Intro
UK law firm insolvencies have seen a remarkable 33% increase in the past year. Like many businesses law firms are experiencing a sharp rise in overheads whilst at the same time, some firms are seeing a decrease in instructions on previously strong practice areas and a delay in clients paying bills due to a more challenging economic climate.
In this article we explore why so many firms are struggling and what happens when they can't stay afloat, including the fallout from the recent and high profile collapse of Axiom Ince Limited.
Why are law firms struggling?
Reliance on core practice areas
Many firms focus on a few core practice areas. A sharp decline in instructions within those practice areas (for example the recent downturn in M&A instructions due to persistent inflation) can easily cause some firms to suffer disproportionately.
Law Firm Financials
Cashflow for law firms is often a tricky subject. Firms tend to have high fixed costs and are reliant on clients making prompt payment to meet those overheads. However, maintaining client relationships and the prospect of future work means firms are often reluctant to use more aggressive debt collection and enforcement options.
Law firms often follow different cash high and low points to other businesses, which means they could be hit with a substantial tax bill at a time when they don't have enough cash reserves to make payment. VAT is payable on all invoices billed in the relevant quarter, regardless of whether those invoices have been paid by clients.
Professional Indemnity Insurance deadlines
Law firms must be conscious that they have enough cash available to meet professional indemnity insurance renewal costs, which traditionally fall in October.
August tends to be a quieter period for most firms which places pressure on September cash collection to meet those substantial insurance costs just around the corner. Regulated firms cannot continue without adequate insurance, so any failure to meet insurance liabilities can and often will signal the end of the road for a firm.
What happens when law firms encounter financial difficulties?
Most distressed law firms are rescued via pre-packaged administration sales. Administrators are often not permitted to trade an insolvent law firm. Instead, the firm in administration will transfer its business and ongoing client files to a new firm which will take over conduct of any ongoing work.
Law firms naturally operate in a highly regulated industry. Client interests must always be protected, and if the Solicitors Regulation Authority (SRA) is aware of any risk to clients it has the power to intervene, close the firm down and take possession of client files. Avoiding SRA intervention is key to preserving sufficient value to allow for a successful restructure.
SRA intervention costs must be met by the insolvent law firm. The SRA also have an entitlement to a statutory charge over the firm's assets in respect of its costs, which means it can rank as a priority creditor ahead of even the insolvency practitioner's own costs and expenses.
Axiom Ince Limited – when rescue mechanisms fail
The collapse of Axiom Ince may be an extreme example but it illustrates the impact on clients when a law firm cannot be successfully restructured or rescued.
Shortly after purchasing two previously struggling and much larger firms, Ince & Co and Plexus Law, both via pre-pack administration sales, Axiom Ince itself filed a notice of intention to appoint administrators in early October. That notice of intention came after months of difficulty culminating in the firm's indemnity insurance expiring just before administrators were called in.
On 3 October 2023 the SRA stepped in and closed Axiom Ince to "protect the interests of clients and former clients of the firm”. The intervention followed the SRA's suspension of Axiom Ince's former managing partner Pragnesh Modhwadia for suspected dishonesty.
Axiom Ince had already secured a freezing order against Mr Modhwadia, who's lawyers have now admitted that £64m had been taken from Axiom Ince's client account in part to buy Ince & Co and Plexus Law, as well as a number of high value properties. The extent to which these sums can be recovered remains unclear.
The SRA's discretionary Compensation Fund, intended to support clients who are owed money by regulated firms, currently only totals £18m. As such it falls significantly short of the £64m owed to former Axiom Ince clients alone. There is a possibility that Axiom Ince's insurers may be able to cover some of the losses, however the SRA are now exploring options to increase the Compensation Fund to cover the shortfall.
One possibility is for solicitors to be required to make a one-off payment to contribute, however asking solicitors to meet additional costs at a time when firms are already dealing with increased overheads is unlikely to be popular with the profession.
Another option is for the SRA to exercise its statutory right to limit payments from the Compensation Fund for connected applications to a £5m total. Given the anticipated claims £5m is unlikely to cover even a small proportion of former Axiom Ince clients' losses. Restricting compensation available to clients to such an extent could also impact wider confidence in the profession and raises questions regarding the adequacy of the current safeguards.
Summary
The recent increase in insolvencies among UK law firms highlights the unique challenges faced by the sector in the current market. The intricacies of law firm cash flow management may leave further firms vulnerable to sudden downturns.
If a firm is experiencing financial difficulties seeking professional advice as soon as possible and early engagement with the SRA is key to avoiding SRA intervention, preserving the firms value, protecting clients, and enabling the management team to explore all options available to rescue the business.
Axiom Ince is a stark example of what can go wrong when those in control of a law firm fail to take a proactive and prudent approach to the financial health of the firm, impacting clients, staff, creditors and ultimately the public's trust in the entire legal industry.
Want to hear more from us? 
