Understanding Law Firm Failures and Risks
Over the past few years there have been a significant number of high-profile failures of law firms gracing the front pages of the legal press, as well as a high number of smaller-firm failures that don’t always make headline news. It is these smaller-firm failures that can offer growth opportunities for motivated and well-run practices.
There is no doubt that the sector has been facing unprecedented challenges to maintain its top-line turnover, but as a law firm’s costs can’t be easily reduced in the short-term this has led to reducing profitability. If profit reduces, but drawings remain the same, then cash flow pressure inevitably follows.
In such circumstances strong leadership implementing a well-defined and adaptable strategic plan is a necessity. If a management team cannot deliver the strategic aims and take the key internal and external stakeholders with them, then failure becomes a very real possibility. But as always, one firm’s failure becomes another firm’s opportunity.
Why Law Firms Run Into Trouble
Practices fail because they run out of cash. However, firms do not run out of cash overnight. A typical law firm failure will commence many months before the appointment of insolvency practitioners. The good news is that this gives the firm the opportunity to take advice and then implement decisive action to either trade out of difficulties or if this is not possible, to create and deliver a plan B that protects the trade and maximises value for the creditors and partners alike.
Usually that plan B is to attempt to deliver the sale of the firm to a successor practice. Why is this? Well without a successor practice, the firm tends to just cease to trade. This can be a terrible outcome for almost all stakeholders as:
- Realisations from WIP and debtors are usually very low following a shut down;
- The SRA tend to intervene following a shutdown in order to protect the firm’s clients’ interests;
- Employees may be made redundant and have large claims against the firm;
- Landlords have claims for the residual portion of their lease;
- Run off cover is triggered for the firms PI provider.
The intervention costs of the SRA are the subject of a charge over the firm’s assets; this obviously impacts on the creditor’s recoveries from the insolvency. Even in a LLP if the assets are insufficient, the intervention costs can be personal liabilities of the partners of the firm, as can the PI run-off cover.
Why Pre-Pack Sales Are Essential
It is in everyone’s interests to achieve a sale of a firm as a going concern as this maximises realisations for the creditors and minimises the claims against the practice and the partners personally.
In any other industry, the appointment of administrators allows the administrators the opportunity to continue the business in order to run a marketing campaign offering the trade for sale to the highest bidder. The administrator then negotiates the sale, draws up a contract and then sells the business and assets.
However, for various reasons, an administrator cannot trade a law firm in administration. Therefore, any administrator’s sale of the business must be completed immediately on the appointment of the administrators. This means all the necessary steps such as identifying the likely purchasers, marketing the firm, due diligence, negotiation and agreement of contracts all need to be agreed prior to the appointment of administrators. The only bit that happens after the appointment is the actual exchange and completion and this happens within seconds of the appointment.
How Pre-Pack Sales Work in Practice
Everything is pre-packaged to happen immediately on appointment. Hence the name pre-pack.
So at a time when the management board of a firm is under the greatest pressure dealing with day to day cash issues and spending all its time dealing with the internal and external stakeholders such as the SRA, the Bank and the partner group, they must also find time to run the plan B which is to assist in lining up a pre-pack. They need to do this before the cash resources run out.
Maximising Opportunity as a Purchaser
In the current climate, the list of firms with the resources and ability and appetite to purchase a firm from administration is limited. If you have identified a target firm early in the distress process and you are motivated to move quickly, then you may be able to negotiate a very good deal on a purchase. This may be preferable for creditors, the partners and the SRA.
Early-mover advantage gives a potential purchaser excellent leverage to obtain a bargain, as the key stakeholders have so much to lose by not securing a sale as a going concern. It takes a very brave banker, partner or regulator to turn down a deal that secures a successor practice and gives a reasonable return for the firm’s WIP and debtors and avoids the need for an intervention which crystallises other liabilities.
However in order to do this, you must be prepared to move fast and complete quickly to avoid the risk of intervention or an alternative party coming to the table. Being aware of the opportunities in the market and letting the insolvency practitioners know the opportunities you are seeking gives you the best chance possible of securing the opportunity you are looking for.
If you’d like to learn more about the benefits of pre-packs or the financial stability of your firm, contact Baker Tilly’s Matt Haw, a Restructuring and Recovery Partner specialising in professional practices.
e: matt.haw@bakertilly.co.uk, t: +44 (0)20 3201 8000
