The risks affecting the sustainability and viability of law firms

February 1st, 2019
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By Thomas Harban

Many legal practitioners indicate that they face a constant struggle to survive economically in practice. There are a multitude of reasons for the challenges faced by these practitioners and there are a number of risks posed by the challenges associated with the sustainability and viability of the legal practices concerned.

The Law Society of South Africa (LSSA) reports that there are currently 26 701 attorneys and 6 669 candidate attorneys in South Africa (SA) (www.lssa.org.za, accessed on 19-11-2018). There has been a steady growth in the profession in the past decade and this growth must be considered against the background of the slowing economic growth and other factors that affect the profession. With the unique nature and structure of the South African economy (and society) in general, questions must be asked regarding whether or not the landscape of legal practice is saturated and to what extent current practices are sustainable in the medium to long-term. Is the available ‘legal services economic pie’ large enough to cater for the growing number of legal practitioners? Does the current spread of legal services offered by the profession cater for the ever-changing needs of the consumers of legal services? Is there an appropriate spread of legal skills and instructions to meet the needs of all stakeholders in a sustainable basis?

It is against this background, that the question of the sustainability and viability of individual legal practices must be considered. The statistics published by the LSSA indicate that in 2016, of the
12 373 firms in the country, 10 182 (82,3%) were sole practitioners and firms with between two and nine partners made up 2 084 (16,9%) of the legal practices. The overwhelming number of firms in SA are thus small in terms of the number of partners. Smaller firms face unique challenges in respect of viability and sustainability. Generally, larger firms may have increased resources to share the risks, but this does not mean that those firms (or individual departments/business units within those firms) do not face risks associated with viability. No law firm or other business enterprise is immune from this risk. Similarly, a small firm may have developed and implemented sufficient measures to address the risks of viability and sustainability and could be generating sufficient income to meet its operational needs. The number for claims notified to the Attorneys Insurance Indemnity Fund NPC (the AIIF) indicate that claims arising from sole practitioners perennially make up the highest number by far. In some instances, the quantum claimed exceeds the available AIIF limit of indemnity and the firm does not have top-up insurance in place (or does not have a sufficient amount of top-up cover). The result is the practice faces significant exposure in respect of the claim/s and its continued existence is threatened. The firm will be regarded as self-insured for the exposure in excess of the available insurance cover.

The assessment of the viability of the firm must be one of the considerations taken into account in the ongoing assessment of the risk environment in which the firm operates. The factors affecting the viability of the practice may be internal or external. Some of the factors may be within the control of the practitioner while others are not. The financial stability of a firm is one of the risk factors affecting the viability and sustainability of a firm, but is not the only factor. The ability of the firm to meet its operational needs can be affected by a wide variety of factors. In circumstances where the firm is not generating sufficient income to meet its operational expenses, serious consideration must be given as to whether or not it is prudent to continue with the practice in its current form or even at all. The risks associated with pursuing a technically and financially insolvent practice must be appreciated. In mitigating this risk, some of the options available will be to consider –

  • cutting the past losses and closing or selling the firm;
  • investigating whether or not a merger with another firm is viable;
  • downsizing;
  • exploring new areas of practice; or
  • even upskilling oneself in order to be better equipped to meet the challenges of practice.

A marketing strategy (within the Rules) and other measures of securing new clients can be considered. One may be technically gifted in ones chosen area of specialisation in practice, but it does not necessarily follow that such a person has the necessary business acumen or the required work ethic to be an astute and successful business person running a successful firm. It is important to be able to do an honest self-assessment and to identify your strengths and weakness even where these are not necessarily aligned with your intended ambitions and plans.

The factors posing a risk to the legal profession in general include:

  • The generally challenging economic environment across the globe, an economic downturn is often followed closely by an increase in professional indemnity claims against legal practitioners.
  • Organisations outside of law firms offering services traditionally carried out by law firms (these include banks, audit and advisory firms, estate agents and legal consultancy organisations, which are not law firms. In some jurisdictions internationally, audit firms have purchased law firms).
  • The slowdown in some areas of practice (such as conveyancing as the property market stalls or Road Accident Fund claims as the legislative environment changes).
  • The loss of key clients.
  • The loss of key staff.
  • Certain areas (geographically and/or in terms of area of practice) may have become saturated.
  • The negative reputation of the profession in some circles.
  • An inability or refusal by some practitioners to adapt to the changing legal, economic and technological environment.

Practitioners must recognise the internal and external risks which, if they materialise, will affect their individual firms and also to assess the potential impact on the risks materialising. Appropriate planning is essential in addressing these risks. The risk or risks associated with the long-term sustainability of the firm must be one of the key risks addressed in the firm’s risk management plan. When any risk materialises, its potential impact could have severe consequences for stakeholders within the firm, as well as external parties.

