Staying solvent in troubled times
If you’ve been reading the legal
press recently, you’ll have noticed a number of articles focusing
on the financial difficulties facing legal firms, writes BDO Business
Restructuring Partner Dermot Power. Winmark’s network for managing
partners reports that consolidation is the name of the game for 2011.
Five of the UK’s top 30 law firms have been put into “intensive
care” by the banks, notes The Law Society Gazette. Their
conclusion: “There are too many lawyers, and too many law firms.”
So what are the causes of this situation? Many areas of business have taken a hammering in the recession. Specialist market segments such as residential conveyancing, corporate transactions and commercial property have shrunk alarmingly. With many firms failing to react to the demands of the recession, recovery rates are dismal.
As well as the nature of their business, past activities have landed many firms in trouble. Volumes and margins that made sense when business was booming become dangerous when things are going in the wrong direction. Issues that were glossed over during past mergers and acquisitions start to pose problems.
Many firms have found themselves facing unexpected costs, which they don’t have the reserves to pay. Problems include professional indemnity insurance, repaying retiring partners’ capital accounts, and tax liabilities, particularly relating to Work in Progress (WIP).
In the good years, banks were throwing money at professionals. Few partners thought to contribute significant amounts to their working capital. They relied on banks lending – and not just for working capital, but for credit cards, personal practice loans, car loans and more.
The concept of the LLP caused problems for banks, as they had no idea what their underlying security looked like in practice. Unlike partnerships, LLPs provided no personal guarantee from partners. Although LLPs could grant a debenture, the banks had no real idea what the assets were and how much they were worth.
Things are very different now. As well as demanding more personal guarantees, banks will be looking to mitigate their risk by:
- • re-pricing
- • becoming more knowledgeable about debtors and WIP
- • taking a charge over client files themselves
- • taking periodic assignments of unpaid invoices, so taking greater control of debtors
- • reclaiming tax rebates.
In the current climate, it’s advisable for all firms to review whether their current practice management is effective. This includes looking at recent trading performance, the current financial position, projections and capital structure.
For those in trouble, the first question to ask is whether the situation is saveable. If it is, then what part is worth saving? Is it just a question of money? While there’s no point throwing good money after bad, if the business is good enough, sometimes a cash injection may be all that’s needed.
The disparate structure of many legal practices puts them in a weak position when approaching a bank for help. A lock-in agreement can strengthen their hand, allowing them to act as one body rather than a disparate group. The same applies when considering selling or merging, which could be another viable option.
Administration is the reluctant final choice. Significantly, the latest guidance note from the Solicitors Regulation Authority (SRA) focused on the procedures involved in closing down a practice. The SRA is working closely with insolvency specialists and looking at protocols and ways of dealing with clients when in financial difficulties.
Even in the insolvent phase, firms should attempt to carry on as normal – market themselves, build on existing work, keep staff jobs safe (and stop staff and partners being poached by other firms) and maintain continuity of custody of client files. With “too many law firms” about, it’s vital to remain competitive.
