Firms at risk: A new approach to resuscitating law firms in distress

The Solicitors Regulation Authority (SRA), Legal Standards Board (LSB) and Law Society need to undertake an urgent review of their positions with regards to helping ?law firms in distress.

A fresh approach is needed to reduce the costs of intervention and insolvency, potentially turn legal practices around, increase client protection and call a halt to asset-stripping by other firms once a practice is in financial difficulty.

A new commercial approach should be taken, with outcomes-focused regulation at its core. This would involve ?early support provided by a panel that the legal sector feels confident in engaging with and that provides advice on turnaround strategies that truly assist law firms.

Law firm failures

The cost of law firm failures is being felt across the UK legal profession. It was recently reported that the unprecedented ?bill for the SRA intervening in failing firms means that we will all ?have to pay an extra £23 each towards the compensation fund in the coming year.

The well-managed firms pay for the failed ones and a solution to this dichotomy is needed. In addition to all of this, we have unprecedented insolvencies and a professional indemnity insurance (PII) crisis to contend with; the end result is bad for business and the profession as a whole.

Interventions are due to the reactive approach taken by law firms, the SRA and banks when financial failure is imminent. The SRA want to avoid the destructive mechanism of interventions, and insolvency is not a compelling alternative.

The current system of regulation is shrouded in cynicism, disquiet and mistrust. Law firms do not easily accept failure and find it difficult to look outside of their inner sanctum for business advice. They do not find contacting the SRA an easy avenue to take when under pressure.

This problem is not going away, as evidenced by recent law firm failures due to an inability to obtain PII and cashflow issues. Most recently affected was Harris Cartier, a firm that had done much good in the wake of the Bristol babies’ hearts scandal.

Counting the costs

The introduction of a commercial and sector-specific panel of support would provide some control to a situation that has led to the current perilous state. In fact, it is essential given the costs and pressure associated with interventions and the negative effects of insolvencies. The cost of intervening in troubled firm Atteys has exceeded £1m. One wonders if this cost could have been reduced or even avoided with a different strategy.

While the SRA has avoided direct costs by not intervening, it should be remembered that insolvencies also carry a high cost to business. In her recent review for the Department for Business, Innovation and Skills, professor Elaine Kempson said that the fees generated in managing insolvencies are too high. She noted that there is a significant absence of evidence of independent review to ensure that time charged is for work that is necessary and properly performed, leaving unsecured creditors with only recourse ?to the courts.

One option is to consider competitive tendering when insolvency practitioners are appointed to ensure lower fees and allow for a proper assessment of whether or not fees ?are reasonable. This would, in turn, open up the possibility of a greater degree of compliance monitoring of fees in corporate insolvencies than is currently the case.

Cobbetts’ creditors are reportedly set to recoup less ?than 2p in the pound after the firm was controversially pre-packed off to DWF earlier this year; it will be the bills ?of administrator KPMG that will take precedence.

Meanwhile, the administration of Challinors falls into the ‘bizarre’ category after its administration coincided with that of its administrator RSM Tenon, with the two reportedly carrying £11m and £80m of unsecured debt, respectively. It will be interesting to see the level of RSM Tenon’s fees that will be charged and how much Challinors’ unsecured creditors will recoup.

This state of affairs cannot be allowed to continue.

Spotlight on PI

These issues are most prevalent in the personal injury (PI) sector, which has never been as fraught with so much uncertainty and financial instability as it is today. With the impact of LASPO, cashflow issues, deregulation, M&A activity and reduced PII availability, potential business failure is staring many in the face. Accessing early specialist sector advice is crucial; without this, more will unfortunately fail.

Prior to an intervention, partners or the firm’s bank may retain accountants to look at the sale of part of the business to raise urgently-needed cash. PI cases being sold in this way often results in cases being sold below value to assist in salvaging a failing law firm for a couple of weeks or months. Outcome-focused regulation (OFR) and clients’ needs are usually not a top priority.

It is a market in distress and many law firms do not truly appreciate the value of their PI work. The sector has been driven by purchasers with deep pockets. PI ‘cases for sale’ deals lose value because of:?

