Law firms found a successful yet quiet first quarter transformed in its final weeks as a global trade war boosted firms’ short-term prospects but could threaten their long-term prosperity
Despite improvements in demand late in the quarter, the Thomson Reuters® Institute Law Firm Financial Index (LFFI) score fell 13 points in the first quarter of this year to a score of 51 points, signaling that the next few quarters may be rocky indeed.
Key takeaways in Q1
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- The drop in the LFFI score indicates a possible significant decline in law firm profitability despite higher client demand for legal services.
- Law firms implemented aggressive rate increases, growing worked rates by an all-time high pace compared to Q1 2024 levels.
- Direct expenses — those related to compensation — grew in response to continued performance bonus disbursement and ended up surpassing the average rate growth.
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A shifting picture of client needs
The first quarter of any year is typically dominated by rate-setting news as law firms implement new rate schedules and test their client’s willingness to accept them. On that front, firms came out of the gate with their most aggressive increases since at least 2005.
Initially, this aggressive rate setting seemed necessary to counteract a forecasted slowing in demand growth. However, as the current trade war heated up, law firms found themselves flooded with client demand in March. Despite the surge, productivity contracted due to one less working day compared to Q1 2024.
The net result of this increase in client demand is that the historically aggressive rate increases of 2025 seem to have been accepted by clients with minimum pushback so far. Indeed, from a realization perspective, law firms seem to be achieving better realization in the Q1 2025 than they did in 2024.
Further, the ongoing trade conflict seems to have given a boost to just about every major practice area. Both transactional and counter-cyclical demand rose significantly, with firms of all sizes finding some level of greater traction. However, one practice in which strong performance was anticipated in 2025 but appears to be underperforming the market’s expectations is mergers & acquisitions.
While the short-term rates and demand picture may seem solid, challenges are emerging. Direct expenses shot up as law firms competed for talent and paid out performance bonuses from 2024. This may mean a concerning long-term outlook, as the trade war boosts short-term demand but poses risks for future transactional demand.
Concern over the economic outlook
While law firms may be enjoying significant boosts from the client side so far in 2025, there are looming risks. The US economic outlook has notably deteriorated compared to Q4 2024 — just one quarter previous — with rising expectations of instability, inflation, and even recession. This year was originally forecasted to be relatively unimpressive from a demand profile, however, a deteriorating economy could see the transactional work that is still considered the bedrock of large law firm performance weaken in the long term.
Looking back at the last major recession experienced by the United States, that of the Global Financial Crisis that began in 2007, law firms saw a notable sugar-rush of demand in 2007 as well, helping make it one of their strongest years ever. Then, the floor fell out as transactional work dried up and counter-cyclical work struggled desperately to hold on. It took firms the better part of a decade to rebuild demand back to 2007 levels, a trying period which few firms would consider worth it just to experience a single strong year of demand.
There are concerns that, if the economic situation continues to destabilize and the US indeed plummets into a recession, that law firms risk facing a similar situation, in which the current rush of client demand is the prelude to a similar long-term drop in transactional demand.
However, 2025 still holds potential for stronger-than-expected firm performance, but future prospects are now in jeopardy in a way they weren’t just a few months ago.
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