Pressure cooker: turning down the heat post Jackson

With the Jackson reforms starting to impact on cash receipts and the professional indemnity insurance (PII) renewal season upon us, there’s no let up of pressure on the majority of claimant personal injury (PI) law firms.

The market is consolidating in a number of ways and, while there’s a long way to go, it is clear that the firms with a handle on their finances are identifying routes to market that allow them to control the cost of acquisition and justify the working capital investment involved.

Common factors are a multi-skilled ownership structure, and a business that remains solely owned by lawyers, incorporating a motivated and multi-skilled management structure, involving individuals whose core skills do not come solely from a legal background, including accountancy, IT, marketing and/or business management core skill sets.

Another part of the equation is the subset stepping back from claimant PI. This also includes similar robust firms, with the same diversity in skill sets, either through internal appointments or by engaging with outsourced services. Of those identified to date, they are multidisciplinary practices where the analysis of revenues achievable post Jackson has led to decisions to reinvest the working capital into other areas of
the practice.

Skill sets

The by-product of stepping back from claimant PI, either as part of an immediate action to divest the book or place it into external run off, is that it demonstrates to professional indemnity insurers that the second highest rated service sector is something the firm is no longer exposed to or that there is a clear strategy to end the exposure. This will undoubtedly assist when brokering fresh PII.

The challenges become greater when the burden of change is resting on fewer shoulders and narrower skill sets. If you do not have access to multifaceted skill sets, the challenge of identifying the best course of action intensifies, often the outcome being to delay, postpone or defer action in the hope something materialises to put a plaster over everything.

Get down to a sole trader and the issues can be crippling; not only will there be lifestyle factors and family expectations, but also a debilitating fear from having to face these challenges alone.

There will always be those that take the moral high ground and throw stones at those who need to step back or engage with a process that will allow them to cease their business or restructure. ‘Everyone knew change was inevitable, they should have sorted themselves out before now,’
or ‘The gravy train of PI could never last, that
was obvious’; these comments serve no
positive purpose.

The fact is few anticipated the severity of change in such a short period of time. It is highly questionable whether the legislators or the Solicitors Regulation Authority (SRA) truly understood the impact the changes would have on the profession, especially those who had embraced the entrepreneurial spirit, created business, employed others and took on all the pressures that brings it within the framework created by the earlier advent of access to justice.

Given the revenues achievable in the noughties, it’s no wonder so many firms emerged or got into claimant PI. At those levels, cost structures emerged that are simply unsustainable post Jackson. Partners’ drawings, key employees rewarded disproportionately, property and inefficient risk management are all areas that are particularly painful to reverse if lifestyles have adjusted, have become the norm and then are faced with a 30 to 40 per cent reduction in possible revenue. That is, of course, if you can maintain the same level of new inceptions. If not, the situation is even worse.

All of this is compounded by some serious barriers to getting out. Not only do you have to consider a complete reinvention, even if you want to get out, you have the cash flow issue of redundancy costs, the aggressively discounted ‘work in progress (WIP) buying’ culture and run-off cover.

Tinkering away

Rather than creating barriers the profession should be rallying to mitigate the impact of change on their fellow practitioners. Likewise, the regulator should be a proactive component of the process, as opposed to stuck in the past with a rule book that’s no longer fit for purpose or tinkering around the edges.

Greater use has to be made of voluntary arrangements, whether creditor, partnership or individual, to avoid a more formal process further down the line.

Simple economics will drive the change through regardless over the next three to five years, but what can be mitigated is the carnage created within the transitional period. The number of firms failing through a formal insolvency process and individual bankruptcies
is unacceptable. Yes, individuals have to take responsibility and act earlier, but likewise, those that created the environment in which these firms prospered and then pulled the rug out from under them also need to take responsibility for
the outcome.

