‘Cash is king’, the practice management mantra for firms in the downturn, is sadly more honoured in the breach than in the observance. The collapse last month of Key Business Finance (KBF), the specialist solicitors’ lending arm of the failed Icelandic bank Landsbanki, is a case in point.
Around one in ten solicitors’ practices in the UK was a recipient of short-term loans from the failed bank, typically helping tide them over for practising certificate fees, insurance premiums and VAT. ‘The number of firms that would have used our product in any 12-month period would have been in excess of 1,000 and in 2008 we would have certainly advanced in excess of £200m,’ reckons KBF’s managing director Nick Sanders. ‘We had already achieved £180m at the time the administration came about.’
Some commentators are uneasy about the profession’s apparent dependency on funds from an Icelandic bank in the first place. KBF used cash from Heritable Bank, a UK subsidiary of Landsbanki, which collapsed and was nationalised by Iceland’s government on 7 October.
‘I’m always concerned where lenders have an apparently good relationship with a bank and then go off and borrow from someone else,’ says a contact at one of the high street banks, who did not wish to be named. ‘It suggests they don’t want us to know about it.’
Legal management consultant Simon Young takes a more pragmatic line. For most practitioners, such arrangements are ‘a cashflow convenience rather than an absolute essential’. He explains: ‘It’s a fairly specialist market. It’s convenient because it is off-balance sheet and short-term. They are usually very easy to set up and they do not look for security. It is a handy cashflow expedience.’
The departure of KBF, which served the profession for 20 years, leaves a sizeable hole in the finances of many a firm. Sanders stresses that KBF’s problems were caused by Heritable, its one source of credit, and stem directly from the credit crisis. ‘It is only in the last three years that KBF has been part of Heritable,’ he explains. ‘The reality was that it has been a very successful and profitable business. The only reason it found itself in administration was to do with the banking crisis.’
Bruce Mackay, a restructuring partner at accountancy firm Baker Tilly, notes that KBF going into administration is not necessarily a problem for its clients. ‘I would be very surprised if KBF’s administrators were looking to do anything other than keep the book together in the hope of selling it,’ he says. ‘Any prospect of the business fragmenting or loans being called up would probably be counter-productive. It is the continuity of the revenue that provides the value.’
Sanders reports that a number of ‘interested parties’ have been looking at the business but so far ‘negotiations have not proven to be successful’. At press time, KBF’s management team was trying to reinstate the business back to its proprietorial independence of three years ago.
Mackay adds that, were it not for the economy, there would ‘probably be a queue of people wanting to buy a business like this', but admits that the ‘queue might be fairly short at the moment’.
Credit burdenBarclays is looking to establish a new facility to ease the present credit burdens of firms. ‘We’ve had significantly more interest in this area and we are looking to do something to meet that demand in the short term,’ says Nick Anthony, head of the professionals and public sector services team at Barclays Commercial Bank.
‘Until recently, KBF had been doing a good job providing credit and we had not competed in that market,’ explains Anthony. ‘The issue for us is providing support for law firms. If we are serious about being industry specialists and supporting the sector we need a full range of products.’ Anthony adds that he ‘could not and would not guarantee that we would provide loans for every firm that KBF lent to. They did it on a very different basis'.
Trisha Healy, managing director of brokerage Fidelis Professional, which was set up eight years ago and deals mainly with law firms, unsurprisingly sees the market leader’s disappearance as an opportunity.
‘As far as law firms are concerned, they need to understand there are other lenders out there,’ she says. But Healy predicts conditions will harden for firms looking for credit. ‘Everything has changed,’ she says. ‘You are looking for a lot more information to get your client the facility they need. A lender that was providing £200m is no longer there and that’s a significant amount of money.’
Healy says Fidelis was modelled on KBF. ‘I built my business around what KBF were doing, particularly before it was bought by Heritable,’ she says. But she is quick to make one distinction: Fidelis has ‘a good portfolio of seven lenders’, she says.
Bankers are increasingly becoming fair-weather friends, says Tony Williams, founder of management consultancy Jomati and a former Clifford Chance managing partner. ‘Firms are much more anxious and, certainly at the smaller end of the market, there has been a massive squeezing of credit. If you want credit because you cannot manage your work-in-progress (WIP), or for partner distributions, tough luck. Terms have quite significantly hardened. Banks are wanting arrangement fees and much higher margins over base are being charged, and so even if interest rates come down it won't help firms dramatically.’
