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COVID-19: Solicitors’ solvency and insolvency

When faced with a potential insolvency, practices will need to consider their options and the practical consequences of SRA intervention.

Executive summary

The current COVID-19 pandemic has impacted the financial stability of businesses across a diverse range of industries, with the legal profession no exception. The impact on cash flow and liquidity of solicitors’ firms has led to serious concerns over the potential insolvency of some practices. When faced with a potential insolvency, practices will need to consider their options and the practical consequences of Solicitors’ Regulation Authority (SRA) intervention or involvement.

COVID-19 and challenges to solicitors’ solvency

COVID-19 and the associated restrictions and Government guidance continue to generate fierce challenges for legal practices. The emerging picture is that for some firms, cash flow pressures will be short-term and may be satisfactorily addressed by taking advantage of the Government initiatives such as the Job Retention Scheme or deferred income tax payments under self-assessment. For firms which were already operating on tight margins, the drop-off in work, the inability to work cases to the point of recovery, and a potential increase in the cost of professional indemnity insurance may toll the death knell for the practice.

In response to a recent Law Society of 774 small firms, including sole practitioners, almost three quarters of high street practitioners commented that they believe that they may have to close their doors within the next six months.

Without change, the Law Society warns that the legal aid sector is facing collapse. Debts which might have been manageable in normal times are unsustainable in the present circumstances. Andrew Hosking, a partner of financial advisors Quantuma, who were involved in the recent pre-pack sale of high-street firm McMillan Williams, has estimated that 250 firms nationally may be restructured or forced to merge as a result of the crisis.

So what are the options for an insolvent firm?

The SRA is a relatively active regulator when it comes to insolvencies of law firms in a number of ways. Firstly, the SRA has a statutory right to intervene over any legal practice which essentially shuts the practice down and in the process vests all practice monies in the SRA. For obvious reasons this can play havoc with the plans of an insolvency practitioner looking to manage a firm through a restructuring or insolvency process. For this same reason, certain processes are almost impossible to implement for a legal practice, such as a company voluntary arrangement (CVA) or partnership voluntary arrangement (PVA) as the action of sending out a proposal to creditors runs the risk of an intervention and subsequent starvation of cash to fund the CVA/PVA. Further, regulatory restrictions make a trading administration of a law firm impractical. This obstacle is similarly burdensome when considering a creditors’ voluntary liquidation which requires notices to be sent to members and creditors to call meetings and, in so doing, potentially stirring the SRA into intervening.

From a firm’s point of view, intervention represents the worst of all worlds. Intervention essentially freezes the firm’s accounts and assets and moves them away from the business so that the regulator can ensure that clients’ interests, assets and confidential information are safeguarded.

In recent times pre-pack administration sales have grown in popularity as they are seen as a way of dealing with the insolvent practice that avoids instant closure or intervention. In a pre-pack administration, the law firm is sold as a going concern on terms arranged prior to entering administration. In circumstances where the business, clients, client information and assets are transferred to the acquiring firm, the SRA’s primary concerns are usually satisfied. Therefore, whilst the SRA does not formally approve of pre-pack sales, it does not tend to bar a sale provided the disposing firm can demonstrate compliance with its regulatory requirements and secures run-off cover.

Corporate Insolvency and Governance Act

The introduction of the Corporate Insolvency and Governance Act 2020 (“the Act”), which received Royal Assent on 25 June, has the potential to overhaul insolvencies for law firms. The Act introduces a new restructuring tool, the Restructuring Moratorium, which may offer insolvency practitioners the opportunity to secure practice monies prior to intervention. The reality is that it is likely to increase tensions between the SRA and IPs if not properly managed but for now should be welcomed by the insolvency profession as one of the more useful tools when dealing with an insolvency law firm.

The moratorium works to give businesses valuable breathing space without creditor input for an extendable 20 working day period. This period can be further extended for up to 12 months with the consent of the creditors or court order. The important point here is that the moratorium can be secured without the need to serve notice on the SRA or other creditors.

However, the moratorium is not without its limitations. Some payments will continue to fall due during the moratorium, including loan agreements or rent instalments, and failure to keep up with such payments will trigger the end of any moratorium. Also, the SRA’s powers of intervention are unaffected by the Act.  The relevance is whether the moratorium can provide sufficient time to secure the office account monies for the benefit of the insolvency estate.

It is unclear how this now interplays with a moratorium on all enforcement actions against company assets and this is where tension is likely to arise if a firm implements a Restructuring Moratorium during which the SRA then seek to intervene. We wait with interest to see how this new toolkit will be utilised in practice.

Conclusion

It is impossible to predict the full extent of damage to the profession caused by the crisis and how quickly, and to what extent, firms will bounce back as lockdown measures start to ease and the economy gets back on its feet.

What will be key, however, is for any law firms facing insolvency to manage the different stakeholder interests, keep an open dialogue and understanding with the SRA, and try to uphold creditor interests. Pre-pack administrations and the new tools under the Corporate Insolvency and Governance Act 2020 both present options to law firms faced with difficult decisions and challenges but firms will need to consider their own circumstances in detail.

For any further information, or to discuss tailored advice on this topic, please contact Mickaela Fox, Partner at mickaela.fox@weightmans.com or James Moore, Partner at james.moore@weightmans.com.

Watch our podcast: COVID-19 | Solicitors solvency and pre-pack administration

In the podcast Mickaela Fox and James Moore look at how the pandemic has impacted on solicitors firms, specifically on the cash flow and the liquidity of some firms, particularly those operating at volume end of the market and discuss the options for what seems like the inevitable insolvency of some practices. Listen now!

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