Trouble in the office: What happens to legal firms when they encounter financial difficulties?

Many sectors of the UK economy have been challenged and forced to change in recent years as a result of the COVID-19 pandemic, technological developments, and the highest levels of inflation in decades. Operating in a traditionally conservative sector, law firms are not invulnerable to these issues and, having advised the administrators of Pure Legal Limited since their appointment in November 2021, we are now seeing an increase in financial distress and insolvency in the law firm sector.

Law firms usually have high fixed costs, including rent and salary costs, and many firms have also invested heavily in new IT software and hardware in order to keep up with market trends, drive efficiencies, deliver hybrid working models and/or move into new fields of law. Professional indemnity insurance premiums have also increased substantially, while most firms’ salary costs have continued to increase as wages have grown in a competitive marketplace. In the current inflationary environment, many firms have struggled to increase revenue sufficiently to meet their increased costs.

Ince & Co has been the highest profile casualty, having entered administration and been rescued through a pre-pack administration process in April 2023. More recently, High Street Solicitors, predominantly a volume claims business with similarities to Pure Legal, was also sold in a pre-pack administration in June 2023.

This is a complex and highly regulated sector, where expert advice and careful stakeholder management is essential to preserve value for all stakeholders. The Solicitors Regulation Authority (SRA) is a key stakeholder and client interests (in particular client monies and documents) must be protected at all times through any restructuring or insolvency process. If the SRA is on notice of any risk to clients in this regard the SRA has the power to intervene in the law firm, close it down and take over conduct of client files at the insolvent law firm’s cost. The SRA may then be entitled to a statutory charge over the insolvent law firm’s assets in this regard, ranking ahead of other creditors and potentially even the expenses of the insolvency process.

Managing the process in an orderly manner and avoiding SRA intervention will be a key objective to preserve value in any law firm restructuring. Ensuring continuity of client service is essential in this regard, while also preserving value in the firm’s work in progress, which is likely to be the law firm’s core asset and source of value for creditors in an insolvency.

Most administrators are not permitted to trade a law firm in insolvency and as such law firm rescues are generally completed through a pre-packaged administration sale, whereby the insolvent law firm’s business and its ongoing client files are transferred to a new firm which takes over conduct of the insolvent firms’ ongoing work on the day that the administrators are appointed, preserving continuity of client service for the benefit of the clients and the insolvent estate.

There are a variety of different corporate structures used for law firms, including traditional partnerships, LLPs and public and private limited companies, each of which might require a slightly different legal approach to any insolvency/restructuring process.

The DLA Piper Restructuring team has broad sectoral and recent practical experience with delivering solutions to legal firms experiencing challenges. If you would like to discuss any concerns in this regard please reach out to our team.