At the point an insolvency practitioner is engaged, there are a number of questions that must be asked before a decision is made as to the most appropriate insolvency procedure for an insolvent law firm to enter into.
What is the legal framework of the practice?
Law firms have traditionally been structured as sole practitioners or as partnerships. However, other options have become increasingly prevalent. A limited liability partnership (LLP) offers many of the benefits of a traditional partnership but with a greater degree of personal protection for the partners. More recently, new entrants have tended towards limited companies. In fact, according to the Solicitors Regulation Authority (SRA), in July 2024 the breakdown was as follows:
Sole practitioners 17%
Partnerships 11%
Limited liability partnerships 16%
Incorporated companies 56
What happens if the practice cannot be saved?
If this is the case, then the following insolvency procedures may be relevant for different business structures:
Sole practitioners
A sole practitioner will be liable for all the liabilities of their practice. If the practice is insolvent, creditors can also look to the sole practitioner’s personal, non-business assets for payment of debts. A creditor who is owed more than £750 can petition for the sole practitioner’s bankruptcy (a creditor’s petition). Alternatively, the sole practitioner can apply for their own bankruptcy (a debtor’s petition). An insolvency practitioner will be appointed as trustee in bankruptcy and be responsible for disposing of all assets and making a distribution to creditors, if sufficient monies are raised.
Partnerships
The basic principle is that partners will be personally jointly and severally liable for the debts of the partnership. However, the exact detail of how the partners will be treated will be encompassed in an overriding partnership agreement. If the partnership assets are not sufficient to pay the partnership liabilities then, as with sole practitioners, personal assets must be sold. Creditors can petition for the bankruptcy of some or all of the partners in order to obtain payment. A problem can arise where bankruptcy orders are made against all the partners of a practice but there is no winding up against the partnership itself. This means that the trustee does not have the power to force a sale of partnership assets. In these circumstances the insolvency practitioner can apply to court to consolidate the bankruptcies into one case and for them to have the power to realise partnership assets.
Limited liability partnerships (LLP)
An LLP is a body corporate. Members of an LLP are liable to contribute to the winding up of an LLP, unless the members specifically agree otherwise in the LLP deed or via disclosure in the LLP’s financial statements. Their exposure is generally capped at the level of their capital contributions. Members should also be aware of any personal guarantees they have given. Any unpaid income tax on their share of past profits will be a personal liability as well. If the LLP is insolvent and there is no chance of survival, liquidation may be most appropriate. This can be a creditors voluntary liquidation (CVL). The decision is made by the members, who also nominate who they want to act as liquidator. Alternatively, a creditor who is owed more than £750 can petition for the winding up of an LLP. If successful, a court order is made to place the LLP into compulsory liquidation.
In both types of liquidation it is the liquidator’s duty to realise the assets of the LLP and to make distributions to creditors.
Incorporated companies
Here the shareholders’ liability for company debts is limited to the value of their share capital. Where there is no chance of survival, as with LLPs, either a CVL or compulsory liquidation will be the most appropriate method of bringing the company to an end, selling its assets and making payments to creditors.
What happens if all or a part of the practice can be saved?
If there may be an opportunity to save all or a part of the practice then the following insolvency procedures can be considered.
Sole practitioners
It may be possible for the practice to continue to trade. Creditors will look at the business assets, and also the personal assets and liabilities of the sole practitioner, together with forecasts of future trading. They will then compare the estimated outcome from this course of action against what will be received if the sole practitioner is made bankrupt. This alternative is referred to as an individual voluntary arrangement (IVA). It is a contract between the sole practitioner and their creditors, supervised by an insolvency practitioner. An IVA must be accepted by at least 75% of the unsecured creditors in value. Pre IVA, creditors are set to one side, the practice continues to trade and pay its current liabilities as and when they fall due. Contributions from current trading and the sale of excess assets are accumulated over the period of the IVA. From this fund the IVA creditors will receive a distribution which hopefully would exceed the amount they would receive from a bankruptcy.
Partnerships
Where the individual personal estates are solvent and there is no pressure from non-partnership creditors, a partnership voluntary arrangement (PVA) may be the most appropriate procedure. As with an IVA, the creditors examine the assets, liabilities and future profitability of the practice and compare the outcome with what would be received if the practice was wound up, then decide whether to vote for the PVA to be accepted.
On a practical note it is difficult to make a standalone PVA work. If a PVA is accepted by creditors it does not prohibit creditors from taking action against individual partners. It is better for IVAs to be agreed at the same time as the PVA. This gives transparency regarding the assets and liabilities of both the practice and its partners. However, this process can become rather cumbersome in a practice with a large number of partners, and problems can arise if there are disparities in the value of each partner’s estate. This problem is addressed by having interlocking IVAs. Basically, if a creditor votes against one partner’s IVA, causing it to fail, then all the other IVAs will fail. They are all either approved or failed. This assists in making the overall rescue plan, usually with a PVA, more workable.
LLPs and incorporated companies
Where a practice is insolvent or distressed, but looking forward could be viable, then a company voluntary arrangement (CVA) could be considered. As with the arrangements listed above, the practice’s assets, liabilities, and profit and cash forecasts need to be produced, showing how creditors will receive a distribution from ongoing trading and/or the sale of assets. The major disadvantage of a CVA is that there is no moratorium, therefore a pressing creditor, for example HMRC, can continue with the issuing of a winding up petition. Protection from such legal actions can be achieved by placing the LLP or company into administration prior to getting a CVA accepted.
The administration of a law firm has particular complications as illustrated below, and so may not be possible or the preferred option. However, the purpose of an administration is to rescue the practice, as a going concern. If this is not possible then the administrator, a licensed insolvency practitioner, should aim to achieve a better result for the creditors than would be obtained by the liquidation of the practice. Only if neither of the first two objectives are possible can the administration utilise the third objective, which is to realise any assets to make a distribution to secured and/or preferential creditors.
When an administrator is appointed, they produce a statement of the practice’s assets and liabilities. They then carry out a thorough examination of the practice’s prospects for continuation or sale. The creditors then vote whether to accept their plan. If agreed a progress report has to be issued every six months.
In order to preserve value, and to avoid the cost of intervention, it is preferable to find one practice that will take over the whole of the distressed law firm, become the successor practice, and hopefully remove the need for PII run-off cover. This process can take some time. If there is creditor pressure, from say the landlord, then it may be necessary to place the firm into administration, to gain the protection of the moratorium.
This in turn creates another problem. In order to trade as a law firm, one of the appointment takers must be a solicitor, as non-lawyers are not permitted to be “Managers ” (members/directors) of a law firm. This very often is a non-starter as the appointed “Solicitor Manager ”/solicitor insolvency practitioner can become personally liable for any regulatory breaches that may have been committed.
For this reason it is becoming more common to pre-pack the sale prior to the administration appointment. The insolvency practitioner has to follow detailed guidelines to ensure proper valuations are obtained, and that the business or its underlining assets are properly marketed. This is to illustrate that all has been done to obtain a fair price is received for the business.
In conclusion, dealing with the insolvency of a law firm is a very complex matter. Early advice from an experienced insolvency practitioner with legal sector experience is vital in assessing the most appropriate insolvency procedure, and avoiding the crippling costs and complications for clients arising from an intervention by the SRA.
If you would like advice and support please get in touch for a confidential conversation. Call 0808 144 5575 or email help@armstrongwatson.co.uk
