In 2002, Cobbetts went all out to become a top 50 UK player through a series of ambitious mergers. But its plans ended in disaster when it collapsed into administration this February. Gerard Starkey takes a closer look at the events that brought the firm's 175-year history to an abrupt close

On 6 December 2012, Cobbetts' managing partner Nick Carr released a confident statement about the firm's financial position, saying: "Our half-year results ensure we remain on target, and new client wins mean that trading predictions for the next six months are strong. We expect to meet our financial targets by year end." 

Taken in isolation, this statement is no different to the numerous anodyne comments issued on behalf of law firm managers whenever full and half-year financial results are announced. 

What sets it very much apart is what happened next, as the reassuring statement above was made less than two months before the Manchester firm collapsed into administration, ending months of speculation about its future. 

Such was the speed of Cobbetts' subsequent demise after several years of brutal exposure to the protracted financial downturn that the next formal comment from the firm, made on 30 January 2013, was to confirm its collapse. 

"Having regard to the difficult trading conditions in the professional services sector, we have reluctantly concluded that the appropriate course at this time is for the firm to obtain the protection of an interim statutory moratorium to enable a sale of the business and assets of the firm to be concluded in a short time frame," it said. 

So how did the firm make the unhappy transition from aspiring upstart in the early stages of an ambitious growth strategy to failure within a decade? And how did it all unravel so quickly at the end?

The good times – building a national firm

Close to the turn of the century, Cobbetts was enjoying healthy profits for what was then a modestly sized firm, with turnover of £26m and profits per equity partner (PEP) of £201,000 in 2002-03. It also boasted big-ticket names such as Barclays, Whitbread, Orange and Matalan among its roster of clients.

Cobbetts, led by ambitious managing partner Michael Shaw, had settled on a new strategy that was designed to transform it into a UK top 50 firm by revenue by 2005. 

With the Manchester market becoming increasingly saturated, Shaw decided to look further afield, considering options in Bristol and Newcastle before opting to expand into Leeds and Birmingham.

At this stage, Shaw ruled out a move into London, taking heed of a clutch of other successful regional firms which had struggled to gain a foothold in the ultra-competitive City market. 

"Michael Shaw's strapline was for Cobbetts to become the regional firm without a London office," says one former Cobbetts partner. 

Its first move saw Cobbetts combine with commercial property specialists Hind Read Stewart in May 2002, giving the firm a base in Leeds. The acquisition allowed Cobbetts – then with 54 partners – to add 18 more and £7m in revenue.

Then in 2003, it began talking to Midlands firm Lee Crowder – but as the discussions dragged on, the firm unexpectedly snapped up Manchester corporate/commercial boutique Fox Brooks Marshall that November. The deal added around £2m to Cobbetts' turnover as well as 10 partners to bring total partnership numbers to 93.

The Lee Crowder merger finally went live in May 2004, swelling Cobbetts' headcount to 116 partners and adding £11m to its turnover. At the end of the 2003-04 financial year, it reported growing revenues of £41.6m, while PEP in contrast remained flat at £202,000. 

And the growth didn't stop there. Cobbetts acquired planning boutique Wilbraham & Co in September 2004, with all five partners going straight into Cobbetts' equity partnership. The deal was rapidly followed by the firm's fourth merger in 10 months, with the addition of the Leeds arm of Walker Charlesworth & Foster. By now, the partnership stood at 123 – more than twice what it was in early 2002. 

As well as the spate of mergers and acquisitions, Cobbetts was also mid-way through a lateral hiring programme that saw it recruit partners from bigger national rivals such as legacy Hammonds, DLA Piper and Pinsent Masons. They joined on generous packages by Cobbetts' standards. From 2003 to 2005, the firm hired 21 partners, with a further 10 joining the following year. 

But the strategy was starting to divide the partnership, with one former partner commenting: "The view among partners was that, although good lawyers, the people they took on had been at large national firms but had been spat out. Some long-serving partners started to grumble and when the big names failed to perform, the animosity grew."

By the end of 2004-05, Cobbetts had reached its goal of entering the UK top 50 – making its debut at number 42 with revenue of £50m – almost double what it was two years earlier. But all of the partner additions were taking their toll on PEP, which fell to £190,000, the lowest in the top 50. Meanwhile, partner numbers by this point has risen to 138.

Property complications 

It was against this background of growth that lease agreements were signed on three new buildings – decisions which arguably, as was the case with Halliwells before it, ultimately drove Cobbetts to its demise. 

