Consolidation in the legal services market is widely expected to gather speed. Christopher Parr looks at how to conduct due diligence on a law firm merger or takeover without breaching client confidentiality


Mergers and takeovers among law firms are common, and the tide is getting stronger.



A law firm merger or takeover should be no harder than the equivalent deal in any other industry, except that firms are governed by stricter rules on conduct.



Specifically, solicitors must comply with rule 4 of the Solicitors Code of Conduct. In particular, paragraph 4.01 says solicitors must ‘keep the affairs of clients and former clients confidential except where disclosure is required or permitted by law or by [the] client or former client’.



In addition, under paragraph 4.06, solicitors are told that even the board of the Solicitors Regulation Authority (SRA) has no power to waive this rule.



The rule cannot mean client affairs are confidential unless the law firm decides otherwise for its own commercial ends. The rule is clear – ‘client affairs’ must be kept confidential unless one of the two exceptions applies.



Therefore, the rule creates a major problem for the firms concerned. How is one firm to do due diligence on the other without the other disclosing client information?



It might be argued that, if a confidentiality agreement (or non-disclosure agreement (NDA)) is made, there is no breach of confidentiality. Both firms are bound by the rule and the NDA double-protects the clients.



This is too simplistic. At the point of disclosure, the deal in question has not been done. Therefore, unless due diligence is a pointless exercise, the deal can still collapse and the firms may not merge.



Then, the disclosing firm (the discloser) will have shown confidential files to the other firm (the recipient) and, in spite of the best intentions and the force of the NDA, the recipient may have acquired knowledge that will damage, or be useable against, the relevant client. Imagine the sort of thing that could be read while doing due diligence on another firm’s files.



It might be argued that an NDA could include an undertaking from the recipient. This seems to add force to the otherwise contract-based NDA position.



However, even an undertaking cannot take the parties around the rule. Note that the SRA cannot waive the rule. It must be, therefore, that no individual firm can do so; and, in effect, firm-to-firm disclosure for their own ends would amount to an attempted waiver of the rule.



The argument of ‘necessity’ cannot be used to support the case for NDA/undertaking-based circumvention of the rule. It cannot be argued that no merger or takeover can be completed without disclosure of client files. This argument fails because there are merger and acquisition ‘tools’ which allow the parties to complete the merger without making any disclosure that breaches the rule.



First, why is the disclosure required? There are several reasons. The recipient wants to:

l Verify that the files exist;

l Verify the billings on the files; and

l Check compliance and file management.



The discloser must have other records that support the proposition that it has a number of files open. There will be accounting and billing records, for example.



In addition, it would be an odd firm that did not have some form of central record of all ‘active’ and ‘closed’ matters. If the discloser admits to being unable, from central records, to tell the recipient about ‘open’ and ‘closed’ files, the recipient should be extremely concerned.



Billings on individual files must also be available from the central accounting and administration system. Even the disclosure of billing information about a client might breach the rule.



However, such disclosure tells the recipient nothing about the client or the matter concerned and so there is little chance of damage being done, even if the deal goes off. In addition, it can be argued that financial data belongs to the discloser.



It is reasonable for the recipient to be concerned that the discloser is complying with normal file management procedures.



However, it is unnecessary to disclose client files to demonstrate this. If the discloser participates in an accredited scheme, then there should be records, as part of that scheme, which demonstrate compliance.



Representations and warranties, supported by post-completion remedies for breach, are another potential ‘tool’ to help firms deal with the rule. It is normal for the target to represent and warrant that certain things are ‘so’. Representations and warranties as to the nature, quality and quantity of client files, and work in progress, can be given.



It is also easy to contemplate some post-completion review of the files in question so as to verify those representations and warranties. If there is a breach, then there can be an agreed compensation or restitution.



Finally, it is possible, although not wholly practical, to consider asking clients for permission.



Certainly in industry, it is not unusual for clients to be approached on this basis, before the deal is done. Practically, this is sensible for the buyer because it wants to be as sure as possible that major clients will not cease, or reduce, trading with the business after the deal is completed.



Once the merger or acquisition has been concluded, it is likely that there is no need to ask for client permission for the acquiring firm to have access to the client files. By then, the acquirer and the acquired have become one, and the client has become a client of the merged firm.



In summary, because there are easy ways to resolve the problem created by the rule, any attempt to argue that law firms can circumvent the rule in the case of mergers or acquisitions must fail.



Any other interpretation blows a huge and potentially dangerous hole in the rule, which is one of the cornerstones of the solicitor-client relationship.



Christopher Parr is a partner at London firm Collyer Bristow