Parabis collapse: Lessons learned

The collapse of insurance giant Parabis is the biggest commercial failure the UK legal market has seen since Manchester-based Cobbetts entered into administration in 2013.

Parabis made history in 2012 when it became the first major UK law firm to receive private equity backing after landing a £50m boost from Duke Street. But within a period of three years Parabis Group’s turnover fell from what may have been as much as £200m to £143m. By October 2014 the insolvency experts had been called in.

Parabis’ collapse has led many in the industry to question whether law firms can last in the current market after accepting private equity backing. The issue of whether law firms should be externally owned is all the more topical since Australian-listed firm Slater & Gordon’s share price fell from A$6.98 (£3.74) last year to its current price of 26¢.

Could Parabis’ private equity backing have exacerbated the stress the firm was experiencing as a result of rapid growth achieved through a series of mergers? (See Parabis timeline, below.) Although the firm was affected by external factors such as regulatory change, the Administrators’ Statement of Proposals produced by business advisory firm AlixPartners states that the LLP’s management “failed to integrate its business acquisitions, with separate case management and accounting systems in use across the business”. This created inefficiencies and increased the firm’s costs.

In fact, Parabis serves as a cautionary tale to other firms, particularly the lessons on the importance of integrating acquisitions and financial management.

Regulatory change

Parabis originally launched in 2001 when Plexus Law was created through the merger of Croydon-based Badhams and professional indemnity firm William Davies Meltzer. A year later ex-Berrymans Lace Mawer (now BLM) partner Tim Oliver set up Parabis as a holding company and in September incorporated his own claimant firm Rymills Law into the group. By 2015, after an aggressive expansion strategy, the firm housed 18 different businesses under the umbrella of Parabis Group Limited.

The largest business division was Parabis Law LLP, which itself operated under several trading names. These included insurance claims defendant specialists Plexus Law and Greenwoods Solicitors, as well as Rymills, which had rebranded as Cogent Law. Parabis Group also included Argent Health and Safety, Argent Property Adjusters, and rehabilitation and medical specialist Argent Rehabilitation.

Over 10 years Parabis grew through a buy-and-build business strategy and looked to fund further acquisitions by becoming the first major law firm to receive an injection of capital from a private equity house.

But the UK insurance claimant market has been radically overhauled in recent years, notably by a series of regulatory changes. The effect these changes have had is all too clear in Parabis Group’s collapse.

The key change was the prohibition of referral fees, introduced in 2013 and implemented by the Government to reduce the volume of personal injury claims, particularly suspicious claims. The changes were made as part of the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (LASPO) and they hit Parabis hard.

According to one source, Cogent was by far the group’s most profitable arm, accounting for around two-thirds of the business’s profit. It is also understood that Cogent’s profit margin was in excess of 20 per cent. According to the same source, the profit margin for claimant work fell to single figures following LASPO’s introduction.

Parabis was also hit hard by the introduction of fixed fees for personal injury claims in 2013 after reforms set out by Lord Justice Jackson. According to the Administrators’ Statement of Proposals this resulted in Parabis’ revenue per case falling from an average of £2,300 to £850.

In response to the referral fee ban, Parabis launched joint ventures with three of its biggest clients in 2013: Direct Line Group, RSA and Saga. The alternative business structures (ABSs) allowed Parabis to keep its major insurance clients which were now looking to invest in the legal side of their own business.

The practice of launching joint ventures with insurers has become common within the personal injury market. Insurance and commercial services firm Lyons Davidson, for example, operates a number of ABSs with insurers such as the AA, Admiral and LV=. The firm’s managing partner Mark Savill admits that although some insurers want their own legal solution, operating without an ABS is more profitable for a law firm.

“Parabis serves as a cautionary tale on the importance of integrating acquisitions and financial management”

“We have other joint ventures that don’t have an ABS and just look at working within our business structure,” says Savill. “It gives us more flexibility in terms of efficiency if it can work within the Lyons Davidson umbrella rather than having a standalone legal business.

“It’s more profitable because of the efficiencies and the economies of scale that we can deliver within the overall business.”