At the start of the 2005-06 financial year, senior partner Stephen White was replaced by property head Stephen Benson. However, before he stood down, White – together with Shaw – had helped to negotiate moves into new and bigger premises in Leeds, Birmingham and Manchester.

The feeling was that the firm had outgrown its restrictive and small offices, and the plan was to sub-let any unused space in the new premises (which the firm moved into in 2005-06) to cover the rent.

Long-term leases were agreed on all three new buildings. But while floor space was let out to professional services business Grant Thornton and real estate firm Jones Lang LaSalle in Leeds and Birmingham respectively, two out of the seven floors in the Mosley Street offices (pictured) in Manchester remained empty.  

Some partners were angered by the firm's decision to take out a 20-year lease on the 104,000 sq ft Manchester building. The deal saw Cobbetts agree to pay around £25 per sq ft, which was marginally below the going rate of £28. However, crucially, the contract did not include a break clause.

This meant that when the bottom fell out of the property market – one of Cobbetts' core practice areas – the firm was left with crippling overheads.

One former partner comments:  "The signing of the Manchester lease was never really discussed beforehand, but was rather presented as 'here's what we've done'.

"The decision to sign the lease was crazy. What were they thinking? It came with a decent rent-free period and the intention was to let out the empty space, which if the boom had lasted we could have done at decent rates. But the good times were never going to last."

However, another ex-partner continues to defend the move: "It wasn't a decision, it was a necessity. Our lease on Ship Canal House [the old offices in nearby King Street] was coming to an end and one of our biggest constraints was a lack of space.

"We were operating out of two offices and in terms of making a decision, there was only one office out of the ground that was of a suitable scale. If anyone thought we were being over-ambitious at that point, we had little choice."

Bad times take root

With the markets still buoyant, Cobbetts' turnover climbed more than 7% to £53.8m during 2005-06. But PEP remained static and a review was launched, which would ultimately see around 20 partners exited. The firm also hived off an 11-lawyer family practice to north-west rival DWF.

"The culling of partners was completely inevitable," says a former partner. "After the mergers, there was too much dead wood, particularly in Manchester where there were some severe underperformers who shouldn't have been there in the first place. I don't think management went far enough. They should've stripped out more while they were at it."

The cull did result in an upturn in PEP, with partner profits increasing by 29% to £246,000 in 2006-07. But the rebound was not enough to change the fact Cobbetts' PEP was the lowest in the top 50 during what were still boom years.

By contrast, similar-sized businesses were posting much healthier results. Burges Salmon, for example, recorded a PEP of £470,000 in the same year on turnover of £61.4m.

This disparity in profitability did not stop the firm from opening a small office in London through the hire of two partners from Wedlake Bell. While Shaw (pictured) insisted that the office would never be full service, the City launch still marked a shift in strategy as the base was designed to service international clients gained through the earlier Fox Brooks Marshall bolt-on. 

Results for 2007-08 showed revenues broadly flat at £59.3m, while PEP soared to £290,000. What the firm did not know at the time was that the revenue figure would represent Cobbetts' best-ever result. 

In 2008, on the eve of the collapse of Lehman Brothers and the ensuing financial crisis, Cobbetts restructured its partnership by scrapping its salaried and equity partner ranks in favour of variable and assured equity status.

In practice, this meant that about 30 salaried partners invested roughly £50,000 each into the business in return for 10% of their pay becoming tied to firmwide profits. 

Some salaried partners saw this switch as an opportunity to secure their long-term future during what was a time of uncertainty. "There was a certain degree of buying into the firm which made us more secure and more likely to stay – it put us in a stronger position," argues one ex-partner.

In the event, though, the introduction of a link between the firm's performance and partner pay failed to produce an increase in remuneration for any of these former salaried partners. 

In 2006, Cobbetts had managed to clear an overdraft that at one stage stood at several million pounds. But by 2008, the firm found itself with bank loans and overdrafts totalling £6.5m. The increase was partly attributed to the cost of fitting out its new offices.

And Lehman's collapse then had a devastating impact on the property sector, one of Cobbetts' core practice areas. Revenues and profits fell off a cliff. Turnover in 2008-09 fell by 22% to £48.5m, while PEP plunged 314% to just £70,000.

The poor trading results prompted management to implement a host of cost-saving measures. During the second half of 2008 alone, Cobbetts conducted three redundancy rounds that saw around 69 staff, including fee-earners, leave.

In addition, the firm requested its transactional teams and support services staff work a four-day week for 12 months, while fee-earners within the corporate division were asked to job share in the hope of avoiding further redundancies.

