Law firms’ financial stability and insolvency

1st December 2014

It began in 2012, when the Solicitors’ Regulatory Authority (SRA) introduced a new requirement for insurance firms to disclose their credit rating in order to be accredited for providing Professional Indemnity (PI) Insurance to the legal profession. 

The PI renewal date is October 1 each year and last year the SRA operated an Extended Policy Period (EPP), which provided a 90-day period of further cover for firms that did not obtain a new indemnity insurance policy by 1 October. Any firm that failed to renew by the end of the EPP had to close down. 

But rising costs of premiums of up to 40%, coupled with a number of insurance companies either refusing cover or going out of business themselves meant that many law firms were unable to meet the deadline and by January 2014 136 had been forced to close.

However, the situation also exposed the financial vulnerability of many law firms that have been operating with severe cash flow problems. Revenue from legal aid has plummeted due to Government tightening restrictions on eligibility for legal aid and introducing means testing. There is in any case a lengthy period from the start to the completion of a case and payment.

In addition from April 2013 the Government also banned the payment of third party referral fees to law firms and reduced fixed referral costs to lawyers for road traffic accident cases by as much as 60% in some cases.

Also the SRA continues to introduce reforms and from April 2015 will be phasing in new Continuing Professional Development regulations by which law firms have to maintain and demonstrate professional competence.

All this means that smaller law firms will come under continuing pressure both financially and professionally.

There are solutions, but they depend on law firms recognising that they need to change their culture. In many industries where margins are falling, IT has enabled significant productivity gains.

Whilst Turnaround Practitioners might be able to realign the business model, marketing and IT professionals are now a common requirement to maintain a successful and profitable legal practice.