The ABS deals Parabis constructed involved the firm seconding its staff to each of the new businesses and taking a share of the profit. However, due to the structure of the ABSs, the profitability of the firm’s claimant work fell from £250 per case to less than £50.

Failing to integrate

The fall in profitability meant that any inefficiencies within Parabis that were previously of little consequence suddenly became acute. According to the administrators, many of the major inefficiencies were caused by the management’s failure to integrate the increasing number of divisions owned by Parabis into one coherent business.

Parabis Group was a combination of many business divisions, each with its own specialism, such as noise-induced hearing loss claims at Plexus, rehabilitation claims at Argent and in-house work through the firm’s joint ventures with insurers. According to a source close to the firm, each business used different IT systems, hindering any attempts to collect valuable centralised information. According to the Statement of Proposals, the firm continued to use separate case management and accounting systems across its business.

“Multiple systems created inefficiency and increased costs,” adds the report produced by AlixPartners. “Furthermore, with multiple systems in place, the keys to managing the fixed fee work of operational control, good data quality and the ability to leverage fee-earners, were all more difficult to achieve.”

Sources also suggest that this lack of communication was not only prevalent within the firm’s technology but also its people. Outside of the group’s senior management, partners apparently knew little about the rest of the business. One ex-partner even claims it was not known how the group calculated profit and turnover figures that were presented to the public.

High borrowing

Many large firms operating in the insurance claimant market have adapted to regulatory restrictions by expanding, either through acquisitions or joint ventures. But to be successful these businesses must be integrated at an early stage. This is the strategy Lyons Davidson has followed for many years. It has developed individual IT systems for each client (see How to Integrate Successfully). This approach is key for those wishing to grow in a similar way.

“If you lose the people who do big ticket, complex hourly rate work, you get into difficulties. That’s what happened to Plexus”

For Parabis, once the profits began to drop the weight of its high-level borrowing became hard to support. During its final financial year, the group’s total borrowing stood at £183.6m. During the same year the firm’s turnover fell by 22 per cent from £131.9m in 2013/14 to £103m.

Even at the peak of the firm’s profitability, the complexity of Parabis’ business structure made understanding its turnover and profit difficult. A brochure published in recent years, and still accessible online, states: “With over 2,500 people working for Parabis, the group’s turnover is in excess of £200m per year.”

While the brochure says the group’s turnover is £200m, determining the firm’s total revenue is difficult due to the many branches of its business. The highest turnover figure stated in the Administrators’ Statement of Proposals was reached after Plexus Law merged with Greenwoods Solicitors in 2013. According to the report “the merger increased the group turnover to £150m”.

After becoming the first law firm to receive private equity backing with the £50m cash injection from Duke Street, Parabis still owed the investment company £43.2m in its final year of business, and it also had £16.7m of borrowings on the books from Lloyds Banking Group, £8.8m from Royal Bank of Scotland and £20.6m owed to asset management company Cross Ocean Partners (COP). COP specialises in distressed assets and bought into the syndicate in June 2015 having purchased the debt from Santander.

Duke Street

Filings indicate that much of the Duke Street money soon left the firm. A month after the deal in August 2012, founding partners Tim Roberts and Oliver each received payments totalling £16.9m for their stakes in the business. Each sold their shares in Parabis Limited and Parabis Holdings Limited for £505,000 and £4.8m respectively. Roberts and Oliver also both received a £11.5m goodwill payment from Parabis Law LLP.

It was originally understood that the funds were used to expand Parabis’ business, but sources close to the firm suggest that in fact the partners kept a significant proportion of the funds.

After asking Oliver whether the £16.9m he received from the sale of his shares were reinvested back into the law firm, The Lawyer received this emailed reply: “The accounting for the transaction was particularly complicated but suffice it to say a considerable sum was reinvested back in to the business to fund acquisitions.”

When pressed to define how much of the funds was reinvested, Oliver did not reply. Efforts to reach Roberts for comment were unsuccessful.

Oliver also stated that he had not been involved in the business for a “couple of years”. He is now listed as a director of Argent Health & Safety Limited, a former subsidiary of Parabis. Following Parabis’ pre-pack administration Argent Health & Safety Limited was sold to Argent Risk ­Management Solutions Limited, which lists Roberts as a director alongside former Parabis CEO Jason Powell and ex-Cogent senior partner Nick Addyman.

