Law firms that are looking to buy, merge or otherwise acquire a firm should always proceed with care. The potential impact on your Professional Indemnity Insurance (PII) is a major consideration.
Many law firms are struggling as a result of the fallout from the pandemic and increasing PII costs. They need to find a solution or a way to exit the profession. Others have had enough of dealing with the ever increasing regulation and compliance, managing employees and the various concerns of running a business. They want to join another firm that will take over their responsibilities, releasing them to get back to fee earning and 'the law'.
At the other end of the spectrum there are firms that are looking to grow and develop. The above scenarios present opportunities for them. However, while you might see significant advantages in an opportunity, do not discount the potential pitfalls and a consideration of the PII position should be high on the agenda of issues to consider. Proceeding with a merger or acquisition that jeopardises your PII could be fatal. Always remember – no PII, no practice.
Successor Practice or run-off cover?
The most important question from a professional indemnity perspective is whether you are going to become a 'Successor Practice' and be responsible for claims against the acquired firm, or whether they are going to take elective run-off cover under their existing PII policy.
When addressing this issue you need to consider the definition of Successor Practice in the SRA’s Minimum Terms and Conditions (MTCs). It is not straight forward and sometimes the definition will deliver a result that you had not expected. The rules are well understood by specialist brokers and insurers in the solicitors’ PII market, who you can turn to for guidance and there are solicitors with expertise to advise on more complex scenarios. The answer to whether there is a succession is always very 'fact specific', so you should ensure that you are able to give a clear outline of what is proposed when you take advice. Some of the more important issues to keep in mind are as follows:
- If you do not want to become a Successor Practice with responsibility for future claims against the firm you are acquiring, then a fail-safe solution is for that firm to purchase elective run-off cover – even if you assist them to fund this. It is important to ensure that the premium for elective run-off is paid before the merger or acquisition. This is essential or the election will fail. Once payment is made and the cover is confirmed, you can relax in the knowledge that you are not going to become embroiled in a Successor Practice argument.
- It is important to note that as from 1 October 2022 it is intended that SIF will no longer provide the free run-off extension at the end of the six year run-off cover provided by insurers. The wording of the MTCs (and in particular the glossary definition of 'Prior Practice') currently ensures that the liability does not revert to the acquiring firm at the end of the run-off period. However, for clarity and to avoid assuming any contractual obligation, it would be prudent to make this clear in any negotiations or documentation regarding the acquisition.
- If you are acquiring a sole practitioner and the sole practitioner is joining your firm then, unless run-off cover is purchased in advance of the acquisition, or another SRA - regulated practice holds itself out as Successor Practice (which is unlikely), you cannot avoid becoming the Successor Practice. Even if the sole practitioner joins your firm as an employed solicitor or a consultant, you will still be the Successor Practice. This has caught many firms out over the years.
- If a firm that is a partnership ceases and the majority of the partners are joining your firm as principals, then you will automatically be the Successor Practice, unless elective run-off is purchased by the partnership prior to the principals joining your firm.
- If you are acquiring a firm that is a limited liability partnership or an incorporated practice, then a succession will only occur if either the LLP or the limited company becomes a principal in the acquiring practice, or if the acquiring firm holds itself out as the Successor Practice.
- If you are acquiring principals or files from an LLP or incorporated practice that is ceasing and you want to avoid becoming a Successor Practice, then it is critical that you do not do anything that could be considered as 'holding out' unless run-off has been purchased prior to the cessation.
- 'Holding out' is where things can go very wrong unless run-off has been purchased and paid for prior to the cessation. If you want to avoid 'holding out' then the detail is important and everyone in the firm needs to be fully briefed including reception and support staff. There must be no reference to 'having taken a firm over' in correspondence, documentation, external or client meetings or telephone communication. Letterhead, the website or signage referring to your firm as 'incorporating' the other practice will see insurers from the former firm argue there has been a succession and they are not obliged to provide run-off cover. This is an argument insurers are very keen to pursue if the former firm is insolvent and cannot afford to pay for run-off cover, or if they have a poor claims history with further notifications expected. We encourage firms to take advice on this issue to ensure that they have a clear plan of what they need to do – and that this is shared with everyone in the firm. Even a careless tweet could cause you problems – and do not underestimate the potential for the insurer of the former practice to make a 'mystery shopping call' to test whether or not your firm is 'holding out'.
- You can have more than one Successor Practice to a firm. This will occur where, for example, two firms have held themselves out as being the successor to a particular practice, or where a four partner firm ceases with two partners going to one firm and two going to a different firm. Each Successor Practice succeeds to the whole of the firm – you will each be 50% liable for all claims. We have seen scenarios where the successor firms agree to each take responsibility for claims arising from different areas of practice within a firm, but this is a separate 'commercial arrangement' that would need to be separately agreed with the insurers of both firms and the consent of the SRA would need to be obtained.
- If you are acquiring the majority of partners from a firm that is a partnership in the expectation that their old firm will continue and you will not be a Successor Practice, then you must still beware. The potential departure of top fee earners can cause those who will be remaining in the firm to review their position. If the announcement of a departure causes the existing firm to implode and the remaining partner(s) shut the doors on the day that the partners you are taking into your practice leave the firm – then you will be the Successor Practice. Do not discount the potential for this scenario.
- Once a Successor Practice always a Successor Practice. If the merger does not work out and you agree to go your separate ways, you cannot rewrite history. If you are the successor then you will retain responsibility for all the future claims (arising from past work) of the firm you succeeded to. The practice that was succeeded to will need to apply to the SRA as a new firm, but it will have a 'clean slate' as far as past liabilities are concerned.
Discussions with your PII broker and insurers
Remember that your PII broker acts for you – they are on your side. Do not delay talking to them about your plans, the possible application of the Successor Practice rules, the information that your insurer will want and your insurer’s potential view of the proposal. Will the profile of the firm still fall within your insurer’s appetite and underwriting criteria? What additional premium will they charge and what will their position be on renewal? Are there any 'show stoppers' from their perspective and will there be any changes as far as the self-insured excess and limit of indemnity is concerned?
If you carry excess layer PII (sometimes referred to as 'top-up cover'), you will also need to consider if you want this to be endorsed to provide cover for the acquired firm’s activities. If you do, then your broker will likewise need to liaise with those insurers.
Brokers understand that the merger and acquisition discussions are sensitive and confidential. They are used to dealing with this scenario and you should never be deterred from taking them into your circle of confidence.
Due diligence is critical. Sometimes firms are not sufficiently thorough or considered in their approach. Many leave it until the last minute, or proceed on the basis that everything will be fine because they have known the partners in the firm for years 'and they have lots of great clients'. In contrast you should always heed the advice you would give your own client in this situation – undertake your due diligence carefully and thoroughly.
The following list is by no means exhaustive, but it does detail some of the more important areas to investigate and includes information that insurers will also want to see:
- Previously completed PII proposal forms
- Work split
- Claims history
- Details of prior practices and their claims histories
- Complaints history
- SRA/Disciplinary issues
- Compliance with SRA Accounts Rules
- Approach to risk management including systems used and accreditations
- Financial management (e.g. profitability, level of bad debt, unbilled work in progress)
- Financial commitments (e.g. premises)
- Principals and staff to be integrated and any potential HR issues
- Compatibility of IT systems
In conclusion, be cautious and always take advice.
Jenny Screech LLB(Hons)
Howden Insurance Brokers Limited