Challinors reported to SRA as second client claims he lent firm £400k

A client of financially-strapped Midlands firm Challinors has complained to the solicitors’ professional watchdog after it emerged he could lose some £400,000 loaned to the partners over the last two years – in a move that has fuelled calls for the authorities to intervene in the practice.

Solihull-based businessman Dharmendar Khag claims he gave the partnership two loans in equal tranches of £200,000, with the funds broadly aimed at providing working capital for the firm.

However, Khag – who runs a chain of seven Subway sandwich bar franchises in the Birmingham area – claims the firm breached professional conduct rules by failing to inform him that he should be independently legally advised regarding the terms of the loans and their repayments.

Challinors announced last week that it had appointed administrators KSA Group owing to “financial difficulties” and that ultimately it was looking to sell the practice (24 July 2013).

It is understood that the firm owes more than £11 million, with back rent on Birmingham offices racking up nearly £213,000 and West Bromwich property investment services business Real Estate Investors owed more than £350,000.

Khag is the second client to take action against Challinors in recent weeks.

Some 10 days ago, Derbyshire games designer Cosmic Concepts claimed it had loaned £250,000 to the firm at the beginning of the year to pay a VAT bill, only to receive a letter earlier this month from administrators informing the company that it was unlikely to be repaid in full (18 July 2013).

Khag made his first loan in July 2011 and produced a second tranche in February of last year. He was initially satisfied with the arrangement as the firm met monthly interest payments without difficulty.

However, by last February, the partners allegedly asked for the full repayment of the loan to be delayed. Khag agreed, stipulating that the extended repayment terms were contingent on the firm informing him of any prospective material changes to the practice.

At that stage, the partners allegedly told him they were in the process of discussing external investment with a private equity house specialising in law firm alternative business structures.

The extended full repayment date was set for this month, but, alleges Khag, “by the middle of June, I’d heard nothing form the partners. The next communication I had was from the administrators. I immediately instructed lawyers and they wrote to the partners and to KSA asking for the loan to be redeemed. We’ve heard nothing from either of them.”

Specialist partnership lawyers point out that law firms should always point clients towards separate legal advice when entering into loan agreements.

“If a law firm is doing a commercial deal with a client,” commented London-based partnership expert solicitor Ronnie Fox, “then general ethical principles stipulate that you have to tell the client to take separate legal advice. On first principles, whenever a lawyer does any sort of transaction with a client other than supplying legal services, he ought to tell the client to be separately advised.”

Indeed, the Solicitors Code of Conduct stipulates that law firms are prohibited from “lending to or borrowing from a client, unless the client has obtained independent legal advice”.

The development has reignited calls for the Solicitors Regulation Authority to intervene in Challinors. So far, the authority has maintained there is no need, as in its view clients are not at risk.

But there is an increasing tide of disagreement. “I can’t work out how the SRA can be so confident that there is no risk to clients in this case,” commented Fox. “The risk is not just in relation to money in the client account, it is also in relation to the completion of jobs. If a lawyer is halfway through a job, and the firm goes into administration, how do you know that the solicitor that has been dealing with the file is going to be there on Monday morning?”

Former client Khag said: “I’d like to see the SRA intervene in the practice and close down the firm.”

However, the authority today continued to decline to address specifics around Challinors, with a spokesman saying: “We would not discuss whether or not we are considering decisions to close a firm. Also, we don’t normally confirm or deny if we have received a complaint about a firm, it’s only if disciplinary action becomes necessary that it becomes a matter of public record.”

The spokesman continued: “Intervening into a firm because of financial instability is something we do only when all other options have been exhausted. It is without question in the clients’ best interests if, through constructive engagement, we can either help the firm wind down in an orderly manner, or provide assistance that keeps the firm solvent and trading while it explores other options.”

Challinors partners were unavailable for comment.