"I know of one corporate lawyer who got a second job at a sports store in order to top-up their money," recalls a former partner. "For some, there was a sense that it was better to have a reduced-hours job than no job at all."

Other cost-saving measures included a temporary halt on pension contributions.

Nice guys finish last

But despite these cuts, some partners within the firm felt that the redundancies did not go far enough. They cite the fact that the firm held three redundancy rounds in quick succession as evidence of management caution. 

As one former partner reasons: "When making decisions, we took a moral as well as commercial view. In relation to the redundancies, we could have cut numbers further, but everyone thought we were experiencing a single-dip recession. 

"As such, we took the view that we should keep hold of as many good people as possible on the basis that recruiting once the market had picked back up would have had cost implications."

On the whole, Cobbetts remained a collegiate partnership standing behind Shaw and Benson (pictured). Though the duo faced leadership challenges from board member and commercial property partner Tony Fitzmaurice and former Read Hind Stewart managing partner David Hymas in 2008, Shaw stayed in his post until 2012, while Benson saw out Cobbetts' final days before transferring to DWF after the subsequent pre-pack administration deal was agreed.

"The general feeling was the firm had not been badly managed," says one ex-partner. "The market had gone mental and the management was trying to make the best of a bad market. The view was they were trying to protect as many jobs as possible."

Another former partner says: "If anything, Shaw was too nice and struggled when it came to the tough decisions." 

Mounting debts

While many firms were struggling during the downturn, the troubles at Cobbetts were particularly evident. Revenue sank to £43.8m in 2009-10 – its lowest level since 2003-04 – while debt continued to creep up. In January 2010, the firm refinanced its credit facilities with the Royal Bank of Scotland (RBS), offering its debt recovery arm Incasso as security. In return, it secured a £6.5m loan and a £2.5m overdraft.

In addition, Cobbetts also borrowed £1.5m through a short-term asset-based leasing agreement to pay its January tax bill. At the time, Shaw said the loan would avoid having to call on partners to provide extra capital. But a number of partners have told Legal Week that a cash call of some kind did occur that year. 

"There was a capital call around that time, but the overall capital contributions of around £250,000 [per partner] weren't particularly high and we were only asked to put in a small additional amount depending on the number of points you had," says one former partner.

Then, after the close of the 2010-11 financial year, Cobbetts switched its banking facilities from RBS to Lloyds TSB with whom it agreed £7.5m in loans and an overdraft facility of £2.5m. 

"The firm didn't want to move from RBS, but put simply, there were better terms with Lloyds," says a former partner.

Revenue for 2011-12 climbed marginally to £44.5m, with profits available for division falling from £11m to £10.6m. Despite this, with partner numbers falling from 85 to 79, Cobbetts' top earner took home £400,000, up from £292,500 the previous year.

Against this backdrop, towards the end of 2011, the firm entered into merger talks with DWF. Led by managing partner Andrew Leaitherland, DWF had by now overtaken Cobbetts as the northwest's most expansionary commercial law firm.

Negotiations were called off in early 2012 due to what was described as "current uncertainty in market conditions". But there was speculation that Cobbetts' high debt levels were responsible for the impasse. 

Soon after the culmination of these talks, it was announced that Shaw would not stand for re-election when his term came to an end that April. One partner notes: "I think generally people were sad to see Shaw go. He hadn't supported the discussions with DWF. Putting it nicely, he didn't think there was a cultural fit, so he decided to stand down when he could see the direction the firm was taking."

Another partner observes: "Michael was totally opposed to the deal and not out of selfish reasons because he knew he wouldn't have a role to play at the combined firm as Leaitherland wouldn't have entertained him. He just felt it was a poor fit culturally. Michael's failure was in not finding a better practice to merge with. That was a big failure of the management."

The contest to replace Shaw was held between then litigation partner Carr and former Manchester office head Paul Johnson, with Carr emerging victorious in May 2012. All the while, the firm's financial situation was deteriorating. 

One internal flashpoint came in August 2012 when Carr and several other partners received a letter from HM Revenue & Customs (HMRC) requesting payment of a tax bill that had been due the previous month. Unaware the firm had not paid the bill on time, angry partners demanded answers from finance manager James Boyd.

"People were angry and for many, it was the final straw," says one former partner. "Boyd would have made the decision, but I'm not sure if anyone else was involved. It was explained that it was cheaper to pay the bill late rather than organise a bank loan. Even Carr didn't know it hadn't been paid and he was livid."

Cobbetts denies delaying payment because it was cheaper, but not that it was delayed without partners' knowledge.

