Case study: Recovering costs can be a costly business

July 2013

Recent dealings with a firm show the importance of having systems in place for proper management of costs recovery and the impact of inadequate financial planning. This case study provides detail on some of the pitfalls to be avoided and lessons to be learnt.

Details

Mr X is a sole practitioner and the firm of "X Solicitors" has been providing family and matrimonial legal services for over 40 years. Mr X has a legal executive to assist with the legal work and an accountant who comes in one day a week to deal with the books. Mr X had a loyal client base and a good reputation, resulting in other practices recommending his services. He is considered an expert amongst the local legal community, but it is unfortunate that his expertise seems not to extend to his management of the business or sound financial planning.

At the end of May, the SRA was notified that HMRC had issued a petition for Mr X's bankruptcy. He owed over £200,000 in VAT and PAYE. Mr X, as the firm's Compliance Officer for Legal Practice and for Finance and Administration, had not made any report to the SRA about the firm's financial difficulties or the bankruptcy petition.

The Supervisor's discussion with Mr X established the following:

  • Total liabilities amounted to £232,000 made up of debts to HMRC, outstanding rent, and outstanding invoices to the firm's accountants.
  • Costs which had been billed but not paid amounted to £246,000.
  • There were 86 live client matters, including some high-value ancillary relief claims.

The firm's financial problems arose from cash flow difficulties directly as a result of poor financial management and recovery of costs. The lack of cash receipts at crucial times meant that Mr X was unable to meet monthly and quarterly liabilities.

Mr X had been in discussions with his landlord and his accountant—both friends of his—who were both allowing further time for the outstanding rent and invoices to be paid. However, Mr X had no contact or discussion with HMRC and had not tried to agree a Time To Pay arrangement. Payments had not been made and he had ignored correspondence from HMRC, resulting in the issuing of the petition. Mr X subsequently asked HMRC to agree a TTP arrangement and requested a three month adjournment of the petition, but HMRC refused both. The hearing is scheduled for July.

Systems and processes

Mr X's difficulties stemmed from the fact that there were no proper systems in place for financial planning or effective financial management of the business. For example:

  • Mr X did not carry out any short term cash flow forecasting. This meant that he was not properly aware of weekly and monthly liabilities and did not seek to match receipts with those liabilities.
  • It was rare for Mr X to request any monies on account of costs at the outset or during the retainer.
  • When costs were received, no provision was made for VAT payments.
  • Mr X would raise interim bills on cases but allow the retainer to continue and further costs to be incurred, despite non payment.
  • There was no central record of outstanding invoices and no process in place for chasing payment. Mr X relied on his clients to make payment, when they could afford to do so.
  • Unpaid invoices were left without action, meaning that enforcement action was then time barred and costs had to be written off. In one such case, the final invoice was over £50,000.
  • Other aspects of the business were not managed properly, with financial impacts. For example, whilst the firm had a policy for destruction of files, none had ever been destroyed. After 40 years of practice, the number of archived files was significant with unnecessarily high storage costs.

Impact

The lack of proper systems for the recovery of costs and failure to plan and manage the firm's finances ultimately led to HMRC issuing the bankruptcy petition. If successful in the application, and Mr X is adjudged bankrupt, his Practising Certificate will be automatically suspended. As the only solicitor in the firm, this will affect his ability to deal with client matters and access client monies, as the firm's client account must be operated by a solicitor with a current Practising Certificate. Even if the suspension of the PC is lifted, it may be subject to conditions affecting Mr X's ability to practise.

This leaves limited options for Mr X. He will need to consider employing a solicitor who is able to operate client account. The financial difficulties of the firm are likely to impact on his ability to do so. Alternatively, Mr X will need to consider winding down the practice in an orderly manner, or merging with another firm. Ultimately, if contingency arrangements are not put in place, and clients’ interests are at risk, intervention may need to be considered.

Our Supervisor will also need to consider the conduct of Mr X in terms of his compliance with Principle 8, which requires solicitors to run their business effectively and in accordance with proper governance and sound financial and risk management principles. There will also be consideration of the failure to report the financial difficulties and the issuing of the bankruptcy petition.

Lessons to learn

Some simple financial planning and improvements to systems in the firm could have avoided the situation Mr X finds himself in. This might include the following to improve receipts and cash flow:

  • Requesting money on account of costs at the outset and regularly during the retainer.
  • Delivering monthly bills to the client.
  • 14-day payment terms with clarity of consequences on non-payment for example ceasing work on the matter.
  • Central record of debtors with close monitoring of the debtors ledger.
  • Strict enforcement of payment terms through an escalated procedure.

It is also important to have early engagement with the SRA. This is required as part of the Compliance Officer reporting obligations but also key in terms of potential impacts and consequences—early and constructive engagement is less likely to lead to significant disciplinary or regulatory outcomes.