Adapting to a tighter credit landscape for law firms

Lending metrics are getting stricter for law firms, leaving them the balancing act of building a large supplier-network while maintaining financial prudence – says Sarah Charlton, co-founder of BlueSky Legal Finance Solutions.

Some of us have been in the legal profession for an awfully long time and remember the days when the relationship between a law firm and its bank was very much one-sided – and weighted in favour of the law firm, at that. Lending was regularly approved in the absence of final accounts and/or cashflow statements, and many law firms would have felt insulted if their bank had asked for financial information – therefore questioning their integrity and credibility.

How times have changed – providing accounts and financial forecasts to a lending institute is a ‘light touch’, with more and more lenders looking for additional securities over assets owned by the business or the business owners.

In my view, the tide started to turn back in 2010, following the pre-pack administration sale of Manchester-based Halliwells. Unsecured creditors were valued at £191m, in which a return of less than a £1m was expected. This, combined with the SRA’s new interest in financial stability, instigated a change of attitude to liquidity ratios. The situation further evolved with the introduction of an additional due diligence layer, often provided by retired magic circle partners or financial management experts, which evaluated and interrogated the overall health and wealth of a law firm.

Gone are the days when firms could supplement their income with interest generated from holding client money, and instead we’re bracing ourselves for the possibility of negative interest – paying the banks for the privilege of holding client money. There have been many predictions around the impact of the Legal Services Act 2007, but I don’t recall reading anything about a ‘reversal of power’ between law firms and their banks.

What I would say to firms that still have an ‘untouchable’ list of clients is that it’s unwise to give credit based on past behaviour. There were many SME-sized suppliers that would have provided goods or services to Halliwells which may not have had trade credit insurance to cover the money that was due to them. These suppliers would no doubt have ranged from translators, counsel, experts, other law firms, software suppliers and more. These suppliers may not have been financially resilient enough to absorb such a significant loss and may themselves have subsequently closed. In a pandemic, this risk naturally increases as some firms flourish while others flounder.

The conundrum for any managing director or managing partner is that you’re torn between pacifying your legal team to provide them with an element of autonomy to build and maintain relationships with their clients, while placating your finance director to ensure credit is not being freely given out to clients. Fee earners will reassure you that their client will pay but this doesn’t put working capital in your bank, here and now. Banks expect you to be as cautious with who you give credit to as they are! However, being too risk-averse in managing client/partnership relations can also stifle any entrepreneurial decisions – so it’s always, as with so many things in life – a matter of balancing competing priorities.