Mind your step: Warning to firms facing financial difficulty

A year ago, the failure of a law firm was virtually unheard of, writes Simon Love in his latest article for the New Law Journal.

That sort of thing simply didn’t happen to solicitors. However, a number of high profile failures have made it clear that the solicitors’ profession is not immune to the prevailing harsh economic conditions. Following the intervention by the Solicitors Regulation Authority (SRA) into Follett Stock LLP in November 2013, Helen Herniman, the SRA’s Director of Client Protection, said: “The legal services market is facing a tough economic environment and other firms may find they are in a similar position. We’d urge all those who may be struggling financially to get in touch as soon as possible with either ourselves at the SRA, or other organisations that can offer advice such as their local Law Society.”

Why are more law firms at risk of insolvency?

It is undoubtedly the case that the solicitors market is having to face up to historic challenges on every front. All firms are grappling with the fact that at this stage of the economic cycle there are simply too many solicitors nationally for the available work. It is also the case that, particularly since the financial crisis of 2008 and the new world of austerity, all clients want more for less, driving down rates and the profit available from the chargeable hours business structure. New competitors are coming into the legal services sector—“Tesco law”. Particular sections of the profession have been hit hard by reforms to their practice areas: claimant solicitors are suffering following the change to the recoverability of conditional fee agreements; litigators generally will feel the impact of the Jackson reforms and their goal of reducing costs.

Faced with these challenges, it is perhaps unsurprising that an increasing number of law firms are failing, in line with the increased failure rate of businesses generally in the post-financial crisis recessionary period: the lawyers are suffering with their clients.

Warning signs & responsible behaviour

Naturally, as the profession’s regulator, the SRA is concerned at the implications of this increased failure rate. It has used its experience with firms which have suffered severe financial difficulties to draw up a list of good behaviour to aspire to and poor behaviour to avoid. The lists are not exhaustive but examples of conduct to avoid include:

  • the taking of partner drawings in excess of net profits;
  • the firm being controlled by an “inner circle” of senior management;
  • the drawing of all net profit, with no “reserve capital pot” retained;
  • the heavy dependence on high overdraft borrowings;
  • the use of short term borrowing to fund partners’ tax bills;
  • partners being out of touch with office account bank balances.

The list of behaviour to aspire to includes:

  • the containment of premises costs (approximately £75.6m of Cobbetts' debts were associated with rent and leasing liabilities);
  • the testing of profitability levels and the dropping of unprofitable work;
  • the retention from profit of a capital element and the building-up of a capital reserve account;
  • all partners receiving full financial information including office account bank balances;
  • the provision of funds from income received to meet partners' tax liabilities.

Conclusion

It is often said, in tough economic times, that businesses which fail do so for a reason: the wheat is separated from the chaff. That may or may not be the case in relation to the solicitors’ profession, but it is difficult not to feel some sympathy for those whose livelihoods are affected through no fault of their own.

Being involved in the insolvency of a solicitors firm will always be a traumatic and challenging experience. The best advice to managers must be to run their firms in a sensible and realistic manner, monitoring all key financial indicators. If the events of the past few years have taught us anything, it is that the unthinkable can happen, if it is allowed to.

(to read the full article, please click here to visit New Law Journal)

Simon Love is a senior associate in the professional risks group at Reynolds Porter Chamberlain LLP. The full article was first published by New Law Journal on 5 February 2014.

Filed Under: New Law Journal

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