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Wednesday23 July 2014

When it’s time to call it a day

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Whether it be through retirement or insolvency, shutting down your practice needs to be handled with care

Overview

By Richard Brindley, executive director, RIBA Professional Services

Closing down a practice is a complicated business and requires careful planning, preferably with a long lead in. The worst-case scenario is having closure forced on you unexpectedly due to lack of cash flow, loss of workload or a substantial claim.

Much effort is put into building and running a practice, with too little attention given to succession planning or exit strategies. All practice owners should have an exit or retirement strategy in place as well as a “disaster plan” in the event of some great calamity, such as the death or incapacity of the key partner. Consideration should be given to succession planning – transferring the business to colleagues – or selling to, or merging with, another business. If winding down and closing the practice is the preferred or only option, you will still need a detailed plan and time line.

Planned closure

Decide on the closure date and work back from that. The date will primarily depend on the workload, clients, and when current projects will be completed or transferred to another practice. You will need to ensure you have issued and received payment for all your invoices, recovered or written off all debts and paid all you creditors. The practice entity, be it a company, partnership, or sole trader, will need to be formally wound up with proper legal advice, and you will need professional indemnity run-off insurance (see Legal section). Any staff will need their employment contracts properly terminated with the relevant notice in accordance with employment law. Then there is dismantling the office and the practice assets. There may be leases to terminate, and property or equipment to sell or end the hire agreements for.

As well as all these issues, don’t forget about the needs of the partners or directors. What are their needs for future employment, pensions and finance? It is important to have expert advice on all these complex matters.

Forced closure

If your practice is forced to close due to insolvency, then you must get the best specialist advice you can afford. It is important to keep everyone on side and to act professionally. Keep your funders, clients, staff, insurers and creditors fully informed. Decisions about what to do may ultimately be the responsibility of your funders and creditors. The three options for closure due to insolvency are:

Liquidation This is the quickest way of closing everything down, but leaves clients high and dry, employees out of work and unsecured creditors out of pocket. If prospects are bad, this may be the only solution: it is the most finite and leaves all the wreckage behind you, but it could affect your professional reputation, and make it more difficult to set up a new firm and gain funding and clients for any new venture.

Administration This involves appointing an insolvency administrator to take over the running of the practice from the partners or directors. The administrator’s objective is to find the best deal for the creditors – not the owners. This may mean continuing to trade and build up the business, or selling it on, or selling the assets and winding it up, depending on whichever creates the best value for the creditors. You, and some of the staff, may be asked to continue working for the administrator to keep the business going, if only for an interim period. It may be possible to buy back company assets (including ongoing workload and office leases) from the administrator and transfer these into a new or another existing practice.

Voluntary arrangement Instead of closing down with outstanding debts, existing directors/partners can enter into a formal agreement with creditors (including the tax office) to pay an agreed proportion of the debt over time by continuing to trade. This needs to be formally registered by the courts and be built on a binding agreement with at least 75% of the creditors. It is only feasible if the creditors believe they will get a better deal this way rather than by liquidation or administration. You stay in control, but you need to be realistic that you can rescue the business to eventually close down the practice in a planned way and meet your commitments.

Legal

Patrick Perry, partner with London law firm, Barlow Lyde & Gilbert

When winding up a practice, it is important to make arrangements to protect you and your fellow business partners from professional negligence claims by former clients. The fact that the business has ceased trading does not mean that potential claimants cannot seek to bring claims against you and your personal assets some time in the future.
Taking out what is known as “run-off” indemnity insurance is, of course, advisable, to provide cover both against the potential claims that may be made, and the legal costs that could be involved in defending such actions.

When considering your potential exposure to claims, and the insurance cover required, there are two important issues to consider:

  • The period for which you will be exposed to professional liability claims is much longer than most people think.

Former clients can sue for allegedly negligent work in two principal ways: negligence and contract.

The time limits for contract claims are relatively straight forward. A claim must be brought within six years of the date of breach of contract or, if the contract was signed as a deed under seal, within 12 years of that date.

Negligence claims must be brought within six years of the date when the damage complained of was suffered. For architects, this can be much later than the date of the alleged negligent act. A client can bring a claim outside of the six-year period, provided the client can show he or she did not discover the damage until after the time limit expired. In such cases, the client will have an additional three years from the date of discovery of the damage to bring a claim. However, the client’s claim is subject to a “long stop” limit of 15 years from the date of the alleged negligent act.
While the risk of a claim generally diminishes over time, it can still be a very long period indeed before you can be certain a claim can no longer be brought.

  • Who will be liable for any claims brought by former clients and whom the insurance should cover.

A sole practitioner will always be personally liable for any claim that is brought against them, even after the practice has been wound up. In the case of a partnership, the partners will be jointly and severally liable for the liabilities of the partnership. This means that each partner could be sued individually in relation to work carried out by the partnership.

By contrast, companies and limited liability partnerships (LLPs) have their own legal identity and any claims by former clients will usually be brought against the practice rather than the individual architects. Exceptions do exist though. For example, an architect may still be personally liable where they have signed off work in their own name (for example, a statement of opinion) rather than that of the practice.

Ceasing trading does not stop former clients from bring claims against you

Where your practice has changed its legal structure, from say a sole practice to a company, a client may be able to bring an action against an architect personally in relation to work that was completed before the transition to a company took place. It is therefore important that your insurance will indemnify claims against both you and the company.

Rules and guidance on how to address professional liability issues can be obtained from Arb and the RIBA and it is advisable to take appropriate legal advice.

Financial

Mark Twum-Ampofo, partner with chartered, accountant Kingston Smith

A planned closure of a practice is likely to be the decision of key individuals, perhaps because of a desire to retire or for architects to go their separate ways. Broadly speaking, the most likely cause for forcibly winding up a practice is financial; for whatever reason the practice is no longer able to pay its bills.

Sometimes the closure of a practice for financial reasons can come down to plain bad luck – for example, where a major client goes bust and work goes unpaid. For smaller practices, which are dependent on a relatively small number of comparatively large projects, this is always a risk.

Typically, there is a period of time when the business is facing financial difficulties and the practice owners are doing everything they can to keep the business afloat. Inevitably, all businesses will face periods when trading becomes tight. But when the practice has insufficient cash to pay its debts as they fall due, or where there is a budgeted cash shortfall in the coming months, this desire to seek a successful outcome can carry significant risks.

Partners or sole practitioners in unincorporated practices have personal liability for the practice’s debts and, even where the practice is incorporated as a company or limited liability partnership, directors or members can become personally liable for debts if they are leaving creditors worse off by continuing to trade.

As soon as you become aware that the practice may be forced to close and that it may not be able to pay all of its creditors, you should take advice, firstly from your accountant and secondly from a licensed insolvency practitioner, who will be able to advise you on the best course of action.

The more fortunate will be in a position to wind up the practice in an orderly way.

In addition to the financial aspects, you should consider what will happen to your staff, office and other assets owned by the practice. Also, if the partners are going their separate ways, you will need to agree who will retain any client relationships and who will be responsible for completing any outstanding assignments. The most appropriate split is likely to be fairly obvious, but determining how the practice should be compensated for its contribution to work in progress may be more difficult.

On the financial side, you will need to draw up a final set of accounts. If the practice is being closed for good, hopefully there will be funds remaining after any outstanding debts have been collected and liabilities paid. You will then need to consider how these funds should be distributed.

Each partner or shareholder should consider his of her own personal tax position as there may be tax liabilities that crystallise on cessation of the business. Where you have been in business using a limited company or limited liability partnership, you will need to take advice on the practicalities of having it formally wound up.

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