Law firms’ failure to understand how non-bank financing works is putting them in the firing line of their banks and, potentially, the Solicitors Regulation Authority, according to finance business SpectraLegal.
It said that while many practices have benefited from such lending, not all solicitors take sufficient care when agreeing the terms.
SpectraLegal used the example of costs account funding, where firms receive advances against their costs once cases have settled. Some firms assign their receivables to a lender without the approval of their main bank.
However, an assignment takes the asset out of the reach of the firm’s primary bank and, if the bank has a standard debenture in place, the borrower is required to obtain their permission before completing any such assignment.
Client relations director Matthew Gwynne explained: “The danger here is that if permission is not obtained, then the firm will breach its covenants and the bank will be well within its rights to withdraw its lending arrangements. In the case of overdrafts, this can be done with immediate effect, making the debt repayable at once.
“We have also seen examples where the lender requires the defendant to forward the clients cost award directly to them without any authority being obtained from the client. If the defendant is directed to pay the cost award – that is, client monies – in a certain way by a lender on the authority of the law firm only, the law firm may well be in breach of the SRA’s accounts rules.”
“It has amazed me how often solicitors overlook these dangers. There is no need for firms to put themselves in these positions and a bit of care is all it takes to ensure that this valuable form of funding runs smoothly.”
Zoe Holland, managing director of law firm consultancy ZebraLC, said she had seen similar issues: “Solicitors’ enthusiasm to get funding in place can sometimes come at the expense of understanding what it entails – and that can leave an unpleasant mess to clear up when the regulator or the bank comes knocking.”
Mr Gwynne continued that since entering the UK market in 2015, SpectraLegal had seen many impressive firms, but “there has also been plenty of evidence of poor practices that threaten the viability of others”.
These included: not recording damages estimates, mis-understanding what is in their work in progress, not having clear knowledge of how quickly WIP turns into cash, failing to recognise the impact of inactive files, and the effect of pinch points in the year when cash flow comes under greater pressure and can change the behaviour of the firm.
Mr Gwynne said: “All of these are easily remedied. Understanding work in progress is a valuable tool that helps firms deal with their banks and potential investors, and also judge potential acquisitions. Solicitors just need to show their own practices the same care that they devote to their clients.”
Ms Holland added: “Law firms need to be more forensic in how they monitor and utilise their work in progress. Particularly in the personal injury world, this is now a vital part of being fit for the present let alone the future, and understanding the impact of continuing reform by the government.”