For SME firms, the challenge is compounded by the disproportionate burden of regulatory and PII cost. Legal services involved in PI claimant work carries the second highest rating for PII. This has already resulted in SME firms carrying a PII cost that can be brutal when considered as a percentage of their turnover. The situation is
only going to get worse this year as more
insurers become exposed to picking up the
run off of failed firms without any prospect
of receiving the run-off premium. No amount of tinkering with what is required from PII changes the fundamental risk of being left holding the baby when a firm fails.

Getting out

David Marshall of Anthony Gold stated last year, “get big, get niche or get out”. Unfortunately, the first option simply isn’t available to the vast majority of firms.

The second requires vision and innovation to identify narrow but potentially deep seams of work. This is not easy, but something a small number of firms have done successfully.
Many firms historically relied on work being delivered to them; to suddenly become niche is challenging. This leaves the natural conclusion for a significant proportion of the sector as being the third: get out.

For those reaching that conclusion though, there is an immediate feeling of being trapped. There is simply no way out that does not involve massive change and write-off on a personal level. It would appear that the legislators gave no thought to the challenge, beyond the fact that reducing income by more than 30 per cent and cutting off routes to market would create carnage for a relatively short period, at the end of which there will be a more robust and consistent level
of legal services.

There has been no joined up thinking, no investment in understanding (or disregard for it
if understood) the underlying business model. WIP it

For real value to be achieved from the assets within these businesses, time is required. But time is not what some firms have on their side. Their key asset
is WIP in matters incepted pre Jackson and that asset has depleted. The credible buyers in the market are few and are reducing.

Cash generated by firms who have not been able to embrace the post-Jackson era will now start to dip. If there is third party debt, the burden of repayment will be building and, with PII renewal looming, all the foregoing issues are likely to
impact on the ability to get terms quoted that
are manageable.

While 100 per cent of the value incumbent in
WIP can be realised via outsourced run off, for the benefit of the owners and/or creditors, depending on the solvency at the point of finally reaching
a conclusion, it does require a decision to act to
be reached.

If a decision is taken early enough, it may be possible to avoid the need for a voluntary arrangement or result in an easy ‘sell’ to creditors
as a 100 per cent dividend is anticipated.

Advice is becoming more readily available as specialist firms emerge as a result of the volume of activity. Duff & Phelps, FRP Advisory, Leonard Curtis and Armstrong Watson, among others, now have partners dedicated to this sector.

The key remains to engage with external advisers as early as possible if there is any doubt around
the financial viability of remaining in claimant PI.
The options available to firms close down rapidly
the more distressed the issues become, with delays in engagement resulting in the increase in formal insolvency and bankruptcy activity involving solicitor practices. SJ

CASE STUDY: RUNNING OFF DELTA LEGAL'S PI FILES Delta Legal realised it was facing solvency issues following the huge changes to the legal landscape last year. They approached us to oversee the managed and compliant run-off of 800 personal injury files. It was a move that will allow Delta Legal, a Manchester-based personal injury law firm, to realise 100 per cent of the value incumbent in WIP over the next three years. Delta Legal acted early and approached us as soon as it recognised there was trouble ahead. At first, we directed the firm to other experts, including independent accountants and insolvency practitioners, who advised on a voluntary arrangement. Delta Legal then decided to appoint us. The whole process will last for three years with Delta Legal likely to see 40 per cent of recovery value within the first year, 30 per cent in the second year, 20 per cent in the third and the remaining 10 per cent is likely to be sold on a discounted basis. We have facilitated five panel firms and undertaken the transfer process. We will continue to monitor the liquidated value flowing to Delta Legal on case conclusion while the law firm supervises and manages its orderly wind down. Managing partner at Delta Legal, Daren Ismay, said: “It’s disappointing that the Jackson reforms have resulted in such a draconian reduction in revenues. Having recognised the firm wasn’t going to be financially viable going forward, I decided to take immediate action. By seeking professional advice early, I’ve been able to manage the process, which will improve the situation for creditors and clients alike.”

David Johnstone is the managing director of PI-Solutions