Although not all of the original £50m investment stayed at the firm, sources suggest that Parabis’ senior management expected to receive more external funding down the line. One ex-partner confirms Oliver’s statement that the firm wished to have a pot of money for further acquisitions.

“The way it was characterised at the time was that Duke Street saw Parabis as a major buy-and-build opportunity,” says another source. “So I think they were expecting to inject tens of millions of pounds more equity into the business.”

As well as funding further growth, additional investments could have been used to improve Parabis’ IT systems and integrate its businesses. But further substantial investments from Duke Street failed to materialise despite the long relationship between the firm and the private equity house.

This could have been the result of the 18-month delay Parabis experienced in receiving its ABS licence. Parabis makes clear that it was in talks with Duke Street long before the SRA introduced new rules allowing law firms to receive private equity backing. However, the SRA struggled to cope with the flood of ABS applications on their introduction, setting back Parabis’ ambitious plans. It is thought by some in the financial services sector that during this delay, Duke Street’s internal financial decisions led to it changing its plans for Parabis.

“I think for structural reasons for Duke Street rather than Parabis the investment wasn’t so easy to come by,” adds the source.

Slater & Gordon

Parabis is not the only firm to run up high levels of debt in the personal injury market. Insurance specialist Slater & Gordon also holds a high level of borrowing and currently faces pressures from its lenders to find a way to repay what it owes. Because the insurance market was previously viewed as one where firms could service higher levels of debt, it is likely that many other personal injury firms will be suffering similar financial pressures.

Australian Securities Exchange-listed Slater & Gordon’s business is much larger than Parabis’ but in many ways the firms are similar. Both operate in the insurance claimant market, both grew substantially through acquiring smaller firms and both have secured a high level of borrowing.

In Slater & Gordon’s 2014/15 accounts the firm’s revenue stands at A$627.3m while its borrowing totals A$720.4m. This means that at the last full financial year-end Slater & Gordon’s borrowings were 15 per cent higher than its annual turnover.

While its borrowing-to-revenue ratio is lower than Parabis’ when it entered into administration, Slater & Gordon’s debt has been secured against the firm’s assets.

Following the poor results, Slater & Gordon’s banking syndicate has threatened to call in the firm’s debt in March 2017 if it cannot come up with a suitable operating plan and restructuring proposal. Should the syndicate require amendments, they would need to be implemented by the end of April 2016.

The syndicate’s demands were announced during the firm’s half-year results, which also showed that Slater & Gordon made a A$958.3m loss during first six months of the 2015/16 financial year. It attributed the loss to the £700m acquisition of insurance outsourcer Quindell’s professional service arm, subsequently found to have been a major overpayment. The deal gave Slater & Gordon a 90 per cent share of the group and bolstered its claimant business with the addition of Quindell’s core road traffic incident unit.

Further regulation changes

The traffic incident claims sector has been no less immune to regulatory changes than other insurance claim sectors. In the Government’s last Autumn Statement, Chancellor of the Exchequer George Osborne announced plans to reduce the amount in damages people can claim for minor injuries, such as whiplash, sustained during a road accident.

These regulatory changes again show the vulnerability of the personal injury market to external factors. With the market already rocked by regulatory changes, strong management teams will be working to determine how further changes could impact their firm.

Following the statement, Slater & Gordon announced to shareholders that it did “not expect there to be any impact on its FY16 performance” from the rule changes. But the firm’s share price plummeted 52 per cent from A$1.38 to 65¢.

Despite the firm’s assertions, the UK market generates around 40 per cent of its global revenue and the regulatory changes could severely impact its profitability. As a result of a number of factors, including the regulatory changes, Slater & Gordon was forced to issue a profit warning due to poor November trading results.

The debt debate

While Parabis’ level of borrowing is high and despite its all too obvious issues, the former firm’s approach to debt is one that is gaining traction with some firms, particularly those in the insurance sector.