As well as highlighting communication issues within the firm, the incident demonstrated the seriousness of Cobbetts' cash flow problems. In June, the firm had taken advice from Deloitte about how it could remain solvent, while Pinsent Masons was brought in to assist on issues relating to the continuation of trading and incurring new credit.

KPMG was also brought in to advise the LLP in June by Lloyds TSB, following a request to the bank to defer capital repayments.

By September, the firm was forced into negotiating deferral arrangements with its landlords, HMRC and retiring members – including, ironically, Shaw. Then in November, KPMG and the Solicitors Regulation Authority were asked to prepare a contingency plan by management.

According to KPMG, Cobbetts' management debated selling Incasso and making a £2.5m partner capital call. The latter was later ruled out as unwise given the firm's bleak financial outlook.

Despite the worsening financial situation and the engagement of external advisers – something the wider partnership was unaware of – Carr praised the firm's first-half performance for the 2012-13 financial year, when revenues stood at roughly £20m. He also talked up prospects for the second half of the year. 

In reality, by this time cash flow forecasts indicated that Cobbetts would be unable to meet its financial obligations on 1 February 2013 when impending liabilities, including a £2.4m partner tax bill, were due. On 17 January 2013, the decision was taken to try and sell the business without filing for administration. 

Initial discussions saw DWF return to the negotiation table. But following a brief period of due diligence, DWF concluded that a solvent purchase would not be possible, citing Cobbetts' lease liabilities and unsecured lending levels as insurmountable obstacles.

DWF was willing, however, to discuss acquiring the business along with some of its assets and made an offer on the basis of a period of exclusivity. These terms were accepted, ultimately closing the chapter on Cobbetts' 175-year history, with the firm entering administration and DWF buying the majority of the business in a pre-pack deal (see below).

"Cobbetts couldn't have done much more," said Leaitherland at the time. "On both sides, we tried to avoid insolvency and prevent administration. But it had got to the point of no return. It was the unavoidable fixed costs that did for them – the die had been cast six years ago when they signed the terms of the office lease. 

"To be fair, that was agreed during a buoyant market and they had planned to sub-let some of the floors in Manchester, but that didn't materialise."

Learning the lessons 

According to administrators, KPMG, Cobbetts' downfall was caused by the global financial crash when corporate and real estate transactional work dried up. 

The recession, combined with the firm's inability to sub-let empty space in its new Manchester office, led to a serious cash-flow problem that none of Cobbetts' cost-saving measures could solve.

As a largely commercial firm, with an integral property practice reliant on transactional work, Cobbetts had been set up to reap the rewards of a booming economy. But its dependence on transactional work meant that when the deals dried up, so did its revenue streams.  

Cobbetts was certainly not alone in this predicament and yet the firm's collapse puts it alongside Halliwells as one of the largest UK law firm failures ever to occur.

So could Cobbetts' management team have prevented the collapse if it had done things differently? One former partner says: "We were all aware we had this bias towards the corporate/commercial transactional work and not enough of a contentious litigation offering. This left us exposed and it was a failure of management to not anticipate a downturn and address this."

Lee Ranson, UK managing partner at Eversheds agrees, citing Cobbetts' failure to grasp the fact the world was changing and that the downturn triggered by Lehman's collapse would drag on for several years.

"When they did finally wake up to the new challenges, some poor recruitment and premises decisions, coupled with the financial crisis, left them in a precarious position from which there was no real prospect of recovery," he says.

Wragge & Co senior partner Quentin Poole takes a similar view, arguing that the boom years before the credit crisis lulled ambitious firms such as Cobbetts into a false sense of security.

"Growth back then had little to do with how a firm was being run as demand far outstripped supply. But then the downturn happened and firms kept borrowing. Cobbetts invested heavily ahead of demand and when the workflow diminished it found itself overstretched."

Cobbetts has joined the small but growing list of UK law firm failures alongside names including Halliwells, Semple Fraser and Blakemores. Its demise serves as a warning that law firms – like any other businesses – can and do collapse and that in the new market conditions the UK's leading firms find themselves in, there is far less margin for error than there was in the pre-Lehman days.

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THE DWF PRE-PACK DEAL: WHAT HAPPENED NEXT

Within a week of Cobbetts announcing its intention to appoint administrators, ambitious north west firm DWF – led by Andrew Leaitherland (pictured) – had sealed a pre-pack deal to acquire the majority of the failed firm for a knock-down price. 

The deal, agreed on 6 February – the same day KPMG was formally named as administrator – saw DWF take on all bar a 27-strong litigation team, which headed for Walker Morris. The firm agreed to pay a fee of £3.8m for Cobbetts' debts and work in progress. 

