while they still can. If you're a firm that's maybe not in a particularly strong position and you start to lose a number of partners, a professional practice is actually an environment that can spiral downwards relatively quickly."

Murphy said there had not been many examples of that yet because we are early on in this economic phase. He said his advice to anyone on a management team would be "to really make sure you know what your partners are thinking".

He adds: "Make sure you know how you can lock them in, whether that's legally or through other metrics, because I think the firms that can stay together are more likely to be the stronger ones and be able to see through any difficult trading periods."

Download the table and listen to the podcast here.

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