-Steve Homan

The implications of the U.K.’s Legal Services Act of 2007 – which lifted the legislative restrictions on external investment – on the legal profession and the wider repercussions on the legal outsourcing and offshoring industry are still under close scrutiny four years later. The Legal Services Act, much of which goes into effect this year, permits, through the formation of Alternative Business Structures, external investment in law firms.

The House of Commons website’s review of the key benefits of the Legal Services Act says Alternative Business Structures (ABSs) “enable lawyers and non-lawyers to work together on an equal footing to deliver legal and other services in ways that better meet the needs of consumers. External investment will be possible, and new business structures will give legal providers greater flexibility to respond to market demands.”

But this is a highly charged issue and will change the business model for law firms both in the U.S. and the U.K. Hence, the ongoing concern.

The Legal Services Act 2007 is an Act of the Parliament of the United Kingdom that seeks to liberalize and regulate the market for legal services in England and Wales, to encourage more competition and to provide a new route for consumer complaints. It also makes provisions about the Legal Profession and Legal Aid (Scotland) Act 2007.

The Act allows alternative business structures (ABSs) with non-lawyers in professional, management or ownership roles. The Act creates a system whereby approved regulators can authorize licensed bodies to offer reserved legal services (ss.71-111).

As of March 2008, no date was fixed for the coming into force of these provisions and it has been suggested in the press that such structures are unlikely to be created until this year or 2012. Further, the extent to which the Bar Council will permit barristers to become involved in the full range of such structures has been unclear.

Experts have written that they have been convinced for a number of years that the profit margins routinely enjoyed by the world's leading law firms would prove to be extremely enticing to the private equity market and that once restrictions on external investment were gone, it was inevitable what would follow.

Tony Jomati, former Clifford Chance managing partner, has written about a number of trends impacting on the U.K. legal profession.

His trend number 6 stated: “High-Street legal services will be fundamentally transformed by the Legal Services Act. A number of major brands will dominate the provision of retail legal services. Will that be law firms, or outsiders such as supermarkets or banks? It is too soon to tell whether existing law firms will be able to develop strong enough retail brands.”

At trend number 7, he went on to say that, “If the Clementi reforms (the forerunner to the Legal Services Bill) are broadly successful, one can expect firms higher up the chain to take in outside capital and float on the market.”

The concept of external investment in law firms had remained firmly entrenched within the U.K.’s legal borders until the Law Society Gazette recently published an article entitled “New-Model Law Firms Face Barriers in the U.S.”

On the surface, the article appears to reaffirm the position that the U.S. has some distance to go before the concept of alternative business structures could ever take off over here. However, it was the first time that senior figures within the ABA (American Bar Association) publicly acknowledged the concept and its implications on the practice of law here in the U.S.

Tommy Wells, ABA president is quoted as saying that the concept of ABSs raises, “important regulatory and ethical issues that must be examined and addressed”.

The article goes on to state that if the ABA does not change its stance by the time ABSs are permitted in 2011 or 2012, U.K. law firms that choose to become ABSs will be barred from practicing in the U.S. From a practical perspective, this stance is clearly operationally unworkable for any of the U.K. magic and silver circle firms, with a U.S. presence, contemplating external investment.

The pace of change within the legal professions on both sides of the Atlantic has picked up dramatically over the last few years. The financial crisis acted as a further catalyst of change across numerous sectors of the profession. Clearly, if one reads between the lines, the U.K. Law Society believes that the ABA position is not a static, immovable one. Although the first step may be a modification of the relevant rules to permit U.K. firms with external investment to practice in the U.S., it is predicted that it is only a matter of time before external investment in U.S. law firms is also permitted. Once such investment is common place within both the U.K. and U.S. legal professions, this in turn will only spur the growth towards legal outsourcing and alternative and more efficient law-firm operating models.

The Legal Services Bill received Royal Assent on Oct. 30, 2007. The particular section of the Bill that is having the most far-reaching consequences on the legal profession and could provide a colossal boost to the growth of offshore legal outsourcing, is the provision allowing the formation of ABSs. The summary to the Bill at paragraph 15 states as follows:

“Alternative Business Structures (ABS) will enable lawyers and non-lawyers to work together on an equal footing to deliver legal and other services. External investment will be possible”.

Put simply, non-lawyers can own and invest in law firms. To all intents and purposes this opens the doors to banks, insurance companies, supermarkets and other corporate entities, both owning and investing in existing law firms, or alternatively, setting up their own firms and marketing legal services to the general public.

This legislation can be viewed as a major flattener in the provision of legal services globally. If you combine the impact of the Legal Services Bill with the fact that, finally, the legal profession has woken up to the concept of legal process outsourcing offshore, there is no doubt that over the next five years there will be a dramatic change in the delivery of legal services to the general public.