In total, 72 Cobbetts partners transferred to DWF, all of whom are subject to a two-year lock-in period. In return, the partners are expected to have their capital contributions protected by a mixture of terminal loss relief totalling around £6.5m and a £1.8m contribution from DWF. None of the Cobbetts partners have made equity at DWF. 

According to KPMG, a break-up of the firm would have resulted in increased risks for Cobbetts' creditors, its clients and its employees. In addition, KPMG and Cobbetts' management felt that an alternative sale was unlikely to attract a greater offer. The process was also smoothed by the fact DWF had already completed due diligence on Cobbetts during merger talks 12 months earlier. 

The pre-pack allowed DWF to pick up the parts of the business it had found attractive when previously courting Cobbetts, but without the long-term lease liabilities on the failed firm's Manchester, Leeds and Birmingham offices – as well as Cobbetts' small London office – all of which were sticking points during the first set of negotiations.

An administration report by KPMG revealed Cobbetts' £90m of liabilities included £74.4m relating to lease agreements on its four offices. The unsecured nature of the agreements means that the landlords look unlikely to receive much of the money owed, with early projections forecasting a return of around two pence in the pound.

Meanwhile, secured creditor Lloyds TSB is set to recoup about £2.5m of the £7.3m it is owed. It is not yet known how much of the £2.7m due to HM Revenue & Customs will be repaid.

So far, KPMG has racked up bills amounting to £267,840 for its work on Cobbetts' administration – an average of £346 per hour over 774 hours – while KPMG's legal adviser, Pinsent Masons, has billed £169,367.

Other than the team joining Walker Morris, the only other part of Cobbetts' business left on the shelf by DWF was the Leeds debt recovery arm Incasso, which was snapped up by Worcestershire-based HL Legal on 14 February at a cost of £100,000.

The pre-pack sale to DWF – and the lack of blame apportioned to senior partners by more junior members – is where Cobbetts' collapse differs significantly from that of Halliwells. This suggests the worst of the disputes that have emerged post-Halliwells should be avoided in the case of Cobbetts.

That is not to say that it will all be plain sailing. At a creditors meeting earlier this month in Manchester (10 April), former partners Andrew Wright and Charles Bond, who are now at Gowlings, questioned the transparency of the firm in its final months. 

The pair, who left in March 2012, are owed around £350,000 and £150,000 respectively in capital contributions, with the pre-pack only protecting the contributions of those who were partners at the time of the collapse. 

Wright demanded to know whether or not the firms' partners were aware of the Solicitors Regulation Authority (SRA) and KPMG's involvement in drafting contingency plans, a question reportedly ducked by senior partner Stephen Benson. One former partner says: "People are angry at being kept in the dark about what was going on behind the scenes. We had no idea of KPMG or the SRA's role in the months before the administrators were called in. People now feel quite bitter and cynical." 

At the meeting, questions were also raised as to why partners at the firm continued to take drawings up until the final month. However, the calculation was that a drawings freeze may have led to a damaging exodus of partners from the firm.

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ROAD TO NOWHERE: TIMELINE TO COBBETTS' DEMISE

May 2002 Merges with Read Hind Stewart, Leeds – adds 18 partners and £7m revenue

Nov 2003 Merges with Fox Brooks Marshall, Manchester – adds 10 partners and £2m revenue

May 2004 Merges with Lee Crowder, Manchester – adds around 20 partners and £11m revenue

Sep 2004 Takes over Wilbraham & Co, Leeds – gains five partners and £1m revenue

Oct 2004 Takes over Walker Charlesworth & Foster's Leeds office – gains two partners 

May 2007 Opens London base

Jan 2012 Officially confirms merger talks with DWF (partner meeting held on subject in Nov 2011)

Feb 2012 DWF merger talks called off

Dec 2012 Issues statement insisting the firm is financially stable

Jan 2013 Announces intention to appoint administrators

Feb 2013 Bulk of Cobbetts (419 staff, of which 72 were partners) acquired by DWF in pre-pack deal (redundancies have since been made, while at least seven partners were put on six months' notice to find somewhere else). A minimum of £3.8m paid by DWF for Cobbetts debtors and WIP. Walker Morris takes 27-strong Leeds-based banking litigation team of which two were partners. Undisclosed fee. HL Legal takes Cobbetts-owned debt collection agency Incasso and its 52 staff for £100,000. 

• For more, see Lessons of the new world – why brutal markets mean there is no room for error