An article by Vanessa published in the January 2008 edition of Managing For Success - a publication by the Law Society's Law Management Section. The article advises firms to take a deep breath and consider their future position in an ever changing environment.

Circles, Pitfalls and Entrepreneurs

I invite law firm owners to consider three realities.  First is the need to focus on the financial well-being of the business. The second is the need to embrace change and become entrepreneurs. Third is the need to guard against regulatory pitfalls that might trip up entrepreneurs.

The starting point is financial well being.  Many firms are caught within a vicious circle of an ever increasing overdraft, lengthy periods of lock up, the perceived need to take on more clients to generate more fees to pay more overheads and a lack of time to stop, take a deep breath and consider the firm's future position.

The second reality requires time for strategy development, to improve profit making potential, to consider competition from new market entrants. It also requires consideration of new business models. That is what competitors are doing right now to take advantage of the future ownership opportunities within the Legal Services Act. Alternative business structures (ABSs), including external ownership of law firms, will be possible from 2011.  Legal disciplinary practices (LDPs) co-owned by solicitors and other lawyers and up to 25% non-lawyer managers, will be possible from early 2009.

The third reality recognises that the Code of Conduct exists for compliance and that the Solicitors Regulation Authority (SRA) is becoming more robust in its enforcement activity.  Those firms considering developing contractual links involving the future sale of an ownership interest when permitted, in return for investment or services now, should consider the recent view of the SRA that this might breach the current rules. 

Rules and regulations may restrict the ability for solicitors to compete and to become entrepreneurs.  However, through embracing certain aspects of the Code of Conduct you may, nonetheless improve your firm and explore entrepreneurial ideas.

How might the vicious financial circle be broken? A fresh look at Rule 2 and better disciplines on costs estimating, updating and interim billing might provide some answers.  Rule 5 on business management is worth a closer look, not from a regulatory perspective but a business one.

Rule 2 allows more focus on the service firms provide and how they provide it.  Gone are the days (hopefully) of meaningless retainer descriptions such as "your litigation matter".  More case specific detail will appear in client care documents explaining and limiting retainers.  More innovative and transparent ways will emerge of explaining to clients what the service will be expected to cover and what would be considered as additional, unexpected work.

If these better defined retainers are linked to cost estimates, then estimating becomes easier.  Clients will also have less reason to query cost updates and challenge bills and the Legal Complaints Service will have less reason to suggest that your hard work is done on a pro bono basis!

Interim billing is not embraced by the profession as much as it should be. However, this is crucial to breaking the vicious circle and allowing owners to think about business development.  If your firm has fallen into the trap of taking on more clients to generate more fees, but these clients are also not being interim billed, then the vicious circle is likely to self perpetuate.

It is worth considering Rule 5 which requires, as a matter of compliance, effective systems of management and supervision.  Once out of the vicious circle, perhaps effective management would become a possibility and this might lead to efficiency savings.

One of the requirements under Rule 5 is financial control.  From the SRA's viewpoint, greater financial control is likely to lead to fewer referrals for disciplinary sanctions because of financial misdemeanours.  However, from a business perspective, financial control is essential to the well being of any business.  Many firms do not have systems in place to be able to assess their own financial well being and many will often have no realistic idea of their own profitability (or lack thereof).

In terms of developing new income streams, indeed opportunities exist if owners can ensure time in their busy lives to take stock. However, practices also need to ensure compliance with relevant rules and regulations.  

At one end of the spectrum, it is possible, for instance, to charge administration fees for administering telegraphic transfers.  However, firms should ensure that any administration fees are expressly and clearly distinguished in client care letters and bills, from any disbursement element paid to a third party, such as to the bank.  The SRA takes the view that not doing so is misleading and potentially dishonest.

Rule 2.06 permits commissions for outgoing referrals. Generally speaking, few high street practices receive commissions, but it is permitted. Is this an area to re-consider?

This Rule remains broadly the same as the old Rule 10.  However, under the guidance, the arrangements have to be "in your client's best interests" (either commission set against a bill of costs or you must be able to justify its retention, for instance, retaining it in lieu of the cost of making the outward referral). Also, the construction of commission arrangements needs careful consideration.  The Adcock and Mocroft decision mentioned in the guidance suggests that it is not possible to receive a rebate, for instance on property search fees, because this arrangement is not a commission arrangement.  Instead, this is a disbursement and the client must receive full benefit of any rebate.  This may limit the opportunities when commissions are, in reality, possible.  However, where they are possible, construction will be important.

Rule 9 permits incoming referrals for payment, subject to strict compliance requirements. Many practitioners accept (willingly or otherwise) that, to receive work in certain practice areas, referral arrangements must, at least, be explored.

The educational and enforcement activity of the SRA in this area has been quite apparent over the last few years. It is likely that failure to comply fully will now attract disciplinary sanctions.  This is not a reason for not being involved in referral arrangements if you so wish. However, it is a very good reason for ensuring that your arrangements are fully compliant and up to date with the subtle changes introduced within the new Rule 9.

Another area worth exploring is Rule 21 on separate businesses. The areas where you are permitted to set up a separate business, which would not therefore be subject SRA regulation, are now more extensive than previously.

The setting up of a management consultancy that, as a subsidiary and necessary part involves providing legal advice would be permitted.  Setting up an estate agency and a lettings company as a separate business would be permitted even if this entails, as a subsidiary and necessary part, the drafting of legal documents.  This could not include conveyancing documents as conveyancing is reserved work. However, the separate business may, for instance, be able to deal with tenancy agreements as part of the lettings agency business.

Another example is alternative dispute resolution allowing for the possibility of a separate business providing mediation services, for instance.  Further examples include financial services operations, company secretarial services, acting as a bailiff and "any other business, advisory or agency service" not excluded by Rule 21 itself.

There are, however, pitfalls for the unwary. The interface between the separate business and your firm is subject to SRA regulation. The Rule exists to ensure that clients are not misled, money is kept separate, referrals to and from the separate business are properly regulated and, in the case of separate estate agency businesses, rules provide against conflicts of interest. The regulatory requirements in certain respects have, however, been relaxed.

Despite the possibilities for running a separate business, there are some absolute taboos.  Conveyancing is mentioned above.  Another is a separate business which involves the giving of legal advice in relation to matters that are or could end up before a court, tribunal or enquiry.

In thinking about setting up a separate business, a consideration might be whether to enter into co-ownership with non-lawyers to develop these relationships until they might (if appropriate) formalise as LDPs in 2009 or as ABSs in 2011. The reality is that non-traditional competitors are considering new ABS models right now and are involved in developing partnering arrangements at this very moment in time, in preparation for 2011. 

Other developmental possibilities exist which the entrepreneur could investigate under the current regulatory framework. The above, I hope provides some food for thought.   I urge owners of law firms to consider the realities of business life: focus on your firms financial well being and break out of the vicious circle if you are in it;  embrace change and become entrepreneurs; but in so doing to guard against regulatory pitfalls that might trip you up along the way.