How did we get here?
In July 2003 the Department for Constitutional Affairs (as it was then known) published a report entitled “Competition and Regulation in the Legal Services Market”. That paper was a response to a consultation about competition in the legal profession published by the Office for Fair Trading in March 2001. Annexed to the DCA paper was a scoping study on the review of the regulatory framework for legal services in England and Wales. It concluded that the regulation of the legal profession in 2003 was “”¦ outdated, inflexible, over-complex and insufficiently accountable or transparent; it has limited capacity to adapt to a rapidly changing landscape ”¦ and does not meet the demands of today’s market place.”
Sir David Clementi was asked to prepare a report addressing these issues and, amongst a wide range of recommendations, he devised the concept of alternative business structures (ABSs) which he saw as a way in which the legal professions (solicitors, barristers, legal executives, conveyancers and so on) could respond to the need to deliver legal services in new ways to “meet the demands of today’s market place”. He saw ABSs taking two forms:
- Legal Disciplinary Partnerships (LDPs) – entities delivering legal services owned by lawyers of different professions.
- Multi Disciplinary Partnerships (MDPs) where different professionals would come together to own and manage the entities.
Sir David’s vision for the ABS concept has been realised in a somewhat more ambitious form thanks to the work of Parliament. Part 5 (sections 72, 89, 90-92 inclusive) and Schedule 13 of the Legal Services Act, 2007(LSA) together enable non-authorised persons (ie non-lawyers) to own part or all of entities delivering legal services; those non-authorised persons need not participate in the management of such ABSs. Hitherto entities delivering legal services could only be owned and managed by authorised persons, ie lawyers.
Applications for an ABS licence may be made to a licensing authority from June 2011 with the first licences capable of being granted from 6 October 2011. The Solicitors Regulation Authority (SRA) aims to be a licensing authority subject to the approval of the Legal Services Board (LSB). Many lawyers still seem to believe that this date will be postponed by the Government, but Jonathan Djanogly MP (Minister of State at the Ministry of Justice) made clear in June 2010 that there will be no delay.
Where are we?
The focus of the increasingly heated debate about ABSs has been the MDP form which enables not just professionals but anyone to own and/or run a law firm, subject to a fitness test.
The heat and light being turned on the subject lends more confusion than clarity especially about the likely effect of introducing ABSs. A good example of this is the famous soubriquet “Tesco law” implying that ABSs will be used as a vehicle for extending yet further that supermarket’s services. In fact my enquiries of Tesco confirm that the supermarket has no plans to form an ABS! This is however a good example of how much uncertainty and concern (if not anxiety) is being generated by the present debates around ABSs. For some of course it is in their own interest to talk at length about the devastation to be visited upon the profession.
Private equity is regarded as one of the most likely sources of external investment for law firms when ABSs become possible. However, Jon Moulton (founder and managing partner of Better Capital which raised £67m for project investments on the London Stock Exchange in June 2010) had this to say about the appetite of private equity for investing in law firms:
“Law firms fundamentally lack security of earnings ”¦ It is only bulk providers of such legal services as conveyancing, personal injury and compliance who might benefit from external capital to buy IT and employ lots of junior grades ”¦ [ABSs are] just a big whimper.” (Law Gazette, 17 June 2010)
Who will be affected?
Investment has a price and that price is measured in dividends. The extraction of profit by the external investor and the identification of a (profitable) exit in 3-5 years after capital is injected are the key drivers to investment decisions by private equity.
What legal services are attractive to this kind of investor? The services would have to be provided by reference to clearly established client followings, preferably sourced by a robust contract providing for the delivery of regular workflows, professionally managed (not necessarily by lawyers) in a way that maximises profit.
If Before the Event (BTE) insurers currently provide work to a law firm, they might seek to create their own law firm so as to further reduce the overhead. However, this would be to stop the flow of referral fees paid to BTE insurers by law firms whose services cost them nothing anyway as the work is conducted entirely on a CFA basis. Nevertheless, DAS and the Co-Op (amongst others) are busily developing law firms to be licensed as ABSs when that becomes possible.
A number of firms are taking loans on the basis that those loans will be converted to equity on ABS Day (6 October 2011). In this situation the firms in question run the risk of being in breach of Rule 1 of the Code of Conduct (duty of independence) and usually have not structured the loan appropriately, leading to accusations of undue influence by the lenders in the management of the law firm. The recent case of the reprimands visited upon Optima’s directors is perhaps an extreme case but nevertheless on point.
The future of referral companies
Lord Justice Jackson seeks to have referral fees abolished in personal injury cases (or that they be limited to £200 which would have the same effect) and with that the abolition of a substantial part of the referral industry. Research undertaken by the Consumer Service Panel of the Legal Services Board recently showed that referral fees have widened access to justice. Furthermore, government appears to have little appetite for abolishing referral fees, accepting that it has become an accepted part of society which the public welcome. Henry Bellingham MP, speaking prior to the general election, signalled a shift in the previous antipathy held by the Conservatives for referral fees:
“In a capitalist society, is it right to say we should get rid of a mechanism that the market has put in place? We have to be very careful about making changes. I am quite aware of the damage they can do, but I think they are more a symptom than a cause. If we can start controlling costs in other ways and prevent some cases going to court, then we start to solve the problem.” (Law Society Gazette, 23 March 2010)
However, these competing views have led to uncertainty in the industry, causing players to consider how best to adapt to survive.
There is serious interest amongst referral companies in acquiring the law firms to which they currently send work with a view to reducing overheads by aggregating firms in one place and removing solicitors from all but the key areas where a solicitor is needed, for example in connection with the assessment of quantum in a personal injury claim. Another development is the evolution of former referral networks into branded concepts which, it is believed, are better placed to attract business than the former brands they replace. Tessa Shepperson looks at an example of this approach in her article on Quality Solicitors elsewhere in this issue.
Opportunities and risks
There is much for every firm to consider without necessarily assuming that come 6 October 2011 it will be out of business. The ophthalmological industry is a good example of one where large chains have come to dominate the sector but took some years to do so. The delivery of spectacles is, however, distinguishable from the delivery of a far more diverse range of legal services and so whilst the comparison is not completely identical it does indicate that people’s buying decisions change slowly. Two recent surveys are informative.
In November 2009 moneysupermarket.com conducted research as to the public’s willingness to trust supermarkets providing mainstream banking services. It found that only 4 per cent of those sampled would trust Tesco to delver a mainstream banking service whilst almost one third preferred traditional banks.
In July 2010 a survey undertaken by Oxera (commissioned by the Law Society) found that most solicitors considered a strategy of differentiation by reference to specialised markets was the key to overcoming the “threat” of the ABS. Not every consumer is comfortable with or interested in a post/phone/email/web-based delivery of legal services. The survey also found that existing “commodity” providers may be the firms most at risk when ABSs arrive as it is to this market that external investment (the principal driver for an ABS) will be targeted, rather supporting the views of Jon Moulton, above.
It takes time to change perceptions and buying habits. In my view the profession has 3-5 years from Autumn 2010 in which to decide and implement its strategy for maintaining market share in the new, more competitive environment.
If the decision to go down the ABS route is taken, then equally careful thought must be given to the best structure and whether legitimate steps can be taken now to attract external investment. In our experience too little thought is given to how these arrangements may be structured, leading to early falling out between investors and solicitors.
The primary effect of the ABS project is to compel firms to evaluate their route to market and stress test those routes against possible ABS models, some of which have been set out in this article.
Tony N Guise is a Director of GUISE Solicitors Limited a specialist practice advising on regulatory matters.
