Medium Sized Law Firm Ran Into Trouble By Expanding Too Fast

Many venture capital companies, hedge funds, law firms and accountancy practices trade as limited liability partnerships or LLPs.

LLP’s are tax effective, flexible and offer a less risky trading structure akin to Limited Liability Companies. Unlike ordinary partnerships however, the individual designated members have limited liability.

So what happens when things go wrong and the business becomes insolvent? In many ways the solutions are the same as for companies. If a LLP is insolvent, distressed but could be viable, then CVA can be a powerful agent for restructuring. It may be necessary in some cases to place the company into administration first, but generally if the designated members act early enough a stand alone CVA will suffice.

If the LLP is NOT viable no matter what changes are made then liquidation is the most likely tool, or of course assets may be sold through administration.

The Challenge

A medium-sized law firm was experiencing significant financial distress, despite rapid sales growth driven by its conveyancing practice. The firm had a well-developed but flawed strategy of expanding through acquisitions, which left it highly leveraged with loans from Barclays Bank and other asset-based lenders. When the 2008 credit crunch hit, the firm was unprepared. A recovery plan was created, but it was clear that it couldn’t be implemented without formally restructuring the business, which required closing non-performing offices and making 30-40 people redundant. This was complicated by the Solicitors Regulation Authority (SRA), which would likely intervene if a formal insolvency tool was used. Such an intervention would be costly and would take priority over all other debts, leaving very little for secured and unsecured creditors. The firm also had a winding-up petition from HMRC, adding to the pressure.

The Solution

Recognizing the need for a creative solution, the law firm’s designated members invited KSA Group to collaborate on a turnaround strategy with BDO Stoy Hayward, a firm acting for Barclays. They decided to use a Company Voluntary Arrangement (CVA) as the central control technique, a process that was almost unheard of for Limited Liability Partnerships (LLPs) at the time. KSA used a unique forecasting tool to accurately model the CVA’s effects on the company’s financials over five years. They also worked closely with HMRC to clarify the tax implications of the CVA, given the LLP’s unique structure. With HMRC’s assistance, they managed to stop the advertisement of the winding-up petition, buying crucial time to prepare the CVA proposal. The firm took a proactive approach to creditor relations by keeping them informed and explaining that the CVA would provide a better return than a winding-up.

The Results

The CVA proposal was successfully accepted by a unanimous vote from all creditors who participated. The CVA offered a return of 71p in the £1, a significant improvement over the 3p in the £1 that would have been the likely outcome of a liquidation, which didn’t even account for the high costs of a possible SRA intervention. With the CVA in place, the company was able to move forward with its recovery plan, including closing non-performing offices and reducing staff. The firm also appointed a part-time Financial Director to ensure accurate monthly reporting, a condition of the CVA. Barclays Bank and other lenders were supportive of the plan and provided capital payment relief. Although market conditions remained tough, the CVA provided the law firm with a structured and legally sound path to recovery, allowing it to navigate the severe economic downturn and protect its business.

Summary

Viable LLPs can be deeply restructured and turned around using company voluntary arrangements (CVAs). Rules, structure and proposal process are very similar to limited liability company CVA’s. Care needs to be taken with the tax implications of the designated members in the forecasting process.
For law firms the extra consideration is the possibility of intervention by the SRA (Solicitors Regulatory Authority) when administration or receivership is threatened.
With the future structure of law firms likely to change rapidly after the Clementi reforms become law, CVA presents a powerful solution for struggling law firms trading as LLP’s.
Remember, in the event that a law firm trading as a LLP was to enter, administration, voluntary winding-up, or an administrative receiver was appointed, the Solicitors Regulation Authority would intervene, the costs of which would be a first charge on the assets of the LLP
Inevitably this would severely reduce the value of assets available to the fixed and floating charge holders and unsecured creditors.
Other LLP’s can be sure that CVA can be powerful turnaround tool.
For further advice on LLP restructuring please contact KSA on 0800 9700539 or email keiths@ksagroup.co.uk

Is your LLP viable but struggling? Talk to us about BEATING a petition and the best alternative to winding up!
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