Some believe these are just scare tactics meant to slow the effect of the Legal Services Bill, the deregulation of the U.K. legal profession, and the impact this will have on the legal market as a whole.

An article in the TimesOnline referred to 10 trends that will shape the legal market:

At trend number 4 the author commented that: “Technology will enable projects to be “unbundled”. This may mean that parts of the project are outsourced to India and that they are done in a systemized manner. This could have a significant impact on the need for junior lawyers, particularly if they start to price themselves out of the market.”

Finally, at trend number 7, the author went on to say that “If the Clementi reforms (the forerunner to the Legal Services Bill) are broadly successful, one can expect firms higher up the chain to take in outside capital and float on the market.”

The author was Tony Williams, a former managing partner at Clifford Chance, the world’s largest law firm. When a former Clifford Chance partner talks about supermarkets and banks offering legal services, major law firms floating on the stock market, and the offshoring of legal work to India, it’s time to take this line of thought seriously.

Let’s look at these potential scenarios in a little more detail and consider the impact that this will have on offshore legal process outsourcing.

First, we have the acknowledgement that the technology is available to enable the breaking down of many legal functions into systemized routine tasks capable of being outsourced offshore. Junior associates currently demanding ludicrously high starting salaries and excessive hourly rates for this routine level legal work are clearly those most at risk.

Second, Mr. Williams comments that although it is too soon to forecast what the impact of their entry will be, supermarkets, banks and other corporate entities will enter the legal services market, it is just a matter of when. These major corporate entities will come to dominate the provision of retail legal services. None of the corporations looking to enter the legal services market will be bound by the traditional and antiquated existing methods of legal services delivery. They will simply look for the most cost-effective method of providing legal services to the general public. These companies either already have offshore locations or the capability to scale up significantly quicker than even the world’s largest law firms, to provide legal support from offshore destinations.

Mr. Williams’ final point on the Legal Services Bill, commenting on the potential floatation of some firms “higher up the chain”, only reinforces the belief that this will give the offshore legal outsourcing industry a huge boost. When major firms also have responsibility to their shareholders, as well as their clients, then the salaries that they pay their junior associates to perform relatively routine, off-shoreable level legal work, will raise more than a few eyebrows. When corporate clients increasingly demand that law firms provide an offshore solution in responses to Requests for Proposals, shareholders will not be happy if the firm is incapable of responding to these requests.

The face of the legal profession in the U.K. is changing dramatically, and these changes will have far-reaching, cross-Atlantic repercussions. The U.K. and U.S. legal markets are inextricably linked, with the many of the world’s leading law firms having offices on both sides of the pond. What happens in the U.K. does not stay in the U.K. but will soon be felt all around the Western legal world.

Mark Ross, the director of LawScribe in 2008 wrote:

“The dynamic movement within the LPO industry has not gone unnoticed in the private equity and venture capital sectors. The confidence that investors have demonstrated in the industry over the last couple of years illustrates the bright prospects for the future. In November 2007 Infosys, India’s second largest IT company signaled its intent to enter the legal outsourcing market with the launch of its own legal process outsourcing operation. In April 2008, WIPRO, India’s largest BPO followed suit with a similar such announcement.  Established LPOs including Pangea3, Jurimatrix and SDD Global have attracted a significant level of private equity and venture capital funding.

“2007 also witnessed the first acquisition of an onshore provider of outsourced legal services, CBF Group Inc, by a company traditionally viewed as being a leading offshore financial and legal services outsourcing company, Integreon.  This dynamism has further been augmented by strategic partnerships between LawScribe and IQWEST and Quislex and Strategic Legal Solutions, aimed at leveraging the resulting synergies across the e-discovery and document review spectrum.  This type of activity has placed legal outsourcing companies in the position to scale up dramatically.

“According to the independent research company ValueNotes in its July 2007 report, ‘Offshoring Legal Services to India - An Update,’ the revenues from legal services offshoring are forecast to grow from $146 million in 2006 to $640 million by the end of 2010. The legal outsourcing industry in India currently employs around 7,500 people and this number is expected to rise to 32,000 by 2010. Neeraja Kandala, the analyst behind the ValueNotes updated report, believes that consolidation is inevitable:

"Most Indian legal service vendors are self-funded, and may not have the capability to develop adequate marketing infrastructure without VC funding. For a large number of the smaller vendors, growth beyond a point will be difficult. While a few will manage to grow given their strong onshore presence, several smaller players will be vulnerable. On the other hand, the interest of large BPOs such as Infosys and HCL in this space is growing. As these BPOs look to build presence and scale rapidly, the acquisition of smaller vendors is an option. Though there is not much activity yet, over time we will see consolidation, with large BPOs and LPOs acquiring capacity and capability."

An article published on July 22, 2010 by Rachel Rothwell, stated that private equity investment is set to transform legal process outsourcing in a trend that will see many commercial firms miss out on work and could affect the training of future solicitors, leading experts have predicted.

