While any M&A deal invariably involves a range of legal and commercial considerations, the sale of a law firm presents a distinct set of regulatory and structural complexities.
Whether you are an existing partner looking to retire, or a buyer looking to expand, understanding the specific considerations that shape law firm M&A transactions is essential.
This article explores a few of those key considerations.
What is a Successor Practice in Law Firm M&A?
A critical consideration when undertaking a sale / acquisition of a law firm is whether the acquiror will become a “successor practice” of the target firm.
A successor practice is a new firm that takes over some or all of the target firm’s past advice book after the transaction. Essentially, a successor practice agrees to take on certain liabilities of the target firm in respect of any past legal advice provided to clients.
As referenced above, a purchase can be structured so that only part of a firm’s advice book is acquired – i.e. if the target law firm has historically undertaken residential property and probate work, the acquiror can agree to only become a successor practice for the probate work (and visa versa).
Examples of some key considerations for the buy-side here are:
- Legal Due Diligence: undertaking case file reviews of past advice to assess historic compliance and potential client redress. Where a seller is able to demonstrate the past provision of high-quality advice and regulatory compliance, a buyer may feel comfortable with a lighter package of warranties and indemnities.
- Professional Indemnity Insurance: typically, we would expect the buyer / sellers to acquire a policy of run-off professional indemnity insurance to cover the advice-book of the target up to closing. Both parties will need to review these terms, and it is crucial for the Buyer to be aware of any policy exclusions (i.e. personal guarantee advice etc).
- Warranties / Indemnities: does the buyer require specific assurances within the purchase contract against past-advice liabilities (particularly those that are not covered by the policy of run-off insurance).
Deal Structures When Buying or Selling a Law Firm
The purchase of a law firm is typically structured as either a member’s interest purchase, a share purchase or an asset purchase. There are several well-established advantages and disadvantages associated with the abovementioned sale structures, but in this context, the deal structure will usually be influenced by the corporate structure of the target entity – i.e. an LLP, Limited Company or unincorporated partnership.
It is common for law firms to operate as an LLP or an unincorporated partnership. Where the target is an unincorporated partnership, the sale will need to be structured as an asset sale as there will not be any tangible “shares” or “interests” for the target to sell. This means it will be the “members” personally selling the assets that they own collectively through the unincorporated partnership.
Conversely, where the target firm is an LLP, the members will sell the “interests” owned in the LLP under a member’s interest purchase agreement.
SRA Authorisation Requirements for Law Firm Transactions
Acquiring / selling a law firm requires regulatory approval by the SRA. The complexity of this will be dependent on whether the acquiror is already an SRA approved individual / entity (i.e. an existing solicitor or existing law firm).
The SRA recognise two ownership structures of a law firm, that is a recognised body (meaning a traditional law firm wholly owned by solicitors) and an alternative business structure (an ABS). The ABS structure permits non-solicitor ownership and management of the firm creating a blend between lawyers and non-legal professionals.
Where the acquiror is an existing regulated person / entity, they will typically be able to benefit from the SRA’s “deemed approval” process (subject to conditions).
Whereas for an ABS acquisition, the process is slightly more involved as the acquiror will need to submit an express application which can typically be expected to take up to 90 days.
In both scenarios, the purchase agreement will need to be structured to clearly set out the rights and obligations of both parties with respect of the approval process. Both parties will need to ensure that all requirements of the SRA for approval are carefully complied with to avoid unintended delays and consequences (fines, regulatory action etc).
Treatment of WIP and Debtors in Law Firm Sales
For law firms, unbilled costs (WIP) represent a significant unrealised asset.
Given it is unlikely that the time recorded for existing clients will be billed prior to completion of the sale, it is essential for the purchase agreement to contain a clear mechanism for reconciling and valuing work in progress.
Hand in hand with the allocation of work in progress comes the responsibility of managing debtors.
For sellers, the priority will be ensuring that: (a) they receive credit for sums paid by debtors relating to work carried out prior to Completion; and (b) that the acquiror takes reasonable steps to pursue pre-completion debtors while they remain outstanding.
Conversely, the buyer will want to ensure that it does not “overprovide” for any accrued income / debtors and that it retains the flexibility to manage debtors in a way that does not harm the goodwill of the business / relationship with existing clients.
Final Thoughts on Law Firm M&A
The sale of a law firm requires the parties to navigate a number of regulatory and commercial complexities. It is crucial for the parties involved to understand these at the outset so that they can be properly addressed at each stage of the transaction.
At Herrington Carmichael we have specialist Corporate and Regulatory solicitors who can guide you through all aspects of a law firm sale or acquisition.
If you would like to know more about how we can help, please contact us.