1. poor management information and WIP figures that are ?not robust under scrutiny;

2. poor assessment of risk and value in cases which lead to them being in a distressed state with lower market value; and

3. an inability of firms to properly value their more serious injury and complex work – not just in terms of WIP value to date, but the future opportunity value and upside in relation to factors such as increased hourly rates and costs building.

But, in all of this, who is protecting the interests of the firm’s clients when they are sold for the highest price? The purchasing firms face their own challenges as they have to ?gear up overnight to take on caseloads which may be ?fraught with their own levels of distress. Lack of in-house resources to some of those purchasing files could lead to further levels of distress evolving in the sector.

With business advice and a specialist strategy, PI work may be traded out rather than sold and an orderly winding down achieved, which is what the SRA wants to achieve for those looking to exit the sector. If PI work is sold, ensuring the deal is done in accordance with OFR has to be the overriding strategy if law firms are to truly focus on client protection.

A fresh approach

Intervention and insolvency are drastic steps. It is good that the SRA and the Law Society are looking at changes to cope with the level of distress in the sector, but all interested bodies, including the LSB, need to look afresh with a more proactive approach in the interests of the profession, client confidence and business success.

The SRA, LSB and Law Society need to adopt a new approach to regulating law firms in crisis which is both outcomes-focused and commercial. A new sector specialist panel should be developed to provide early support for firms in distress.

This would comprise a multidisciplinary group of professionals, namely: solicitors who understand regulation and compliance for law firms; solicitors specialising in law firms in turnaround; and expert accountancy/ insolvency practitioners who will learn from and work with lawyer-led specialist teams to ensure OFR, compliance and governance is at the panel’s core.

The panel could be called upon by the SRA when it is aware that a firm is in financial distress or has failed to secure PII. Law firms could access the panel directly for strategy and business advice that is OFR compliant and driven by a desire to avoid intervention or insolvency.

The panel need not be costly to the profession. It could be formed and governed by a representative board of interested sector bodies, and law firms engaging the panel’s services could enter into normal commercial terms.

The biggest hurdle would be getting law firms to engage early enough with the representative panel, in which there must be trust, understanding, sector specialism and business acumen.

Engaging with the panel would enable law firms to avoid intervention and obtain specialist support. If the sale of the whole or part of a firm were required, the panel would ensure that best value is achieved for clients and the firm itself. What happens with live cases is always a major issue in intervention and, if ?they were to be purchased, the panel would ensure they were sold for the best price and in the best interests of the clients ?to sector-specialist law firms.

To date, what we have tended to see is an asset-stripping approach that sells the most valuable and lucrative work at low cost and leaves the closed and unattractive files with the SRA.

Purchasing firms should take the rough with the smooth. Not only would they have to prove their ability to take on these clients in terms of expertise, compliance and their own financial stability, but they would also take a representative proportion of closed files to ease the burden of intervention costs.

The profession would embrace this. If there are businesses with pockets deep enough to buy cases at distressed value to turn a profit, surely they should also take some of the ‘pain’ in the closed cases and assist in funding the intervention costs. In addition, higher sale values could go some way to ameliorating the cost to the SRA and the law firm’s stakeholders.

In some situations, full intervention may still be required but, by working with firms to solve their problems or at least organise an orderly OFR disposal of the whole or part of the business, these can be kept to a minimum.

Answers within the profession

This is a difficult time for law firms and for the SRA, but the regulator should make use of the expertise available in the market to lessen the impact of law firm failures on everyone, particularly clients whose claims are, more often than not, ?the last thing on the minds of turnaround or insolvency ?teams in today’s current approach to failing law firms.

The answer lies within the profession – specialist ?lawyers are adept at running a profitable and sustainable business and they care about and want to invest in their profession. It is incumbent upon those with expertise to challenge accepted practices of assisting law firms and ?their clients in order to give those firms a fighting chance ?of survival, with their clients’ best interests preserved.

Lesley Graves is a solicitor and managing director of ?Citadel Law (www.citadel-law.com)