As some noteworthy large law firms struggle in an environment of financial stress, the reality of reduced, delayed or permanently missed partner distributions in self-proclaimed successful law firms has been revealed. We hear the term “undercapitalization” applied with increasing frequency as a full or at least partial explanation in the crisis confronting these firms. However, these law firms typically have large amounts of capital contributions from their partners, and substantial amounts of debt, typically in the nature of working lines of capital with major banks.
Two recently failed large law firms, Heller Ehrman and Howrey, each had aggregate partner capital contributions in the many tens of millions of dollars and working capital debt lines of more than $50 million drawn when they collapsed into bankruptcy. Each of them was generating substantial amounts of profit. What happened? How can a service business that does not employ a large amount of capital as an income-producing component to its business go out of business with so much stated capital? One reason might be because … it really isn’t there anymore.
