Prepare for impact: fallout from Jackson to be felt by PI firms this year

One year on and it’s clear Jackson has made quite an impact, but the claimant personal injury sector and those servicing it should brace themselves, as the real impact may be yet to come.

Curve ball

Figure one shows the distribution curve associated with revenues that flow from settling matters from a standing start. Assuming the case numbers incepted monthly are consistent, once at the top of the curve a firm should enjoy consistent revenue streams.

Average revenue for an individual matter has fallen dramatically and, for an equivalent number of matters incepted post-LASPO, the distribution curve lies below what could be achieved previously.

Firms know that they have to secure compliant routes to market. Many report incepting fewer matters for a variety of reasons, such as major advertisers restricting the number on panel in order to achieve sustainable business models.

The impact for some firms in 2013 was positive in terms of cash. They were at the top of the distribution curve and cash inflows were reasonably consistent; combine that with reduced outgoings, due to a fall in spend on case acquisition, and the cash position improves. The underlying issues were masked, possibly giving firms a false sense of security, unless they had a handle on how rapidly their work-in-progress (WIP) asset was depleting.

The challenge for firms securing similar workloads is to cope with dropping from one curve to the
other over time. For those securing less work, the challenge is intensified, as the back end of the
curve is far steeper than the front. The resulting rapid reduction in cash generation can take firms
by surprise.

Some firms will be considering their balance sheet for the first time since the end of the last
tax year. Many in that position will identify that
their asset has fallen significantly compared to
their liabilities.

As is reported repeatedly, the earlier advice is sought, the more options there are. Identifying where a firm sits within the distribution curve requires investment in financial management information and this is not necessarily high on the agenda for small- to medium-sized practices.

Those servicing the sector are potentially contributing to the challenges and/or the suppression of dealing with situations at the earliest opportunity. Small- to medium-sized businesses rely on their bank and accountants for advice in areas that are not necessarily a solicitor’s core skill set. Regrettably, many at the coal face of those professions do not fully understand the underlying dynamics.

Banks only appear to react to the situation when cash flow is impacted, but banks must proactively look after their clients’ security. In turn, firms will benefit from earlier assistance.

Accountancy businesses are emerging that have a specialism around legal practices and law firms would be well advised to research their choice of adviser in this field.

Cash flow

The situation is further exasperated by behaviours partly driven by some service providers and partly from cash-flow issues, both of which can contribute to the creation of shortfalls in client accounts.
The rules are clear in respect of professional disbursements: on recovery either extinguish the debt or place the funds in client account.

Agreeing time to pay with a disbursement provider is not a valid creation of additional working capital and any shortfall must be addressed before the most effective strategies are available.

Fresh opportunities still exist for well-financed, well-managed firms with clear strategies in terms of client acquisition or niche specialism, where the return on capital employed is deemed acceptable.
A number of multi-disciplinary firms have made strategic decisions to redirect the working capital into other areas where they can generate an improved return.

2014 will see an increase in the visibility of firms adopting this strategy, as what started life as an internal run off is converted to a commercial arrangement. Solvent, standalone personal injury firms will continue to be the subject of mergers or acquisitions as others strive for market share.

The wider professional reputational risk is minimal in such transactions as it will be managed in an orderly fashion. This would apply whether it is a merger, outright sale or outsourced run off.

Of greater concern is where there is an element of financial distress. Situations have arisen already this year where the most client-focussed and commercially acceptable solution is not achievable as a result of shortfalls in client account.

WIP has a perceived value when there is an assumption of it being a going concern. Where that assumption no longer remains, the value of WIP is directly affected. If WIP is to be immediately liquidated – turned into cash – then on a solvent sale one can expect to realise between 35 per cent and 50 per cent and write off the balance. Where time is of the essence, in a distressed situation, this will fall to ten to 20 per cent, if achievable at all.

Greater value can be achieved on an earn-out basis, via an outsourced run off, where the entity effectively winds down in an orderly fashion. This can only be achieved where the client account is in order. Depending on the individual circumstances up to 80 per cent of the value can be achieved.

Outcome focused

Intervention by the SRA is the final possibility. As things stand currently, an insolvency event and an intervention are not a ‘joined-up’ event. While a commercial arrangement, in the majority of situations, will provide a seamless transition for clients, the process will be more drawn out under an intervention, first passing through an intervention agent to decide whether it’s alive or dead before finally being re-homed either with the intervening firm itself or basically any other firm.

At present there is not a tool in the SRA’s toolbox that can accommodate a commercial solution where there is a shortfall in client account. It is not through a lack of desire to allow the most logical solution to proceed, perversely the existing framework ties the SRA’s hands to the extent
that it is a barrier to the regulator achieving its
own outcome-focussed objectives in respect of protecting claimants.

For staff and creditors, secured or otherwise, intervention offers the worst possible outcome as the intervening firm uplifts the asset and leaves behind all liabilities. There is no closure, nobody to assist in claiming lost wages or redundancy, no insolvency practitioner managing collection and distribution of assets as they have been removed.

Indeed, identifying an insolvency practitioner to liquidate the Armageddon that is left behind will be a challenge, as all value has been extracted by the intervention and no realisable asset left to cover
the cost.

Of course 2014 will see further change. As firms are impacted by decreasing cash receipts more will recognise the need to engage outside assistance or will have it foisted upon them by their creditors. Already this year we have seen firms engage prior to failing to meet liabilities as they fall due and hopefully that trend will increase as it has the potential to transform the outcome.

However, it has been said many times that the reduction in the revenue line achievable in claimant personal injury, combined with a rapidly changing market in respect of how firms attract new clients, represents unprecedented change that many will still be trying to come to terms with.

It is lamentable that the profession shows a lack of willingness to engage with the SRA and external advisers. Yet the message remains the same: the later firms leave it to engage, the harder it becomes to avoid the worst possible outcomes. SJ