SME Legal Sector Suffers
Times for the SME Legal Sector
Andrew Hosking, Partner and legal sector expert, Quantuma LLP
Sean Bucknall, Director, and legal sector expert, Quantuma LLP
The legal services profession operating in the small and mid-tier market is currently in the midst of a perfect storm. Whilst the majority of UK business appeared to have weathered the post-recession storm with insolvencies down year on year (3,617 companies entered insolvency in Q2 2016 which was 4.2% lower than Q1 in 2016 and 2.7% lower than Q2 in 2015) the legal sector is facing increasing challenges such, that there is expected to be increasing consolidation within the marketplace.
What are the issues?
Increased costs of Professional Indemnity Insurance (PII)
Whilst the risk management of firms has improved significantly over the past 15 years, so too has the underwriter’s view of acceptable risk management. Therefore, what may have been considered to be good risk management in the past is no longer the differentiator in an underwriter’s perception of risk. As a result, PII premiums, especially in the SME market, have increased significantly over recent years, such that many Firms have seen these costs double.
The Legal Aid, Sentencing and Punishment of Offenders Act (LASPO) became law in April 2013 as a result of Lord Jackson’s review on civil litigation. LAPSO has imposed fundamental changes to the costs of litigation and notably, what a losing party has to pay, and therefore the recoverability of the claimant’s legal costs. In addition it has brought about the test of proportionality of costs as well as the abolition of referral fees paid by solicitors to secure personal injury clients. Such changes have had a serve impact on the profitability of the personal injury market and to firms exposed heavily in this sector. This has been further compounded by a reduction in the categories for which civil legal aid is available and a narrowing of the means-test criteria. The result is that fewer people qualify for legal aid and therefore a reduction in the volume of claims which are pursued.
Criminal Legal Aid
In June 2015 the Ministry of Justice (MoJ) announced its decision to proceed with a second criminal legal fee cut of 8.75 per cent. It also announced that the number of contracts for solicitors providing 24-hour cover at police stations in local communities would be reduced to 527 from 1,600 thereby restricting numerous firms who previously operating in this market.
Introduced in 2007, The Legal Services Act allowed for the introduction of Alternative Business Structures (ABS) which allows a non-lawyer or non-legal entity to own or invest in a legal practice. This has enabled equity to be raised from a wider pool of participants and allowed non-legal staff to hold board / partner status thereby enhancing commercial knowledge, skills and operations within the firm. This has widened the market of service providers and led to increased competition in the market place. Again this competition is mainly directed at the consumer end of the market and therefore principally in the SME marketplace.
The legal sector is a highly regulated profession which carries with it a significant investment of time in compliance and regulation. In addition to day to day work commitments, detailed and careful financial management can be placed on the back burner. In a recent report published by the SRA, it cited poor financial management as one of the key drivers of financial difficulties in law firm. A lack of financial control typically results in poor forecasting, the overpayment of monthly draws to partners, an over exposure to contingent matters where there is WIP lock-up and this results in cash shortages and a requirement for expensive short-term loans to meet VAT, PII and other commitments thus driving down profitability.
The increased competition and regulatory changes in the sector have seen a large number of law firms placed into an insolvency process. Quantuma has significant experience in advising the legal sector manage the difficulties it is currently facing. Whilst Quantuma cannot disclose any advisory instructions, formal law firm appointments include King & Wood Mallesons LLP, Jeffrey Green Russell Limited, Challinors Solicitors (Partnership at Will), Davenport Lyons Solicitors (Partnership at Will), Linder Myers LLP, St John Law Limited, Isaac Abraham (Partnership at Will), Maitland Hudson Limited and Prolegal Limited.
How can Quantuma assist? In conjunction with Ashfords’ specialist regulatory team, we can provide the following specialist planning services for law firms facing financial and regulatory challenges:
1) Options evaluation – provide a review of the current threats facing the firm and the options available to it, including both regulatory matters and cash-flow pressures.
2) SRA Communications – liaise with the SRA and reduce any threat of regulatory action, including intervention risks.
3) Merger talks – To introduce potential merger partners and oversee merger talks with interested parties.
4) Introduction of potential acquirers – we have a network of firms who are interested in acquiring legal practices and can facilitate introductions.
5) Financial forecasting and cash management
6) Regulatory guidance – where required we can support law firms with regulatory investigations and provide guidance in terms of regulatory outcomes.
7) Business Structure planning – to include obtaining regulatory authorisations for Newcos with recognised body status and/or Alternative Business Structures.
8) Negotiating with key stakeholders – This includes secured and unsecured creditors, key stakeholders and other partners / staff within the firm.
9) The acquisition of the Firm by way of a merger, solvent or insolvent transaction, either in whole or in parts.
10) Contingency planning –support and guidance for contingency planning to include scenario planning in the event that a distressed sale fails to complete.
We are happy to discuss your situation, whatever stage you may be at. The earlier that you address any issues, the more we can do to help.