Law firms can be great customers for banks. A law firm’s needs can be many: working capital loans, equipment financing, depository services, trust department services, and capital loans for partners. The relationship that evolves from these needs can spawn further relationships – introduction to attorneys and staff who have personal banking needs; introduction to law firm clients that have business banking needs. As long as the bank/law firm relationship is a smooth one, it can prove to be a long lasting and lucrative partnership.
When a law firm’s loan with the bank exhibits signs of tension or trouble, it is imperative that the bank gives the matter its immediate attention. Indeed, because a law firm’s asset value is in its attorneys that can resign at any time, a loan workout with a law firm is challenging. For most banks, the fundamental objective of getting paid is coupled with a desire to see the law firm smooth out its bumps in the road so that the law firm remains a good customer going forward. In other cases however, the circumstances may have advanced to where there is little hope that the relationship will continue, and the focus of the bank is directed solely to getting paid. Whatever point on the workout continuum the law firm falls, there are certain basic steps the bank should take when facing a law firm loan workout. These steps work regardless of the severity of the situation, and position the bank so it can obtain the best result possible.
THE SITUATIONAL OVERVIEW
As is the case in any workout, take a snapshot of the situation from 50,000 feet so that you get a sense of the overall situation. You’ll dig into the details later, but you will want to start your preparations by viewing the entire landscape, especially since law firms can be fragile institutions. Determining the situational overview allows you to know if the problem is manageable, and whether it is a problem for others. No doubt it is a problem for your law firm borrower, but there can be others, whether contractually bound or not, that may have an interest in seeing the loan workout succeed. You’ll want to know the identity of those parties and understand their motivations. Performing this preliminary assessment will provide needed context as you go forward.
DETERMINING SOURCES OF RECOVERY
No workout should go long without determining all available sources of recovery. Obviously, the law firm borrower is a source, but you may have guarantees from various partners or affiliates. Few law firms are general partnerships anymore, but look at the nature of the business organization to see if additional parties may be liable as a matter of law.
What collateral do you hold? Is there collateral from the other parties that are liable, whether they be guarantors or otherwise? Do your collateral documents give you a security interest in the borrower’s “unfinished business”-the underlying profit in the client work in process?
DRILLING DOWN
Now is the time to review all the basic documents. Loan agreements (and any ancillary documents such as account control agreements), correspondence and the law firm constituent documents must be carefully reviewed. Does the law firm’s documentation waive and release an attorney’s unfinished business? What is the law firm’s current cash situation, future cash needs and the quality of any offset rights held by the bank.
You have already determined the extent of your collateral, but in this stage it is imperative to research whether others have competing liens, whether you are perfected in your collateral and the quality of the collateral that your hold. If you have a lien on accounts receivable, but they are over 180 days old, you may be less secure than you would desire.
Your review should also include examining the most recent financial statements or other financial reporting from the law firm. If others are liable, review any financials in the file that they have provided. If you have the right to ask for updated financials, be prepared to make that request. Does the law firm appear solvent?
Assess the bank’s relationship with the borrower and anyone else that may be liable to the bank. Is the law firm’s management trustworthy? Does the law firm appear to trust the bank? Has the relationship become strained and if so, what are the reasons? Are there steps that can diffuse the strained relations? Is the management team long-standing or new? Is it experienced and capable? Is it willing to listen and will it work with you? Even if you have a favorable impression of the management team, is it distracted by something, and if so what distracts it?
A closer look at recent history is vital. Is the firm’s current situation the result of turnover, in particular the loss of attorneys with the most client relationships? Have there been recent client departures? Is the law firm facing an onslaught of litigation and if so, is it covered by errors and omissions policies? Is the insurance adequate to cover the potential exposure? What recent distributions have been made to thelaw firm’s owners (and others) and are the distributions consistent with the law firm’s constituent documents and past practices?
Are you dealing with any timing constraints? Having to respond to an emergency compels a completely different tact than when ample time exists to develop a plan that contemplates a law firm repositioning.
On the basis of this investigation and understanding of key facts, your action plan will probably fall within one of four options. Hopefully, the situation allows for you to continue the relationship but simply be more attentive in the future. Even if that is not the case, your second option may permit you to reach a consensual resolution with the law firm in which the bank shores up any substantive deficiencies and additional covenants are imposed in a loan modification agreement. If the foregoing two options are not realistically available to the bank, requesting the law firm borrower to move the loan to another lending institution may make sense. No doubt that risks the continuation of tangential banking activity that currently exists, but losing the ability to provide those services may be a small price to pay in order to assure payment of the outstanding loan(s). Finally, if those options do not fit your situation, you may be left to exercising your remedies against the law firm.
OUTSIDE ADVISORS
In performing your analysis, you already may have enlisted the assistance of outside advisors such as attorneys, financial advisors and accountants. Unless the situation with the law firm is completely benign, a call to your outside advisors is warranted. With their assistance, the bank should decide on its ultimate objective. Once the objective is established, your team can work together to develop a comprehensive plan designed to achieve the bank’s objective, including alternative paths to implementation depending on the array of responses possible from the law firm.
CONTACT BORROWER
Having assessed the situation and consulted with your outside advisors, the next step is starting the dialogue with the law firm. If appropriate, contact can be relatively low key with the bank relationship manager contacting the law firm managing partner to request a meeting. When the situation has moved beyond the low key stage, contact may need to be initiated by your professional to the law firm management unless it is already represented by counsel, then the contact goes from professional to professional. In this communication, whether low key or of the more intense variety, it is appropriate to make any request for additional reporting or other deliverables. Anything other than the low key approach justifies asking the law firm to execute a pre-negotiation letter in which all parties agree that the discussions are confidential. This letter also typically protects the bank from later claims about oral agreements to extend the loan or provide additional financing.
MEETING WITH THE BORROWER
The meeting with the borrower is vitally important. It is almost always better to seek a consensual resolution of any issues and the tone of the meeting and the conduct of the bank can have a profound impact on whether this can be achieved. That means conducting yourself professionally, listening to your borrower’s position and striving to understand what it is telling you. Be respectful of your borrower-remember it was not that long ago that you were delighted that it was a bank customer. Once you understand the borrower’s position, deliver the bank’s position to the borrower clearly, firmly and without emotion. Listen to its response if there is one, and assess any reaction that can be gleaned from the borrower’s words, conduct and body language. Based on what you hear and observe, try to assess whether the borrower’s current management is up to the task. If you think not, consider whether you want to recommend that the borrower seek outside assistance. But do not recommend whom they should select. Finally, before the meeting ends, establish the bank’s expectations and deadlines.
POST MEETING FOLLOW UP
Convene with your advisors after the meeting and decide on next steps. Your next steps should be selected after reviewing the bank’s original objective and plan. While there is nothing to prevent the bank from changing its objective or modifying its plan (especially if something said at the meeting suggests the plan is flawed), most often the original objective is sound. If so, evaluate any modification of the plan, settle on the final plan to be executed and then, implement the plan. Taking these steps will prepare you for a law firm loan workout and position you as the give and take of the workout unfolds. Remember, your law firm borrower’s assets (attorneys) depart the office every day. Whether they return the next day may depend on how successful you are in striking the right balance with your borrower.