Take Ownership of Your Firm's Accounts Receivable

The road to disaster involves continuing to do the marketing and production with the same clients, and extending credit rather than collecting fees in the hope that these clients will give you more work. It is imperative to strive to get paid quickly for the work that has already been done. If a client has not paid the fee for the last matter while you begin work on the next, you have in essence extended a no-cost loan to that client. Just as most banks will not carry you in the hope that you will pay on an outstanding loan, it makes no sense to do the same thing with your clients on a vague hope of being paid as expenses pile up. Never extend credit to current clients if they have not paid for the work already done, hoping that such consideration will enhance the relationship and encourage the client to give you more work.

Simple examples show why collecting (realizing) receivables is important. A lawyer who bills $150,000 in a given month but collects only $90,000 has a realization rate of 60%. In any other business, collecting 60' on the billed dollar will cause financial ruin. The goal is to have a high collected to billable ratio. An overall realization rate of less than 85% is unacceptable.

Realization Realities

These hard numbers unquestionably require discipline and planning to turn around once they get out of hand. Return to our example of the lawyer with the 60% realization rate. If you realize only 60% of what you bill, in order to survive you will need to treat that 60% as 100% of your income. In other words, all your financial decisions will need to be based on the money actually collected, not on the billings sent out. If you can run your business successfully on the 60%, that would be fine, but few lawyers can.

This reinforces the importance of having a receivables policy. The engagement letter sent to all new clients should clearly state the consequences to the client for failure to honor the agreed-upon payment commitment. Your written policy must detail how you keep track of when clients are behind on their payments, and how you contact clients when they are late with payments. It should cover everything from the beginning of the relationship with the client to the payment of the final bill, including these details:

• Credit terms (when to inquire on unpaid balances, when to stop work if payment stops);
• A sample fee agreement, to be modified as necessary;
• Collection terms, including guidelines on when and how to engage a collection agency;
• Incentives for lawyers to have a high realization rate and enforcement actions against those who lag on collections (withholding compensation, or deducting collection expenses from it).

Non-Paying Clients

In accord with the Rules of Professional Conduct, lawyers may stop work for clients who will not pay. The lawyer cannot ethically cease representation when the client will be prejudiced ' for example, by withdrawing within 60 days of a court date. The ABA's Code of Professional Conduct, Rule 1.16 (“Declining or Terminating Representation”) allows lawyers to withdraw if “the client fails substantially to fulfill an obligation to the lawyer regarding the lawyer's services and has been given reasonable warning that the lawyer will withdraw unless the obligation is fulfilled.” To withdraw without adequate communication on and careful records of the client's billing and payment performance may bring a state bar disciplinary action.

If the firm faces the dilemma of a non-paying client, there are two equally difficult directions to go: use a collection agency, or sue the client. There are ethical snares involved in using a collection agency, but you can avoid them by disclosing to a collection service only those details that are absolutely necessary for it to do its job without jeopardizing client confidentiality. Moreover, it is a given that a collection effort should not be made unless you have reviewed the client file and made sure that it contains no valid basis for a malpractice allegation against you.

The New Jersey State Bar's Advisory Committee on Professional Ethics issued Opinion 723 in March 2012, addressing this issue directly. The opinion held that a sale of a former client's accounts receivable to a third party or retention of a collection agency to pursue those accounts is permissible if lawyers make reasonable efforts to determine that the purchaser or agency is reputable and will not take improper or illegal measures to collect the debt, and that the purchaser or agency is not given any client information other than that needed to collect the debt. A more troubling aspect of this opinion was its holding that lawyers may not initiate collection action against current clients. This is not only bad economics, it is unjustified so long as the lawyer continues representation in any open matters consistent with Rule 1.16, and so long as the client formally agreed to the firm's receivables policy.

Suing the client for non-payment is an even more drastic step. This step should not be taken lightly, and not without adequate communication and careful records of the client's billing and payment performance. However, it can be effective ' some statistics show that the lawyer-creditor is successful in more than 95% of litigation against a client-debtor. When lawyers sue for payment of fees, they are often met with malpractice claims either as an offset (counterclaim) or direct attack (cross-complaint). There is no way to assure that such a complaint will not be filed. Assess where the firm stands from a malpractice standpoint, evaluate the risk, know the insurance carrier's risk management policies and evaluate the likelihood of winning an unpaid billing claim before filing suit. Then, define your claim, file suit and be prepared to prove your case.

Receivables As Assets

One final problem in receivables resolution has arisen as a direct result of the Great Recession. As firms were forced into insolvency or appeared to be on the brink of such a fate, their lawyers departed and went to other, often major firms. When the firms left behind need to collect funds to pay their creditors by selling off assets, computers, furniture and real estate are of minimum value. Accounts receivable are a major asset. But what if the lawyers who billed for them are no longer there? When partners go to new firms and clients follow them, they generally take their books of “unfinished business.” Clients of course have a right to seek their own choice of lawyer. But it can be argued that the profit to the new firm truly belongs to the old firm that provided the intellectual property and physical resources to help earn the billing. When a failing firm needs to come up with cash, it can make a very plausible argument that receivables which walked out the door with its former lawyers belong to the originating firm itself.

