Will Your Firm Pass a Stress Test?

The recent economic crisis put a strain on many law firms. Although there has been a tepid recovery, trends in the industry continue to expose weaknesses, as highlighted by the recent demise of a large, reputable law firm, Dewey & LeBoeuf LLP. In fact, over the last 25 years, more than 40 major law firms have gone bankrupt. How is it possible that outsiders and a majority of partners saw no warning signs before the sudden collapse of the Dewey firm and many others like it? What causes a law firm to suddenly implode?

There are common threads among law firm failures over the past few decades: failures of appropriate governance, inaccurate financial reporting and excessive leverage. These issues underscore the need for a change in law firm governance. It remains to be seen whether the current risks in the economy will accelerate the trend toward a more corporate style of partnership governance that is employed in some large firms.

Firms have navigated through issues to address profitability in the short run. However, changes in the marketplace for legal services are threatening the ability of firms to maintain growth in the long run. These external threats include increased price competition, commoditization of legal work and competition from in-house legal departments. Effective leadership and some rethinking of the law firm business model will be required. As competition intensifies and profit margins narrow, successful law firms will be the ones positioned to deal with threats and capitalize on opportunities.

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