Lenders 'reviewing or reducing' law firm borrowing

Banks and other lenders are reviewing their exposure in the legal market, and reducing or withdrawing borrowing facilities, the SRA board was told yesterday.

Relationship manager Samantha Palmer said that although they lent money at the start of the year to cover partners' January tax bills, the same funding might not be available in July.

Palmer said despite what might be considered the 'perfect storm' that was hitting the profession, there was a direct relationship between financial performance and whether firms exhibited 'good' or 'poor' behaviours.

She said an example of poor behaviour was when firms were controlled by a 'tight inner circle' without key information being shared with rank and file partners.

Other signs were drawings exceeding net profits, high borrowing to asset ratios and increasing debt to continue funding drawings.

She said that in some firms, so-called 'capital injections' by partners were really off-balance sheet loans, not reflected in the accounts.

Palmer said further examples of bad behaviour included not having any 'reserve capital' or 'rainy day money', relying on short-term loans to pay partners' tax bills or treating VAT received as cash received, resulting in further borrowing to fund the VAT due to the HMRC.

She said 'good behaviours' included keeping a capital reserve account and containing the cost of premises, for example by renegotiating leases.

Firms were facing 'financial stability issues across the piste' as a result of the ban on referral fees, the Jackson reforms and increasing restrictions on legal aid work, said Palmer.

Other factors included the impact of government spending cuts on public sector legal work, a 'flat-lining' conveyancing market and new entrants to the probate market.

Samantha Barrass, director of regulation at the SRA, said it was crucial that firms had contingency plans.

Richard Collins, director of policy and standards, said the regulator should consider toughening up its financial reporting requirements, and creating further powers 'to get firms to take issues seriously' without the need for interventions.

'The question for us is whether our rules have kept up with the move to LLPs and limited companies,' he said. 'Do we need to alter them to take into account the fact that personal liabilities are different?'