Unsecured creditors of Cobbetts are likely to recover just 2p in the pound following the ‘pre-pack’ deal that saw the collapsed firm acquired by DWF, the Gazette can reveal. Owed an estimated £41m, creditors are not expected to receive any money for some years.
According to documents seen by the Gazette, ‘several’ legal practices expressed an interest in acquiring parts of Cobbetts, including one unnamed firm which wanted to take over the whole business.
These suitors were all rebuffed, however, after DWF - with which Cobbetts had discussed a merger in 2011 - demanded exclusivity when it was approached as a potential saviour. Had DWF’s offer not been accepted, Cobbetts would have had just two weeks to find another buyer.
It was unlikely that it would have been able to pay the February wages of its 439 staff, which would otherwise have been due today.
The circumstances of Cobbetts’ demise and resurrection are detailed in a report by administrator KPMG made under Statement of Insolvency Practice 16.
The root cause of the administration was a significant downturn in trading performance from 2009, partly arising from lower corporate and property transactions. In 2008 the firm had turned over nearly £60m, but two years later this had shrunk to £44m.
While turnover then stabilised, profits continued to decline, partly as a result of taking on expensive new leases in 2006 and 2007. Cobbetts had attempted to sub-let space in its Manchester headquarters to cut costs, but without success.
It also asked its Manchester landlord to help with this process or cut the rent - again without success.
By June last year, Cobbetts was experiencing cashflow pressures and its management board took professional advice regarding whether the business was solvent; whether it could continue trading; and whether new credit could be incurred.
By September KPMG had been engaged at the request of Cobbetts’ bankers Lloyds TSB, to prepare a contingency plan and an initial information memorandum in case it proved necessary to market the business for sale.
Steps were taken to defer rent payments and payments to members who had left, and a time-to-pay agreement was negotiated with HM Revenue & Customs.
The business also borrowed substantial sums from Wesleyan and Syscap to fund its professional indemnity premiums, practising certificate fees, and part of its VAT liabilities.
By November, the Solicitors Regulation Authority had become heavily involved and required Cobbetts to produce a detailed contingency plan in the event that the firm could not overcome its cashflow difficulties.
Poor trading during December meant that Cobbetts was seemingly doomed. It did not have the cash to pay wages or payments required in respect of deferred rent, VAT, and partners’ tax of £2.4m.
KPMG was therefore instructed on 17 January to implement the contingency plan. Continued trading was dependent on the support of Lloyds TSB, which was only prepared to provide monies to pay the January wages and other outgoings if Cobbetts granted security.
DWF entered the fray at this point with what seems to have been a commercially astute approach. The firm said it was prepared to look at taking on the whole of Cobbetts’ business, but only if given exclusivity. It the businesses was marketed to others, then it would would withdraw its interest.
‘The only alternative would have been to carry out a very short marketing campaign in an attempt to achieve a number of sales of elements of the practice on a break-up basis which would have been likely to result in a reduced outcome for the LLP’s stakeholders,’ says KPMG.
A break-up sale would have resulted in ‘both additional direct and indirect costs together with a potential for increased claims from both creditors and members’. Cobbetts had 73 partners at the time of the collapse.
At the same time, the SRA was pressing Cobbetts to find a solution that would protect the interests of its 8,000 clients and client account money of around £35m. The SRA’s preference was for a disposal to a single firm and KPMG was mindful of the risk that the regulator would intervene in the business.
The Cobbetts management board therefore decided to go with the DWF proposal and did not market the business more widely. The terms of sale were unanimously approved by Cobbetts’ members.
Cobbetts had to file a Notice of Intention to Appoint Administrators to protect itself from creditor action, because of steps that the landlord of its Manchester office was threatening to take.
Cobbetts then went to the High Court in London on 6 February to ask for an Administration Order which would enable KPMG to complete a pre-package administration sale of the business to DWF.
The court was not asked to approve the terms of sale but the terms of the proposed sale were explained to the court, particularly those terms that appeared to benefit members at the expense of creditors.
The judge was satisfied that it was appropriate to make an Administration Order and said it was a matter for KPMG’s commercial judgement, as administrators, whether to enter the sale agreement with DWF.
Under the sale agreement, DWF acquired the whole practice of Cobbetts with the exception of debt recovery subsidiary Incasso. All the members of Cobbetts transferred to DWF, although there was an immediate back-to-back sale of its professional negligence business to Walker Morris.
At the heart of the sale agreement is a guaranteed payment by DWF of £3.8m for the debts and work in progress.
KPMG reported that this sum represents 30% of the net book value. However, it is understood the full book value was £22m and creditors are likely to ask KPMG why there was such a substantial write-down in the value of Cobbetts’ main asset.
If DWF recovers more than £9.4m from the debts and work in progress, then it has to pay 25% of any further recoveries to the administrators.
Members had borrowed £8.3m from a variety of banks to provide capital to Cobbetts. KPMG says the losses incurred by Cobbetts in its last period of trading will enable members to extinguish any further liability for tax payable on profits previously earned, and to make a terminal loss relief claim estimated to be worth £6.5m.
The members agreed that these tax refunds will be used for the sole purpose of repaying the capital loans. In addition, DWF is making £1.8m of realisations from book debts and work in progress available to the members to pay off the balance of those capital loans.
The deal therefore works out well for DWF, the members and employees of Cobbetts, and its clients, but the creditors may be less happy.
Unsecured creditors are estimated to be owed £41m, of which £24m relates to landlord claims. The estimated dividend is 2p in the pound and creditors are unlikely to get their money for perhaps three or four years.
Aside from landlords’ claims, the largest creditors are Lloyds TSB Bank (£5.2m), Cobbetts’ pension scheme (£3.1m), HM Revenue and Customs (£2.2m) and Wesleyan (£1.9m).
There is no suggestion of impropriety in the Cobbetts/DWF transaction.
However, Andy Taylor, of Crawley firm asblaw, who is representing the Cobbetts pension scheme trustees, questioned the degree to which the deal serves creditors’ interests. He said: 'The [KPMG] report indicates that the SRA's perspective is to protect clients and clients' money. It's the same in an intervention, when they notify clients and secure the clients' money. But maybe the SRA should have a wider responsibility to creditors as well as to clients and members (partners).
'It's not the fact that a law firm has gone into administration and been rescued - that's the whole point of the administration process. The perplexing thing is that members haven't suffered to the extent that the creditors have.
'Halliwells went this way and lessons were learned and applied, which improved the process. Two top-100 firms going down the same route is setting a precedent for others to follow.
'Pre-packs are the only way to proceed with law firms because the SRA won't allow firms that are in administration to trade. And anyway, all the clients would go away if a firm was in administration.
'So many creditors losing their money could make lenders perceive the heightened risk and make it even harder for firms to borrow money. Firms are already creaking and with Jackson on the horizon, the problems could be accentuated.'