What can we learn from the English ABS experience after five years?

(published first on slaw.ca)

After five years of ABS liberalization in England (and Wales), it is worth having a look at what has happened. Surprisingly and significantly, the answer is “not much”.

ABS liberalization in England

A decade ago, Legal Services Act 2007 brought about significant changes to the practice of law in England. These changes included allowing what were called alternative business structures to provide legal services where only lawyers were previously permitted to serve clients. The first alternative business structures were licensed in late 2011.

The essential idea of alternative business structures is that constraining ownership of legal practices constrains competition and innovation. This is not to say that the practice of law is not competitive without non-lawyer ownership. The fact is that there is a large number of legal practices that intensively compete with each other. But the nature of those practices is the same. Highly educated professionals spend time providing services to clients with the assistance of their staff. The practice of law is highly labour intensive and the labour is expensive labour. While these practices compete with each other, they do not have to and are limited in their ability to compete using different ways of providing legal services. From one perspective, law is highly competitive. From another perspective, competition is highly constrained where only practising professionals can provides legal services and own professional practices.

The ABS idea contemplated that allowing non-lawyer ownership would encourage competition and innovation in two ways. Liberalizing access to capital inherently facilitates the provision of services in ways that are less, or are not, labour-intensive. Liberalizing non-lawyer ownership facilitates management of legal practices by non-lawyers who have business expertise and experience. The result was expected to be the entry of new participants into the legal services market. The result was also expected to be the evolution of existing practices because existing practices could have improved access to capital and to non-legal expertise and because existing practices would have to evolve to better compete with new entrants.

The English context

There are important differences between England and Canada that should be kept in mind in considering the English ABS experience. There is a divided bar although solicitors are increasingly permitted to act as advocates. There are eight distinct legal professions[i] with separate front-line regulators, each front-line regulator being under the supervision of the Legal Services Board. There are far more solicitors than all other types of legal professionals combined.

Perhaps most significantly, licensing is not required in England to provide legal services in substantial areas where licensing is required in Canada. In England, only the exercise of a right of audience, the conduct of litigation, reserved instrument activities, probate activities, notarial activities and the administration of oaths are reserved to licensed legal professionals.

The reason that this limited reservation (or limited monopoly) is significant is that being or becoming an ABS isn’t necessary where it is not necessary to be licensed. Accordingly, ABS liberalization and consideration of its results is limited to these reserved areas. ABS liberalization was designed to address what we would see as core areas of legal service.

Bifurcation of the legal services market

Before looking at the English ABS experience, it is also important to distinguish between the consumer and the business legal services markets. It is clear that there has been substantial change in the supply of services to large businesses and other organizations over the last decade. In-house counsel have taken on increased shares of legal work. Alternative legal service providers have emerged to directly supply in-house counsel groups and to provide services through external counsel.

Significantly, it does not appear that this significant evolution requires or is dependent on ABS liberalization as is clear from the fact that much of this evolution has occurred in the United States, which is entirely hostile to non-lawyer ownership and unauthorized legal practice.

In considering the impact of ABS liberalization in England, it is worth keeping in mind that the “big business” demand for legal services is not the same as consumer demand and, more significantly, that the nature of the legal services that are consumed and the way that legal services can be supplied are quite different in these very different markets.

The 2017 Legal Service Board Report

With five years of ABS liberalization in England, it is possible to assess how these intended market impacts have played out so far. With this in mind, the Legal Services Board has released its report Evaluation: ABS and investment in legal services 2011/12-2016/17 (“2017 LSB Report”).

ABSs were first licensed in 2011. By March of last year, 892 ABS licenses had been issued by four licensing authorities[ii] and were in active practice[iii]. To put these nearly 900 ABSs in context, there were just over 10,000 solicitor firms as of the end of 2016[iv] of which 25% were sole proprietorships. It is fair to observe that a significant number of ABSs have been licensed.

According to 2017 LSB Report, the active ABSs are predominantly existing firms that have converted to ABS status. Only one in five of respondent ABSs is a new firm. This means that there are approximately 180 new entrant ABSs and approximately 720 existing practices that have converted to ABS status.

Much has been written about the new entrant ABSs. A significant number have been personal injury consolidators with Slater and Gordon being the most famous new entrant and the most famous failure. Not surprisingly, many new entrants have focused on the more lucrative areas of practice. Not surprisingly, rapid growth and consolidation has been a risky business strategy.

But what about the substantial number of existing practices that have taken on ABS licensing? This is a bit tricky to tease out from the 2017 LSB Report as information some of the reported information is not broken down between new entrants and converted existing practices. But the implications of the reported data is pretty clear.