The structure, size, geographical location of the firm and the suite of services are some of the factors that will impact on its viability in the event that there is no effective risk management plan in place. Appropriate resourcing must also be taken into account in order to address the risks. This includes the human resources, as well as the infrastructure and other resources necessary to enable the firm to meet its business and operational needs and its servicing obligations to clients and other stakeholders. This, in many ways, can lead to a so-called ‘chicken-and-egg’ situation for emerging firms in that in order to operate successfully, these resources are required. However, the acquisition of these resources requires a significant initial capital outlay before the financial benefits can be reaped. The firm may not have the financial resources to procure such resources upfront. This is of particular significance in the South African context, where entry barriers to the profession by historically disadvantaged groups persist and the adequate distribution of certain types of legal work remains a challenge.

As many institutions seek to rationalise their expenditure, one of the areas where they seek to reduce are costs associated with legal expenses. Such institutions may, for example, choose to build up their internal legal resources and make appointments of legal advisers and corporate counsel, resulting in a reduction in the amount of work sent to law firms. The reliance on a key client is also a significant risk in that the firm will be affected where, for instance, the key client may elect to engage the services of another law firm, go out of business or is the subject of corporate activity or where the business relationship deteriorates.

When faced with challenges related to meeting the bottom line of the firm, practitioners normally dedicate an inordinate amount of their time, resources and energy to ensuring that the business continues as a growing concern. While dedicating an inordinate amount of time to addressing these challenges, the focus on other key risk areas, as well as on the management of the firm is usually placed on the back burner and not seen as an immediate priority. This situation creates the perfect environment for errors to occur, significant risks to the viability of the firm to materialise and the practitioners affected often comment that the risks arose out of a so-called ‘blind spot’. Similarly, in a firm facing significant challenges in respect of income, there may be an increased temptation for the theft of trust money.

While a significant amount of expertise can be built up over many years in practice, no one individual is equipped with the specialist skills required for each and every risk faced by a business enterprise. The fact that there may be one (or few) key individuals in a practice who are able to deal with a variety of areas and functions in the firm is, itself, a risk of overreliance on a key person. Where a firm’s institutional knowledge is centralised with one key person, this is also a risk. In the event of the unavailability of that key person, the continued existence of the firm is then placed at risk. Depending on the personality of the person involved, the key individual may have a dominant character, which excludes others from the proper appreciation of the risks. A young practitioner, for example, may have the desire to pursue a practice for their own account but may not have the business acumen, the appropriate goodwill and reputation or the necessary desire to deal with the administrative responsibilities of practising for their own account. A lack of employment opportunities after the completion of the term as a candidate attorney or pupillage may result in some practitioners opening their own practices when they are not ready to embark on the entrepreneurial journey or do not have the acumen, interest or discipline to be self-employed. Similarly, an experienced practitioner may consider venturing out on their own when they are not equipped to practice for their own account.

In order to address the risks highlighted in this article, firms can consider:

  • Developing business plans that address issues of the sustainability and viability of the practice in the medium to long-term. The business plan must address the unique circumstances of the firm. Simply following a precedent or downloading a generic business plan off the Internet will not be sufficient to properly deal with the risks in the practice.
  • Including these risks in the risk assessment and identifying appropriate risk mitigation measures.
  • Identifying appropriate risk treatment options (acceptance, avoidance, mitigation or transfer of the risk). The purchase of appropriate insurance cover is one example of a risk transfer option. It must be noted that the purchase of insurance does not eliminate the underlying risk, nor can insurance be used to make an otherwise loss making practice profitable.
  • Consideration of whether or not the practice should continue (in its existing form or at all).
  • Getting help from appropriate institutions available to the profession. Depending on the nature of the assistance required, practitioners can consider approaching institutions such as the Legal Practice Council, the Legal Practitioners Fidelity Fund, the AIIF, the Attorneys Development Fund (for funding), Legal Education and Development and the LSSA for assistance.
  • The use of IT as a business enabler and as a means of facilitating and enhancing the efficient management and administration of the law firm.
  • Obtaining appropriate training and/or mentorship.

Practitioners must never turn a blind eye to the red flags associated with risks of viability and sustainability. All areas of potential risk must be appropriately addressed. It must be remembered that there will always be potential liability on the part of the practitioner concerned in the event of any of the risks materialising.

Thomas Harban BA LLB (Wits) is the General Manager of the Attorneys Insurance Indemnity Fund NPC in Centurion.

This article was first published in De Rebus in 2019 (Jan/Feb) DR 16.

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