But that is not everyone’s experience. Young says he spoke with ‘a fairly senior commercial bank manager from one of the mainstream banks’, with unexpected results: ‘His comments surprised me. They haven’t changed their lending criteria or received instructions from head office to do so. It is not a case of them being told: "Thou shalt not lend to law firms".’
That seems borne out by the experience of the bigger players, too. David Thornbury, senior credit officer at Citi Private Bank’s law firm group, deals with mainly top-25 firms. He reports a 26% increase in the take-up of overdraft facilities over the last year. ‘The economic cycle turning the way that it is means clients are taking longer to settle invoices and working capital is being constrained. So firms are using their overdraft facilities to a greater extent,’ he says.
Thornbury does not believe this is an indication of any underlying problem. ‘We are comfortable with the way firms are using facilities and don’t anticipate firms have any difficulty in repaying the outstanding amounts.’ He insists Citi is operating in ‘a business-as-usual environment and we haven’t changed our underwriting criteria’.
Williams's prognosis for the next 18 months is fairly grim, but he stresses this is consistent with a long-standing analysis (see Gazette [2007] 21 June, 12). ‘People called us party poopers then,’ he says.
‘The brutal fact is, when you look at a firm’s outgoings they are pretty fixed,’ he says. ‘They do not change much through the year and you only need income to be cut by a relatively small amount and you go very rapidly into not just lower profits, but losses.’
Williams is not convinced that the Solicitors Regulation Authority ‘yet appreciates the scale of the difficulties faced at the smaller end of the market’.
‘I think that we could well have 2,000 or 3,000 firms that just disappear over the next couple of years,’ he says, and ‘quite a number of these will be as a result of SRA interventions’. He adds: ‘When people get desperate, the last line of defence is always the client account, unfortunately.’
Unsurprisingly, the banking crisis has precipitated a deluge of phone calls from anxious clients wanting to know about the security of their money in solicitors’ client accounts, such as deposits on houses, compensation awards and money from legacies. According to the accountancy firm BDO Stoy Hayward, solicitors hold around £1bn in client deposits. The Law Society reckons the figure could be as high as £3bn.
Protecting clients‘The message for clients is – and it would be sensible for solicitors to give clients this message – that they are no more protected because the fund is in a solicitor's account than if it were in their own bank accounts,’ says Mark Stobbs, director of legal policy at the Law Society. Under the Financial Services Compensation Scheme (FSCS), large businesses receive no protection for money lost in the event of a bank collapse, whereas small firms (turnover smaller than £6.5m and no more than 50 employees) and private individuals receive a maximum cover of £50,000.
Stobbs says it is the ‘understanding of the Law Society’ that if a bank account is held by a solicitor on behalf of a client and the bank goes bust, ‘it is going to be the client’s problem rather than the solicitor’s. This is more a matter for the financial regulators’. The FSCS has said as long as the solicitor had informed their bank they were depositing money from multiple clients into a single account, each client would benefit from the maximum £50,000 protection.
‘I do not see why solicitors should not disclose to clients where an account is held,’ Stobbs says. ‘It has to be good client care. At the moment, as we understand it, the £50,000 guarantee applies to all the money held on behalf of that client in the bank. So, if the client has an account at the same bank as the firm, any compensation would be reduced by whatever was in the solicitor’s client account.’ It is also crucial for solicitors to have a clear audit trail, Stobbs advises. ‘We think that that might be an issue where the solicitors split client money between different banks. It would be very prudent for solicitors to have ways of establishing which client’s money is in which account.’ The Law Society is presently seeking further clearance from the FSCS on that point.
So how do firms weather the storm? Cash is king, replies Williams. He insists firms with good cash balances and relatively low debt, ‘accompanied by almost obsessive control of WIP and debtors, can survive and flourish in these turbulent times’. ‘WIP and debtors are not cash in the bank, and some will never be,’ Williams says. ‘Bankers want their money back and any available borrowing is much more expensive.’