Deciding who gets the benefit from departing lawyers' receivables is likely a battle that will be fought for years, including in the courts. But the fact is that the largest pool of cash available to the bankruptcy trustee for a defunct firm is likely the receivables of the new firm where the defunct firm's lawyers went. Whether legitimately or not, new firms have been economically compelled to settle many of such claims in order to go on with the new firm business for the lawyers they added.

This cautionary tale reinforces the fact that every law firm should take active ownership and management of its accounts receivable. In recent decades major firms such as Finley Kumble, Altheimer & Gray, Howrey & Simon and Heller Ehrman all went to their demise with millions of dollars in receivables still on their books. Had these firms been more diligent and aggressive at collecting the receivables they were owed, they might have remained alive. Ultimately, law firms are not the victims of their delinquent clients. Firms themselves cause their receivables problems by not telling clients from the beginning what is expected from them, and then continuing to follow through. Accounts receivable are the biggest financial asset on the books of any firm. To ensure that they remain an asset, take active ownership of your own firm's accounts receivable management and collection.

Ed Poll, J.D., M.B.A., CMC, Principal, LawBiz Management, helps law firms increase profitability, coaching them on issues of internal operations, practice development, and financial matters. He practiced law for 25 years, has coached lawyers for 20 years, and is the author of 14 books. Poll is a member of this newsletter's Board of Editors, a Fellow of the College of Law Practice Management, a board-certified Coach to the Legal Profession, a charter member of the Million Dollar Consulting' Hall of Fame and Recipient of a Lifetime Achievement Award, State Bar of California (LPMT Section). He can be reached at 800-837-5880, www.lawbiz.com, www.lawbizblog.com, and www.lawbizforum.com. Edward Poll ' All rights reserved ' 2012.

For every law firm, “The Business of Law'” is driven by a three-part cycle. Lawyers must, in turn, win the work (the “marketing” function); do the work effectively and efficiently (the “production” function); and get paid (the “collections” function). These three functions are distinct and separate. Most lawyers are familiar with and capable in marketing and production, but they fail to grasp the importance of collections.

The real need is to balance the three functions which define what I call the “3Dimensional Lawyer'.” Too often, lawyers over weight the marketing and production sides rather than receivables. They equate financial success with billable hours ' the end product of marketing and production. Any lawyer's solvency rests not on billable hours, but on the amount of cash that is realized from those billable hours. Realization is simply the percentage of what is billed that is actually collected. Generally, the greater the billings, the greater will be the resources needed to do the work. Since the time between when a firm sends out a bill and when it receives payment averages more than four months nationally, the more client invoices a firm has outstanding, the tighter the cash flow and the greater the need to focus on accounts receivable and their collection. Failure to do this will necessitate either a reduced lawyer (equity lawyer) draw (compensation) or increased debt to carry the firm while waiting for payment.

Road to Disaster

The road to disaster involves continuing to do the marketing and production with the same clients, and extending credit rather than collecting fees in the hope that these clients will give you more work. It is imperative to strive to get paid quickly for the work that has already been done. If a client has not paid the fee for the last matter while you begin work on the next, you have in essence extended a no-cost loan to that client. Just as most banks will not carry you in the hope that you will pay on an outstanding loan, it makes no sense to do the same thing with your clients on a vague hope of being paid as expenses pile up. Never extend credit to current clients if they have not paid for the work already done, hoping that such consideration will enhance the relationship and encourage the client to give you more work.

Simple examples show why collecting (realizing) receivables is important. A lawyer who bills $150,000 in a given month but collects only $90,000 has a realization rate of 60%. In any other business, collecting 60' on the billed dollar will cause financial ruin. The goal is to have a high collected to billable ratio. An overall realization rate of less than 85% is unacceptable.

Realization Realities

These hard numbers unquestionably require discipline and planning to turn around once they get out of hand. Return to our example of the lawyer with the 60% realization rate. If you realize only 60% of what you bill, in order to survive you will need to treat that 60% as 100% of your income. In other words, all your financial decisions will need to be based on the money actually collected, not on the billings sent out. If you can run your business successfully on the 60%, that would be fine, but few lawyers can.

This reinforces the importance of having a receivables policy. The engagement letter sent to all new clients should clearly state the consequences to the client for failure to honor the agreed-upon payment commitment. Your written policy must detail how you keep track of when clients are behind on their payments, and how you contact clients when they are late with payments. It should cover everything from the beginning of the relationship with the client to the payment of the final bill, including these details:

• Credit terms (when to inquire on unpaid balances, when to stop work if payment stops);
• A sample fee agreement, to be modified as necessary;
• Collection terms, including guidelines on when and how to engage a collection agency;
• Incentives for lawyers to have a high realization rate and enforcement actions against those who lag on collections (withholding compensation, or deducting collection expenses from it).

