Insolvencies in professional partnerships

13 Jan 2014

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With the number of professional services insolvencies on the rise Mark Sands, partner at Baker Tilly, looks at some of the factors affecting insolvencies, key issues for partnership insolvencies and some of the most common insolvency procedures.

There have been a number of professional services insolvencies recently, particularly solicitors and accountancy firms—why do you think this is?

The legal profession has seen changes which have simply become too much for an increasing number of firms—conveyancing volumes have halved, and have only recently shown signs of recovery. Private clients faced with tightened belts look at low cost answers to problems such as will writing, divorce and other family related issues, demanding low fixed fees or sidestepping the profession and using the internet and blogs as sources of self-help. Legally aided work has been significantly cut in the overall budget, and corporate and commercial clients have reduced spending both as a result of reduced activity and seeking lower or fixed fees for routine employment, property and commercial work.

These issues have driven many firms to consolidate and streamline their businesses while new entrants have sought to commoditise an increasing number of products at low and/or fixed costs. Faced with the combination of the above and competition driving down margins, many practices can simply no longer compete.

Partnerships are ‘unique’ in that partners should only take drawings from profits whereas corporate entities pay senior staff, deducting those costs to arrive at a figure for profits. However, partners may become used to a level of drawings and continue to draw funds from the partnership at their traditional rate for some time after profits have fallen below the combined level of partners’ drawings—so even when making a notional profit, a partnership can find itself with a material outflow of cash which has to be funded by increased debt levels. The situation may be worsened by the build-up of work in progress in the lead up to insolvency, meaning that cash generation is even lower than calculated profit.

What common problems do professional partnerships face that have led to an increase in insolvencies in this sector in recent years?

In the past year many businesses, including professional practices, expected to see an upturn in their markets which has not yet happened. Clients of professional practices—whether financially squeezed private clients or businesses facing challenges of their own—are not turning the taps back on. Practices which did not radically adjust at the start of the downturn are faced with another year of low or non-existent profits—and if experiencing this for the third or fourth year failure is a real option.

In terms of solicitors’ practices, over the years there has been a reduction in availability of insurers willing to provide cover, exacerbated by poor claims records at struggling firms. With less work and less cash, corners are sometimes cut and partners overstretched, increasing the likelihood of poor work, complaints and negligence claims. This has been particularly so in the past year with the number of firms without cover at the usual renewal date exceeding 140.

What is the most common insolvency process for professional partnerships, and why?

As well as the headline failures, a larger number of firms simply cease to exist. Partners wind down the practice, shut up shop and either look for a job or retire. Some solicitors’ practices are subject to Solicitors Regulation Authority (SRA) intervention, leaving little for a recovery professional to work with, leading to liquidation and bankruptcy. Voluntary arrangements have been used to good effect in a small number of instances, and administration is the most effective approach. In these cases attempts at a sale or merger will have been ongoing for some time, and if the business cannot be saved, a sale of parts of the practice or a ‘merger’ into a solvent practice will be the only way forward. To put the plans into effect even when the value of the business means that the entity is insolvent, a sale by an administrator, usually through a ‘pre pack’, offers the best solution. In a solicitors’ practice this is particularly important given the restrictions on recovery professionals trading a practice unless a solicitor is involved and the need to avoid an intervention if the value in the client files and work in progress is to be protected. An administrator can be appointed very quickly once the need is confirmed.

What are the main challenges when working on a professional services partnership?

In solicitors’ practices the main challenge is the regulatory framework and the need to head off an intervention by the SRA. Working closely with the SRA and other professionals skilled in dealing with their sector specific issues such as client confidentiality and compliance failings will assist. If clients are protected and realisations for creditors are maximised, we have a ‘win-win’ situation.

A key challenge is keeping stakeholders working together—especially the partners, but also the SRA and key lenders. Once partners know insolvency is likely, often with their personal assets being at stake, panic, disintegration and a clamour to protect one’s own position can ensue. In firms with a positive collegiate culture the outcome is maximised, often despite dire consequences for partners concerned. Where there is conflict between the best outcome for the partnership and the best way forward for individual partners, tensions can rise and conflicting advice may be sought. Interlocking PVAs and IVAs (where the partnership VA and IVAs for all partners are proposed as a single integrated solution) is, in the classroom, the most elegant solution, but one which in practice is rarely implemented.

Do you expect to see more partnership insolvencies?

Yes—in many respects the partnership model is outmoded, the sectors most likely to have partnerships as a business structure are showing limited signs of recovery and competition, often from non-traditional business models, is increasing. There is no respite for traditional partnerships in the legal sector and beyond.

Mark Sands is a Partner at Baker Tilly Business Services Limited and has more than 25 years' experience of insolvency issues. The last 12 years have been focused on the personal insolvency sector, including several reported cases involving bankrupts seeking to put assets beyond the reach of their creditors.

He is an active member on the council of the Insolvency Practitioners Association and a leading commentator on personal bankruptcy and financial issues, regularly contributing to national print and the broadcast media.

Mark sits on the Lexis PSL Restructuring & Insolvency Consulting Editorial Board.

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