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March 2013 - Why a Successor Practice should be on your radar

Why a Successor Practice should be on your radar

Background

It has always been fundamental for a law firm to be able to know whether it is in a Successor Practice (SP) situation. However, the Rules are technical and do not benefit from abbreviation. Now perhaps more than ever, law firms need to keep the Rules firmly in mind whenever there is:

  • talk of mergers and acquisitions (M&A), elections and pre-packs
  • lateral hires of teams
  • taking on the best assets of a firm in closure
  • looking beyond the coming months to the PII Underwriters considering your new Proposal Form ahead of 01 October 2013


Why is SP so key?

The fundamental here is that of Professional Indemnity insurance (PII). Policies are written on a 'claims made' basis. The insurer that pays the claim is the one extant when the claim is made, rather than when the act or omission occurred. This may have been many years ago, at a time when the merged firm was not a part of your business. Due diligence on M&A comes into focus when a claim appears out of the woodwork from the new ceased practice.


Rule changes

A few years ago, the Rules changed to introduce an element of flexibility, enabling firms to elect to have run-off cover, to draw a line under itself, before it merges with another firm.  Insurers naturally become nervous of finding that their insured firm has accidentally become a SP because that Insurer now has a rather larger bag of unknowns to deal with, which it neither knew about nor underwrote cover for, and the premium they are charging can suddenly look very unattractive.

As a firm ceasing to trade, without a SP in place, your insurer at the date you close is obliged for public protection, to provide you with run-off cover for six years. You are required to pay the premium for that which may be two or three times your annual premium - probably at the time you least want to pay out large amounts of cash, unless you had this in your business plan and budget for some years already.


Business Plan

Lateral hires may already be part of your five year strategy, however, an opportunity may arise at short notice. Perhaps this is the consequence of a competitor firm announcing it is entering Administration. You see a chance to acquire a team of good lawyers and partners/members to strengthen your service to clients and expand your client base. Your due diligence process is essential, as is your discussion with your insurance  broker as to whether this will put you in to the SP situation, even without you holding your firm out , expressly or implied, as the SP to the previous firm.

As such, discussing your business plan with your broker is prudent, both as active risk management and teamwork, ensuring your business is seen in its best light by Underwriters at renewal.



The Rules

A discussion on SP can only be useful if it covers the Rules and then gives you a link to the resources available to you.

The Solicitors Indemnity Rules are the starting point, regulating indemnity provisions for Solicitors and Licensed Bodies and there are requirements such as Notification NS1. If your firm has succeeded to the whole or part of another firm or your firm has split, to enable the SRA to calculate the correct turnover based on your PC renewal fees, the more fundamental is set out here from the definitions in Appendix 4 of the SRA Indemnity Insurance Rules 2011.

Successor Practice means a practice identified as B where:

  1. A is the practice to which B succeeds
  2. A's owner is the owner of A immediately prior to the transition
  3. B's owner is the owner of B immediately following the transition
  4. 'transition' means merger, acquisition, absorption or other transition which results in A no longer being carried on as a discrete legal practice

The definition goes on to describe a number of differing scenarios which will mean that B is the successor practice to A.

This definition has the appearance of uncanny simplicity and surely has not troubled Insurers and their indemnity specialist lawyers for years?  Let's use a familiar scenario to test its simplicity.


Example

Where the majority of principals in A do not become principals in another legal practice, but one or more do become principals of B`s owner and B trades from the same premises as A previously had, then B is the successor practice, unless another practice (let us call that C) is held out as the successor of A. Similarly, if the majority of the employees of A become employees of B, even where only the minority of principals of A have become principals of B, B is still the SP.

What if you are a large firm which through the transition process acquires a lawyer who was a niche sole practitioner A, who you decide to make a principal or simply an employee of your business B?

You as B will be the SP to A. You therefore have to decide how much you need that individual lawyer i.e. are his/her clients only coming to you if he/she comes too?  If so, you need to build in either the payment of run-off for A, or a quote for your indemnity cover in the SP scenario.