Non-Paying Clients

In accord with the Rules of Professional Conduct, lawyers may stop work for clients who will not pay. The lawyer cannot ethically cease representation when the client will be prejudiced ' for example, by withdrawing within 60 days of a court date. The ABA's Code of Professional Conduct, Rule 1.16 (“Declining or Terminating Representation”) allows lawyers to withdraw if “the client fails substantially to fulfill an obligation to the lawyer regarding the lawyer's services and has been given reasonable warning that the lawyer will withdraw unless the obligation is fulfilled.” To withdraw without adequate communication on and careful records of the client's billing and payment performance may bring a state bar disciplinary action.

If the firm faces the dilemma of a non-paying client, there are two equally difficult directions to go: use a collection agency, or sue the client. There are ethical snares involved in using a collection agency, but you can avoid them by disclosing to a collection service only those details that are absolutely necessary for it to do its job without jeopardizing client confidentiality. Moreover, it is a given that a collection effort should not be made unless you have reviewed the client file and made sure that it contains no valid basis for a malpractice allegation against you.

The New Jersey State Bar's Advisory Committee on Professional Ethics issued Opinion 723 in March 2012, addressing this issue directly. The opinion held that a sale of a former client's accounts receivable to a third party or retention of a collection agency to pursue those accounts is permissible if lawyers make reasonable efforts to determine that the purchaser or agency is reputable and will not take improper or illegal measures to collect the debt, and that the purchaser or agency is not given any client information other than that needed to collect the debt. A more troubling aspect of this opinion was its holding that lawyers may not initiate collection action against current clients. This is not only bad economics, it is unjustified so long as the lawyer continues representation in any open matters consistent with Rule 1.16, and so long as the client formally agreed to the firm's receivables policy.

Suing the client for non-payment is an even more drastic step. This step should not be taken lightly, and not without adequate communication and careful records of the client's billing and payment performance. However, it can be effective ' some statistics show that the lawyer-creditor is successful in more than 95% of litigation against a client-debtor. When lawyers sue for payment of fees, they are often met with malpractice claims either as an offset (counterclaim) or direct attack (cross-complaint). There is no way to assure that such a complaint will not be filed. Assess where the firm stands from a malpractice standpoint, evaluate the risk, know the insurance carrier's risk management policies and evaluate the likelihood of winning an unpaid billing claim before filing suit. Then, define your claim, file suit and be prepared to prove your case.

Receivables As Assets

One final problem in receivables resolution has arisen as a direct result of the Great Recession. As firms were forced into insolvency or appeared to be on the brink of such a fate, their lawyers departed and went to other, often major firms. When the firms left behind need to collect funds to pay their creditors by selling off assets, computers, furniture and real estate are of minimum value. Accounts receivable are a major asset. But what if the lawyers who billed for them are no longer there? When partners go to new firms and clients follow them, they generally take their books of “unfinished business.” Clients of course have a right to seek their own choice of lawyer. But it can be argued that the profit to the new firm truly belongs to the old firm that provided the intellectual property and physical resources to help earn the billing. When a failing firm needs to come up with cash, it can make a very plausible argument that receivables which walked out the door with its former lawyers belong to the originating firm itself.

Deciding who gets the benefit from departing lawyers' receivables is likely a battle that will be fought for years, including in the courts. But the fact is that the largest pool of cash available to the bankruptcy trustee for a defunct firm is likely the receivables of the new firm where the defunct firm's lawyers went. Whether legitimately or not, new firms have been economically compelled to settle many of such claims in order to go on with the new firm business for the lawyers they added.

This cautionary tale reinforces the fact that every law firm should take active ownership and management of its accounts receivable. In recent decades major firms such as Finley Kumble, Altheimer & Gray, Howrey & Simon and Heller Ehrman all went to their demise with millions of dollars in receivables still on their books. Had these firms been more diligent and aggressive at collecting the receivables they were owed, they might have remained alive. Ultimately, law firms are not the victims of their delinquent clients. Firms themselves cause their receivables problems by not telling clients from the beginning what is expected from them, and then continuing to follow through. Accounts receivable are the biggest financial asset on the books of any firm. To ensure that they remain an asset, take active ownership of your own firm's accounts receivable management and collection.

Ed Poll, J.D., M.B.A., CMC, Principal, LawBiz Management, helps law firms increase profitability, coaching them on issues of internal operations, practice development, and financial matters. He practiced law for 25 years, has coached lawyers for 20 years, and is the author of 14 books. Poll is a member of this newsletter's Board of Editors, a Fellow of the College of Law Practice Management, a board-certified Coach to the Legal Profession, a charter member of the Million Dollar Consulting' Hall of Fame and Recipient of a Lifetime Achievement Award, State Bar of California (LPMT Section). He can be reached at 800-837-5880, www.lawbiz.com, www.lawbizblog.com, and www.lawbizforum.com. Edward Poll ' All rights reserved ' 2012.