This is a time of significant change for the profession’s regulatory framework with economic pressures impacting on large and small law firms. Failing firms can sometimes be saved by merger, acquisition or sale but the regulatory framework is a disincentive. That can lead to messy interventions. Faced with these financial pressures, it remains to be seen whether all compliance officers will live up to the Solicitors Regulation Authority’s expectations.

Compliance officers

A mandatory principle of the SRA Handbook requires solicitors’ firms to practice sound financial risk management. Compliance officers for legal practice (COLPs) and finance and administration (COFAs) need to notify the SRA if they believe their firm is in serious financial difficulty. This is an onerous task. Will some officers face internal pressure to keep silent in the hope that their firm can trade its way back to health without SRA supervision? Insurers should encourage firms to properly manage their exposure to risks and to notify the SRA of any concerns. No insurer wants to be left with run-off cover after a firm collapses after burying its head in the sand.

There have been a number of recent high-profile examples of law firm casualties, following what appears to have been an overly optimistic view of their firm’s financial viability. Examples of risky behaviour which can lead to collapse include drawings exceeding net profits, high premises costs and a small group of senior managers controlling finances.

Instability in the legal sector is likely to continue for a while, both financial and otherwise. This is something that the Law Society is acutely aware of and is offering additional guidance. The economic climate remains poor and lenders are reluctant to provide capital. The ban on referral fees in personal injury cases and other reforms to civil litigation pile further pressure on a large number of firms. Some firms have been heavily reliant on business generated by referral fees. Those who are not already looking at maximising other income streams will be particularly vulnerable. The weight of the duty on COLPs and COFAs to report financial concerns is not going to go away.

Successor practices

It is very difficult to rescue a stressed firm by merger, acquisition or sale. The solicitors’ minimum terms and successor practice rules ensure there is insurance to cover claims against collapsed firms whose business has been taken over by other firms. This presents a serious risk to successor practices, especially if their cover carries a large excess. It can also have a major impact on the successor practice’s claims record, risk profile, insurance premiums and reputation. In short, firms need to be careful who they marry.

Press reports indicate that some bidders for parts of Atteys and Blakemores pulled out because of associated risks, perceived or otherwise and one suspects that there may have been associated issues with insurance arrangements. Save for a few exceptions, such as a pre-pack sale, the only remaining option might be a messy intervention.

Last resort: interventions

If a stressed firm cannot find buyers to rescue it from insolvency and an orderly end cannot be achieved, the SRA will intervene. The SRA has spent £2.2 million on interventions in failed firms in the first quarter of 2013 - almost £1 million more than for the whole of 2012. This represents 10 per cent of the SRA’s annual budget. Had Cobbetts required an intervention, the SRA estimates that it would have cost £6 million.

A properly managed end to a firm is far better than a collapse. Interventions are a huge costs burden on the legal profession. They also cause real difficulties for insurers of the intervened firms. Not only can the intervention lead to the closure of the firm with the insurer on risk for the run off cover but also insurers must liaise with the intervening agents when claims come in and they can find it difficult if not impossible to claw back the intervened firm’s excess.

Lessons

The legal profession is in a period of unprecedented change. Insurers will want to stay alive to their insured law firms’ risk profiles and brokers should look, so far as is possible, to be kept in the loop in what is going on with those insureds on the ground. Most importantly, insureds, insurers and brokers all have a keen interest in proper financial management and where necessary a properly managed end to a firm.