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Alternative business structures

Important: The guidance below was written and issued before the introduction of the SRA Handbook on 6 October 2011, and may refer to regulatory material that is no longer in effect. Although it may still be relevant, this guidance has not yet been reviewed in light of the wide-ranging regulatory changes implemented on 6 October. It will be reviewed and updated (or archived) in due course.

This guidance was issued in November 2010. For the latest information about alternative business structures, please visit www.sra.org.uk/abs.

Preparing for alternative business structures

 

  • 1. This guidance, issued in November 2010, replaces the version issued in July 2009. For the latest news on the SRA's progress towards regulating alternative business structures (ABS), please visit www.sra.org.uk/abs.

  • 2. The SRA is conscious that some firms will want to engage in exploratory conversations with potential investors. This guidance is intended to assist and support you in that. In the context of complex provisions in the LSA 2007, it is critical that you familiarise yourself fully with the legislation, the current rules and the new rules which are expected to apply from October 2011, as they are issued. It is primarily for you to make your own judgments on the law and regulatory obligations. In making any preparatory arrangements there is a substantial onus on you to ensure that your integrity is not undermined.

Background

  • 3. On 6 October 2011 the SRA expects to be licensing the first Alternative Business Structures (ABS) to provide legal services to the public in England and Wales. Part 5 of the Legal Services Act 2007, permits ABS which will allow participation by a larger proportion of individual non-lawyers in a firm than currently permitted, as well as allowing external ownership or part ownership of law firms.

  • 4. The SRA welcomes this development and believes that it will bring benefits to consumers through increased competition, the development of new services and ways of delivering them and the integration of the delivery of legal services with other related services. The SRA intends to extend its regulatory remit to cover ABS as well as traditional law firms.

  • 5. In order for the SRA to license ABS, the SRA has to be authorised to do so by the Legal Services Board. Our programme for obtaining the LSB’s approval is on track and the key future stages of our programme are:

    • currently our revised regulatory Handbook, which will form the basis of our application to the LSB, is out for consultation until 13 January 2011. This Handbook contains our regulatory Principles, the Outcomes we require regulated providers to achieve and detailed Rules governing issues such as Authorisation, Discipline, etc.;
    • in March 2011 we will be making our application to the LSB for approval as a licensing body for ABS;
    • we expect our application to be accepted by the LSB in May 2011, at which point we will publish our complete regulatory requirements to apply to traditional law firms and to ABS from 6 October 2011;
    • from August 2011 we will accept applications from organisations seeking to be authorised as ABS from 6 October 2011 onwards; and
    • from 6 October onwards we will be issuing licences to ABS that have passed our Authorisation process.

  • 6. We recognise that organisations considering becoming an ABS after 6 October may wish to prepare for the new regime before 6 October and we wish to facilitate this preparation as far as we are able subject to the fact that:

    • we must not jeopardise public protection;
    • the detailed arrangements under which we will be authorising ABS are still in development and still subject to approval by the LSB; and
    • there are statutory provisions within which organisations must operate and which define the extent to which organisations can put in place arrangements before they are authorised as ABS by the SRA and become regulated by us.

  • 7. The position differs as between:

    • existing organisations (and newly created organisations) not currently providing reserved legal activities to the public and not currently regulated by the SRA; and
    • existing law firms, currently regulated by the SRA, who may wish to change their status to that of an ABS post 6 October 2011.

Organisations not currently regulated by the SRA

  • 8. We recognise that there will be a number of organisations who will wish to become regulated as ABS to provide reserved legal activities from October 2011. In addition, there will be individuals and organisations contemplating the creation of brand new ABS organisations from this date.

  • 9. The major issues affecting the preparations for such organisations are, in our view, likely to be current legal restrictions applying up to 6 October 2011 and the availability of information on which to base their planning and business decisions.

  • 10. Businesses that are not regulated by the SRA are not directly affected by our regulatory requirements. You must however comply with the law that applies to the provision of legal services. This includes:

    • you may not hold yourself out as a solicitor or provide, or hold yourself out as providing, reserved legal activities prior to any authorisation by the SRA as an ABS;
    • you may not hold yourself out as regulated by the SRA prior to any authorisation by the SRA;
    • you should not assume that you will be authorised by the SRA as an ABS until any such authorisation is granted; and
    • if you are a provider of legal services regulated by another legal services regulator you must comply with your existing regulatory requirements.

  • 11. For further information, the key documents to refer to at present are:

    • the Legal Services Act 2007;
    • the current draft of our Handbook which contains the regulatory framework and Rules under which ABS will operate from 6 October 2011, and which is out for consultation until 13 January 2011, and
    • our Policy Statement on our regulatory approach, Delivering OER: The Next Steps, published on 30 November 2010.

