More large law firms are expected to fail over next few years and the risk of theft of client funds is rising, the Solicitors Regulation Authority (SRA) has warned.
It has also speculated that in future professional indemnity insurance or even policies purchased by clients may need to cover the cost of intervening in firms.
Launching a consultation with the profession on using the Compensation Fund to cover the unexpectedly high cost of interventions this year, the authority went further than ever in predicting an extended period of “market correction”, in which law firm failures were anticipated – perhaps until 2016.
The consultation was approved at the end of last month by the SRA’s board. But the need for it was also challenged, since senior officials have made it plain they do not believe there is any option.
According to the paper, the fund, which is expected to total £45m by the end of October after existing claims have been paid, is the only source of cash of sufficient size to deal with unexpected law firm defaults. Until 2010 it was used to pay for the costs of interventions, when the cost was shifted to practising fees.
As well as covering the shortfall between the SRA’s operational budget and actual intervention costs in 2013, the fund will be expected to cover all future costs thereafter.
In a gloomy assessment of the range of economic factors assailing law firms, such as legal aid reforms, the referral fee ban in personal injury cases, and greater market competition, the SRA said that while so far a firm “of any significant size” had not failed because of them, “given our knowledge of the financial position of a number of substantial firms and current market conditions we now expect to see more”.
It predicted that “a period of significant market correction perhaps over the next two or three years” was likely. An outcome was a heightened risk of a misuse of client funds among firms in financial difficulty, it said: “There remains the risk of significant default of a common nature such as theft of conveyancing and probate funds.”
The consultation stressed the SRA is carrying out a root-and-branch review of compensation arrangements and that all options were on the table. These included the possibility that clients would have to buy fidelity insurance to cover the possibility of law firm defaults.
It will ask questions such as: “Can compulsory professional indemnity insurance be expanded to cover some or all of the claims paid from the current Compensation Fund? More broadly, is the regulated community willing – and able – to pay for the defaults of others?”
The expectation of further large firm failures is significant, since the overall cost of interventions in 2013 is currently estimated at £7m, against a budget of £1.3m, plus more than £1.8m for the cost of in-house intervention agents and archiving.
The paper emphasised that high profile failures resulting in interventions in 2013 – which have included Blakemores and Atteys – differed from that of Cobbetts, which was not intervened in because its business was acquired by other firms. However, lower profitability in some areas of work made such acquisitions in future less likely, it said.