There has been a sudden spike in the number of law firms of all sizes reporting to the Solicitors Regulation Authority (SRA) that they are facing financial problems, it has emerged.
The need to repay the government’s Covid support and deferred tax bills are among the reasons.
Sean Hankin, the SRA’s head of forensic investigation and intelligence, said the regulator set up an internal group two years ago to monitor law firms’ financial stability in light of rising professional indemnity insurance (PII) costs and the pandemic.
“We’ve really played a waiting game until recently,” he told the Institute of Chartered Accountants in England and Wales’s solicitors conference. “It’s not been until the last month or so that we’ve actually seen a number of firms that are reporting difficulties to us.
“The concern is that these haven’t just been the smaller firms – it has been right across the board. We’ve seen some very large firms that have reported difficulties.”
The SRA was investigating the reasons, but he suggested that the removal of government Covid support was “one area that has left firms exposed”, along with PII.
“We’ve also had the cost-of-living rises, which have led to reduced demand in the market. So firms are really having to look at how they take their business forward and whether it can be profitable in the long term.”
Mr Hankin stressed that it was not the SRA’s job “to second-guess business decisions that firms may or may not have made that have led up to them being in financial difficulty”.
He went on: “All we want is a positive outcome for each of their clients. If a firm does have to cease trading, what we’d want to see is a robust plan to protect clients’ best interests and to ensure there is an orderly wind-down of the practice.”
In the absence of such a plan, the SRA may have to use its intervention powers.
He said the SRA would “always try and work” with firms reporting financial problems and urged any to make contact sooner rather than later.
“It’s never worked against a firm to report [problems] to us. It’s far worse to wait until the last minute,” he said.
Andrew Hosking, a managing director in the restructuring team at Quantuma – who has been the administrator in several high-profile law firm failures – agreed that firms were well advised to contact the SRA. “It’s never too soon,” he told delegates.
He said he found law firms to be “particularly optimistic” about how merger could be a way out of financial difficulty. “If I have a pile of mud in one hand and a pile of mud in the other and smash them together, they don’t make diamonds. You don’t even get two handfuls of mud.”
Banks, he added, were not impressed by this strategy.
His colleague and often joint administrator, Sean Bucknall, a managing director at Quantuma as well, also highlighted the pressure on cash flow of firms having to repay Covid loans and deferred tax bills.
Another problem, he continued, was the change in HM Revenue & Customs’ (HMRC) status as a preferential creditor, ranking it above other creditors.
“Where there is significant debt, especially HMRC debt that’s accrued over the Covid period, because the balance sheet is typically made up of work in progress and debtors – which are floating charge assets – the banks are effectively unsecured.”
As a result, banks were being more restrictive in their lending and looking at personal guarantees from partners and directors “to securitise their positions”.
Indemnity insurers were also increasingly looking for personal guarantees. “Insurers are taking a far more risk-based approach to the renewal process.
“Rather than just submitting an application and receiving a quote for a premium, insurers want to see management accounts, want a demonstration of the firm as a going concern. They are also looking at service types and service volumes.”
John Kunzler, risk and error management leader at broker Marsh, said the picture of this year’s PII renewal process was beginning to take shape.
There were no new insurers and no departures either, while “underwriters are not competing too hard for new business”, focusing instead on their existing firms.
Premiums were set to rise, but at a lower rate than in previous years, and Mr Kunzler said “we may be coming towards the end of year on year increases”.
But insurers were “very nervous” about taking on conveyancing practice, he cautioned.