Increased insolvency rates amongst law firms
In 2010 the Insolvency Service recorded no law firm insolvencies. Since then, the number of law firms in financial difficulties has steadily risen until in 2018 there were 39 law firm insolvencies.
Historically, obtaining partnership in a law firm was commonly seen as a passport to prosperity. Although the outside world might not yet appreciate the change, those in the industry know that partnership has associated risks.
Whilst most firms now operate with limited liability, either as an LLP or a limited liability company, insolvency still has implications on the “partners” beyond the loss of their firm, investment and source of income. Where there are personal guarantees, (“PGs”), or misconduct has occurred, the loss of qualifications and bankruptcy may result.
Before the 2008 financial crisis, law firms were the darling of bank managers due to the high credit balances on client accounts. To secure these client accounts, banks were desperate to accommodate the lending needs of both firms and partners. Roll on 10 years and the bank manager is less cooperative.
Throughout this period, the profitability of many firms has reduced as a result of, inter alia; the conveyancing industry opening up; the increased prevalence of fraud/misconduct resulting in increased PI premiums and increased competition putting downward pressure of fees.
At the same time, the working capital requirements of many law firms have increased, especially where the firm undertakes a significant amount of work on a CFA basis.
This funding gap has opened the door to secondary lenders. These corporate lenders are now becoming as well-known as their notorious personal counterparts, the pay-day lenders. However, the sceptical approach one might take to a pay-day loan does not appear to be replicated by attitudes to corporate secondary lenders. Circumstances dictate that the solicitors taking these secondary loans are left with little choice and, as with payday loans, the initial loan is often quite modest. However, the associated interest rates add stress to a business which is not always in the best of health and a downward spiral often results.
Secondary lenders will insist on PGs from the partners so the benefit of incorporation is immediately lost. Added to this is the ferocity with which those PGs will be pursued once the prime debt is in default.
With this in mind, any solicitor considering the funding needs of their firm is encouraged to think very carefully before giving a PG especially in relation to a secondary lender.
Where the loan, (and PG), already exists but the firm is struggling, we would encourage you to seek early advice. Any failure of the firm will have knock-on implications onto the partners in their personal capacities. Early action means you have much more scope in both respects.
If you have any concerns, please contact Lynn Gibson at Gibson Hewitt for a confidential and free initial meeting on 01932 336149. We will discuss the options both for the firm and for the guarantors personally.
