“… If someone is completing on Friday it does not help them if their solicitor ceases to practise on Thursday …”

Some legal practices are only now, with one week to go, receiving premium quotes for their 1 October 2010 professional indemnity insurance renewal. It is nail-biting for them as they may have only one quote – it is “take it or leave it.”

There is talk of practices being quoted premiums in excess of 400% of last year’s premium, with no discernible reason other than that they fall into a particular “demographic” (for example, being a practice with four or less principals).

There is much less capacity and a lot more caution in the insurance market, following the withdrawal of Quinn (which insured 10% of the market).

And it does not help that the number of legal practices in the Assigned Risks Pool (ARP) has swollen to over 400, compared with typically less than 30 in better times (28 in 2007/8).  Insurers who insure the solicitors’ profession have to pick up the tab for claims against practices in the ARP, and thus naturally seek to recoup their losses through higher premiums across the board.

In the past, practices in the ARP were usually there because they were otherwise uninsurable, in other words the risk of substantial losses arising is so great that no insurer with half his marbles would insure them.

Such practices are still in the ARP, but there is a new breed of potential ARP entrant, that is the perfectly good practice that in previous years has been insured for a premium that is a reasonable proportion of their turnover, which has led an exemplary existence and “deserves a break”, but is not getting one in this year’s renewal season.

Faced with an unaffordable premium, such practices have the unenviable choice between entering the ARP (and paying an unaffordable premium) or ceasing their practice before 1 October 2010 (or, if they are confident of obtaining a better quote before the end of October 2010, relying on the 30 day “grace period” – firms which put insurance in place within that period are treated as though they never entered the ARP).

But cessation at short notice is not as straightforward as such practices might hope. There are obligations to clients to give them reasonable notice to enable them to find a new home for their work. If someone is completing on Friday it does not help them if their solicitor ceases to practise on Thursday. Such conduct risks breach of contract claims and disciplinary proceedings, and in a bad case possibly Solicitors Regulation Authority (SRA) intervention. Solicitors who have been so cavalier as to, in effect, abandon their practice may find that they are uninsurable in the future, even if the SRA and/or the Solicitors Disciplinary Tribunal do not pull the plug on them.  Others may simply have to accept that they are insolvent and have an obligation to creditors to cease to trade, whatever the consequences may be.  In such cases, it may be “cavalier” to trade on.

If cessation can be achieved before the renewal date there will be a run-off premium for the obligatory six year run-off policy. That will typically come in at 250% or more of the current year’s premium. Still, reasons to be cheerful, that is better than more than 400% (with an additional sting in the tail – see below) for only one year if the practice continues.

Those trading behind the firewall of an LLP might not be personally liable for the run-off premium, but even if they are not their LLP will probably go into insolvent liquidation, and they might face clawback or other claims from a liquidator or even be at risk of being disqualified for wrongful trading. They will also risk disciplinary proceedings for being in “policy default”.

So closing down carries certain difficulties with it. If the partners decide to continue in practice, there are finance deals out there to finance the unaffordable premium, or failing that the practice can go into the ARP (which runs its own instalment scheme). Either way, the practice is now committed to a premium that it cannot ultimately afford to pay, much like a house buyer with a NINJA* loan which will assure him a few months in a mansion before it is repossessed.

The ARP premium may be as punishing as (or worse than) the premium offered by the insurance market, and if in due course the practice ceases whilst in the ARP without a successor practice (see below) then there will be an ARP run-off premium.

If the practice continues without going into the ARP, but subsequently ceases without a successor practice, its run-off premium will be based on its premium for the year of cessation, so if it ceases in 2010/11 the run-off premium will be be 250%+ of its 400% (of the previous year’s) premium for the 2010/11 year.  That means that having paid a premium of say £50,000 in 2009/10, the total cost of professional indemnity insurance incurred in 2010/11 could be say £700,000 (2010/11 premium of £200,000, plus run-off premium of £200,000 X 250% = £500,000, total £700,000).

One option may be to try to keep the practice going at least as long as it takes to get the best value for goodwill, preferably on a merger, even if that only means the partners being credited in the books of the merged firm with the value of their capital in their current firm.  At the other end of the scale, preserving goodwill may only result in being able to get a job (not necessarily a partnership) at another practice on the back of the book of work that individuals can bring with them.

In the latter case, taking work away from a failing/ceasing practice needs to be done in a structured way by mutual consent of the partners.  If one partner “does his own thing” and takes away a group of clients without a “by your leave” then the others would have grounds to recover the value of that work from the partner concerned.

(And partners seeking a merger or new position must be careful to ensure that they are not moving from frying pan to fire.)

Clients of course are entitled to exercise their own judgement in the matter and may not co-operate in being moved across to wherever partners can find new berths.

Even if transfer of goodwill (and obtaining some value for it) can be achieved, there may well be difficulties such as lease liabilities and claims from redundant staff.  Even in a merger, such claims are likely to remain as liabilities of the old pre-merger practice (which will continue a separate existence for the purposes of being wound up, either in dissolution or liquidation).  

In some cases transfer of a book of work can amount to a TUPE transfer, with the result that potential acquiring practices may be cautious. They will want the partner and his work but not the entire team.

To add to these difficulties, practices acquiring partners of ceasing practices and/or their goodwill may wish to be very careful to ensure that they do not automatically become a successor practice to the ceasing practice. If they do they will become responsible for insuring the risk of future claims arising from the ceasing practice’s past work. This is a minefield that can be traversed, but only with the “right equipment” (an in-depth analysis of the proposed course of action, with a copy of the succession rules at your side, tweaking the proposal as required to avoid succession).

With effect from 1 October 2010 the succession rules themselves have been tweaked, with the result that a partner or partners joining one or more new practices will be able to elect to pay a run-off premium rather than bring the burden of succession with them to the practice that they are joining.  This will make obtaining a job easier (especially for sole practitioners who are closing down their practice) but leaves the job-seeker with the run-off liability.

The best solution may be not to close down the practice but to look for “birds of a feather” – good practices in similar difficulties (brought about by the catastrophic insurance market, not poor business stewardship or poor claims history) with whom to merge.  Being “in the same boat”, such firms will not be as “picky” about succession and other issues. Such a merger will be too late to affect the premium that each practice (or the merged practice) has to pay this year, but at least being a larger practice next time round in 2011 might give rise to a lower premium, especially if there is a focus in the meantime on better preparation for next year’s renewal, for example putting better risk management processes in place which will be attractive to insurers.  And in the meantime economies of scale may be achieved.

This avoids a run-off premium or an ARP premium and/or an ARP run-off premium.

In any event, practices in this predicament may well have to find ways to reduce their partner numbers so that the increased premium leaves the remaining partners with enough profit to live on.

Poorly-performing partners may be given the choice of leaving with an indemnity or remaining in the practice and sharing the burden of greatly reduced profits and large potential liabilities if cessation occurs in the future. Some partners may regard the opportunity to leave as a “Get out of jail free card”, indeed those managing the process may be trampled in the stampede towards the exit. It is important to get the balance right with a view to retaining the most effective partners.

Faced with many different options, the partners in a practice facing a difficult insurance renewal would do well to prepare a number of different spreadsheet models, to enable them to ascertain and compare the possible outcomes.
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*No INcome, Job or Assets (sadly for aspiring mansion owners these loans are no longer available).

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