Head in the sand – or head in the right direction

SWIFT action can save a firm from going under, but partners must face facts, finds John Forsyth

‘I like to think we help people.” The kind of help an insolvency practitioner represents is not always immediately welcome. But Claire Middlebrook of Henderson Loggie says it is not uncommon for businessmen and women whose enterprises she has called time on to call her up a year or two later to say they only wished they had spoken to her sooner.

Timing is at the heart of the blunt message Middlebrook will deliver when she speaks on Professional Practice Firms & High-Profile Cases at this week’s two-day ICAS Insolvency Practitioners’ Conference at Gleneagles. Seeking advice as soon as things get difficult can mean the difference between saving a firm and losing the business, and a lot more besides.

Professionals as a group, she says, and solicitors in particular can be in “massive denial” until it is too late.

“They know the advice they would give their clients but can’t seem to apply it to themselves. The biggest factor in the failure of professional services firms is that of indecision. Professional services firms need to be masters of their own destiny. Too many firms are hamstrung by indecision.”

Middlebrook’s analysis is brutal. “I believe the future for Scottish professional services firms is bleak. Indeed, I don’t believe we have ever faced such difficult trading conditions.”

She does not just have law firms in mind but they are unmistakably on the radar. Independent financial advisers have been leaving the industry by the thousand across the UK and regulation that comes into force on 31 December, putting an end to payment by commission, is expected to squeeze another 10 per cent out of the 28,000-strong sector.

Alternative business structures, introduced in England & Wales in 2011, preceded a sharp rise in distressed firms south of the Border, 61 per cent higher in the last quarter of 2011 than the same period in 2010.

“This leads me to think that while ABS provides opportunities for non-legal firms, such as Tesco, it is only going to make the marketplace more competitive for solicitors,” says Middlebrook. “The recession, of course, has certainly had an impact and the decline in new loan approvals, uncertain or falling property values, plus deposit constraints on entrants to the mortgage market, have all taken a significant toll on firms that traditionally relied on property-related work.”

Personal injury providers have been adversely affected by the trading failure of claims providers such as Claims Direct and The Accident Group. Clients of professional firms are also at greater risk of failure than they have been for many years; the recession has placed pressure on fee revenues, pressure on operating margins and client bases.

“Another factor is the lock-up [work in progress] in solicitors’ firms,” says Middlebrook. “That is having an impact on cash flow. Research in August found the average number of lock-up days has increased from 130 in 2011 to 148 in 2012. That can increase the risk to bad debt exposure.”

The insolvency in August of Inverness-based Chapman & Co brought to 17 the number of formal failures of legal practices in Scotland in the last three years. These figures do not take account of the firms that simply closed their doors as they could no longer cope. The Law Society of Scotland’s AGM in May noted that a record number of law firms – six, from Wick to Kirkintilloch – were under the remit of a judicial factor, including Ross Harper, one of the biggest-ever law firm failures.

“Judicial factory”, sounding uncomfortably like a industrial production line of legal distress, is another unique Scottish legal construction. The appointment of a judicial factor, an officer of the court, in terms of the Solicitors (Scotland) Act, is sought when irregular activities are uncovered involving client accounts that might lead to a call on the guarantee fund.

Some struggling firms can be tempted to “dip into” client accounts to assist cash flow with the intention of replacing the funds at the first opportunity. But the opportunity never seems to come, or there isn’t quite enough to fill the gap. Once in this predicament it is difficult for a partner to ask for help, as it will reveal the irregular practices. The hole gets deeper.

Judicial factory was almost always carried out within the law society until the latest surge required “outsourcing”. Henderson Loggie has been appointed to manage the enormous task of winding up Ross Harper after half a century as the most recognised name among Scotland’s solicitor firms, with tens of thousands of client files.

Morna Grandison has been in the judicial factor unit of the Law Society of Scotland for 20 years. She recognises both the commercial vice that can begin to squeeze the life out of a firm and the personal difficulties that creates for the partners involved.

“It’s the ‘too hard conversation’ that can overwhelm people who may have a long career and have established a successful business but when it gets into trouble they can’t admit it to themselves, never mind anyone else. It’s the unspeakable problem that they can’t share at home with a partner who is used to a certain lifestyle, or the kids who are in private education. That’s who you are and that’s what your standing is. It’s a collision of personal and business.”

Many partners are finding themselves effectively trapped in their firm, with banks unwilling to lend the money for an aspiring partner to buy out an existing one. Their lifetime’s investment is either unsaleable or, at best, is far from the retirement nest egg they expected. With enough time the law society can and does matchmake between a firm that is in trouble and another that can absorb its business.

And with enough time the insolvency practitioner can realise some value from the assets and goodwill – the wills and title deeds held by a solicitor firm and representing its client base. Often the insolvency practitioner will try to pass these on to another firm for payment and the benefit of creditors of a firm on which even its partners may have given up.

A client cannot be transferred to another solicitor without explicit agreement. Clients often feel that they are at the end of the line when a firm closes or, in particular, when a judicial factor is appointed. They are assured they will not suffer financial loss due to the guarantee fund but are often shocked at how long – months, years – the process can take.

Middlebrook says employees are in the same, slow boat. “If they are due a redundancy payment, they expect it more or less immediately. That turns out not to be the case.”

The Scottish Law Commission consulted almost two years ago on its proposals for modernising the judicial factor system. It offered the alternative of creating an entirely new agency, or modernising the existing and unique institution whose roots are in the 19th century.

Commissioner Patrick Layden says that responses tended towards the latter option. Final proposals and a draft bill are expected in January.