Strangled by a necklace of bad debt

Tim Miller explains the background to the demise of Deacon Goldrein Green, which is facing bankruptcy proceedings

When Andrew Macfarlane addressed the Law Society's legal aid conference three years ago he issued a chilling warning: “Bankers don't have social consciences.”

Macfarlane, the then managing partner of Deacon Goldrein Green (DGG), told the Lord Chancellor that many of the major players would “go under” unless urgent steps were taken to improve the lot of legal aid practitioners.

Conference rhetoric to rally the troops? This month his prediction takes on a particular poignancy. Creditors of DGG have filed bankruptcy petitions in Liverpool County Court against Macfarlane and his partners, with a hearing scheduled for 13 December. The firm is believed to owe between u4 to u5 million. “DGG the concept is now a faded dream,” says Macfarlane.

Rumours had been rife that the high-profile practice was finding it hard to maintain its go-for-growth strategy. But the human tragedy was no less shocking as a result. Nor could professional gossip prepare the public for the downfall of Deacons – a name synonymous with front-line legal services in Liverpool.

The practice, formed in 1985, achieved what the managing partner once described as “an upward spiral of success” by developing a smart corporate image underpinned by heavy advertising and aggressive marketing. But at the end of last month, its main office and 17 satellite branches fell into the hands of the receivers.

Legal aid lawyers are already pointing to the DGG collapse to bolster their case in pay negotiations with the Lord Chancellor, claiming that cash-flow problems and low profit margins make it impossible for them to invest sufficiently in the business.

The 1994 pay freeze undoubtedly placed extra strain on DGG, and all legal aid practices, but it was only a contributory factor in the firm's plight.

Matters came to a head at the end of October when the Royal Bank of Scotland (RBS) pulled the plug. The partners' accounts were frozen following the failure to negotiate individual voluntary arrangements with creditors and the firm had to invite intervention.

The post mortem, to date, has focused on the status of the Legal Aid Board (LAB) as a u700,000 creditor, with DGG accused of cheating the system by failing to disclose when cases were completed. The figure is misleading because it fails to take into account the cash owed to the firm by the board for work in progress. The matter is now in the hands of the Solicitors Complaints Bureau (SCB), but Macfarlane insists it was “sloppy admin- istration” which led to the mix-up rather than fraud.

Steve Orchard, the board's chief executive, confirms the LAB was alerted to the problem by the firm but only after a “significant” debt had built up. DGG put forward a proposal which it claimed would see the cash paid back by Christmas this year, but Orchard says no agreement was reached. A key consideration would have been the firm's ability to meet the obligations of any agreement. “Our overriding duty was to protect the legal aid fund,” says Orchard.

What is certain, is that the repayment problems were symptomatic of a deeper malaise. Insiders say the firm's rapid expansion – from 6,500 to 35,000 client files in less than a decade – had made it unwieldy and hard to manage.

In 1992, the RBS sent in accountant Coopers & Lybrand, which demanded a restructuring. Founding partner, David Deacon, was sidelined, but later issued writs against his old firm, which was refounded on 1 December 1992.

Difficulties at the start of the decade were compounded over time. One former partner claims that checks on files in the week before the collapse revealed u100,000 in unclaimed disbursements. “It just got out of hand. The sheer volume of cases meant it was easy for things to be missed,” he says.

Macfarlane, who says his attention has so far been fixed on sorting out client matters, can now shed further light on the problems. “It would be quite wrong to single out one factor responsible for what happened,” he says.

Instead he points to a fatal combination of over-expansion, the high cost of professional indemnity, acrimonious litigation and the demands of franchising.

“None of us were from rich backgrounds so the firm was built on borrowing,” says Macfarlane. But he does not blame the banks, insisting that RBS did more to help than the other creditors and genuinely attempted to find a solution.

With the benefit of hindsight, Macfarlane believes the difficulties can be traced back as far as 1987 when the firm embarked on a huge commercial litigation case. It was a success but it only served to mask the firm's vulnerability – covering up cracks which were to grow significantly. He adds that the accompanying diversification into the commercial arena was a costly mistake.

Urgent steps were taken to stop the rot with the dissolution of the practice in 1992, but the radical changes only added to the costs. Between 1992 and 1994 nearly u200,000 was taken out of the partnership in legal fees, accountancy fees and specialised bank charges.

“The necklace of debt adorning the old practice was dragging the new practice back as it tried to make improvements,” says Macfarlane.

Nor could franchising help. The path to prosperity through efficiency savings, proved to be yet another financial drain on the practice which had little capital to spare. Its application was turned down after its financial troubles came to light.

Problems were exacerbated with two separate cases of staff plundering client accounts. Assistant Paul Edwards was stealing funds to pay back debts to his former employer. Salaried partner Celia Crofts was also caught out. For each case, the partners were forced to fork out for the excess payment under the firm's indemnity cover. Macfarlane feels aggrieved because he believes there was nothing more the firm could have done to prevent the money from being taken and no major claims had been made against the firm for years.

These additional set-backs hit the firm at a time of continued over-borrowing, but a trade-down did not fit in with its vision of being a model legal aid practice. DGG remained hell-bent on expansion to the end. In September this year, six new trainees were taken on.

The firm's collapse, as well as raising issues about how practices are managed, has also prompted criticism of the Law Society's handling of major insolvencies. One ex-partner hit out at the society's inertia in responding to the firm's initial request for an intervention. DGG alerted the society on 21 October, but it was not until 26 October that a representative was sent to Liverpool following an emergency meeting of the adjudication and appeals committee the previous day. Firms which took over offices later complained of long delays before files were transferred.

But Macfarlane's chief concern is that the SCB effectively blocked Deacons' attempts to appoint a receiver for seven days. The bureau insists that it has no powers to stop a firm calling in a receiver, but Macfarlane says it was “too risky” to proceed without the SCB's sanction. The danger of pressing ahead without the bureau's backing was that a full intervention would be affected which DGG believed would be against the interests of the firm and its clients. When the proposal was made, the SCB insisted on taking legal advice and it was a week before the go-ahead was given, Macfarlane says.

A spokeswoman for the SCB says: “It was the firm's prerogative as to when and if they wanted to appoint a receiver. Everything was happening at fast-track pace and we acted as soon as possible.”

Andrew Holroyd, president of Liverpool Law Society, praises the DGG teams which he says helped to ensure that problems encountered by clients were kept to a minimum. Many ex-DGG lawyers turned up at court the day after the closure to fill the breach.

The full force of what happened can only really be appreciated by those who now face bankruptcy. The prospects for salaried partners remain unclear, but the uncertainty of their plight brings home the horror of the situation.

As one of their number, Roger Williams, told the local press days after the collapse: “I'm just a glorified employee – just one of the poor bloody infantry. Maybe I should have asked a few more questions.”