Lockdown – financial stability and claim trends

Financial stability

There has been a lot of commentary over the last decade about the financial position of law firms. When writing in April, I commented that: Firms that have existing high debt, and financial stability plans based on high lawyer hours, will likely face the greater challenges as a result of this coronavirus crisis. Since then, the legal press has been dominated with reports of furloughing, 80% pay schemes (some requiring 100% of the work), pro-rata time and salary agreements and graphs identifying how relatively small reductions in turnover could put some firms in the red. 

We also heard last week of a Top 100 law firm going into administration, and being bought via a pre-pack.  The firm was McMillan Williams and it was bought by Taylor Rose. This has created a combined firm with potential turnover of £40m plus, and numerous offices across the country. Quantuma were the instructed administrators and are quoted as saying: The high fixed cost base and highly leverage model of many law firms leaves them particularly vulnerable to the fall-out from the Covid-19 pandemic. We are already seeing many law firms already in serious financial difficulty and unfortunately this administration will be the first of many.

This echoes comments made 5 or 6 years ago when it was reported that a number of Top 50 firms were at risk of insolvency. That did not materialise, in part one would guess due to the combination of the economic upturn, and low borrowing costs. However, that upturn was fragile and was in its relative infancy when Covid-19 came along. The banks are now under pressure to lend to a number of businesses across the country and so it is potentially going to be more difficult for law firms to get unsecured credit, so often the lifeline. 

Volatility in the legal market is never a good sign, and it is hoped that Quantuma’s prophecy does not come true. Of course, a law firm entering administration is an opportunity for others and this may see the ‘consolidation’ trend continue yet further. However, bigger is not necessarily better. 

As we approach the next traditional indemnity insurance renewal date of 30 September, insurers may want to be slow to agree terms whilst the summer plays out, and also will want to ensure they have good/up to date financial data on the law firm, so as to form an assessment as to its medium term stability. In addition, caution should be applied when deferred / interval payment of premiums are requested.

Permanent changes

Slater & Gordon announced last week that it is to close its London office and find a smaller premises to allow for meetings. It is understood the lease ends in September and so the decision is perhaps simpler than for other firms. The result being that ‘work from home’ will continue to be the norm for staff based in that office.

We could see this trend expand across the profession but my prediction would be that it will be more nuanced. The point being that it was already there with hot/warm/zonal marking-desking arrangements in place. The challenge for many firms will be the inability to desk-share in the short-term. However, there is a risk in being too short sighted here. Whilst many can currently work from home, it is because there is no other option. By choice, many would not choose to (or not choose to all of the time) and a deep dive assessments of the wider benefits of office life (to the business and also from a well-being perspective) needs to be done. 

What we have learnt for sure is that some change to our working lives is both viable and for the better, and law firms that can hold on to the best bits will do well. 

Claim trend (1) – Litigation

In terms of future claim trends, we are clearly entering into an exceptionally litigious period. At the top of the pile is the Covid-19/Business Interruption dispute, the Mastercard group action, claims against Mercedes Benz, an £18bn claim against EasyJet for data breach, and auditor-based litigation. Below that, we can expect contract disputes to be in abundance, as well as claims arising from tax advice. Recently PwC were reported to be facing a £170m claim arising from advice given to Matalan tycoon John Hargreaves. This is in addition to a claim for £40m from investors into a Ponzi scheme.

Given this increased activity level (which will inevitably continue), in 2 to 3 years time, it is likely there will be a rise in notifications coming from litigation work. 

Claim trend (2) – Lender claims

The country remains in a precarious position, and potentially is facing the worst recession for a lifetime. Traditionally, recessions result in property values falling, lenders repossessing and taking the opportunity to review the original transaction. Often, problems only come to light when it comes to a later sale. With the cost of a conveyance remaining low, and the ‘conveyor belt’ approach still adopted to dealing with the work, there is little reason to be optimistic that the third coming of lender claims will not materialise. That said, if interest rates remain low, it is possible that homeowners will be able to continue to meet repayments, and many of the problems experienced in the past could just be avoided. 

Claim trend (3) - Tax 

In a recession, HMRC will sharpen its pencils and look to recoup whatever tax it can as part of the Government’s need to rein in the cash. With an increase in such activity, it can be expected that advice given to clients will come under scrutiny and claims will follow adverse findings. 

Claim trend (4) – Matrimonial Claims

The Network of Independent Forensic Accountant recently reported a 44% increase in matrimonial cases over the last 5 years. The current lockdown is likely to result in a spike in matrimonial work, and any ongoing financial settlements will be more difficult to advise on given market volatility. Valuations of pensions, property and other assets will be changing almost daily. This could well result in an increased level of matrimonial based claims in the medium term. 

Claim trend (5) – Scammers

It is understood that there has been an increase in attempts to attack law firms, and inevitably there will be casualties. With most lawyers working from home, there is a clear and present risk that mind-sets may be less alert and this could lead to successful attacks being made. The consequences could be devastating. Client monies stolen, confidential information obtained, or a law firm’s systems locked and held to ransom. All of these are realities not speculation. These events are ‘immediate’, resulting in insurers needing to make payments and take expensive action to arrest the problem.

Summary

As with all businesses, the sooner lockdown measures are eased further, the less concerning the potential exposures will be. However, liquidity and access to funds is likely to be the largest single concern for managing partners of law firms (or CEO’s of PLCs). Banks will be proceeding with higher levels of caution and will not see the entire profession as a ‘safe bet’. Some law firms will already be too highly leveraged, and they are likely to be the ones who are forced to make overhead cuts sooner and deeper, even if there is to be a V-shaped recovery.

In addition, the anticipation is that professional indemnity premiums will continue to rise for all but the very best risks, and that was the trend pre-Covid. This additional ‘hard’ cost is something that the profession needs to wake up to and plan for, sooner rather than later, as it could be the straw that breaks many a camel’s back.  

What is of critical importance to insurers is that law firms do not take their eye off the ball when it comes to risk management and critical assessment of work (and clients) taken on.