The focus of the 2017 LSB Report is on the investments made by ABSs and the sources of capital for those investments. It is reported that two-thirds of ABSs have “either have already invested or are planning to do so, since they gained their ABS licence” and that “[t]hese investments have mainly been made to hire more staff, increase marketing activity or to purchase IT. The report sees “this as evidence of the increased scale that allowing non-lawyer ownership was designed to enable”. The report also notes that “[t]here are statistically significant links between higher levels of non-lawyer ownership and the likelihood of having made an investment. Larger organisations are also more likely to have invested in their business.”

These observations are entirely unsurprising. One would expect practices that take on an ABS license to make investments. Larger organizations are naturally more likely to make investments. It would be odd to find that practices with non-lawyer ownership were not making investments.

What is surprising is the source of capital used for investment. According to the report:

The most frequent source of funding for investments was business profits or cash reserves, which were used by 49% of those who had invested in their business. Just over a quarter of investments were solely funded using a loan from a bank, and a quarter were solely funded using the business’ overdraft facility. External sources of equity finance accounted for only a minority of investment funding sources either as the sole or joint source of investment funds, and only 12% of ABS had used any form of external finance.

We know that the usual sources of investment capital for ordinary legal practices are business profits/cash reserves and bank debt. According to the 2017 LSB Report, 88% of ABSs invested using these traditional sources of capital. Only 12% of ABSs used non-traditional sources of capital for investment purposes.

As noted above, only approximately 20% of ABSs are new entrants. As just discussed, only 12% of ABSs has used external finance for investment purposes. Putting these points together, one can only conclude that very few existing practices that have become an ABS have accessed capital that was not previously available to them. It may be that becoming an ABS has been attractive to recruit and to offer incentives to non-lawyer staff. It may be that becoming an ABS has been used to allow family members to participate in ownership. But it appears clear that, so far, access to capital has not been a significant reason to convert to ABS status. As the report puts it “Except perhaps in the personal injury sector, it would appear that bank lending is a substitute for external capital”.

The essential conclusion of the 2017 LSB Report is that there is not yet sufficient competition in the legal services market to require existing practices to innovate:

The low level of external investment seen to date may be a symptom of weak competition in the market overall, as found by the Competition and Markets Authority market study, LSB’s Market Evaluation and the joint SRA LSB research revealing that levels of innovation are not increasing. The dynamics of competition create incentives for suppliers to increase productivity through innovation, which lowers costs and hence prices through time. This is likely to involve taking a different approach to delivering a service, or developing new services completely. In the absence of strong competition, there is insufficient impetus for law firms to take the greater risks (and rewards) involved with using external capital. Until these incentives change we may not see significant growth in the use of external capital by ABS firms.

So what are the implications for Canadians?

What appears to be clear is that not much has happened in England as a result of ABS liberalization. The conclusion of the 2017 LSB Report is essentially that existing practices have not had to innovate because they have not faced strong competition particularly from new entrants. But the report does not address why relatively easy entry into the legal services market and the fact of unreserved areas of practice have not led to increased competition.

It may be that the emergence of new entrants simply takes time. It may also be that existing legal practices are reasonably well suited to the work that they do and that there isn’t substantial profit to be made serving existing reserved legal markets though new forms of practice.

So the implication of the first five years of ABS liberalization in England is that it has not led to much accessing of external capital nor to much innovation. At the same time, it does not appear that ABS liberalization has led to significant problems either. That said, spending substantial regulatory time and effort to enable a significant regulatory change of rather limited impact does not seem like a great use of resources.

Of course, things don’t necessarily stay the same. It is clear that technology continues to advance significantly. There is ample evidence that unlicensed direct-to-consumer legal services are being provided in Canada and that the volumes are likely to increase especially as technology evolves. It seems logically to follow that this will lead to competitive pressure on existing legal practitioners who will require access to external capital to respond effectively. There is a credible argument that limiting access to external capital will handicap existing practices against new entrants.

But it must be admitted that these credible arguments are not yet supported by market evidence in the very significant and competitive English market. The dilemma is that there isn’t cogent current evidence for regulatory reform while our ability to respond nimbly if and when required is doubtful. In resolving this dilemma, my inclination is to watch and wait given the advantage of having the English “experiment” to guide our thinking.

_________________________________

[i] Solicitors, Barristers, Legal Executives, Licensed Conveyancers, Patent Attorneys, Trademark Attorneys, Costs Lawyers and Notaries

[ii] Most of these were issued by the Solicitors Regulation Authority.

[iii] Nearly sixty ABS licensees are not in active practice.

[iv] 84% of English and Welsh lawyers are regulated by the Solicitors Regulation Authority based on data from the 2017/2018 Legal Services Board Business Plan

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