The Solicitors Regulation Authority (SRA) has issued a new warning to law firms involved in their own merger or takeover deals that they must conduct adequate due diligence and prioritise clients’ interests. 

The warning is intended to remind law firm managers in England and Wales of their obligations when involved in such deals, including pre-pack sales and acquisitions of firms in administration. 

It forms part of the regulator’s response to the high-profile collapses of consolidator firms including Metamorph Law and Axiom Ince. The SRA is itself subject to a review by the Legal Standards Board over its conduct in relation to Axiom, which bought two firms out of administration last year before the SRA intervened over more than £60m missing from its client account. 

The regulator has also faced backlash from the profession over the strain such interventions have placed on the compensation fund, which is paid for by solicitors and firms, with the SRA saying last month that annual contributions would have to increase to plug the shortfall. 

The warning noted that multiple acquisitions in a short period of time “can create challenges in respect of business integration, organisational culture, and maintaining standards of service to increased client numbers”. 

It added that managers of a firm “should always make sure that acquisitional growth does not lead to ineffective governance structures, systems or controls which could cause detriment to clients or undermine trust in the profession”.

The regulator is “concerned that clients’ interests are not always paramount” during such deals, noting that it had seen firms treat client files as a “commodity that can be bought or sold irrespective of what the clients want to do or who they want to represent them going forward”.

Other behaviours the SRA said it had seen that could put firms at odds with its regulations included failing to obtain informed consent from clients or ensure that client money was properly reconciled prior to transfer to a buying firm and, once a firm had been acquired, failing to identify urgent client matters so that deadlines were missed. 

“We appreciate that it can sometimes be in clients’ best interests for a firm to seek a purchaser for a swift acquisition, which ‘leaves nothing behind’, in order to avoid disruption or delay to their matters,” the SRA explained.

“On other occasions, it can be in clients’ best interests for the firm, for example, to arrange to transfer specific parts of the business or particular matter types. When these kinds of decisions are being made, it will be important to ensure that clients’ best interests are at the forefront of those considerations and are clearly documented.”

Making decisions “purely on the grounds of expediency or commercial reasons” would be inappropriate, it added. 

The warning highlighted the need for both sides of a deal to conduct adequate due diligence, noting it had seen instances of firms failing to do any due diligence on the firm they were buying or consider if they had the capacity to do the work they would be getting. Meantime sellers must “investigate concerns about the acquiring firm’s competence, systems, staffing or capacity to act in your clients’ best interests going forward”.

The SRA reminded firms that they must tell it promptly if they are in serious financial difficulty and report that they are being acquired leaving enough time for the regulator to ensure clients’ interests are being protected. 

It added that the SRA had seen situations where solicitor managers had not been appointed when a firm entered administration or liquidation, perhaps to save costs or because the firms were unaware of the need for one. 

“This potentially puts at risk client confidentiality and privilege. It might also lead to breaches of the SRA Accounts Rules in respect of the handling and management of client money,” it warned. 

Failure to have proper regard to the warning notice is likely to lead to disciplinary action, it added. 

The collapse of consolidator firms like Axiom Ince has led to questions over how proactive the SRA is in monitoring firms that grow rapidly through acquisitions. Legal Futures reported that the regulator’s chief executive, Paul Phillip, said last autumn that more active checks on law M&A deals before they conclude would significantly increase its workload and therefore costs. 

However, the new notice warns that “as well as considering enforcement action, we will swiftly take preventative action where we consider that a solicitor or law firm presents an imminent risk to clients, future clients, the public or the public interest. Commonly, this will be where there is a need to protect the public, for example from dishonest solicitors”.

The notice could be updated to include learning from the SRA’s ongoing consumer protection review, which is looking at issues including risks associated with M&A, and its thematic review of growth strategies across the legal sector. 

There is also the potential for further guidance or changes to the SRA’s approach in its oversight of law firm M&A once the LSB’s review into its own conduct is completed. 

CM Murray partner Corinne Staves, who specialises in partnership law, commented: “Significant consolidation in the legal services market looks set to continue in 2024, with cash being a critical issue for firms of all shapes and sizes. What the SRA’s note doesn’t do is answer some of the criticisms levelled at the SRA in the wake of Axiom Ince. Critics may argue that reiterating that firms in financial difficulties must tell the regulator in a timely fashion would not have prevented the harms the profession has recently witnessed. 

“Having said that, the fact that the SRA has issued this warning notice reassures – and warns – law firms that this issue is now a priority for the regulator. The prominent link to enforcement action may mean that firmer enforcement action will follow.”