Basics of Law Firm Partnerships
A law firm partnership is essentially a merger of minds between two or more lawyers. It is a collaborative career platform that enables one or more licensed attorneys to run the practice as a single legal entity. Even with two or more separate individuals running the business, there is yet a unified field of practice—the benefit of which supports specializations that may otherwise be too time-consuming or difficult for a single practitioner to maintain.
The actionable compliance requirements needed to maintain law firm partnerships are set forth in the form of partnership agreements. These working documents contain stipulations that clearly identify the terms of the relationship , including profit sharing and means of termination.
Without solid agreements in place, law firms can be subjected to misunderstandings and partnership-related disputes. Such conflicts are not uncommon, and they can lead to a significant decline in client satisfaction, a dangerous possibility for even the most sophisticated law practices. Thus, having a law partnership agreement in place is essential in establishing boundary lines to support a thriving firm.
Key Provisions in a Partnership Agreement
There are several clauses that are essential to an effective law firm partnership agreement. Among them are the following:
Management Structure.
Some law firms are structured with two basic layers of management. Some firms have a committee or board of members that make decisions about the big picture direction of the firm as a whole, while day-to-day decisions are made by a single individual. Other law firms have a simple structure, with no layer of members concentrating on the overall direction of the firm. Whatever the structure, the method by which management decisions are made should be set forth in the partnership agreement and all firm members should have a clear understanding of that structure.
Profit Sharing.
The profit-sharing formula is one of the most critical components of any law firm partnership agreement. The way profits are distributed should reflect the significant contributions of each member of the law firm. While partners may debate the exact formula, it often depends on the level of participation by members. Some law firms, for example, distribute profits equally among all members. Others take into consideration a member’s own billable hours, or management responsibilities, or contributions to marketing. If, for example, one partner is responsible for client development and the other acts only as a rainmaker, the partner who generates client business may be entitled to a larger portion of the profits. Having a formula that reflects the efforts of all partners — from senior partners and rainmakers to junior members — is a critical part of a law firm partnership agreement.
No-Compete Clauses.
Many law firms bar lawyers from working for competitors after leaving a firm. No-compete clauses are an element of many law firm partnership agreements, but limits on how long a lawyer may work for a rival firm, and how far from the previous firm the rival may be located, should be spelled out in writing. Courts generally will enforce reasonable no-compete agreements that are part of a partnership agreement.
Buy-Sell Agreements.
A buy-sell agreement is another essential element of a law firm partnership agreement. A goodwill valuation formula, a formula based on net book assets or a combination of both methods can be used to set a price for an asset. A buy-sell agreement is potentially worth millions of dollars when a partner buys out, dies or retires, so a well thought-out arrangement is critical to its future success.
Creating a Legally Compliant Agreement
A Partnership Agreement is a contract, and legalese will not be avoided. We recommend at a minimum including the following attributes: (i) terms of ownership; (ii) management of the firm; (iii) firm name; (iv) conditions for withdrawal; and (v) procedures for dissolving the firm. These are the fundamentals but the level of complexity will be driven by the length of the agreement and the size of the firm. In any event, the previously noted considerations should be outlined.
There is no standard form partnership agreements as this document, in its most basic sense, regulates the relationship between partners, and the relationship between partners and the firm. That said, the backbone of a partnership agreement will be the Law Firm Governance Model. The firm’s organizational structure and management approach will serve as a starting point (including changes) for your Law Firm Partnership Agreement. The internal rules and regulations notwithstanding, State law materially affects partnership agreements. Similarly, Federal tax laws will affect the terms and conditions of the agreement, particularly in the case of a multi-tiered partnership, where there are different classes of partners.
Drafting the Law Firm Partnership Agreement – To insure certain legal protections, the partners should confer with legal counsel when drafting the Law Firm Partnership Agreement. Further, the firm’s accountant and/or financial expert should be brought into the process. This team will help to identify how best to address the tax implications of the partnership and review the language of the document.
Common Mistakes to Watch Out For
The reality is that law firm partnership agreements are commonly flawed, often from the outset. In many cases, these flawed agreements can be corrected without any adverse consequence. In others, flaws can result in costly litigation.
The most common mistake we see made in the agreements that are prepared by firms is a failure to properly align the division of profits and losses with the contributions each partner is making and with how decisions are made in the management of the firm.
A related pitfall is creating a management committee or board that is improperly aligned with the partnership structure. A board or committee should mirror the partnership structure and equalize control among the partners, not create a small group of insiders able to dominate the others.
