The implementation of the Legal Services Act in October 2011 has brought a significant wave of changes and challenges to the legal profession, which is only just starting to be felt by law firms.

Law firms are facing several challenges and opportunities: new regulatory structures for legal services, a new independent ombudsman service to deal with consumer complaints, and the introduction of new forms of legal practice, such as legal disciplinary practices, multidisciplinary practices and alternative business structures.

However, coinciding with this period of change, law firms are still facing turbulent times as the recession continues to bite.

The current economic climate has led to a rise in the number of law firms facing financial difficulties and even closing; mergers are very much at the forefront of the minds of law firm leaders. Rising costs, a lack of work, drops in profits have hit many firms; even the historically low interest rates - normally a good thing - have meant that firms are not earning as much interest on their client accounts as they used to. The consequence is that some firms are struggling to support partner drawings out of shrinking profits.

How are law firms dealing with these problems? Some have acted as soon as they recognise they have a problem; they have sought professional advice in order to resolve their financial plight. However, there are also many firms who have ‘buried their heads in the sand’; they have delayed acting, or done little or nothing to resolve, or at least alleviate, their financial problems. These zombie firms are sleepwalking to disaster.

For those firms who are losing money and struggling to stay operational, insolvency is a real possibility and doing nothing is no longer an option. The issue of monitoring and managing finances is of growing concern for law firms.

Particular attention must be paid to Outcome 10.3 of the Solicitors Regulation Authority Code of Conduct, which came into force on 6 October 2011. This clearly states that law firms must promptly notify the SRA of any 'serious financial difficulty'. However, the SRA does not define or clarify what 'financial difficulty' actually means. This has created a grey area. It could be argued that a firm is in this financial difficulty if it cannot pay its staff or suppliers, or perhaps if it enters a "time to pay" agreement with HM Revenue & Customs, or even if its bank account is overdrawn or the firm is given special watch status by the bank. It could be any or all of these things. It is essential that the SRA clarifies this at the earliest opportunity.

In order to manage risk, the SRA Authorisation Rules 2011 contain an obligation for all law firms (except in-house legal advisers) to appoint compliance officers: a compliance office for legal practice (COLP) and for finance and administration (COFA). However, this requirement is not without its grey areas too. For example, should the COLP, the COFA, or the partners be responsible for monitoring and reporting the firm’s financial position to the SRA? From my understanding, the COFA is responsible for ensuring adherence to the Solicitors Accounts Rules, and the COLP must ensure that the firm complies with the SRA’s regulatory requirements (and reports any breaches of these requirements).

Prior to the introduction of Outcome 10.3, insolvency professionals and the struggling law firm would sit down and explore the restructuring options together. If, after assessing all the available options, bankruptcy cannot be avoided, the insolvency practitioner would then notify the SRA. However, under Outcome 10.3, the SRA would probably have to be notified at the outset of the process.

If a firm is in financial difficulty, the SRA can be notified of this through its helpline. However, it is not a dedicated helpline for distressed businesses. It would very helpful if this changed and the SRA created a team who could exclusively deal with these calls.

Without doubt, distressed firms should be encouraged to notify the SRA of any problems at the earliest opportunity, so that all options can be explored. However, it is important that certain issues are addressed in any notification made to the SRA, pursuant to Outcome 10.3.

This may include the holding of money owed to untraceable clients; contractual arrangements between the distressed firm and any acquiring firm; the storage of client files; the forwarding of post and other communications; updating clients on developments; providing details of any outstanding undertakings; and whether any solicitors within the firm intend to practise in the future.

The SRA has confirmed that just because a firm has reported a financial difficulty it does not mean that immediate intervention is inevitable. The SRA will try and assist firms in finding a solution. When intervention is necessary, the SRA has confirmed that the average cost of intervention over the past three years has been £30,000 per partner/member. However, it has also said that it does not automatically take the view that costs are payable by individuals, as opposed to the firm, although there are circumstances when they are. Costs are often joint and several between the firm and individuals.

The overall message coming from the SRA is that intervention is a last resort.

If a distressed firm is heading for insolvency, there are usually three options: Company/Partnership Voluntary Arrangement, administration or liquidation. It is possible to sell a law firm whilst it is in administration if there is a solicitor licensed insolvency practitioner (SLIP), but this is an unattractive option, as the SLIP will arguably become liable for all former breaches of undertakings of the law firm and insurance companies are reluctant to provide cover to SLIPs in such circumstances. Consequently, more law firms will have to be sold through pre-packaged administrations.

These restrictions placed on law firms in administration limit the insolvency options available. The liquidation of an LLP can also be an unattractive option to its members because the liquidator, under the provisions in section 214A of the Insolvency Act 1986, can investigate and, if necessary, reclaim any excessive withdrawals made from the LLP.

Further clarification from the SRA on some of these issues raised is required.

Christina Fitzgerald is a partner, a solicitor licensed insolvency practitioner and head of the professional practices group at Matthew Arnold & Baldwin LLP