Economic turbulence and recession and how this affects law firm risk and protection

With the current uptick in interest rates it is probable that personal savings will be eroded over the short term and combined with cost of living increases there is a risk that there will be an increase in  house repossessions. When that happens our sector sees corresponding sharp increases in file requests from lenders to our clients as the lenders look to recoup their losses by challenging solicitors around their adherence to CML standards and protocols. Pressures on volume from the summer of 2021 add to the exposures as law firms came under pressure to get transactions through and wished to capture as much business as possible. A tougher CQS regime will add to the stresses. Most fee earners will be able to identify problem cases from the recent past and some firms would benefit from a review of their recent conveyancing work in readiness for what may come. There are some good consultants who can provide an independent assessment. PII premiums will moderate in the medium term but for those caught out they will rise sharply and some firms will become uninsurable.

The forecast of three successive quarters of economic contraction and subsequent recession (if it happens) will create the environment in which mortgage fraud becomes more prominent and conveyancers as ever will be in the dock. There will be a real need to be diligent over the course of the next 18 months as risks increase. Falling property values, and increasing borrowing costs mean that exposures in this area are growing. Any firm that lacks a decent modicum of supervision will be at risk.

It is suggested that 80% of commercial office property in the UK is over 20 years old and that with the shift in work patterns many firms are looking for modern, efficient office accommodation with green rooftop spaces, and environmentally friendly structures. This leaves a large portion of older locations at risk and there are likely to be defaults as property owners cannot make the numbers work. This will bring more lease work in the shape of litigation and particularly review of terms and conditions.  Claims against law firms for issues in the original drafting of lease transactions are likely to increase, again, as investors and lenders seek to recover their losses. It is important for department heads to understand what sits within their “back book” and to be prepared where they can.

There are a good number of law firms making significant profits who will looking at their interest being eroded and seeking to offset this problem. Insurance captives won’t give a direct answer but their tax concessions certainly will do. Growing law firms paying PII premiums of £250k and above could achieve benefits from their own captive cell into which business losses can be included. The transition from a traditional Insurance model into a captive can be managed over a period of time.

Immigration has to continue because at present there is a labour shortage, so law firms in this space are unlikely to get locked out. An anticipated spike in UK covid rates in the winter, and the approach of some countries such as China’s zero tolerance approach, might affect this situation. Some of the proposal forms we have received from immigration-based law firms have indicated large swings in income over a period of three years, and the lack of a consistent global approach to managing covid makes this sector of the legal profession vulnerable to further change.

Crime usually increases during a downturn and the press are reporting an uptick in rural crime already. The government are putting more money in to speed up court waiting time – but the “industrial action” in this sector doesn’t look like making a big difference and there aren’t enough lawyers in the sector to do the work. We are seeing greatly increased numbers of legal aid criminal law firms closing or reversing their firm into another, to ensure that they do not have to pay for run off Insurance. The SRA have said that they will extend the life of the indemnity fund for claims which exceed a six-year period post closure, however medium-term continuity of the fund is still not available and this influences the decision as to whether to close the practice or subsume it into another. It also affects asking prices for law firms, and the need to conduct proper due diligence on a firm being purchased. Insurers are nervous of acquisitor law firms who make more than two to three acquisitions a year due to pressures on backfilling senior staff members who will depart and supervisory pressures alongside day to day client work.

Debt recovery will increase and we have already seen that over 16,000 firms have gone bust taking government bounce back loans down with them.  ATE is a good vehicle to assist recovery of debt where the defendant is still in funds and many law firms still do not adequately understand the mechanism and how to get the best out of it.

The significant lack of qualified staff in the sector is a huge issue at present and many firms are well advised to seek an acquisition to provide more resource rather than chase down a dwindling pool of good people. However, if recession does hit and property markets slow, the need for those individuals will drop off. Some law firms increasingly use the consultant model for getting client work done, and there is room for expansion in this sector. Many firms dislike it because of lack of control and the payaways involved, but increasingly it will become a requirement and it will help some law firms to understand the model a little more.

Along with this the changes in divorce procedure enabling quick online processes mean that fees from this aspect of private client work will come under pressure. Many firms are specialising on the pastoral elements of divorce, with advice on mediation and a negotiated settlement to enable them to adapt and reposition their work and source of fees. In this respect some firms are crossing the line into consultancy as opposed to legal work and that requires a different approach to Insurance protection.

Increasing volumes of HR capacity may be required to enable business closures, purchases and restructures to be made swiftly and with the minimum of stress. We are seeing some firms strengthening their teams in this area and there is an increase in firms taking on HR teams in readiness.

There are a number of things that firms can do to prepare themselves for the next 6 to 12 months to batten down the hatches, with the potential for business volumes to ease. Whilst we are able to protect firms who make claims, the disruptive aspect of high volumes of file requests from lenders, a mortgage fraud issue, or increases in litigation, mean that business success becomes even more elusive as the firms senior staff seek to keep the offended parties at bay.