Demergers during a pandemic: key considerations for law firm spinoffs

Zulon Begum and Wonu Sanda at CM Murray on what law firms need to know when going through a demerger.

During these economically turbulent and uncertain times, many law firms will be seeking to insulate themselves from short-term financial difficulties and position themselves for longer-term growth. For some firms, which have expanded and diversified into varying practice areas in more buoyant years, this may involve scaling back and divesting non-core practices through a demerger. Such appears to have been the case for global law firm Clyde & Co, which recently announced its demerger from Simpson & Marwick (a Scottish residential property practice it merged with in 2015). It’s likely to be a growing trend and, in this article, we discuss some key reasons for and implications of a demerger.

Why a demerger?

Demergers involve part of a business breaking away from a larger firm (divesting firm) to form a new firm (demerged firm), usually by way of a transfer of business, assets and people. As with Clyde & Co – which is predominantly focused on the core specialisms of dispute resolution, professional liability, and insurance – a niche practice area like residential property may simply no longer align with its overall practice and strategy going forward. Often, divesting firms see demergers as an opportunity to strategically re-align their focus on their core business competencies and streamline expenditure and operations. For the demerged firm, financial and management independence and the ability to potentially unlock untapped value for partners and employees in that part of the business can be a compelling driver.

The implications and aftermath of a demerger

There are many issues for law firms to consider in a demerger. As a starting point, firms will need to factor the constitutional provisions that are relevant to the demerger into the timetable and commercial terms of the deal – including the requisite partner approval for the transaction and notice requirements, payment of outstanding capital and current account balances, restrictive covenants and other provisions affecting those partners who are transferring to the demerged firm.

Both firms will want to ensure that a fair and balanced approach is taken to determining and valuing the assets and liabilities transferred, such as the work in progress and book debts of the transferred business and agreeing how these are dealt with going forward. Additionally, the divesting firm will be keen to ensure that professional indemnity and successor practice liabilities are transferred to the demerged firm.

It’s likely that the demerged firm will need to be authorised by the Solicitors Regulation Authority prior to completion of the demerger – this can be a lengthy process and should be initiated at an early stage to avoid delays. The demerged firm will also need to put in place the necessary infrastructure to ensure that it can carry on business as usual from day one; this will include matters such as office space, appropriate professional indemnity insurance, employee benefit schemes and so on.

A demerger may also trigger the application of Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE), such that the employees and possibly LLP members (if the divesting firm is an LLP) may transfer to the demerged firm with preserved employment rights. If TUPE applies, then obligations to inform and consult and specific timescales will apply and will require careful forward planning.

It would be wise for the demerged firm to consider with, specialist advice, how any partner or senior employee’s restrictive covenants will be treated and potentially varied (including on any issues with TUPE connected variations being rendered void) to ensure that the restrictions remain relevant and enforceable by the demerged firm.

We expect to see more firms choosing to demerge to streamline their operations in the coming months and it’ll be important that they ensure the right advice and steps are taken so that the process is smooth and the demerger is ultimately successful for both parties.