Buying or merging with another law firm?
Professional Indemnity Insurance considerations……Proceed with care.
Consolidation continues at pace across the legal services market. Some firms are looking at merger opportunities to grow their practice, others are looking to be acquired as a way to exit the profession.
A further group want to rid themselves of management responsibility, join another firm, and get back to fee earning and “the law”. For those firms that are looking to buy, merge or otherwise acquire a firm it is important to proceed with care. The potential impact on your Professional Indemnity Insurance (PII) should be a major consideration.
Successor practice or run-off cover?
The rules regarding succession for law firms are complex and we would always recommend you seek guidance from a broker specialising in solicitors’ PII.
Some of the more important issues to keep in mind are as follows:
1.If you do not want to become a successor practice, then a fail-safe solution is for the firm you are acquiring to purchase run-off cover – even if you assist them to fund this. It is critical to ensure that the premium for the run-off is paid before the merger for this arrangement to be effective
2. If no run-off cover is arranged, your firm will become successor practice if:
a) you acquire the practice of a sole practitioner and the sole practitioner joins your firm;
b) a partnership ceases and the majority of the partners join your firm as principals;
c) you acquire an incorporated firm and either the LLP or the limited company becomes a principal;
d) you acquire the majority of partners from a partnership in the expectation that their old firm will continue, but the remaining partner(s) shut the door on the day that the other partners join you.
3. If you are acquiring principals or files from an LLP or incorporated practice that is ceasing and you want to avoid becoming a successor, then it is critical that you do not do anything that could be considered “holding out” unless run-off has been purchased prior to the cessation. “Holding out” occurs where there is some reference to “having taken a firm over”. This is another complex area that firms need to consider carefully and everyone in the firm needs to be fully briefed on the issue.
4. You can have more than one successor to a firm, for example where a two partner firm splits and the partners move to two different firms. In that case there will be two successors to the whole of the firm – they will each be 50% liable for all claims.
5. Once a successor practice, always a successor practice. If the merger does not work out and you agree to go your separate ways, you cannot rewrite history.
Before you make a decision on whether to proceed with the purchase or acquisition of another practice, due diligence is critical.
The following list suggests some of the more important areas to investigate:
a) Previously completed PII proposal forms
Providing these have been completed accurately in the past, these forms will help you understand how the firm has represented their business to insurers. Your insurer will also want to see them.
b) Claims history
This is absolutely critical. Remember, the claims record of a prior practice will become part of your claims record upon succession. If there are any sizeable payments or reserves, then get chapter and verse on the background to the claim. Talk to your broker about the potential impact the merger of the claims history could have on your premium.
c) Complaints history
This will inform you regarding the culture that exists in the firm. In addition to the nature of the complaints, consider how the firm responds in each situation. Is their approach to clients compatible with yours?
d) SRA/Disciplinary issues
A firm’s most recent insurance proposal form will generally provide you with a good overview of any SRA or other disciplinary related matters.
e) SRA Accounts Rules compliance
As well as the disciplinary aspects of accounts compliance, it is important to note that in some circumstances the SRA may assert that an acquiring firm is responsible for shortages on the prior firm’s client account.
f) Risk management
Undertake a comprehensive review of risk management within the firm, including related systems and processes.
Is the firm’s risk management culture compatible with your own?
g) Areas of practice
Make sure you understand the areas of practice that the firm undertakes and the percentage split by gross fees. If they undertake work you do not engage in, then you need to consider whether the knowledge and experience exists within your firm to supervise this work.
A poor financial position will often be a catalyst for a firm looking for opportunities to merge or be acquired. Ask for the accounts and understand what the pressures are.
Are you going to inherit any HR issues? Are there potential redundancies? It is important to identify this and take appropriate advice as early as possible in the process. Decisions here need to be based on sound business sense and not sentiment.
j) Details of prior practices
Take care to identify whether the firm you are acquiring is itself a successor to any other practice. If it is, then you should make enquiries regarding the due diligence that was undertaken prior to the succession and obtain the claims history for that practice prior to merger if it falls within the last 10 years.
k) IT systems
It is important to understand the compatibility, or otherwise, of IT systems. What will be the challenges and cost of integration and how quickly can this realistically be achieved?
l) Impact on your PII
If you are going to be the successor practice or assume additional contractual liabilities, ensure that you have communicated with your broker at a very early stage to ascertain the view of your current insurer. You certainly need to know if an acquisition is going to be a “show stopper” from their perspective.
Never under-estimate the time, cost and energy that will be expended integrating with another firm. In terms of best practice we suggest the following:
- Ensure that there is a clear vision for the new firm and that this is communicated to all staff in advance of the merger.
- Identify what you need to do pre and post-merger including combining or transferring systems, training and social integration. Make sure you have a clear plan that you share with others in the firm as appropriate.
- An increased focus on risk awareness and supervision during the integration phase will pay dividends and identify areas where extra work is required.
- Leadership is important at all levels, but especially from those at the top. Be cautious and always take advice from your insurance broker.
Find out more
This article comes from our latest Legal Benchmarking Report. This annual report draws insight from legal practices across the UK and focuses on some of the pertinent issues and trends in income, profitability, employment costs and lock up
Click here to read a copy of the full report.