Rolling credits

The Legal Services Act will enable outside investors to put money into law firms, but the inescapable fact is that an increasing number of legal services providers and sole practitioners are facing insolvency. With the expectation that there is more to come, firms that may recently have been courting potential investors come 2012 may now be battling to stay afloat. In the midst of this situation, there is a serious argument for law firms to consider adopting modern business structures such as limited liability partnerships and limited company status if they are going to appeal to investors in the crowded new world of legal services providers.

In recent years, we have seen a strong drive towards specialisation andthe streamlining of legal practices '“ refining and focusing the business model quite narrowly. Those that specialise in property transactions and conveyancing have been the first to suffer. Those with services targeting a wider client base '“ for example, healthcare, insurance litigation and commercial services '“ will be in a much stronger position to weather the storm. In the large firms, although individual departments might be struggling, there will be supporting fee income from others.

That said, even the larger organisations are constantly reviewing their financial position and cutting costs where possible. A number have cut staff hours and offered sabbaticals in response to a decline in work load.

Firms in the danger zone are, however, generally small, second-tier practices that have been struggling with a decline in fee income for a period of time. This can manifest itself in a variety of ways, with some rather unfortunate stories illustrating the point; such as senior partners supplementing their falling drawings and earnings with personal credit cards and overdrafts. If both the firm and a number of individuals running it are in financial difficulty, this situation will not sit well with creditors. Once the Solicitors Regulation Authority (SRA) intervenes, it will appoint a law firm from a selected panel to take over the cases. This is disastrous for the creditors of a practice.

Exploring the options

There are law firms out there at the moment that are already legally insolvent but have been allowed to try and trade their way through it. If the practice is otherwise sound, the SRA may hold off an intervention and allow the firm to continue trading normally through a formal procedure such as a voluntary arrangement. The SRA will broadly base its decision on whether debt has been ring fenced and if there are other lawyers in the practice to effectively supervise those that might be subject to such an arrangement. Each firm must explore the range of options available to ensure the future of the firm and maintain careers and jobs where possible.

On the high street, firms have been hit by a drop off in residential conveyancing, while corporate firms, which have expanded on the back of commercial property, IPO and M&A transactions, have seen transactional work dry up. Add this to rocketing professional indemnity premiums and banks' reluctance to extend overdrafts and it is easy to see why the anticipated rush from investors post Legal Services Act might in fact turn into a crawl.

Although the outlook remains bleak for the near future, there are still many lawyers and law firms out there determined to continue trading. We are seeing a significant increase in the number of solicitors entering into voluntary arrangements (both individual (IVA) and partnership (PVA)) with their creditors to which there can be a number of benefits for all parties involved. If the solicitors in question can continue trading, they can continue paying off all, or some of, their debts and perhaps even consider selling or merging the practice with a more resourceful firm.

By agreeing to a VA, partners in a firm which hasn't been converted to LLP status may be able to keep their homes and other assets which they would otherwise lose should they be declared bankrupt. For it to work, in excess of 75 per cent of creditors voting at the meeting must agree on the terms of the VA. An insolvency practitioner would broker a deal between the partners and the creditors, and afterwards act as a supervisor until the end of the agreed period '“ usually five years. Once an IVA has been agreed, the creditors can no longer charge interest or petition for bankruptcy.

Fundamentally, the assets of a legal practice in the main consist of its client files. A VA can work to preserve the value in such files and in so doing enhance the return for creditors.

Professional advisers are at pains to point out that a business needs to be 'groomed' for sale if it is to attract maximum value '“ and the same applies to law firms looking for external investment. Outside investors will not be willing to take on any personal risk should the firm fail, so any business structure leaving stakeholders personally liable in the event of financial difficulty is not going to be attractive.