A build-up of WIP and debtors is always bad in the professions ‘because professional people just aren’t very good at talking to their clients about money’, says Robert Mowbray, principal at accountancy firm MacIntyre Hudson. Mowbray delivered the Law Society’s Law Management Section ‘Facing the credit crunch’ webinar, available on the section’s website. ‘Looking after the cash is really crucial,’ agrees Anthony at Barclays. Every partner should demonstrate ‘a personal commitment to regular billing and taking ownership of the collection process’, he says. Many partners ‘still do not seem to get the linkage between billing/collection and the cash position of the firm’, he insists, nor do they recognise ‘the impact of their own individual and collective contribution to the indebtedness of the firm.
‘Businesses, including law firms, get into trouble because they run out of cash – and I have seen it already in the market.’
So how do clients improve cashflow? Mowbray says: ‘I am talking to clients about whether they can receive money up-front; in some other jurisdictions that is more common. Also, whether firms can become better at interim billing, rather than waiting until the end, and whether they can tighten up on their credit control.’
George Bull, head of Baker Tilly’s professional practices group, advises firms to ‘bill properly and, where you can, bill on account and avoid giving special terms to any clients, because that means you cannot control your debt collection’. He also calls on firms to have an organised approach to debt collection. ‘It is often best if debt collection isn’t at the discretion, or in the hands of, partners. A specialised credit control function works really well within the firm.’
There is no excuse now to lack the information needed to roll with the punches, says Mowbray. ‘When this happened 15 years ago a lot of firms went to the wall because there was no information, whereas this time around there is no excuse. Firms should know exactly where they stand and what they need to do.’
But this does not seem to be happening. There are ‘probably more law firms now being looked after in banks’ intensive care departments than there have been for a very long time’, says Bull. It was recently reported in the legal press that around 500 firms were in these ‘intensive care units’.
It was also claimed that 21 of the UK’s top 150 firms were in Barclays’ ‘business banking support’, but Anthony denies this: ‘That’s simply not true. At the very most there is a small handful,’ he says.
Mowbray says that ‘if a firm is going to survive and a bank is going to support them through that period’ they will need a persuasive business plan. ‘A lot of smaller firms might have an annual budget but none of them really have credible medium- to long-term business plans,’ he says.
‘If the lender is now saying "show me where your future is" I think a lot of them would struggle.’ It is ‘imperative to keep doing cashflow forecasts and be honest with banks, not mislead them, and to focus very, very heavily on cash control. Profit is a secondary thing and running out of cash is the real problem’, he says.
Young agrees. Forecasting is vital, he says, but law firm financial forecasting is ‘very weak and firms’ management information and accounting systems often don’t provide any help’.
‘Unless firms recognise where the peaks and troughs of the cashflow are going to be, they can be hit by horrible spikes that come together.’ As he says, the next few months will be tight 'because there are several hits such as PI, practising certificates, and a dead couple of months of cashflow over Christmas and New Year’.
Sensible firms should be making cashflow forecasts on a fortnightly basis, says Mowbray, ‘planning three to six months ahead just to make sure that, if there is a problem, they can talk to the banks now, rather than at the 11th hour’.
Navigating minefields by mitigating risk
The Law Society has updated its interim advice on mitigating any risk of liability for client accounts in the event of a banking collapse. ‘Recent unprecedented events have put strong pressure on the undertakings you give,’ says Law Society President Paul Marsh. ‘We are in uncharted territory. However, it's vital that the value of solicitors’ work is not diluted, and that you can continue to act in the best interests of your clients. The Society is discussing these pressing issues with the Financial Services Compensation Scheme.' See www.lawsociety.org.uk/bankingcrisis for details of the changes and to check for further updates.
There are also words from the Society specifically for conveyancers: ‘Without solicitors, clients cannot move from house to house on the same day. This is our unique selling point in the market and the Society's focus is on preserving this role. So while your liability for undertakings is of clear concern, it is important not to overreact, particularly in light of government statements of support for depositors. Solicitors may wish to review where they hold clients' money, but it would be disastrous to threaten the strength of our undertakings in conveyancing transactions, and so undermine our status as the linchpin of the property market.’
Jon Robins is a freelance journalist
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