Increasing numbers of law firm proprietors are seeking an exit for themselves and their firms, with many having planned their future for some time, but some on the basis that they cannot continue for reasons of affordability of Insurance premiums or SRA and regulatory issues.
Looking ahead to the immediate term, CQS’ intent to visit firms as part of onsite accreditation visits, continuing uncertainty around the personal injury space, legal aid cuts and the increasing use of tech mean that there will be no easement in the regulatory or competition burden for many firms.
Most understand the mechanics of run off and its cost. It is written into the PI policy as a multiple of the current year premium, however some firms do not fully appreciate how it works for or against them in commercial terms. In planning for exit, it is worth knowing that at the lower end, one Insurer requires only two times the expiring PII premium to provide six years run off, whereas at the upper end, three and a half times the expiring premium is required. In addition, in run off we have come across uncapped excesses (open ended liabilities) and Insurers can pursue vendor partners and directors into the future for their excess post closure.
Acquiring firms sometimes only review the vendor’s financials and don’t audit files and search for other liabilities, which leaves the potential for future risk and disruptiveness which is at best distracting and at worst fatal. Indeed, the more voracious law firm acquirers are sometimes bound by their Insurers nervousness at seemingly constant growth. This is manifested in a tight regime imposed by the Insurer in understanding that, where senior inbound vendors wish to retire in the short term, adequate supervisory headcount is in in place in order to backfill the space left behind.
Crucially, if vendors want a relatively speedy sale, they should undertake, via their appointed consultant, vendor due diligence. This ensures that a clear set of documents are available for suitors to review, including financials, past liabilities, leases, ownership details, lines of business and key staff and their cost vs income overview.
Making the vendor firm responsible for their excess following buy out via indemnity clauses is not unusual but many purchasers still omit what is an essential aspect of managing risk within a growing firm. It is also acknowledged practice for the vendor to undertake a “drains up” on any potential past issues within their client work, so that these are notified to their current Insurer, as opposed to following them across to their purchaser’s record. What many are not aware of however, is that the current Insurer is required to formally accept these matters as claims before the firm goes into run off.
Many are also unaware that in terms of PII a process must be followed when one firm purchases another, whereby if run off is triggered, the Insurer of the purchaser will often request sight of that run off policy before accepting the inbound firms future Insurance protection.
In what is an increasingly competitive backdrop to the legal sector, there are instances where firms are acquired where the vendor purchases PII Insurance run off and purports to also run wind down their book of client work to close all of the files. Some purchasers do not notify their Insurers of the arrangement, despite the fact that they may automatically be a successor practice, in the belief that they are purely inheriting a new office location. That has resulted in Insurers refusing to renew some firm’s policies and rendered others uninsurable.
It is also worth remembering that warranty and indemnity cover is available to protect against buy side or sale side (or both) risks, and is far more affordable than previously. It is also possible to amend some Directors and Officers Liability Insurances to protect against personal guarantees.
In a sector where maximising the scope of the deal is important, it is useful to engage with those who not only understand the Insurance placement aspects of M and A, but that also have first-hand experience of having bought and sold firms across commerce and industry and who understand that process.