Cash flow problems, financial difficulties, and business exit strategies are significant concerns for leaders of smaller law firms. This guide provides essential information and advice on navigating these challenges. Understanding the risks and knowing your options can help mitigate personal liability and ensure the best outcome for your firm, clients, and career.
Signs of a law firm in financial trouble
Smaller law firms, in particular, face unique financial risks that can threaten their competitiveness and viability. Recognising the warning signs early is crucial. These can include:
Key fee earners leaving your practice.
Difficulty attracting talent and new staff.
Inefficient IT systems or outdated office infrastructure.
Loss of confidence from lenders, making it hard to secure financing.
Problems with Professional Indemnity Insurance (PII), such as being unable to secure a new policy.
Lack of a succession plan for the business.
When you notice these signs, it's vital to seek expert advice promptly. The sooner you act, the more options you have to protect yourself and the firm.
Risks for law firm leaders
Failing to address financial difficulties can have severe consequences for solicitors, extending beyond just the firm itself.
SRA intervention
The Solicitors Regulation Authority (SRA) can intervene if it believes clients or client monies are at risk. An SRA intervention is likely to be catastrophic for the Firm, as[LC4][JA5] it can erode the firm's value, with the SRA taking possession of all client files and firm money. It can also create significant personal liability for solicitors, who may be held responsible for the costs of the intervention.
Avoiding intervention is a primary goal. Proactive measures and early engagement with the SRA and restructuring advisors when experiencing financial trouble are essential.
Personal guarantees
Many law firm partners and directors provide personal guarantees to lenders or key creditors. An unexpected business failure or SRA intervention significantly increases the chance these guarantees will be called upon, putting your personal assets at risk.
Insolvency and your liabilities
In some cases, an insolvency process, like administration or liquidation, is the only solution. If handled correctly, it can preserve all or parts of the business and protect jobs.
However, insolvency practitioners have a duty to investigate antecedent transactions for potential offences, such as transactions at an undervalue and preferences, along with other potential offences including wrongful trading or misfeasance.
Identified offences can lead to personal liability and sometimes disqualification for law firm leaders from acting as a company director/member of an LLP. Early advice is vital so that risks can be mitigated.
If the firm is an LLP, a liquidator might seek to recover withdrawals made by members in the two years before liquidation. This includes any financial benefit received by that member, including drawings and salaries. For traditional partnerships, partners are already personally liable for all firm debts. Again, early advice can help mitigate these risks.
Personal insolvency: bankruptcy vs Individual Voluntary Arrangement (IVA)
Older firms structured as traditional partnerships face additional stress as the partners will likely be jointly and severally liable for debts. But even members of an LLP and company directors risk bankruptcy from intervention costs and/or personal guarantees crystallising.
Insolvency can lead to personal bankruptcy, which has serious consequences for solicitors:
Your practising certificate is immediately suspended.
You cannot act as a company director or LLP member without court permission.
An Individual Voluntary Arrangement (IVA) is often a better option. An IVA doesn’t automatically suspend your practising certificate and can allow you to continue practising, although the SRA must be informed and may impose conditions.
Exit strategies and mitigation options for law firms
Taking early advice from restructuring specialists is the most effective way to protect yourself and your firm. Here are the key options to consider:
Financial restructuring and refinancing
A review of your firm’s finances can help identify options like refinancing debt or negotiating with key creditors. It’s critical to prepare detailed cash flow forecasts and actively work to convert Work in Progress (WIP) and outstanding debts into cash. This is also the time to notify the SRA of your firm's serious financial difficulties, as required by regulation, and an obligation of both the COLP and the COFA.
Where firms are unable to secure a new policy, they enter into the 90-day Extended Policy Period (EPP), split into a 30 day Extended Indemnity Period (EIP) and then a 60 day Cessation Period (CP). Crucially, to allow the firm to continue trading and preserve value there must be PII in place or at the very least the firm must be within its 30-day Extended Indemnity Period (EIP). If no PII is in place at the end of the 60 day Cessation Period, the firm must close.
Several options may be available, some of which can be run concurrently. Option A may be to refinance the firm and perhaps negotiate onerous leases where relevant. Option B may be to find a merger partner or purchaser, but alongside these options a contingency planning exercise for an insolvency may be undertaken as Option C. All of this planning will help mitigate risks and help ensure the best outcome for all parties.
Sale or Merger
A merger or sale can be an excellent way to exit the business and preserve its value. The timeframe for this depends on your firm's financial health, and you should work with your advisers before embarking on this process.
If you have 10-12 months before serious financial pressure, you have time for a full sale or merger.
If you are in financial distress, an accelerated sales process or a pre-packaged administration might be necessary to sell the firm's business and assets quickly.
A key factor in a sale is the issue of Professional Indemnity Insurance (PII) and successor practice rules. In a solvent sale the buyer may take on the successor practice liabilities, or the selling firm must purchase costly run-off cover to protect against future claims.
Where it is not possible to transfer or sell the whole of business to one party, selling or transferring tranches of different case types to multiple different firms can avoid successor practice issues.
Orderly firm closure
If a sale or merger isn't viable, an orderly closure is the next step to avoid SRA intervention. This process requires careful planning and adherence to SRA guidelines. Key considerations include:
Notifying all clients of the closure
Completing existing cases or transferring them to another firm
Properly distributing client funds
Arranging for the storage of archived files
Ensuring you have the required six years of run-off cover for your PII.
It's important to remember that after the firm ceases trading , the firm remains responsible for all its creditors like HMRC, landlords and lenders. Where the firm is a corporate entity or LLP it is likely that a liquidation process, solvent or insolvent, will be the appropriate solution to formally wind up the firm
Take advice early
By taking early advice and acting decisively, you can explore all available options, mitigate personal risks, and secure the best possible outcome for your law firm, yourself, and your career.
Please get in touch for further advice and support if your law firm is facing challenges. Call 0808 144 5575 or email help@armstrongwatson.co.uk.
