Do You Think You Can Buy Client Loyalty?

Reprinted from:

Published 9/09

A delinquent client account spells more than less cash flow for your practice. It can also be a sign that the relationship is in trouble.

If your clients pay each bill every month like clockwork, your mutual relationship is working. But if the client owes a great deal of money and shows very little inclination to pay it, the relationship is clearly on the rocks. Shared expectations, effective communication and dependable follow-through by lawyer and client all define the kind of good relationship that results in current client billings. You truly have a good relationship with your client only when the client's account is up to date. Delinquent accounts indicate one of two fundamental problems in that relationship:

• A negative client who doesn’t respect you, or is attempting to defraud you, or who is dissatisfied with you and showing that dissatisfaction by not paying the bill.
• A troubled client whose cash flow is temporarily interrupted, despite good intentions to pay you quickly, or who is actually in financial difficulty and can’t afford to pay you.

Aggravating Problems

In large firms, when such a troubled relationship develops, the overall cost of an individual bad debt to each partner is generally minimal. Lawyers in small firms or in sole practice see an immediate reduction of take-home pay. If a non-payment situation develops, lawyers often continue to work for the non-paying client in the misguided hope that continuing the relationship means getting paid and receiving referrals in the future. However, in today’s economy, more than ever, law firms should not be banks that carry their client’s expenses. Do not do this with a vague hope of being paid as expenses pile up because the likelihood is that you will at the very least have aggravating problems, and at worst will not get paid at all.

A good example of this is a situation I learned of in a recent coaching session, when a lawyer described to me her experience trying to work with “the client from Hell.” The client continually missed deadlines, failed to turn over necessary documents, constantly needed to reschedule court appearances, all the while letting tens of thousands of dollars in fees pile up. When the lawyer finally reached the end of her rope and emailed an interim invoice to the client, saying that no more work could be done until the fees were paid, the client “couldn’t open the attachment” – an issue the lawyer got around by cutting and pasting the bill into the body of an email.

Collection Policy

Attorneys and law firms often reach such an impasse because they have failed to establish, explain and enforce effective collection policies. Lack of a firm-wide written collection policy can lead a firm to financial disaster. While the collection policy need not be part of the engagement letter’s fee agreement, the engagement letter should clearly state the consequences to the client for failure to honor the agreed-upon payment commitment. Your written policy must detail how to keep track of when clients are behind on their payments, and how to contact clients when they are late with payments.

Assume that every client will be a collection problem. That way, you will be well-armed with a variety of signed—and initialed—agreements, which will demonstrate the client's advance knowledge and acceptance of the costs incurred. Train your staff to let you know quickly about who is not paying their bills so that you can take immediate and necessary action.

Your collections policy should cover in usable electronic form everything from the beginning of the relationship with the client to the payment of the final bill. Hire a collections manager, or designate a staff person, to handle all the details of the collections policy, including:

• Credit terms (when to enquire 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 collection percentage on the fees they bill (realization rate) and enforcement actions against those who lag on collections (such as withholding compensation, or deducting collection expenses from it).

Monitor Realization

A further elaboration of this final point is helpful. It is possible to estimate the progress of realization by using the accounting measure of turnover ratio: accounts receivable balance divided by the result of billings per days in the billing period (either monthly or annually). The turnover ratio tells an administrator to expect payment for billings X number of days after a client receives a statement. The national average for law firms, according to past surveys, is often as much as 120 days. Of course, it’s vital to do everything possible so that A/R (accounts receivable) turnover is high; the longer a billing is outstanding, the less likely it is to be realized and the more likely a collection agency will have to be engaged.

This is obviously an extreme situation, and the best way to avoid it is to constantly monitor your firm’s realization rate. The goal of any realization is to have a high billed to collected ratio. An overall ratio of less than 85% is a recipe for trouble. The law firm that realizes only 60% of what it bills must be run on the money actually collected, not on the billings sent out. If you can run your business on the 60%, that would be fine, but few law firms can.

Stop Work

The more practical approach is, consistent with the ABA’s Code of Professional Conduct, Rule 1.16 (“Declining or Terminating Representation”) , stop work for clients who do not pay. That step should focus the client’s attention on the problem. Ask the client what he or she would like you to do to resolve a billing dispute. Listen carefully to what you are told. In a collection situation, it is important to do whatever is necessary to resolve the conflict. Clients who argue about over-billing are often just angling for a discounted bill. If, after all other efforts to collect have been exhausted, the client is merely interested in a fee discount, give it. Do it to get rid of the matter—and the client.

If a fee payment impasse develops, the lawyer cannot ethically cease representation when the client will be prejudiced – for example, by withdrawing within 60 days of a court date. If you try to withdraw without adequate communication on and careful records of the client's billing and payment performance, the result may be a State bar disciplinary action requiring future "involuntary servitude" (or pro bono work) to fulfill your ethical obligations toward the client.

Other Bankrolling

We have been talking about non-payment of bills as a form of client bankrolling; there are other examples as well. For example, one way of bankrolling clients is through costs advanced, a particular problem for IP firms that often pay patent and other filings fees before being reimbursed by the client. Such an interest-free loan to the client can eat up cash flow for months. Some cash basis law firms deduct such advances in the year paid as ordinary business expenses, with the firm taking repayment of the costs as ordinary income. Others try to treat such advance costs as an actual loan to the client. Commentators have indicated the IRS increasingly rejects the tax-deductibility of both approaches, taking instead the position that advanced costs can only be deducted on the law firm’s tax returns as a bad debt.

Another form of bankrolling is even more insidious: charging a flat fee at a volume discount. The billing rate is stipulated in the engagement letter, before the assignment even begins and will not vary by time or result. For the client, this certainty is a benefit; for the law firm, it’s a two-edged sword. If the flat fee is high enough, it encourages use of technology so that work can be done faster, thus increasing the effective hourly rate. However, strictly speaking, it’s not possible to make more money while charging less, unless the client provides more business. Your firm cannot set an accurate flat fee unless it fully reflects your budget, profitability and billing structure. Guaranteeing a flat rate without knowing these variables is yet another loan to the client.

Money and Loyalty

In many respects, these issues of bankrolling clients come down to a question of loyalty. Lawyers and law firms may believe that carrying clients’ unpaid bills and expenses will somehow buy client loyalty. The bottom line is that loyalty is the product of performance. Performance is a factor of many different things: communication, understanding and focusing on the corporate client’s business objectives, use of technology, and specialized knowledge. It defines a true collaborative partnership, goes both ways and benefits both sides. Lawyers must value and respect clients to earn their loyalty. But it’s a two-way street: You truly have a good relationship with your client only when the client's account receivable is up to date. Delinquent accounts indicate that the client has neither respect nor loyalty to you. No practice can long continue with such clients, nor should it.