What is really happening with alternative business structures?

The legal services market in England and Wales is valued at well over £20bn. Until now, only lawyers have been able to have a share of the returns. But recent legislative changes mean that there is scope in the future for non-lawyers to invest directly into law firms and for new legal forms to be adopted by those law firms – be it a limited company or a public limited company (PLC) floated on the stock exchange.

Alternative business structures represent another significant step in what has become a steady process of removing anti-competitive restrictions on providing legal services. There are already a number of alternative business structures within more specialised parts of the legal services market, where the regulatory framework has permitted them for some time. The Legal Services Board (LSB), the new oversight regulator for the legal services profession, is committed to allowing this new type of service provision right across the sector.

The concept is simple: from mid-2011, lawyers and law firms will be allowed to structure their businesses in new ways, they will be allowed to raise capital through new means and they will be allowed to deliver new combinations of services. These changes will be permissive rather than mandatory, but even those who do not wish to form an alternative business structure will need to respond to the increased competition and improved consumer focus that they are likely to bring.

The idea is far wider in scope than the commonly used ‘Tesco law’ suggests. There are great opportunities for all within the new regulatory framework ushered in by the Legal Services Act 2007 (LSA). It is unlikely that the average consumer will look just to their local supermarket when contesting their divorce or selling their home. Any legal services provider that has the ability to raise significant amounts of capital quickly could increase their customer base significantly.
Any number of businesses with a strong customer base may look to grow it by adding legal services to their customer menu – adding value to their service offerings, or increasing their margins, by providing the legal services their customers want.

It may not be about economies of scale – it may be a more tailored, personalised service that succeeds. For example, the provision of independent financial advice alongside making a will or obtaining probate, or accountancy advice alongside the negotiation of a commercial lease.

The first major change the LSB ushers in is a new style of regulator. The LSB has a mandate to promote the consumer interest as well as competition – as too do the direct front-line legal regulators it oversees, such as the Law Society and the Bar Council. Regulation will, therefore, be more focused on the needs of consumers and ensuring that the key essentials for competition are provided.

New style law firms could mean a new culture within those firms and a new dynamic, where the consumer becomes the key focus. It is likely that the confluence of legal disciplines and non-legal disciplines within the same organisation will result in a fruitful cross-pollination of ideas and skills. But some perceive risks from allowing lawyers and non-lawyers to practise together – and also from outside investment. So there are protections built in to the regulatory framework. In particular, people owning and managing alternative business structures will be subject to a ‘fit and proper’ test, and dedicated compliance officers will ensure that the lawyer’s duty to the court and their client comes before making a profit.

Australia has already brought in similar changes. Slater and Gordon and Integrated Legal Holdings Limited have both floated on the ASX following similar market liberalisations. Slater and Gordon has grown from a mid-sized firm to be a household name across the continent. They have managed to incentivise their top-earning lawyers with equity and options that continue to provide income once they move on. They have succeeded in creating new career structures that appear more in tune with what younger lawyers may want.

On 18 November 2009, the LSB released a new consultation on the core principles and outcomes that should govern the regulation of alternative business structures. The consultation offers everyone a chance to tell us what they would like to see in the new regulatory framework. The consultation is far-reaching in its scope and puts forth a set of new ideas on how legal services could or should be regulated. There is a clear shift in tone towards regulating on the basis of principles and outcomes that seek to identify the core risks to the regulatory objectives that govern the LSB, and those who will license alternative business structures.

The consultation aims to create regulatory architecture that is responsive to emerging risks, but flexible enough to allow innovation. Our general approach is to recognise that the primary legislation allowing for alternative business structures is already extremely prescriptive in what safeguards are appropriate, and that regulators should seek to be as responsive as possible. The paper includes a number of important issues including proposals about the appropriate types of test for external owners and how compensation and indemnification arrangements may work in the new landscape.

In the context of a harsh economic climate, where consumers expect more for less and legal services providers are being placed under immense pressures, this new framework gives the most innovative law firms the opportunity to evolve and adapt. It represents an immense opportunity for everyone, not just large businesses – the high-street lawyer could benefit as much as big players with deep pockets. The removal of a few key restrictions could have ripples throughout the marketplace and perhaps beyond the limits of the legal services sector.