Merging or absorbing law firms can get very messy indeed if the new owners neglect to insure the predecessor businesses. Andrew Cromby outlines how lawyers can avoid the pitfalls


It is a boom time for change in the world of legal practices. Law firms seem to be almost constantly engaged either in merging, dissolving or being absorbed into other law firms.



It will come as no surprise to anyone in private practice that the key driver in this process is, though sometimes a function of the personalities involved, generally profitability. Maximising profits is everyone's goal. In practice, this involves fitting together a mosaic that includes elements as diverse as the firm's fee-earners, premises, facilities and insurance. Get the dynamics wrong and profitability wanes.



We are all familiar with the potential increasing cost of obtaining insurance in the current market. Such costs can put a strain on the profitability of a business. Even so, solicitors obviously need to ensure that they have adequate cover to protect themselves or their business. What is less commonly considered is the need to obtain cover for a former practice in the wake of a merger, dissolution or other 'transition', as it is euphemistically termed by the Solicitors Regulation Authority (SRA).



Any solicitor preparing to sell, abandon, purchase or merge a legal business should give careful consideration to the provisions of the SRA's catchily titled Minimum Terms and Conditions of Professional Indemnity Insurance for Solicitors Registered in England and Wales 2007 (the 'minimum terms').



This document sets out the current minimum insurance requirements for solicitors in private practice. These requirements are non-negotiable professional obligations and, accordingly, insurers often incorporate large chunks of their wording in their policy terms, as part of their assurance that the cover offered is 'compliant'.



The minimum terms set out the rules on whether a successor practice will come into existence and who or what this is likely to be. If there is to be one, this practice must maintain insurance cover for claims against the old firm. If there is no successor practice, run-off cover must be purchased for the old business. The cost of run-off cover can be significant. The minimum terms apply to limited liability partnerships as well as to traditional partnerships.



Examples of possible successor practices to former law firms are: a firm which 'holds itself out' as being the successor to a previous practice; a firm which has a former sole practitioner as an employee or principal; a firm consisting of the majority of principals in a former law firm which has fragmented; and a firm in which one or more of the principals of the former practice have become principals and which:



(a) trades from the former practice's address; or



(b) has inherited the majority of staff previously employed by the former practice; or



(c) has assumed the liabilities of the former practice.



The provisions of the minimum terms interact with each other, and this can cause uncertainty. On even a cursory reading, it becomes clear that the determining factors regarding who picks up the (not inconsiderable) costs of obtaining successor practice cover may include: what a business says about itself, where it is based, who owns it, who it employs, and whether it has done a deal to move the liability elsewhere.



As the buck for obtaining continuing cover stops with the successor practice, the significance of understanding where this substantial liability will fall should not be underestimated. In theory (and sometimes in practice), a small successor practice could find itself liable to maintain cover for all of the liabilities of its significantly larger predecessor, at a crippling cost.



The situation has parallels with buying bananas - in the bottom of the box there may lurk a spider, and an incautious purchaser could find that he is taking home more than just fruit.



The minimum terms set the scene for potential difficulties. The facts of a complex dissolution - with some partners perhaps staying in situ, some finding new firms to practise from, still others retiring or setting up on their own - can provide all that is needed for confusion to reign.



Throw into the mix the possibility that insurers may themselves be uncertain as to how the rules should be interpreted in complex circumstances and the position can become hair-raising.



Ultimately, from a practitioner's perspective, the acid test is whether he has obtained insurance in accordance with the requirements of the minimum terms. If so, he is likely to be relaxed. But if the insurers come to a conclusion, based on their own significant experience, which does not accord with the parties' expectations, the proposed 'transition' may be derailed.



All this needs to be considered early in the process. If you are planning a merger or dissolution, ask yourself the following questions:

- Will there be a successor practice and, if so, who will this be?

- Does any action need to be taken or avoided to pin the liabilities of the former practice to another organisation or practice?

- On a dissolution or merger, should there be any agreement between the former partners as to the payment of a contribution towards the costs of insurance that should be made by one proportion of the former partners to the other?



This may have a huge impact on the viability of one or more of the proposed new practices. There may be circumstances where one part of the former partnership might, if it is likely to be saddled with liability for the cost of insurance cover as a successor practice, prefer to cease practising and impose liability for run-off cover on all of the former partners.

- Can an early quote be obtained from insurers so the scope for argument and ambiguity is minimised as soon as possible?



Provided that this issue is on the agenda at an early stage, it need not create difficulties. Forewarned is forearmed. But always beware the spider at the bottom of the box.



Andrew Cromby is a partner specialising in partnership disputes at London firm Bracher Rawlins