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Law firms needing extra capital from banks to weather the rough economy are finding that the times � and the terms � have changed. Many law firms are seeing a slowdown in work and a lengthening in their client payment cycles. At the same time, banks that provide lending to law firms to help cover their revenue gaps and fund bigger projects are implementing more onerous requirements for doling out credit. The upshot is that, just as law firms need more money, they’re having a harder time getting it. While Dan DiPietro, client head of the law firm group at Citi Private Bank, doesn’t expect interest rates to climb, he does see a change in the terms, or covenants, under which law firms borrow. “We’re looking at the number of partners who leave in a given year,” he said. “We’re looking at cash flow coverage and asset coverage ratios.” Perhaps taking a cue from the demise of San Francisco’s Brobeck, Phleger & Harrison, which had $90 million in bank debt when it collapsed in 2002, law firms generally reduced their borrowing in recent years, according to the latest data provided by Citi. In 2000, firm liability was 19.8% of net income compared with 14.1% in 2006. Despite the overall decline, the average borrowing for Citi’s clients so far this year has ballooned, DiPietro said. Borrowing was up 32% in January, compared with the same month in 2007, he said. In February, borrowing rose 26% and, in March, it climbed 22%, compared with the same months in 2007. A slowdown in client work � and in the time that many of them are taking to pay their legal bills � is exacerbating the revenue shortfall that law firms routinely experience at the beginning of the year, DiPietro said. In addition, many firms are feeling the full weight of the salary increases implemented last year for associates, including $160,000 for first-years. “We are being much better about practicing fiscal hygiene,” said Stephen Colgate, executive director of DLA Piper, the nation’s largest law firm. “We’re being more careful to make sure our bills get out the door.” The 3,623-attorney firm in the past seven years has doubled its partner capital contribution amount to avoid acquiring debt for expansion, Colgate said. He added that law firms seeking financing these days to cover expenses may well find stricter terms, although he is not “losing any sleep” over DLA Piper’s financial picture. But many law firms “are very nervous right now” about their financial situation, said law firm consultant Richard Gary, principal of Gary Advisors in Tiburon, Calif. “All you have to do right now is look at what law firms are doing in terms of layoffs, summer hiring freezes and extension of first-year start dates by several months,” he said. Just as the ramifications from the subprime mortgage mess are creating a slowdown in law firm work, they also are prompting Citigroup and other banks to tighten the credit reins as they try to balance their own books. Citig alone posted a $5 billion loss during the first quarter of 2008, although the loss was relatively good news compared with the $10 billion punch it took in the fourth quarter of 2007. Citi is the largest lender to law firms and has “relationships” with about 600 law firms, DiPietro said, including most of those in the AmLaw 100, a list of law firms with the highest revenues published by The American Lawyer, an affiliate of The National Law Journal. Other national lenders to large law firms include Wachovia and Bank of America. Nearly all big law firms borrow money through lines of credit to cover the first-of-the-year gap. And most firms pay off the money borrowed when they collect their fees during the second half of the year. Many law firms also borrow for expansion into new markets, updates to technology and office furnishings. In general, a law firm’s collectable value of unbilled time and accounts receivable should run about five times its total bank debt, advises James Cotterman, a consultant with Altman Weil. He also suggests that debt should account for no more than 100% of the net book value of fixed assets, and that law firms should not use credit to pay partners or as the first source of working capital. In the case of Philadelphia’s Duane Morris, an ongoing contribution of 4% of all partner income plus a capital infusion of $8 million in 2000, partly from the firm’s representation in tobacco litigation, has put it in good stead, said Charles O’Donnell, the firm’s chief operating officer. But regarding the industry in general, he predicts trouble. “We will see some firm bankruptcies,” O’Donnell said. “The economy will have some impact on firms that didn’t come into this time from a stable standpoint and are starting to lose partners from their ranks.” Rules are changing When borrowing, law firms can lock in terms for a certain period of time, but as they come back to a bank with additional capital needs they are discovering that the rules have changed. For example, if a bank in the past limited a borrowing base to 85% of accounts receivable less than 180 days old, a bank now may reduce that base to 80% of receivables less than 120 days old, said Andrew Johnman, head of the U.S. professional services team at Barclays Capital. In addition, a covenant that previously required law firms to retain 80% of their partners from one year to the next may now require them to retain 85%, he said. A large number of partners departing is a “lead indicator of distress,” he said. Indeed, the loss of capital created by defecting partners has prompted at least one law firm to change its policy in order to hold on to the money longer. Mayer Brown last summer revised a provision in its partnership agreement to allow the law firm up to six months to return partner capital contributions, as opposed to returning it immediately. The Chicago-based firm has lost more than 20 equity partners and demoted about 45 partners to nonequity status. Other firms could follow Mayer Brown’s lead and adjust their partnership agreements to retain partner capital longer, DiPietro said. On the whole, law firms are a good bet for banks. Their work is steady, they pay their bills consistently and the industry in general has grown. And as big U.S. lenders start to clamp down on credit, Johnman sees opportunity for banks such as Barclays. While not immune from the subprime cancer, some foreign lenders can forge new relationships in the current climate, he said. “We’re getting a much warmer reception,” he said.

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