Law firms currently regulated by the SRA

  • 12. For existing SRA regulated law firms considering applying to become ABS from October 2011, the relevant information sources are as set out above. However, existing law firms must also consider how the existing legal and regulatory requirements apply to any preparatory steps that they may take prior to any authorisation by the SRA to operate as an ABS.

  • 13. It is a requirement that, when practising solicitors provide legal services, they do so through a regulated firm so that clients and others benefit from the protections laid down by Parliament and by the SRA's current regulatory rules.

  • 14. The SRA has no power to recognise a firm whose structure or business arrangements do not comply with s.9A of the AJA. This means that (with the exception of LDPs established under s.9A) non-lawyer individuals or businesses are currently prohibited from having any ownership interest in a law firm, or exercising any control or management over a law firm. Your arrangements must, therefore, remain within the framework permitted by the current legislation and by the SRA's rules.

  • 15. Within this framework the SRA is keen to enable firms to make appropriate preparations for the setting up of ABS, and these can include, for example:

    • discussions with potential business partners;
    • an agreement to enter into exclusive negotiations with a potential business partner;
    • a non-binding arrangement with a potential business partner for the setting up of an ABS (i.e. an arrangement "subject to contract");
    • certain conditional contractual arrangements to be activated once the regulatory requirements have been changed (i.e. post-October 2011) and all necessary approvals granted by the SRA, e.g. an agreement to accept new non-lawyers, or an outside investor, into partnership;
    • practical preparatory arrangements such as discussions with banks, the registration of company names, the acquisition of domain names, etc.;
    • joint planning;
    • public announcements; or
    • joint marketing, including meetings with clients.

  • 16. The application of these issues to any particular circumstances will be heavily dependant on the detail of the arrangements being contemplated. For example, it is possible that certain conditional contractual arrangements could amount to a breach of current Rule 14 of the Code of Conduct by creating a third party interest over the existing ownership rights in the firm. Therefore, it is important that you consider the legal and regulatory issues arising from any contemplated arrangements as well as other issues, such as business and finance arrangements. Importantly, you need to have confidence in the identity of any individual or business that you are contemplating arrangements with and that they are likely to be regarded as suitable future owners or managers of a regulated body. In deciding to enter into arrangements with external individuals or organisations before October 2011 to create an ABS, it is important for existing regulated law firms to also have regard to the following issues.

Arrangements that you may not enter into

  • 17. You may not enter into any arrangement which would:

    • involve selling your ownership interest in the practice or any part of it (or any service company) before you have been authorised as an ABS, e.g. you should avoid granting any option to purchase your interest in the firm for nominal value, in circumstances which would suggest that the ownership and/or control of the firm has already passed;
    • put your future business partner in control of material decisions about your business;
    • put your firm in the position of acting as a "front" for another organisation;
    • put any outsider in de facto control of any votes in a meeting of the partners, members, shareholders or directors, as this would put the firm outside the definition of a "legal services body" under section 9A of the AJA;
    • create a situation where a third party becomes a "shadow director" of your firm with effective blocking power on decisions made by your firm; or
    • allow your firm to become, in effect, a subsidiary of an outside organisation - which could jeopardise the protections put in place for the clients of regulated law firms, as well as being contrary to the current law. By contrast, there is no objection to a firm adopting a common logo or branding style to link the firm's image with that of other service providers.

    Arrangements to remain prohibited post-October 2011

    18. Even after ABS are allowed, certain arrangements will remain prohibited because they would be contrary to the public interest, for instance any arrangement which would:

    • compromise your ability to give independent advice to your clients, directly or indirectly; or
    • allow a third party access to confidential information concerning your clients.

Arrangements that may be acceptable after October 2011, or acceptable with safeguards

  • 19. Certain arrangements may be acceptable once you have been authorised as an ABS, or may be acceptable in some circumstances or subject to appropriate safeguards. However, as the law and our rules stand, you cannot enter into any arrangement which would:

    • compromise your firm's independence - e.g. you should avoid any funding agreement (other than a normal bank loan or overdraft) which would give the funder control over the management of your firm or allow it to use the threat of putting the firm out of business to influence daily operational behaviour, or a fee sharing agreement which would involve parting with such a proportion of the firm's profits as to jeopardise the firm's independent financial survival, or the granting of a "call option", which could indicate that control of the firm has already passed; or
    • involve you in co-ownership structures which could put you in breach of the separate business rule (rule 21) prior to the implementation of checks on "restricted interests" under Schedule 13 to the LSA.

Service companies

  • 20. A regulated firm's service company has to be wholly owned by the firm. By a "service company" we mean a company which, while it has no face to the public, carries out "support functions" essential to the running of the firm, such as the employment of staff and the leasing of premises and equipment.