David Hawley, partner in the consulting strategy department at Deloitte, said private equity firms have largely switched their focus away from investing directly in law firms when the Legal Services Act of 2007 permits external investment. Instead, he said there is a strong appetite for investing in LPO and technology companies that provide services to law firms.

Hawley said: “A year or so ago there was a lot of interest in law firms from private equity, but that has dropped off as people have understood the sector more. They are still interested in law firms at the volume end, for example bulk conveyancers, which are not so dependent on the partners.

“But now the focus has moved to people who provide law firms with services. For example, LPO providers.”

Hawley added: “In the conversations we have had with private equity, [they] have been quite interested in technical companies involved in LPO. The support services universe could change substantially.”

Hawley said private equity investment could lead to technological advances that would considerably improve firms’ processes and efficiency. He said: “Investment in tools and capabilities will enable firms to be managed better, and that must be a good thing. But from a competitive point of view, if everyone is doing that, it is hard to differentiate yourself.”

He added that the “obvious customers” for LPO providers were corporates rather than law firms.

Jeremy Black, associate partner in Deloitte’s professional practices group, predicted that LPO providers will ‘end up taking a whole chunk of work from law firms’. He said basic work which is normally performed by junior lawyers will instead be done by LPO providers. This would include contract drafting, contract review, disclosure for litigation and due diligence.

Hawley warned there could be a knock-on effect on firms’ willingness to take on trainee lawyers. “If LPOs do all the junior work, why would you pay a junior lawyer in a law firm to do anything? All you want is partner equivalents,” he said.

Stephen Mayson, director of the Legal Policy Institute, said there were clear reasons why a private equity investor would be interested in investing in an LPO provider that would become big enough to service a large section of the City firms, achieving economies of scale. He said the next step would be to provide the work directly to clients and “take it out of the market.”

Mayson added that City firms did not anticipate this development and were ‘missing the point’ about some aspects of the LSA reforms.

Private equity investor Lyceum announced its intention to invest up to £255m in legal services in March 2008. Last November the investor sealed a deal to invest £25m in new business process outsourcing group Laureate Legal Services.

This past January, in the first of a two-part article, Duncan Finlyson of Legal Futures Lawyers Defense Group investigated the reasons for law firms to outsource certain functions and the regulatory issues that can come up:

“They, whoever ‘they’ are, are constantly telling us that as a profession, lawyers must all start to embrace new business models and practices if we are to survive the ABS revolution.

“They, whoever they are, are probably right. However, and it is an important however, as lawyers we must approach any changes with a degree of circumspection and ensure that we are not moving forward in a way which places our clients, or own firms, at risk.

“Nowhere is this more topical than in relation to the ever growing trend for firms to outsource.

“If one looks more widely and considers issues such as cloud computing external IT services, the benefits become even more apparent. Not only can firms can reduce capital expenditure on expensive IT equipment and the cost of IT support departments, but also they can allow fee-earners the greater flexibility of being able to access data and programmes anywhere where they can gain access to the Internet.

“It looks like a win all round. But is everything really that easy? Can the firm simply find the cheapest supplier of services and watch the overheads fall?

“The simple answer to that question is ‘No.’ There are risks associated with all forms of outsourcing and all firms would be well advised to review and address those risks before they even begin to think about the financial benefits.

“So what are the risks associated with outsourcing and to what extent should firms be concerned about them?

“There are at least 11 separate regulatory risks associated with outsourcing:

Data security – information being lost or corrupted;

Lack of confidentiality – information being disclosed to third parties or even the use of information to assist in crime;

Risk of conflict of interests – there are a limited number of outsourcing suppliers and therefore a real danger that outsources may become involved in both sides of the same matter. Firms wishing to outsource must therefore ensure that appropriate conflict checks are undertaken at the service provider and that where appropriate information barriers are put in place;

Loss of supervisory control – the outsourcing firm not knowing what the service provider is doing or how they are doing it;

Quality of service – the work undertaken by the service provider not being of a sufficiently high quality or of a variable quality;

Level of understanding and knowledge of the work being undertaken – service providers may not keep up to date with relevant developments or may miss cultural indicators that would have been picked up locally;

Availability and the reliability of ready access to information – the outsourcing firm not being able to gain access to information, data or files when required;

Consumer perception – whatever the safeguards that are put in place many consumers may have concerns about work being outsourced generally, may have objections to work being outsourced abroad (and thus depriving the home market of jobs) or may have concerns about the security of data outsourced abroad;

Contractual problems – breakdown in the contractual relationship during the work being undertaken and the ability of the outsourcing firm to recover papers and data or to be able to handle the work without the service provider’s assistance;

Problems with local staff – an increase in outsourcing could cause local staff to fear that their jobs are at risk. This could lead to low morale, unwillingness to work with the outsources or even straightforward sabotage of the outsourcing arrangements;

Regulatory problems – breach of rules in the jurisdictions of either the outsourcing firm or the service provider, irrespective of whether any of the foregoing risks exist. This could include, for example, reserved work being undertaken by unqualified staff where the regulator felt that inadequate supervision existed.

