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Looming questions as private equity takes stakes in English law firms

Publication: 
Editorial Staff
chiefofficersnet

The biggest revolution in the English legal profession is under way. Not only does it appear that the Bar is carefully managing to take back its previous control of advocacy in the higher courts, new schemes to register approved advocates in some lower courts are dividing the solicitors branch. But these pale alongside the chances that have allowed solicitors practices to incorporate under a Limited Liability Partnership structure and to take in private equity.

It's going to take a while to stop talking about "law firms" - if it ever happens. In the financial sector, even the Financial Services Authority uses the term "firm" to refer to corporations instead of its correct application to, exclusively, partnerships. In the USA, the concept of "law corporations" is long established but it is only since the passing of Legal Services Act 2010 that English law firms have been able to consider any structure other than a partnership.

At a time when there is increasing debate in the USA over where to continue to allow external funding of individual cases, the move in England and Wales to allow private equity funding of law firms raises significant questions.

The firms that are proving the most attractive to equity investors to be those that are well run and have invested in technology and skills, becoming leaders in their chosen markets. For example Keoghs, a specialist "provider of claims-related services to insurers, businesses and other suppliers to the insurance sector" is the second firm to take on private equity.

The most interesting thing about the investment in Keoghs is that the firm is what is often called a "defendant's firm," i.e. it does not act for plaintiffs. That means that its income is derived from fees not, as is increasingly common, contingency fees. The investment, then, is not directly comparable to the situation which is causing concern in the USA.

Keoghs' investment comes only days after its "alternative business structure" was approved by the Law Society of England and Wales. The "significant investment by LDC, part of the Lloyds Banking Group will give the investors 22.5% of the company.

The Keoghs investment brings the second equity investor into English law firms: Hamilton Bradshaw announced several weeks ago that it had agreed to invest in Knights, a very long established Midlands firm for which lawyering is only a part of a wide portfolio of services. It was announced that James Caan, who runs the investment company, will join the board of Knights, subject to the approval of the profession's regulator, the Solicitor's Regulation Authority (SRA)

Later, Caan put the cat amongst the professional pigeons when he said, in a speech, that one of the major problems in the legal profession is that profit is seen as a dirty word. But his company's investment in a very business-like and progressive company is a clear indication of the type of law business that external investors will be looking for.

The so-called "Alternative Business Structures" were created under the 2010 Act that came into force in 2011. There have been a number of applications from law firms but it can hardly be described as a rush. However, what is noticeable is that non-lawyers are making applications. Providers of social law services e.g. law centres, Banks, even a supermarket have made or are reported to be contemplating making applications for approvals.

There are safeguards: investment is permitted only from persons that the SRA deem fit and proper (in 2010, Robert Heslett , then the president of the Law Society is quoted in the Guardian as saying "fit or proper" but that must be an error).

This is similar to the ownership requirements in financial services businesses. But unlike those businesses, there is (currently) no mechanism for listing, even on alternative exchanges, shares. The idea, it is claimed, is to prevent ownership of law firms passing to those who are "disreputable."

Actually, it's a clever way of pre-approving ownership of law firms which, at present, is subject to a power to terminate a person's ownership or part ownership of a firm but not to prevent their ownership commencing.

It is said that duties to shareholders must take a back seat to duties to the Court and to clients. That hasn't worked out too well in the financial sector despite the strong provisions requiring financial advisers, etc. to know their customers and to give best advice, first given effect in the Financial Services Act 1986 and carried through subsequent law and regulation.

There is a requirement that multi-faceted businesses are clearly defined so that those parts that are regulated by the SRA are easily identifiable.

It all sounds fine on paper.

But, to take just one example, what happens if there is an investment in a plaintiff's (in the baby language of recent changes a "claimant") firm which attracts business on the basis of a no-win, no-fee structure. These are exactly the cases (along with class action cases that are little more than extortion) that are causing concern in the USA. Who will be taking the decisions? A representative of the investor or the litigator concerned? Will advice be tempered to take account of the demands of shareholders? Will each case have to stand on its own financial merits, with those most likely to be the most profitable taking precedence over those where profits may be lower?

The ABS is not limited to private equity investment: anyone can apply to create and own a law firm, provided they can meet the fit and proper test and it engages advisers that the SRA recognises. And it they stuff up, the fines that the SRA can impose range up to GBP250 million (yes, million). For a firm operating under a traditional structure, the maximum fine that can be applied without referring to a tribunal is GBP2,000 - although the SRA is trying to get that limit increased, without much help from the Ministry of Justice which has said no to SRA's first request.

Time is the most scarce resource in a legal practice: who will decide how, when and where that resource is allocated? Will shareholders demand that cases that are in progress should be either delayed or the clients told to find other representation?

These are all distinct possibilities as the concept spreads even though there is nothing to indicate problems with the two investments mentioned.

There are, as yet, no answers. Everyone is talking up the concept as a great leap forward for the English profession. Not everything new is good.

Whether it turns out to be remains to be seen.

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The Keoghs' investment is due to complete today.

 


 

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