Vol 4 (2007) - Issue 4

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Re DKLL Solicitors: Obtaining an Administration Order to Facilitate a Pre-Packaged Sale of the Business and Assets, in the Face of Opposition from the Majority Creditor

Background

DKLL was an unlimited liability partnership formed in 2000, as an amalgamation of eight local firms of solici-tors that had been trading in the Surrey area from as early as 1940. The partnership provided general legal services including family and matrimonial, property, criminal, commercial litigation and commercial con-veyancing, to both individuals and businesses. The partnership had two equity partners and four salaried partners, and employed 55 staff operating out of four offices.

As part of the amalgamation process, significant investment was made in acquiring the goodwill of the practices that were eventually incorporated into the partnership, the investment being recorded in the bal-ance sheet of the partnership. The partnership’s last audited financial accounts for the year ending 30 April 2004 indicated that the partnership made a net profit of GBP 216k on turnover of GBP 2.9m. However, whilst the partnership had focused upon consolidating the business and building up its client base, which included operating a number of loss leading service streams, it failed to adequately maintain its internal financial systems. As a result, the partnership had accrued a significant liability of c. GBP 1.8m to HM Revenue & Customs (‘HMRC’) in respect of unpaid VAT, PAYE and NIC contributions.

The partnership had been in discussions with HMRC since late 2005, with a view to resolving the issue of the arrears, and had implemented a cost-reduction exercise so that a suitable repayment plan could be proposed. Although periodic discussions continued through 2006, the issue of the liability to HMRC was not resolved. The failure of the partnership to settle the arrears or implement an agreed repayment plan ultimately resulted in HMRC serving a statutory demand for the outstanding debt in November 2006, and subsequently a winding-up petition against the partnership on 28 December 2006. Bankruptcy petitions were also presented against the two equity partners.

The partnership was clearly insolvent on both a net asset and cashflow basis. The equity partners were unable to provide or obtain any additional funding to support the partnership and, as a result, took professional advice regarding the options available. It was apparent that, although the partnership had a potentially viable core business, it did not have the necessary funding to settle the historic liability to HMRC. A number of parties were, however, potentially interested in acquiring the business and assets of the partnership through an administration sale. These parties included a number of the salaried partners, who were considering establishing a limited liability partnership (‘LLP’) to acquire the existing business and assets.
It was considered that a sale of the business as a going concern would provide a number of benefits, including:

– the maximisation of the value of the partnership’s assets and goodwill for the benefit of creditors;

– the preservation of the employees’ jobs (and therefore a reduction in the preferential claims of employees against the partnership which would be paid in priority to the claims of unsecured creditors, including HMRC, in any formal insolvency process); and

– continuity of service to the partnership’s clients and the existing client matters.

Achieving a sale and continuity of service to clients was particularly important given that, if a winding-up order was made against the partnership, it was likely that the Law Society would intervene in the partnership’s affairs to protect client interests. The consequence of this would be to immediately erode any remaining value in the business (the break-up value of the partnership’s assets being negligible), and any realisations would first be applied to the costs of the intervention. As a result, it was estimated that in the event of an intervention, it was unlikely there would be any return to creditors.