For firm's sake, partners may have to part with cash

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Published on 4/13/09

Has your firm asked you to pony up money? Have you faced a capital call recently? Are your partner distributions being reduced?

Media reports indicate that several top law firms are asking their partners to increase their capital accounts and/or are reducing the partner distributions, all in an effort to raise more cash for the law firm. At least one mega-firm has "invited" income partners to make a capital contribution to the firm in exchange for equity.

The phenomenon illustrates anew the flaws in the broken law-firm model. Why seek to join a partnership when the "buy-in" to the partnership is at a value asserted by that partnership rather than by an independent study?

And once you are a part of the partnership "elite," irrespective of what your earnings from the firm may be, you will be jointly and severally liable for the debts of the law firm in the event of the firm's collapse.

That, of course, is the issue raised by the increased efforts of firms to raise capital from their partners. The new focus is on reducing law-firm debt and increasing liquidity in an era when banks are restricting their loan portfolios, even for "favored customers." With revenues and profits constricting, law firms have no choice but to review their debt structures.

Law firms do have credit lines, but, given the headlines about lawyer and staff layoffs, banks may be reluctant to give credit to any law-firm customer. This is particularly true because credit line terms can fluctuate substantially, however the bank dictates.

Banks often set formal credit line amounts, such as three times the monthly expenses excluding partner draws. The bank also usually prefers that the law-firm borrower be out of debt for at least 30 to 90 days each year. The firm may be able to borrow and repay at will, up to the amount of the credit line. However, the line of credit is reviewed regularly by the bank and extended, cut or terminated as circumstances warrant.

When the law firm cannot open the bank's loan window, or does not want to abide by the many restrictions and covenants that are attached to any bank loan, the firm will look to partners. And, for those partners who are themselves financially thin, they may have to be the ones asking the bank for help in order to satisfy the capital call. To get the personal loan needed to fulfill the capital call, the lawyer may have to mortgage his or her home, pledge other assets as additional collateral or even get guarantors.

To survive tough times, such as we currently are experiencing, reduced debt and a reservoir of savings is essential to survival. The firm that borrows for operating expenses, in the hope that collections and revenues will materialize to cover the loan, may well find that hope to be an empty one.

The result for the firm and its individual partners can be a damaged credit rating, not to mention civil and potential criminal penalties. Seen in this light, a partnership requirement to contribute more to the firm may well be the lesser of evils.

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