An increasing number of Top 100 law firms rate pressure from clients to slash fees as the greatest risk to profitability, says legal information provider Sweet & Maxwell, a Thomson Reuters business.

58% of Finance Directors at Top 100 law firms surveyed by Sweet & Maxwell say that pressure from clients to discount fees will pose a high risk to profitability, up from 54% in 2011. Other major threats to profitability include the continued slowdown in corporate work ranked a high risk by 54% of firms (46% in 2011), and, more surprisingly, increased competition created by the Legal Services Act which is rated as a high risk by 19% of law firms.

Sweet & Maxwell says this is the third year in a row that Finance Directors have identified fee discounts as the biggest threat to the profitability of their firms. Such is the pressure from clients over fees that some law firms are under-pricing “fixed fee” work – where law firms cap their fees for a particular project. 44% of law firms surveyed said that they view cost overruns on fixed fee work as a high risk to profitability.

One recently reported example of a low bid being put in to secure work was that of a Spanish law firm offering to work for a €1 fee to advise on the establishment of a fund (the Fund for the Payment of Creditors -FFPP) that will inject a planned €35bn into the Spanish economy (as part of the response to the Eurozone crisis).

The second highest risk to profitability identified by law firms in 2012, is the continued slump in corporate work, with 54% of Finance Directors saying this poses a high risk – up from 46% in 2011. Both corporate finance and M&A work are still far below their pre-credit crunch levels.

Concern grows that post-Legal Services Act competition will hit profits

Perhaps the most surprising finding is that 19% of law firms see competition from other legal services providers – as a result of the Legal Services Act – as a high risk to profitability. This stands in sharp contrast to 2010 when no law firms polled identified this as a significant threat to their profits.

Until now it has been thought that competitive pressures created by new entrants to the market were going to be felt most keenly by high street law firms. However, larger law firms might now be concerned that the commoditised elements of their practices could suffer if competition ripples through the market. Recent research by investment bank Espirito Santo found that half of insurers are considering setting up their own law firms which could compete with “bulk” insurance practices of large commercial law firms.

Finance Directors might also be concerned that if significant amounts of private equity money are invested into smaller commercial law firms then this could lead to more competition for higher margin work.

“The Legal Services Act is aimed at increasing competition and choice in the legal market and some will judge the success of the Act on whether it leads to a tangible increase in service levels, or a pressure on fees,” said Teri Hawksworth, managing director, Thomson Reuters Sweet & Maxwell. “The big question is how high up the league table of law firms the ripples from the Legal Services Act spread. While none of the Magic Circle firms we spoke to identify the Act as a risk, we are seeing more firms outside the Top 10 paying more serious attention to its impact.”

Changes to “no win – no fee” arrangements expected to hit commercial litigation

42% of the Top 100 law firms surveyed thought that changes to “no win – no fee” arrangements would be a high or medium risk to their profitability. Changes due in April 2013 may make “no win, no fee” arrangements less attractive to businesses and individuals that want to pursue a claim but do not want to take the risk of paying their legal costs if they lose their case.

Whilst “no win – no fee” cases are normally associated with personal injury claims they have been increasingly used to fund litigation between businesses. 36% of Top 100 law firms surveyed said that they expected the number of commercial cases they take on through “no win, no fee” to be reduced by the changes due in April 2013. 44% expected a fall in medical negligence cases.

Conditional Fee Arrangements (CFAs) had been seen as effective way of allowing cash strapped businesses a way to access the courts and pursue an important legal claim. The CFA, ‘no win, no fee’ model will change in April 2013 as a result of the Legal Aid, Sentencing and Punishment of Offenders Act 2012. The Act will mean that the winning party will not be able to recover the success fees and After the Event insurance premium from the losing party. Instead clients will have to pay lawyers’ success fees out of the monies awarded in damages.