In April 2005, the Financial Services Authority produced a report on the risks associated with outsourcing to India. It concluded that “the main risk identified is the complexity of achieving suitable management oversight and control from a distance”.

Clearly the level of risk will depend upon the particular type of outsourcing. Thus a firm that outsources part of its secretarial function will have fewer concerns than a firm which uses an Indian-based company to undertake a part of the legal work. However, both would need to be conscious of the requirement for confidentiality and data security.

The Solicitors Regulation Authority, in its response to the Legal Services Board consultation “Alternative business structures: approaches to licensing,” was clear how it would regard outsourcing when stating that it would be allowed “subject to the regulated firm remaining at all times responsible for the activities of the outsourcer [service provider], which brings with it the necessity to monitor outsourced activities to ensure that the desired outcomes are being achieved.”

Looking over your shoulder: the Code of Conduct is very specific on the level of supervision a firm must have in place

“The Solicitors Code of Conduct 2007 has some important things to say about outsourcing, especially in relation to issues such as confidentiality, supervision and practice management. The new Code of Conduct that will come into effect on 6 October will place a duty upon firms to measure outcomes as an indicator of compliance, meaning confidentiality, supervision and management are going to be fairly near the top of the Solicitors Regulation Authority’s list of matters solicitors should be aware of.

Rule 4 – confidentiality

“So far as con1fidentiality is concerned, rule 4.01 states: ‘You and your firm must keep the affairs of clients and former clients confidential except where disclosure is required or permitted by law or by your client (or former client).’

“It goes on to clarify this at guidance note 8 to rule 4 by saying: ‘(f) If you outsource services such as word processing, telephone call handling or photocopying you must be satisfied that the provider of those services is able to ensure the confidentiality of any information concerning your clients. This would normally require confidentiality undertakings from the provider and checks to ensure that the terms of the arrangements regarding confidentiality are being complied with. While you might have implied consent to confidential information being passed to external service providers, it would be prudent to inform clients of any such services you propose to use in your terms of business or client care letters.’

“Thus, firms planning to outsource any aspect of work containing confidential client information – or even information capable of indicating that the firm acts for a particular client – must take all necessary steps to ensure that those providing the service will keep that information confidential and should ensure that the client is aware – for example through the firm’s terms and conditions – that such outsourcing could take place.

“Rule 5 – business management: ‘The requirements of rule 5 will also present those wishing to outsource with something of a headache since they are quite specific in the extent to which firms are responsible for ensuring that matters are properly managed and supervised. In particular it requires that firms:

Exercise ‘appropriate supervision over all staff, and ensure proper supervision and direction of clients’ matters’ (5.01(1)(a));

Identify conflicts of interests (5.01(1)(d)); and

Manage risk (5.01(1)(l).

“In particular, it is worth noting in relation to rule 5 some of the points raised in the guidance notes, including:

Guidance note 8: ‘For example, if certain work is to be done by unqualified staff it may only be done at the direction and/or under the supervision of persons who are allowed by law to do that work themselves.’

Guidance note 9: ‘The duty to supervise staff covers not only persons engaged under a contract of service, but also those engaged under a contract for services to carry out work on behalf of the firm, e.g. consultants, locums and outdoor clerks. You cannot avoid responsibility for work carried out by the firm by leaving it entirely to staff, however well qualified.’

Guidance note 12: ‘If a firm has more than one office, the recognised body and its managers, or the recognised sole practitioner, must be able to demonstrate the adequacy of their arrangements throughout the firm. This includes supervision and management of staff not working from a conventional office – for example, homeworkers, teleworkers, those visiting clients, attending court, at a police station, at a consulting room open only for a few hours a week, or staffing a stand at an exhibition.’

Guidance note 19: ‘Firms must adopt a systematic approach to identifying and avoiding conflicts of interests, dealing with conflicts between the duties of confidentiality and disclosure, and maintaining client confidentiality.’

Guidance note 47: ‘Those supervising client matters… would need to have sufficient legal knowledge and experience to be able to identify problems with the quality or conduct of the work; but might not need to be an expert in the area of work. The training, qualifications and experience of the member of staff whose matters are being checked… will be relevant in assessing the level and type of expertise required by the person conducting the checks.’

Conclusion

“There are undoubtedly substantial benefits to be derived for many firms in looking to outsource elements of their work and practice. The caveat to that, however, is that great care needs to be taken in how and to whom the outsourcing is undertaken. The risks which we have looked at here are only the regulatory ones.”