The Legal Services Act 2007 will implement fundamental changes to the structure and regulation of legal services in England and Wales. It presents significant commercial opportunities for law firms, as well as their potential business partners and investors.

It is vital that, when planning for the exploitation of those commercial opportunities and/or the implementation of the new regulatory regime required by the Act, law firms' management teams give proper consideration to the impact of any proposals on their staff – a professional practice's most valuable resource – as well as their legal obligations to them.

The Act introduces changes aimed at increasing competition in the provision of legal services, creating greater flexibility within the legal profession and protecting and promoting the interests of consumers. Its key measures are:

• It creates the Legal Services Board – a single supervisory body with responsibility for overseeing approved regulators such as the Law Society and the Bar Council.
• It establishes the Office for Legal Complaints – an independent body to deal with all consumer complaints against lawyers and/or about legal services (although professional disciplinary matters remain the responsibility of the approved regulators).
• It amends the statutory powers of the existing front-line regulators, such as the Solicitors Regulation Authority (SRA), to enable them to authorise the creation of legal disciplinary practices (LDPs) – firms owned and managed by a mixture of different types of lawyers, such as solicitors, barristers and conveyancers and/or with a minority of non-lawyer managers (partners, members or directors).
• It permits alternative business structures (ABSs) – enabling lawyers to enter into multi-disciplinary practices with other kinds of professionals, such as accountants, and allowing external investment in and ownership of law firms.

The ABS regime will not be available until the Legal Services Board has been empowered (which is unlikely to be before 2010) and has established the requirements pursuant to which it will authorise bodies, such as the SRA, to license ABSs. It is therefore unlikely that ABSs will be possible before 2012.

However, the introduction of LDPs is not dependent on the Legal Services Board. The LDP regime will be available as soon as the regulators have completed their consultation processes (the SRA has already published 10 consultation papers in the eight months since the Act received Royal Assent) and updated their rules, regulations and procedures. The SRA aims to be in a position to enable LDPs by the spring of next year.

Currently, the regulation of law firms is focused on the qualification, discipline and regulation of individual lawyers, particularly through the annual practising certificate exercise. However, the Act provides that both individual lawyers and the firms that employ them must be properly authorised. This requires the introduction of firm-based regulation.

Firm-based regulation is not a new concept – the regulatory regime of the Financial Services Authority (FSA) is based on the approval of employers as well as employees. However, it is a new approach for law firms and their management teams.

The Act permits an LDP to have up to 25% of non-lawyers as managers, provided they have been approved as suitable by the relevant approved regulator. Law firms will need to apply to the SRA to register non-lawyer managers and to demonstrate that they are 'fit and proper' – requirements also imposed by the FSA. The SRA has been consulting on the development of a 'character and suitability' test for this purpose.

It remains to be seen exactly how the SRA, and other approved regulators, will implement firm-based regulation and 'fit and proper' tests. However, the implications of a regulatory regime much closer to the FSA model are significant for both law firms and their staff. For example, the FSA rules require the registration and de-registration of regulated individuals and their ongoing satisfaction of detailed 'fit and proper' tests and impose strict obligations with regard to reporting the reasons for the termination of a regulated individual's employment and giving references in respect of them.

These make both disciplining and dismissing underperforming employees (without destroying their careers) and alternative compromise solutions much more difficult. Law firms are likely to face similar issues under the SRA's new regulatory regime – which will have a substantial impact on the way they are able to manage their staff.

Restructuring issues

The Act permits the establishment of new structures for firms providing legal services – initially LDPs and then ABSs. These could take any number of forms – from multi-disciplinary professional partnerships to companies wholly or partly owned by non-lawyers – and commercial organisations will be able to set up or acquire legal practices. Exploitation of many of the possibilities will require law firms to restructure. Any move away from a traditional partnership structure may see partners becoming employees and therefore acquiring full employment rights.

In addition, in February this year the SRA issued a warning that the Act may require some large international law firms operating as limited liability partnerships (LLPs) to change their corporate structures. For both regulatory and financial reasons, many such law firms have developed complex, multi-tiered structures incorporating several corporate members, but the SRA believes the Act (unintentionally) prevents LLPs from having more than one level of corporate membership.

It is vital that law firms' management teams consider, and plan for, the impact any restructuring might have on their employees – both lawyers and support staff. For example, the announcement of any proposed merger or acquisition will inevitably create uncertainty and concern about potential redundancies, particularly among support staff. Law firms will need to take steps to ensure the retention of key individuals, particularly its experienced lawyers, some of whom may be resistant to change.

There are numerous ways of incentivising employees financially to remain with a firm, including the grant of retention bonuses or real or phantom share options payable or vesting after a specified minimum period of service post-restructure. Law firms should fully explore their options well in advance of announcing any intention to, or even possibility of, restructure. Consultation with staff is also key to maintaining morale during a process of change.

Law firms may also have legal obligations to their staff on a restructure. If a firm's proposals will result in redundancies it is obliged to carry out individual consultation processes with every potentially redundant employee (or compensate them for unfair dismissal at a cost of up to £63,000 per employee). If there is a potential for 20 or more redundancies within a period of 90 days, the firm must notify the Department for Business, Enterprise & Regulatory Reform and commence collective consultation with elected representatives of all affected employees at least 30 days before any employee is given notice (or 90 days if 100 or more are at risk of redundancy). If it fails to do so, it will be liable to pay a 'protective award' of up to 90 days' pay (uncapped) per employee.

Additional issues arise if the restructure involves the transfer of a business, function or activity from one partnership or company to another – including intra-group. In those circumstances, the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) will impose certain restrictions and obligations on law firms and their business partners. For example, TUPE provides that any changes made to an employee's terms and conditions of employment for a reason connected with a transfer are automatically void – even if the employee consents to them. As a result, strictly merging firms cannot harmonise their terms and conditions or amend their employees' existing contracts to ensure they are subject to restrictive covenants that provide proper protection for the merged entity.

Many law firms consider their values and culture to be vital for distinguishing them from competitors and for attracting and retaining talent. These firms will have already faced challenges maintaining their values and culture as they evolve and grow. Those challenges are likely to be even more difficult on conversion to an LDP or ABS if external management, ownership or investment is involved.

Law firms are already attracting significant interest from private equity and corporate finance houses, notwithstanding the fact that the ABS regime permitting external investment will not be available for several years. Commentators have expressed concern about the impact a private equity investor – focused solely on maximising profit – could have on a firm's values and service model.

There are, however, measures law firms can take to protect and maintain their culture. Proactive firms have already taken steps to identify and articulate their values, in consultation with their staff – employees are more likely to embrace and perpetuate their firm's culture if they are involved in this way. Firms should (where practicable) undertake a full due diligence process in respect of prospective managers, business partners and investors to determine whether there is an appropriate fit. If a firm considers its values and culture important, it should ensure their preservation is high on the agenda in any discussions with potential business partners and investors.

Melanie Lane is a partner in Olswang's employment group and a member of its partnerships and professional practices group.