Rob Walters, fresh out of the hospital and fully recovered after testing positive last month with the coronavirus, has a unique perspective on the potential impact that the “one-two punch” that COVID-19 and dirt-cheap oil prices could have on Texas law firms and businesses.
“By most credible accounts, we could be staring at a deep recession or even a depression,” Walters, managing partner of the Dallas office of Gibson, Dunn & Crutcher, told The Texas Lawbook. “This appears to be profoundly different from challenges that businesses and law firms have faced in our lifetime. Overnight, we’ve gone from a burgeoning economy to a moribund one.”
“We are all struggling to comprehend what the world looks like in six to 12 months,” said Walters, who successfully represented AT&T in its legal battle with the Trump administration over its $86 billion acquisition of Time Warner in 2018. “This will affect the entire legal industry. Sadly, this crisis could prove fatal for some fine businesses and law firms.”
Law firm management insiders say Walters is right to sound the alarm that corporate law firms large and small across Texas should be more worried about their future than they appear to be.
Many corporate law firms in Texas need to cancel summer associate programs, inform newly minted lawyers that they may not be needed this fall, start reductions in associate salaries, hold back partner draws and work with their banks to increase their lines of credit, according to industry experts.
“It could get very bad and the Texas legal market will take an even bigger hit than others,” Jim Cotterman, a principal and legal industry consultant at Altman Weil, told The Texas Lawbook.
“Law firms should hope for a short-term skirmish but prepare for a long-term siege,” Cotterman said. “Law firm leaders need to be brutally honest with their folks right now that they are planning for considerable reductions in expenses and in compensation and that this will be across the entire law firm.”
“If an expense is not crucial to the business, it needs to be cancelled or at least put on hold,” he said. “Any law firm not planning for a long, very severe economic contraction is going to find itself in deep trouble. The problem is, you go to bed thinking you have a handle on things, but you wake up and watch 30 minutes of news and go, ‘Oh crap!’”
Kent Zimmermann, a law firm consultant at Zeughauser Group, said leaders at the more vulnerable firms – those who have lower profit margins or have already used up significant portions of their lines of credit – need to start taking steps now for self-preservation.
“There is wide variation on how long this will last and how much it is going to impact revenues,” he said. “Some models that I have seen show revenues could be down 50% for the rest of 2020.”
Zimmermann said law firms that specialize in commercial real estate or oil and gas transactional work that do not have strong bankruptcy and restructuring practices are likely to get hit the hardest.
“The sooner that firms make the hard choices to cut, the sooner they get the benefits of the headcount reduction,” he said. “It would be very surprising to me that some Texas law firms do not cut monthly partner draws or reduce attorney and staff headcount or delay or cancel their summer associate programs.”
Norton Rose Fulbright, which has its U.S. operations based in Houston, announced Thursday that it is deferring partner payment distributions, delaying any bonuses and offering certain staff employees the opportunity to go to four-day work weeks for reduced compensation. But the announcement stated that this applies only to the firm’s offices in Asia, Europe and the Middle East – not those in the U.S.
“In this current crisis, we believe that it is prudent to take preemptive action to protect our people and our business,” Peter Scott, managing partner of the firm’s practices in Asia, Europe and the Middle East, said in a statement. “We know this is a challenging time for all of our people and we want to safeguard jobs as far as possible.
“It is not likely that all parts of the business will be adversely affected by the current situation. So it is quite possible that employees who have signed up to the scheme in some parts of the business will not be required to reduce their working hours.”
Reed Smith, which has about 112 lawyers in its Austin, Dallas and Houston offices, announced Monday that is reducing partner distributions. Baker Donelson, a Tennessee-based firm that has two-dozen lawyers in Houston, announced Wednesday that it reduced the draws and salaries for its partners and plans to furlough employees over the next few weeks. Cadwalader, which no longer has offices in Texas, stopped paying partners and cut associate salaries.
Tom Melsheimer, managing partner of the Dallas office of Winston & Strawn, and several other prominent law firm leaders said they fear Walters’ prediction of a deep recession is more likely than the hope that everything returns to normal in a month.
“Nobody should fool themselves that this is not going to have a financial impact,” he said. “The critical question is whether it is a 30-day, a 90-day or a much longer shut down. Our lawyers were very busy in March – much busier than we expected. But will it continue? I agree with Rob that we just don’t know.”
The Texas Lawbook interviewed leaders at 19 corporate law firms in Texas during the past week and all said they have no plans for layoffs or compensation cuts at this point.
