Might we expect to see firms beginning to fracture, and if so, when?

The current pandemic has created an unprecedented challenge for solicitors' firms. Never before have firms had to deal so quickly with new ways of working whilst facing dramatic upturns and downturns in different practice areas.

Stories of employee furloughing and partner profit retention have featured daily in the legal press, alongside more general speculation about the property market and longer term changes to working patterns. Might we expect to see firms beginning to fracture, with partners (or members, in the case of LLPs) either being compelled to leave or choosing to do so, and if so, when?

At some point, many firms will need to review their profiles and potentially reduce the numbers of partners in certain areas, but they are unlikely to rush to make decisions about who should stay or who should go. Not only can downsizing send a negative message to clients and competitors, but partner departures result in a need to pay out capital and increased exposure for continuing partners.

It can also be particularly difficult, but important, to avoid a challenge to partner removal at present: there is more incentive to contest removal in a difficult recruitment climate and rushed decision making is more prone to error, whilst any challenge provides unwelcome disruption at a time when management is already under pressure.

Any management board considering removal of a partner must start by checking the deed – what does it require in terms of reasons for removal and process? The need for care does not end there – mere compliance with the express terms of the deed may not be sufficient. Most discretionary powers are subject to implied restrictions on how they are to be exercised.

Usually the power must be exercised in good faith, i.e. honestly and in the interests of the members as a whole, and in the partnership or LLP context, there may well be an obligation to give reasons for the decision and to give the partner who is the subject of the decision an opportunity to be heard.

Meanwhile, will those uncertain of their firm's financial prospects and hoping to avoid the consequences of insolvency rush to the door and perhaps trigger insolvency by so doing? If they are first to the door, will they have done themselves a favour or made life worse for themselves?

LLP members may face claims from two sources in an insolvency – the administrator/liquidator and third party creditors. Liquidators may seek to recover drawings paid on account of profits that never materialise, or, more rarely, they may bring a claim under s214 or 214A of the Insolvency Act 1986 for a contribution to the insolvency (or seek to set aside a preference or transaction at an undervalue).

Under s214A (which applies exclusively to LLPs, and which is subject to slight amendment by the Corporate Insolvency and Governance Bill), the court may adjust withdrawals from the LLP's assets made by a member in the two year period prior to the commencement of winding up if the member knew or ought to have known that as a result of the withdrawal (together with other withdrawals made contemporaneously or in contemplation at the time of the withdrawal) the LLP would become insolvent. Landlords and banks may seek to enforce guarantees.

At the same time, members may be owed significant sums by the LLP. Former members may not have succeeded in extracting the sums owed to them before insolvency strikes. It has even been held in McTear v Eade [2019] EWHC 1673 (Ch) that there is no set off of sums owing to a member against a claim by the LLP for recovery of drawings, although that decision is controversial and some practitioners think unlikely that it will be followed on this point.

Although the former member will have no right to force payments of the balances on her tax reserve and capital accounts, HMRC will still require discharge of the former member's tax liabilities, and banks who have advanced capital loans will still expect to be paid. A departure shortly prior to insolvency does not therefore necessarily avoid all the risks.

Those that stay to the end may in fact end up better off. A pre-pack arrangement only works if members transfer, and in order to secure a transfer, creditors and the court may be persuaded to accept the discharge by the buyer of member liabilities as part of the deal. There is no incentive for anyone to accept the discharge of the liabilities of members who have gone elsewhere.

There is plenty of incentive for partners to stick together for now. By autumn, however, there will be greater clarity as to how firms can and need to change, and greater pressure for them to do so as cashflow dries up, deferred tax liabilities have to be met and opportunities open up for innovators and rain makers.

Recruitment consultants and insolvency practitioners are likely to be busy as we get nearer to the end of the year.

Jennifer Haywood is a barrister at Serle Court

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