The current economic climate in the UK has led firms to reassess their view of what is an acceptable level of debt to carry. The Lawyer’s UK 200 Financial Management report last December analysed debt and lock-up levels at more than 100 of the top 200 firms and found that although many firms continue to shun balance sheet borrowing, others have actively increased their debt. Clyde & Co CEO Peter Hasson is one such lawyer in favour of increasing borrowing.

“Law firms have an irrational fear of debt,” Hasson told The Lawyer in December. “I’d say it’s almost bordering on professional negligence with interest rates this low not to have any debt in your structure.”

Despite many lawyers believing that this is the best time to borrow, high levels of debt do expose firms to greater risk, such as when regulations are changed.

“Four years ago, people saw the personal injury market as one that was naturally going to consolidate and naturally one with strong earning streams,” says a source. “Therefore you could establish higher debt levels. In fact, because of the regulatory changes, cash flows became significantly squeezed and a lot of firms’ debt assumptions became a lot more challenged.”

With falling turnover and increasing borrowings, Parabis eventually faced a “funding shortfall” and risked not being able to pay its staff. The firm managed to buy itself more time after Duke Street invested a further £13m in December 2014. When this failed to halt the slide, Duke Street refused to provide further funding to the group.

Retaining talent

For any firm facing similar issues to Parabis, retaining talent will be key to survival. Before its collapse Parabis was struggling to hold on to partners who worked with many of the firm’s biggest clients. DWF, for example, picked up the Greenwoods team of lawyers responsible for the Aviva account. At the time The Lawyer reported that the 50-strong team left because Aviva felt uncomfortable using Greenwoods’ personal injury team following its decision to merge with Parabis’ defendant arm Plexus Law.

One source close to Parabis says that some partners left the firm after hearing Duke Street wanted to outsource a lot of the firm’s work to paralegals operating in a processing centre. This did not suit the complicated high-value work being carried out by some of the partners.

“You need the big ticket, more complex hourly rate work to balance the books,” adds the source. “If you lose people who do that because your business model doesn’t fit their client base, you will get into difficulties. That’s what happened to Plexus.”

For Slater & Gordon partners, the question whether to leave is perhaps more difficult. Many have taken share options as part of their pay package, and with the shares currently worth so little, it is not such a good time to head for the door. Many of the lock-in periods preventing partners from selling their shares are due to end in the next few months and rumours are circulating that some are considering leaving.

The market is divided in its opinion on whether the firm will continue its operations in the UK, but if it does it is unlikely to be without a major overhaul.

Lessons learned

Although Parabis’ financial situation was worsened by its private equity deal, the firm undoubtedly suffered as a result of its management’s failure to plan for a changing market. Parabis’ aggressive expansion policy spread its business too thin and perhaps diverted the senior team’s attention, leaving them unprepared for the sudden market challenges.

“You need to have a deep specialist understanding and expertise in the rhythms of your core business and how things like the Jackson Reforms and LASPO are going to affect your income flows and your profitability,” says one leading insurance partner at a top 20 firm. “If you’re trying to do that type of work on a semi-industrial scale, it’s not easy.

“Any governmental change can have predictable consequences and completely unpredictable consequences. Having your proof of concept and having stress-tested the business model over a two-to-three year period is absolutely key.”

Parabis’ ambitions to expand its market share through a number of high-profile acquisitions is a reminder to others in the market that mergers and business diversification are best taken slowly and carefully, and that firms need a strong internal structure to continue functioning efficiently through the change.

“When looking at multi-disciplinary activity firms need to step back and ask do we have the depth of knowledge in each of these areas that we are trying to diversify into?” adds the partner. “Do we have the depth of knowledge to integrate the inorganic acquisition growth that we’re contemplating? And have we the management structure capability and systems in place to run that as efficiently as one needs in an incredibly competitive market space?”

These questions will be increasingly important as regulatory changes continue to impact the profitability of personal injury firms. One general counsel at a leading insurance firm believes that 80 per cent of personal injury firms will collapse as a result of the reforms. The firms that survive will be those with management teams capable of growing their business prudently while putting in place measures to limit the impact of external changes.

Lyons Davidson operates in the same market as Parabis did, and like the collapsed firm has a claimant and a defendant arm of the business. Lyons Davidson has been developing its own systems for over 15 years.