In the first of two articles focusing on M&A activity in the legal sector, Frank Maher - partner at Legal Risk LLP – shares his insights into recent acquisition trends and the possible implications on a firm’s insurances.
574 law firms closed in the 12 months to end of July 2022 according to Solicitors Regulation Authority (SRA) figures; 20 per cent by merger or amalgamation and 16 per cent by ‘change of status’ (which may include transfer to other regulators)1. The numbers may increase as law firms face not only the economic challenges that apply to all businesses, but other challenges such as legal aid rates and changes in personal injury procedures and costs regimes.
In many cases where a firm closes, other firms may see an opportunity in taking over some of the staff or some of the work, or both. We often hear of firms ‘buying the will bank’ (rather overlooking that the documents are the property of the clients and held under a duty to preserve confidentiality), or they may wish to transfer retainers and take over Conditional Funding Agreements (CFAs).
These scenarios can all have implications for a firm’s insurance, just as much as a merger. It will be important to consider how the deal may be impacted by the successor practice provisions in the SRA Minimum Terms and Conditions, which apply to firms’ primary insurance (£3m for LLPs, limited companies and ABSs, £2m for sole practitioners and partnerships). The writer has seen one example of a fairly small firm that unintentionally became a successor practice and was landed with renewal premiums of £1m and a £1m excess.
Sometimes the plan will be for the acquiring firm to cover the insurance of the target’s existing liabilities; in others the aim will be to trigger its run-off cover, paying the premium for six years’ cover. Where a firm is insolvent, however, that may not be possible, but it increases the risk that that firm’s insurer will seek to establish that the acquiring firm is the successor practice, even, we have heard, resorting to ‘mystery shopper’ phone calls to do so.
But this is not the only trap. Although the risk of triggering the successor practice provisions is well-known to many, with 22 years having elapsed since the rules were brought in with the open market insurance, new issues continue to arise, with potential succession risks arising, for example, through other statutory provisions such as application of the SRA Accounts Rules, to name but one.
Other problems being seen in practice include firms that seek to split into separate practices, including solicitors who have merged but then wish to demerge.
Many of these problems can be addressed, but it is critical that this is done before the deal is agreed. Options can then be explored fully, along with the consequences for individuals who may be affected. There could be concerns, for example, about the adequacy of cover for lawyers who have taken appointments as executors or trustees while in their previous practice; such work can be particularly prone to long time lapses before claims are made.
So the key to avoiding the insurance traps is take advice before you do the deal. The cost may be a fraction of what it would be if a deal goes wrong.
Legal Risk LLP is a specialist law firm advising on professional indemnity and professional regulation for lawyers and professional practices.