We have just seen the substantial US law firm Heller Ehrman forced into an “orderly dissolution”. Redundancies in UK law firms are being reported on a daily basis. We read of the consolidation of regional offices and the closure of high-street practices. Should we now expect the failure and collapse of more UK law firms?
There are a number of issues that could lead to a firm’s collapse and, in reality, it will no doubt be a combination of factors that are the cause. Obvious triggers will be sustained poor trading or an over-reliance on particular areas of work, such as real estate. Firms may find that they have excessive overheads in proportion to their income. Good talent may drain away and lead to a partner exodus. Banking covenants may be breached, causing the firm’s bankers to look seriously at whether they will continue to support the firm.
There will invariably come a point in this scenario when a firm may need to consider whether it should continue to trade and what are the potential consequences of doing so. The insolvency regime applicable to partnerships and LLPs is different.
Insolvency of partnerships
Once a partner knows (or ought reasonably to conclude) that there is no prospect of the partnership avoiding insolvency, he is at risk of wrongful trading if trading continues.
The proper course of action is to take every step with a view to minimising potential loss to creditors. In considering their position, partners would do well to take specialist advice and consider the alternatives available. Rather than petitioning for the firm to be wound up, it might be possible to agree a voluntary arrangement with creditors.
If a winding-up order is made, the authority of the partners to bind the firm and/or to dispose of assets is automatically terminated. Every partner (and former partner) is obliged to deliver up partnership property in his hands. Where partnership assets are in the hands of third parties, a liquidator may use his powers to get that property in.
Partners are individually and jointly liable for the debts of the partnership – meaning they are contributories, with unlimited liability, in a winding-up. They also have the status of officers with the same potential exposure and duties that directors would have in the winding up of a company. The result is that, in addition to wrongful trading, partners are potentially liable for fraudulent trading, as is any other person who has management or control of the partnership business.
Past dispositions made by the partnership may also be clawed back. A liquidator has the power to set aside transactions preceding a winding-up by up to two years. This may affect payments made to partners, including drawings.
Insolvency of LLPs
The insolvency regime for LLPs is largely the same as for limited companies. LLPs, like limited companies, are allowed to:
• propose a voluntary arrangement;
• apply to the court for an administration order;
• go into receivership;
• resolve to go into voluntary liquidation and to appoint a liquidator; and
• resolve to be wound up by the court.
One major exception, however, are the special clawback provisions that apply to members of an LLP. In brief, if an LLP becomes insolvent, its members may be required by the court to repay any monies paid to them in the two years prior to insolvency. This will only happen if the liquidator can show that, at the time the payments were made, the members of the LLP knew or had reasonable grounds for believing that it was insolvent, or that there was no reasonable prospect of avoiding insolvent liquidation. Members of an LLP may also be liable to contribute to the assets of the LLP on a winding-up if they are guilty of fraudulent or wrongful trading.
Members of an LLP may be owed monies by ;the ;LLP ;in ;respect ;of ;capital contributions and any divided but unpaid profit shares. A member risks losing all his capital on a winding-up. A member’s right to make a claim as an unsecured creditor for any unpaid profit will be dependent on whether the LLP has divided its profit among the members. Most LLPs will probably do this once per year, usually at the end of the LLP’s accounting period. Therefore, a practical tip for LLPs is to try to divide and allocate its profits to its members regularly.
A practical consequence of insolvency applicable ;to ;law ;firms ;(whether partnerships or LLPs) is that the Solicitors Regulatory Authority has the right to intervene by appointing an agent to effectively close the practice while protecting the clients’ interests and monies. Indeed, recent reports indicate that the number of interventions has surged to its highest level for five years, with insolvency of sole practitioners’ practices cited as one of the possible reasons for the rise. Importantly, it will be the members or partners of the firm who will be personally liable for the costs of intervention.
In the current economic climate, some firms may find they need to consider the consequences of their trading position sooner rather than later to avoid the unthinkable.
Fergus Payne is a partner and Mark Lim an associate at Lewis Silkin