By Peter Garry, Cripps Harries Hall, Tunbridge Wells


Sale of an insolvent law firm



Partners of an insolvent law firm cannot continue to practise indefinitely. Leaving aside that they should not trade while insolvent, their creditors will eventually reel them in. If they are made bankrupt, their practising certificates will be suspended. If they enter into individual voluntary arrangements (IVAs), they will probably not be permitted to continue running their own firm.



To avoid bankruptcy, the partners will need to persuade the required 75% by value of creditors to vote in favour of their IVAs. One option for the partners is to find a purchaser for the assets of the firm, while it is still a going concern, with a view to delivering the proceeds to creditors via an insolvency practitioner, in return for the creditors supporting their IVAs.



The attraction for a purchaser

Just because a firm is in a position of insolvency, this does not mean that its business and goodwill are worthless. It may be burdened with historic debt, overstaffed, offering some services unprofitably, recording time and billing inefficiently, failing to collect bills, and/or may have suffered some catastrophic event. A purchaser will be able to buy assets free of all indebtedness. If he perceives that other core problems can be eliminated, reduced or left behind, he may be willing to pay more than a rock-bottom price.



He should, however, seek a heavily discounted price, because:

l As creditors circle, the timetable may be very tight and there may be no alternative purchaser;

l When a firm ceases to trade, work in progress and debtors may in practice be difficult to recover. For a vendor, reasonable value realised at a 'fire sale' price is better than little or no value realised on a cessation. There may be a further discount to reflect the purchaser's efforts in effecting collections. Payment may be deferred until after, and be conditional upon, billing of the work in progress and collection of the debtors;

l There are uncertainties inherent in any transfer of goodwill, no matter how the process is presented to clients, more so when insolvency is involved. A purchaser may be able to negotiate a price to be determined over time by reference to future turnover;

l Any such agreement to buy now and pay later reduces not only the purchaser's risk, but also his financing costs;

l Without an ongoing practice, leases and staff cease to be assets and become liabilities. A purchaser may be willing to employ existing staff and/or to take assignments of leases of premises where they work. In an administrator sale, the employment obligations imposed by the TUPE regulations are not as strict as on a normal transfer of an undertaking. With the agreement of employees, it is permissible to reduce their remuneration or fix other inferior terms of employment. The National Insurance Fund will pay pre-existing debts owed to employees, and redundancy to those whom the purchaser decides not to re-employ. The purchaser may wish to take on key and/or support staff to preserve goodwill. If the buyer takes on staff and/or leases, the overall indebtedness of the partners is reduced, making it easier for them to agree IVAs with creditors (by enabling them to offer a higher dividend and/or to reduce third-party contributions). These benefits to partners (and creditors) may be reflected in a further price reduction. A buyer may thus receive a credit for acquiring staff and premises that he might have required anyway in due course; and

l On any sale of the business of a firm of solicitors, succession for professional indemnity insurance purposes may well occur, pursuant to the Law Society's minimum terms and conditions. Succession is beneficial to the insolvent firm and its creditors, as otherwise the firm will be liable for an insurance premium for compulsory, automatic run-off cover. Succession passes on to the purchaser the responsibility for insuring against future claims arising out of the past negligence of the purchased firm, thus increasing the purchaser's premiums for a number of years. This effect can to some extent be mitigated if succession occurs in the early part of the indemnity year because the benefit of the remainder of the policy will pass automatically to the purchaser. A purchaser should consider these potential gains and losses and negotiate accordingly.



The insolvency regime

By virtue of the Insolvent Partnerships Order 1994, much of the insolvency regime applicable to companies is also applicable to partnerships and limited liability partnerships. An intending buyer who is aware of the firm's difficulties should not buy the firm from the partners, even if no winding-up or bankruptcy petitions have been presented. To do so risks an application by any subsequent liquidator or trustees-in-bankruptcy, seeking to set aside the transaction, or extract a higher price, on the grounds that inadequate consideration had been paid. Equally, after presentation of one or more petitions, unless approved by the court, all transactions (other than administrator sales - see below) will be void if a winding-up or bankruptcy order is then made.



If an administrator sale has not been achieved before a winding-up or bankruptcy order is made, the practice will cease. By the time of appointment of a liquidator or trustee-in-bankruptcy, it will probably be next to worthless.



Administration

The only way in which a purchaser in these circumstances can acquire unassailable title to a worthwhile asset is through an administration of the firm before a winding-up or bankruptcy order is made.



While an early administration is advisable, a number of issues may arise:

l Few, if any, insolvency practitioners will want to trade a firm of solicitors, even for a short period. To do so, the appointee would have to be a solicitor.



The compulsory addition of 'in administration' to the name of the firm would do nothing for the value of the goodwill;

l Accordingly, all parties will wish the proposed administrator to be in control of the firm only for long enough to sign his name on the sale and purchase agreement. Best practice is to set up automatic completion of the sale on entry into administration, so that the administrator is in control of the firm for only a notional blink of the eye. But, to achieve this, all of the terms of sale have to be agreed in advance of commencement of the administration.



The partners may not wish to appoint an administrator until they are satisfied that their major creditors are content with the proposed sale terms, and will support their IVAs;

l The four-way dialogue that ensues between proposed administrator, proposed purchaser, partners and creditors puts the creditors on notice of the proposed administration. They will know that once an administration notice has been filed in court, they will lose the ability to present a winding-up petition, and will have little or no further influence over the sale terms;

l Thus, creditors may present a winding-up petition earlier rather than later, especially if they sense that the intending purchaser is beating down the price. By presenting (or supporting) a petition, prior to an administration notice being filed, they ensure that an administration can only be commenced by an application to the court, and that accordingly they will receive notice of the hearing of the application, and can be heard in opposition. Advertisement of a winding-up petition may be the beginning of the end for the firm and its goodwill. Some creditors (especially HM Revenue & Customs, which may act on principle) may be prepared to run that risk to bring pressure to bear on the parties to reach a resolution and/or to show their resolve to achieve the price that they consider to be appropriate.



A race ensues to negotiate terms and commence an administration as soon as possible, before winding-up or bankruptcy petitions are heard.