Undercapitalization is not the real problem in large law firm failures


One of the reasons being trotted out as an explanation

for the current crisis in large law firm

financial condition and performance, and of some

law firm failures, has been “undercapitalization.” If

that were true, then the solution to the present crisis

would be a simple capital call from the partners

or a line of credit from a bank and everything would

be fine with the financial condition of such firms.

But there are numerous firms with substantial

partner capital accounts and large working lines

of debt from banks that are struggling. Recently

failed large law firms in the AmLaw 100 have had

cumulative equity partner capital accounts of $40

million or more, and working capital lines of credit

drawn to outstanding balances of nearly twice the

amount of contributed partner capital when they

failed. Undercapitalization cannot be a cause or

reason for the current crisis; indeed it is not the

problem, rather it is merely a symptom. It is the adoption of unsustainable practices with respect to distributions, and the application of equity and debt capital to fund it, which is destabilizing and in some instances causing the collapse of some large law practices.

(Reprinted with the permission of the Daily Journal Corp (2011)

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