  • 21. A regulated firm cannot invite an outside investor to buy into the firm's service company because this will almost inevitably result in a breach of the current rules. This is because if management and control of a service company has been passed to an outside body, the SRA is unable to regulate it.

Further information and help

Further information

  • 22. In April 2011 we will be publishing a Guide to the ABS application process.

  • 23. Further documents relevant to ABSs and the application process will be published on our website. For more help about what the LSA changes will mean for you, see our LSA frequently asked questions page for answers.

  • 24. If you would like to discuss any issues relating to preparation for an ABS application please email ABScontact@sra.org.uk.

Further Help

  • 25. As we approach the creation of the first ABS we recognise that new (non-regulated organisations) and existing law firms which wish to become ABS will need to put more detailed plans in place and to commit to business and funding arrangements.

  • 26. As outlined above, the responsibility for ensuring that any such arrangements are compliant with the existing law and regulatory requirements, pre-authorisation as an ABS by the SRA, lies with the organisations concerned. Nevertheless, we recognise that ensuring the regulatory compliance of any preparatory arrangements will be very "fact specific" and it is therefore difficult for the SRA to provide all-embracing guidance about what may or may not be acceptable in the absence of information about the detail of what is being contemplated in any particular case. For example, as set out at paragraph 15 above, certain conditional contracts may be compliant but others may not because they could create a third party interest over ownership in breach of the current Rule 14.

  • 27. Given this, we recommend that any firm contemplating putting in place arrangements preparatory to establishing an ABS contact the SRA’s ABS Team to discuss the arrangements being contemplated. If we are satisfied that they are compliant with the current law and regulations (based and dependent on the information provided) we will tell you so. This will be without prejudice to our formal consideration of any subsequent ABS application.

  • 28. If, in our view, they would be non-compliant, again we will tell you. In appropriate circumstances we may be prepared to consider an application for a waiver from the current rules to enable you to put in place arrangements that would (or might) otherwise be non-compliant with the current Code of Conduct. For example, you might be contemplating a conditional contract that might not be compliant with Rule 14 of the Code. However, subject to appropriate and proportionate safeguards we might consider the granting of a waiver on specific conditions to be appropriate.

  • 29. When considering any waiver application in these circumstances we would consider (but not exclusively) the following issues:

    • are the arrangements proposed preparatory to an application to be authorised as an ABS?
    • are the arrangements reasonably required and proportionate to prepare for that application?
    • are there clear and credible reasons why the arrangements have to be put in place at this stage?
    • is the application for ABS likely to be one that will meet the authorisation processes and rules that will be in place in October 2011?
    • are there sufficient safeguards built into the arrangements to ensure that ownership and control of the regulated business remains in the hands of individuals currently eligible to own and control regulated law firms under the current law and regulations?
    • is there any risk posed by the proposed arrangements to our regulatory objectives including the protection of the public and consumers and the upholding of the rule of law?
    • are any external businesses or individuals involved in the proposed arrangements likely to meet the suitability test currently proposed for operation in October 2011?
    • are the arrangements capable of being unwound should any application to be authorised as an ABS be refused?

    Any waiver applications will need to be specific and demonstrate that the organisation concerned has considered the current regulatory framework and can therefore identify the issue for consideration by the SRA. Our consideration of any applications will be undertaken within the resources available and, therefore, if a very large volume of applications are received, it may not be possible for all applications to be considered. We will deal with any applications in the order in which they are received.

What are the possible consequences of breaching existing rules through any arrangements preparatory to establishing an ABS?

  • 30. A non-compliant firm could have its recognition revoked, or could even be subject to disciplinary proceedings. If a solicitors' firm or a currently unregulated business shows, by breaching the current rules, or by encouraging others to do so, or by other conduct contrary to the public interest, that it fails to pay proper regard to compliance with regulatory obligations, this could be a relevant factor for the SRA to take into account if and when the SRA eventually considers an application from the firm or business to set up an ABS.

  • 31. Another possible problem is that you could find yourself contractually bound to establish business arrangements which are at odds with the ABS rules which are eventually made.

  • 32. If, in the light of this guidance, you think that you may already have made inappropriate arrangements, you should contact us. Where this happens we will expect to see proposals for resolving the breach (which may include an application for a waiver in appropriate circumstances as set out above). In that instance, we will work with you to put things right.  We will not seek to take enforcement action either on reasonable decisions made in good faith or in respect of a firm or individual that has run into problems but shows the willingness and capability to work with us to put things right. However, enforcement action will be necessary where there is serious misconduct or there is a risk to the public which cannot be mitigated.

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