Why SRA warning is essential reading

The Solicitors Regulation Authority recently issued a warning notice on mergers, acquisitions and sales of law firms. It underlines key considerations for firms that are merging, or acquiring other practices, including in distress scenarios. Relevant parts of the Standards and Regulations are highlighted, and acting in clients’ best interests is the central message. It is essential reading for law firms considering any form of combination, which in the current market of uncertainty and market consolidation is surely almost all firms. 

The warning notice is part of the SRA’s response to the recent Axiom Ince intervention and collapse of SSB Law. The SRA has faced criticism and that looks set to continue as the profession is expecting practising certificate costs and compensation fund contributions to increase.  

The concerns identified include that some firms are prioritising commercial/strategic factors ahead of the interests of clients. For example, a ‘selling firm’ in financial difficulty may merge with a ‘white knight’ acquiring firm, having conducted insufficient due diligence about whether it has the systems, processes and competence to act in their clients’ best interests. Conversely, an acquiring firm may want to diversify into a new practice area and take on a large volume of cases from a new firm without being able to deal with the substantial amount of work required, both before the merger (including obtaining informed consent from clients) and then post-merger (including identifying urgent matters).

The SRA wants firms in financial difficulty to engage with it, to avoid a situation where the SRA is only given short notice of an acquisition, preventing it from exercising adequate oversight. Enforcement action may be taken against firms and/or individuals whose conduct puts client money/files and so on at risk. This could include intervening in firms and/or individual practices, as well as disciplinary action in the Solicitors Disciplinary Tribunal. The SRA has previously fined two firms which shared confidential information without client consent during a merger. This concern often arises in practice when firms are planning a merger and are considering how to undertake due diligence, including file audits, check conflicts and secure a safe home for archived client files.

The warning notice makes clear that there is a basis for action to be taken against firms/individuals who, without acting dishonestly or in bad faith, fail to have appropriate regard for client interests during a merger/acquisition. The SRA has always been clear about the need to maintain proper written records, for example that clients’ interests were at the forefront during decision-making. This is yet another example of where those records would offer vital protection. Individuals will also be mindful that an SRA intervention can represent an erosion of limited liability for LLP members or company shareholders who derive comfort from operating through a limited liability vehicle: intervention costs can be charged to individual partners where they contributed to the need to intervene.

Would this warning notice have prevented the Axiom Ince or SSB situations, or altered the outcomes? It is impossible to know, but it seems unlikely. In the case of Axiom Ince, it is alleged that huge sums of client money were misappropriated. This was already prohibited under the SRA Standards and Regulations so this warning notice alone arguably would have made little difference.

However, the SRA is conducting a consumer protection review and the Legal Services Board is reviewing the SRA’s oversight. There is potential for further changes once these are complete. This warning notice is probably only step one. Steps two and three seem to be the publication on 21 June of a warning notice on replacing client account shortfalls, and the 28 June consultation document on the SRA’s fining powers and issuing financial penalties to law firms and solicitors.

Law firms can take comfort that the SRA recognises mergers, sales and acquisitions as a ‘legitimate strategy for growth and business resilience for law firms’. In practice, they often represent a key tool in succession, where an effective succession plan has not been implemented enough in advance.

Helpfully, this warning notice anticipates scenarios which arise in practice where client consent to file transfers is not obtained (for example, for archived files and wills). It is helpful that the SRA supports pragmatic solutions which are in the client’s best interests, which was previously unaddressed. It does not however explain how this pragmatism is consistent with the SRA Standards and Regulations or its existing guidance on confidentiality, which leaves room for future uncertainty.

Law firms considering merger, acquisition or sale should therefore continue to ensure they have good housekeeping habits, such as:

• Maintaining good client lists, and understanding which partners are responsible for each file (including closed files). This needs attention when partners leave;
• Archiving closed files and destroying files promptly in accordance with terms agreed with clients. This also helps firms manage storage costs – often a barrier on merger; and
• Advance consent in the firm’s terms of business for limited and appropriate disclosures of information, where that is in the client’s best interests.

A robust LLP deed/articles, supporting policies and client-facing paperwork are all vital. Law firms can ensure readiness, and regulatory compliance, by preparing in advance.

Corinne Staves and Andrew Pavlovic are partners at CM Murray LLP, London