“Our team is in great shape,” Porter Hedges managing partner Rob Reedy said. “We are healthy and our finances are in great shape. We have not discussed furloughs or reduced staffing at all.”
The same is true at the Houston litigation boutique Ahmad, Zavitsanos, Anaipakos, Alavi & Mensing, also known as AZA.
“The past few weeks have been like a long version of the Twilight Zone,” AZA partner John Zavitsanos said. “2018 and 2019 were the best two years in the history of our law firm. The first two months of 2020 have been extraordinary, too. We hear law firms are thinking about laying off people. We will not. We have not discussed it. When we come out of this, there is going to be a litigation explosion and we will need every single person we have to handle all of it.”
(Editor’s Note: The Texas Lawbook plans to publish 2019 revenues of the law firms operating in Texas next week.)
“I think our firm is well-positioned to handle the crisis and come out even stronger,” said Andy Calder, a partner at Kirkland & Ellis in Houston. “But I think every law firm is going to take a hit or two if this goes on for several months or into the fall and winter.”
Chris Kratovil, managing member of Dykema’s Dallas office, said this is the “third black swan” that he has faced in his career.
“The legal industry came back strong from Sept. 11 and the 2008 financial crisis and we will come back from this,” Kratovil said. “We have not discussed staff cuts or anything like that. But if we are sitting here three or four months from now and the economy is still locked up, then law firms are going to have to put everything on the table. But we will get through this, too.”
Cotterman of Altman Weil said a major problem for corporate law firms is that they have too many lawyers.
“The legal profession is 13% to 15% overstaffed,” he said. Law firms have too many people for the work that is out there for them.”
“The good news is that most law firms came into this crisis in generally good shape,” Cotterman said. “Most have strong balance sheets. They’ve built up capital and liquidity and developed better lines of credit.”
“Firms should not be looking to add people,” he said.
The two big expenses for law firms are payroll and real estate, according to Cotterman.
“That is where you can have the biggest and most immediate impact on the bottom line,”he said. “The smartest moves are to stop from moving into more expensive space and to delay commitment to hiring new lawyers. The highest paid people should take the biggest cuts or deferrals and then let it flow down the chain in a tempered manner.”
Cotterman and Zimmermann said that Texas lawyers and firms need to do whatever they can to get in front of their clients – especially in this time when they don’t have direct and in-person access to clients – to show their clients their expertise and the value that they can provide.
“Rob Walters is absolutely right to be thinking about duration,” Zimmermann said. “Higher profit margin law firms have more runway to maneuver and more levers to pull if there are significant revenue reductions. Firms with weaker profit margins and less depth in overall scale have less margins for error.
“If you already have a thin bench of rainmakers, it doesn’t take too many departures to critically weaken a firm,” he said.
Zimmermann and Cotterman say that some law firms will come out stronger.
Yvette Ostolaza, managing partner of the Dallas office of Sidley Austin and a member of the firm’s executive committee, agreed that all law firms should be prepared for the worst, but that financially secure law firms can also take advantage of a crisis like this.
“We’ve already started seeing résumés from lawyers at the traditional Texas-based law firms who are worried about the future of their law firms,” she said.
Vinson & Elkins chairman Mark Kelly agreed that all law firms will take a hit because of the combination of the COVID-19 crisis and the decline in oil and gas prices.
“Good lawyers are needed in hard times,” he said. “We hope things don’t get uglier, but we are a low debt law firm and we had a great couple months coming into this.”
Kelly said that V&E, which employs the most corporate lawyers in Texas and has the highest revenue of any law firm operating in the state, still plans to have about 100 law students participate in its summer associate program year – albeit possibly delayed for a few weeks – and to add 90 new first year lawyers in the fall.
“I don’t like to make short-term decisions,” Kelly said. “In 2015, some firms had layoffs to cut costs, but those firms suffered when the oil market bounced back. Massive layoffs have repercussions and they hurt a law firm’s credibility.”
Haynes and Boone managing partner Tim Powers said firms need to make sure that they are taking care of the healthcare and mental health needs of its lawyers and staff while also ensuring the balance sheet remains strong.
In late March, Haynes and Boone launched a “well-being” initiative modeled by the American Bar Association to help law firms better identify and assist lawyers and staff who suffer from medical, mental and substance abuse issues.
“We want our people to know that they have resources available at a time that is extremely stressful,” Powers said. “It is an interesting and challenging time, but I am sure that we can come out stronger.