Law firm revenue in the U.S. will fall 5 to 10 percent this year even after demand increased in the third quarter, according to Citi Private Bank.

Law firms that rely heavily on financial-services clients will be hurt the most, said Dan DiPietro, head of client relations for the bank’s Law Firm Group in New York.

More lawyers lost their jobs in the third quarter than in the second, according to DiPietro, who says some law firms are now eliminating jobs at the partner level, including so-called equity partners as well as partners who are not owners.

“Some of the tough-love conversations are happening already, and there’s every reason to believe they will continue,” DiPietro said.

Law firms are struggling to maintain profits as the recession cut demand for legal services. Many of the largest U.S. firms fired junior attorneys and staff this year, while deferring start dates for first-year lawyers. Firms including Nixon Peabody LLP and Baker & McKenzie LLP cut pay.

“It’s not an easy year for lawyers,” Leslie Corwin, a shareholder at Greenberg Traurig LLP who advises professional- services firms, including law firms, said yesterday in a phone interview. “I’ve been doing this for 36 years, and this year’s the toughest ever. We’re in a tsunami economy.”

Corwin advised on the dissolutions of Heller Ehrman LLP, a San Francisco-based law firm that closed in 2008, and WolfBlock LLP, a Philadelphia firm that collapsed this year.

‘Bastions’ Collapse

Both were “bastions” of the legal community that went under as a direct result of the economy, said Corwin, whose Miami-based firm is the 10th highest-grossing in the U.S.

Firms with balanced practices that include litigation, bankruptcy and crisis management will be hurt less than others this year, while less well-balanced firms expect large revenue drops, according to a managing partner at one of the top 10 highest-grossing law firms, who requested anonymity.

The less-balanced firms are eliminating lawyers at the partner level, and it remains to be seen what impact the job cuts — some public and some private — will have on year-end financials, according to the attorney. The likely goal of the cuts is to maintain profit levels for rainmakers, or top- performing partners, the attorney added.

Representatives of the other eight U.S. firms with the largest revenue either declined to comment or didn’t return calls and e-mails seeking comment on the revenue estimates by Citi Private Bank, a Citigroup Inc. unit.

Advice to Law Firms

Citi Private Bank’s Law Firm Group provides banking, credit and investment advisory services to law firms and attorneys.

The bank based its 2009 law firm revenue projections on data it began collecting from 131 U.S. firms in 2001, DiPietro said.

Demand for legal services dropped 7.1 percent during the first two quarters of 2009 compared with last year, according to Citi’s data. Demand increased in the third quarter, with the decline for the first nine months of the year slowing to a rate of 6.8 percent, Citi said.

The number of attorneys working at the 131 law firms, which increased by 0.6 percent in the first half of this year, has fallen by almost 1 percent when the third quarter is included, according to Citi. In 2008, lawyer head count grew 5 percent after rising an average of 4.5 percent a year from 2001 to 2007, based on Citi data.

The average billing rate for U.S. law firms grew by 2.5 percent this year to $372 an hour, the National Law Journal, a legal newspaper, reported Dec. 7. That’s the smallest increase in recent years, the newspaper reported.

Fee Increases Fall

This year, as in-house lawyers for companies pressured outside firms for discounts and alternative fee arrangements, some law firms reduced rate increases compared with previous years.

Fifty-eight percent of corporate counsel think law firms are still too profitable while 77 percent of private lawyers say clients are too focused on cost-reduction, according to a LexisNexis survey.

“There’s a Grand Canyon-sized divide between the opinions of corporate counsel and those of law firm attorneys,” LexisNexis Chief Executive Officer Andy Prozes said Dec. 8 in a statement.

LexisNexis, a legal research provider, is a unit of the London-based publisher Reed Elsevier Plc. The firm surveyed 300 private lawyers, 150 corporate counsel and 100 law students, according to the statement.

Hourly Rates Rise

Law firms are expected to raise their hourly rates by 3 percent to 4 percent in 2010, with the largest asking for the most, said Kent Zimmermann, a strategist with Newport Beach, California-based Zeughauser Group LLC.

Law firms are wise to raise rates for new clients while delaying increases for their best ones, DiPietro said in a Dec. 7 interview.

“If firms forgo a rate increase for a year or two, they never make it up,” DiPietro said.

F1 to 2007, profit per partner grew every year at the 100 highest-grossing U.S. law firms, according to the trade magazine American Lawyer. In 2008, as demand began falling, profit per partner fell by 4.3 percent, the magazine reported.

Law firm leaders, while relieved that the free fall appears to be over, aren’t confident the third-quarter rise in demand for legal services is sustainable, DiPietro said.

“The worst could be over,” he said, “but we’re not expecting anything like the profit margins that law firms experienced from 2000 to 2007.”

Less Work

Law firm revenue will continue to drop next year, as 57 percent of corporate counsel plan to shift more legal work in-house and 55 percent plan to reduce their spending on outside counsel, according to the LexisNexis survey.

Rather than hiring to do more legal work in-house, clients are sending more document-review work to outside vendors, according to the managing partner who requested anonymity.

The legal department at Microsoft Corp. plans to reduce its spending on outside counsel by 14 percent for the fiscal year ending June 30, 2010, Brad Smith, the software maker’s general counsel, previously said in an interview.

Microsoft, the world’s largest software company and owner of the third-ranked Internet search engine, is changing its method for paying outside attorneys, choosing alternatives to the traditional billable hour, Smith said. By the third quarter of 2010, the Redmond, Washington-based company projects, half of its legal budget will be spent using alternative fee arrangements, up from 31 percent in 2007.

Billable-Hour Decline

“The billable-hour model has entered a long-term state of decline,” Smith said. The alternative-fee trend will be “difficult to reverse,” he said.

Popular alternatives include fixed fees and so-called success fees, in which lawyers are paid more or less than an agreed-upon fee, depending on their success and efficiency.

With demand low, law firms should focus on generating revenue at the expense of other firms, through discounts or by hiring star partners from rivals, DiPietro said.

“It’s going to be a very active lateral market in the next six months, with more lawyers leaving big firms for smaller firms that will allow them to cut their rates,” DiPietro said.

Zimmermann said more firms should develop their own departments to handle document review at low costs, to prevent clients from outsourcing such work to India. Lawyers should also focus on deepening relationships with existing clients, “the lowest-hanging fruit,” he said.

‘Bet the Company’

Top firms can continue raising rates for “bet-the- company” work, Zimmermann said.

“When Pfizer wants to hold on to a patent for a drug that makes them a lot of money, the CEO is never going to ask about the size of the lawyers’ bill,” Zimmermann said. “He’s going to ask if they were successful.”

Greenberg Traurig’s Corwin said the fourth quarter is off to a good start.

“As a profession, we’ve seen a strong October and November,” Corwin said. “All of us hope and pray that it carries over to 2010.”