Firms in ‘exceptionally dangerous position’

The wages spiral of the past year, which forced most law firms to raise pay at least 10 per cent, pushed expenses up an average 12.1 per cent for the big eight and 8 per cent for the remainder. This has led to upward pressure on fees, with the report indicating standard fees rose by about $50 an hour to an average of just over $600 an hour for all fee earners.

Law firm leaders declined to comment on the report, citing the confidentiality to which they are bound as participants and clients.

Optimism decline

However, the deterioration in outlook is reflected in responses for the forthcoming Law Partnership Survey, with most firms shedding the cautious optimism they expressed mid-year.

The Financial Review’s optimism index – which asks law firms to rate how they feel about the market outlook – fell from 4.2 out of 5 to 3.8, with many citing the economic headwinds caused by rising inflation and interest rates.

Law firm leaders have also been watching the US legal market with concern, with many of the biggest firms there now conducting mass layoffs – usually via performance reviews for associates – to correct “over-hiring” during the long boom from 2019-21.

Bruce Cooper, the chief executive partner at Clayton Utz, said he feared the local economy, and the legal sector, would take its lead from the US and Europe.

“I’ve not seen a change in outlook emerge so quickly as in the last four months,” Mr Cooper said in a survey answer.

“With the GFC, the shock was sudden and precipitous in 2008, but from early 2007 onwards the world was slowing as major markets began to cool in anticipation. The change in the current market sentiment is, in comparative terms, more sudden …

“The biggest issue for any of us will be the revenue challenges playing out as the locked-in expense cost inflation of the last year – mostly wage increases – puts pressure on profitability.”

Adrian Tembel, chief executive partner at Thomson Geer, told his staff in an email this week that the outlook for the legal sector was “sobering”.

“The definition of a recession favoured by most economic commentators and in the media is two consecutive quarters of negative growth in real gross domestic product (GDP). If the legal sector were the economy, then we’d be in a technical recession, but we don’t necessarily describe it that way…

“It is clear that a structural shift is occurring in our sector. This is exactly what we would expect in an inflationary, rising interest rate and falling asset price environment …

“Summing up, the ‘COVID boom’ is over!”

The Peer Monitor report provided commentary on two sectors – the big eight and large law firms – and also data for all firms.

“Both big eight and large firms saw contractions in demand this quarter along with slowed rate growth which resulted in the worst quarterly fees worked reduction in the program’s history,” the report said.

“Each segment experienced double-digit utilisation deteriorations, with the big eight surpassing last quarter’s low point to produce their largest quarterly contraction since at least 2014.

“Expenses expanded at historically high levels, which, combined with flat revenues, places Australian firms in an exceptionally dangerous position to start the year.”

However, it noted the firms which comprise the big eight – Minter-Ellison, Herbert Smith Freehills, Allens, King & Wood Mallesons, Clayton Utz, Corrs Chambers Westgarth, Norton Rose Fulbright and Baker McKenzie – were coming off record peaks.

“Utilisation is down double-digits compared to first quarter 2022, with associates logging the fewest hours in recent history. Solace can be found in that, compared to pre-pandemic times (quarter one financial 2020), firms are still generating 14.5 per cent more revenue …

‘Dangerous path’

“All of this sits on top of rapidly increasing expenses, with direct expenses for big eight firms growing 12.1 per cent. While this is lower than previous quarters, those quarters were buoyed by exceptionally strong revenue growth.”

The results were slightly better for the average large firm – especially on demand and fees worked – but the report said they were still on a “dangerous path”. The 10 large firms in Peer Monitor are Baker McKenzie, Colin Biggers Paisley, Dentons, Gilbert + Tobin, Hall & Wilcox, Jackson McDonald, McCullough Robertson, Mills Oakley, Thomson Geer and White & Case.

“With utilisation for large firms contracting at a historically high 10.1 per cent and their by-title productivity far below the Q1’s for the last three years, large firms are seeing immense pressure on profitability.

“Expenses continue to increase at a record rate, with direct and overhead expenses growing at 14.1 per cent and 7.6 per cent respectively.

“The combination of flat revenue and historically high expense growth is an exceptionally dangerous path.”

The Law Partnership Survey contains data and reports on partners, senior associates, women lawyers and emerging issues for the industry. It runs over two weeks, starting on December 2.