One can see that planning this ahead is a careful matter of timing and your insurance broker can help. If for example you plan a merger or series of mergers to occur on say 1 September, your Proposal forms for PII that summer will have had to be open about the prospect, or you face a tricky non-declaration discussion with your Underwriter when they hear directly or indirectly, that what they thought was on risk for them is now a different size and shape. 'Holding out' trumps everything, so you do need a coordinated strategy for a spokesperson, a merger statement and business cards - whether card or V/E cards; plus all communications.

The most essential of those is that where B is held out, whether expressly or by implication, by B`s owner as being the successor of A or as incorporating A, B is the successor. This could be as simple as a media statement given by your spokesperson or by a press release.

Clearly if you are B and fully planned to be the SP to A, all is fine. The concern and unplanned risk transfer comes when that is not so.


Minimum Terms and Conditions (MTC)

It is now possible to elect to purchase run-off cover before your firm A is succeeded by B.
You must make your election and pay the premium before the date of cessation for the run-off cover to be effective. Your Insurer must give notice of your election to the SRA within 7 days.
As you need to know whether the Insurer of the SP will insure your prior firm on merger, you must ascertain the cost of that when deciding whether to elect for run off pre merger.

You may see the cost of that run-off being one to be borne by the SP as a way of them containing their exposure to you before you come across. Or they may expect you to pay it to support your stance that you are a firm that they really should want to acquire.


Dual Insurance?

If your firm is succeeded during your period of Indemnity, a situation of dual insurance may arise, where 2 or more insurers are on risk at the same time. If so, there is to be a calculation of contribution between insurers based on the relative number of principals immediately prior to succession.


Complaints not Claims?

The SP has responsibility for the acts and omissions of the ceased firm, including thereby the complaints that now come against the SP, even if they relate to acts and omissions of the ceased firm.


PII

You should always consult your insurance broker before you conclude the agreement with your new business colleagues.

Our advice is to talk with your broker and insurer before you make the journey to explore the options to best position your firm with your Indemnity Insurers, so they are not surprised by what you later decide to do.

We have come across firms where they immerse themselves in discussions at the highest level between prospective partners and yet decide not to involve their PII broker 'at this stage'. If you don't engage them, you lose the insight you could obtain, especially if they are a specialist.

Your broker and your PII Underwriter have the most confidential information about you, your business, your people, your finances and your five year business plan. It would be unusual not to include them in your inner circle of trust at this pivotal time in the development of your business.

Your specialist broker has years of experience of seeing all manner of mergers and acquisitions between law firms, be they partnerships, sole practitioners, or licensed bodies. Their knowledge will help inform your consideration of the best route through the issues.


Conclusion

This is a complex and technical area, where each potential M&A needs looking at on its merits to establish whether there is a SP situation and, if so, the best way to handle that.

As a firm looking to be acquired, you want a safe and successful future for the goodwill you already have from your client base and a solid future for your colleagues, staff and their families. You have relationships with your bankers and other professionals that you wish to see flourish rather than wither and die. As such, you look at the very best deal you can achieve with your suitor. That may:

  • require you to pay for run-off to 'clean-slate' your ceasing business
  • need you to negotiate indemnities for errors and omissions
  • carry out careful due diligence on your proposed SP firm
  • truly be sure whether what you are about to do will be a SP situation in the eyes of your regulator and your Indemnity Insurer. If it is and that is the outcome you want, steps can be taken with your broker and Underwriter to avoid unintended consequences


As a firm about to acquire a ceasing business, you are an imminent SP firm and want to be sure what your intended outcome is and that you are happy for it to be so. If not, now is the time to reflect on the attraction of the pre-pack merger, the strategic restructure and the absorbing you have in mind.

It may be your decision that the best outcome is indeed for your firm to become the SP of a particular business. You can assess that once in possession of all the facts. Ensure you are in that position before you and those acting for you, start negotiations with the prospective business.


Resources

http://www.sra.org.uk/solicitors/handbook/indemnityins/appendix1
Appendix 4 Solicitors Indemnity Insurance Rules 2011
Version 6 The Handbook - published 01 January 2013


For further information on this or for a discussion on how Wesleyan Active Risk Management can help your specific business:

Phone: 0800 107 8171

This article is a general guide and is not a substitute for professional advice. No responsibility can be taken for any loss incurred by anyone acting or failing to act on the basis of this article.

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