Another issue that is frequently overlooked is inadequate attention to how equity eat ins and buy ins will be calculated, particularly in two areas.
First , without a detailed written formula it is all too common to have the compensation of the more senior partners compared against newer equity partners in a way that benefits the more senior partner, and at the same time adversely affecting the more junior equity partner.
Second, the calculation of equity capital contributions at a later date can be contrary to the interests of a junior partner if there was no careful written formulation of what the equity capital contribution amount will be.
A final issue is a lack of an adequate buy/sell agreement. Although most agreements do have some form of buy/sell terms, we find that they are far too general, fail to take into account changes in the market place and are otherwise poorly constructed. For example, if a firm is losing an important client, handling an acquisition or an engagement by a new client, is the income related to that work counted in the firm’s base? If not, the formula can be gamed.
The key to avoiding these issues is to put together a solid team with lawyers that know how to draft these agreements.
How to Resolve Disputes Between Partners
The question of what happens in the event of a dispute among the partners will never go away, either just because there’s an agreement or not. Over the years, I have seen many partners "force" their will on other partners simply because they could. They didn’t care about the agreement or what it said. And the harm is not limited to monetary harm, either.
I’ve seen what happens to the "spouse" of the partner who is forced out of the firm. Not only does he or she suffer a huge loss in income and status, but they too live hand to mouth until the spouse can re-establish himself or herself. The expense and damage to personal relationships cannot be overstated and, in most instances, the damage continues on long after the attorney no longer has any connection to the firm.
I’d like to say that having appropriate protections in place will eliminate all of that, but nothing is further from the truth. The ultimate protection is having good partners; partners you hope never to have a dispute with in the first place. As a law firm partner, I can tell you, however, that no matter how much you like and respect the other partners, there are always disagreements, and those disagreements can end with hard feelings, hard consequences, and even worse consequences. No one likes to see a partner who he or she really likes and respects leave. Even worse, there are those who bring the association into disrepute. If a sole practitioner doesn’t like your method of practice, for example, that’s okay, but when bad mouthing turn into obstructionism against profit, that’s a different thing entirely. That’s the kind of thing that can tear a firm apart. I don’t like it and I don’t tolerate it.
There are, of course, other types of disputes. One-time circumstances are one thing, like a loss on a major case. That’s something to get over. But, if one partner is routinely unprofitable and does not seem to care, then that is something else again. That’s when those things in the partnership agreement like what constitutes cause become relevant. A much more common occurrence is where there is a disagreement about what certain language means. For example, to what extent is a retiring partner entitled to future profits? Is it what the retiring partner is entitled to at the time of retirement? Or, is it what the partnership agreement says the retiring partner gets between the time of retirement and the time he or she dies? If the retiring partner went to his or her deathbed having been told that they were getting a percent of the profits "for life," but the agreement did not reflect that, that can be a big problem for the firm.
Often overlooked in these cases is the need for an expensive and time-consuming trial. The beauty of having a solid partnership agreement and the cash flow, in most cases, to enforce it, is that it helps eliminate the possibility of resolving the dispute in front of a jury. That’s a better outcome for the firm, and it saves everybody a lot of money.
In sum, a good and fair partnership agreement is integral to the basic function and efficiency of any firm. When carefully drafted with an eye toward the future, a quality partnership agreement can help all partners avoid tomorrow’s regrets today by ensuring that all partners are already in agreement on the key issues that impact the firm.
Planning for the Future
To truly future-proof a partnership, the most crucial concern is succession planning and exit strategies. While no one likes to think about the dissolution of a law firm, the harsh reality is that partners do leave the firm. Whether due to retirement, illness, personal issues, a chance to make money elsewhere, or just incompatibility with the other partners, divorce from the firm occurs more frequently than most people think. One of the most important clauses in a partnership agreement is what happens to a partner’s interest in the firm once they leave. Will they continue to get credit for new business they bring in after leaving the firm? Will they receive a severance package? And, perhaps most importantly, how will the value of their ownership be determined? Without clear guidance on these questions, things can get ugly quickly. Other partnership models view dissolution and breaks from the group more as the changing of a sock than as an atomic bomb. In these firms, the founding partner delegates day-to-day management to a collection of senior partners who then defer to elected management. There’s a strict plan by which partners regularly rotate in and out of positions in managing committees , citadels and councils. Changes in the firm structure don’t threaten the firm’s continued existence; rather, they are embraced as an orderly evolution for a firm that wants to grow in all dimensions. Some firms, in fact, are constantly on the brink of dissolution and regeneration, using a very modern and interesting model. The firm is actually multiple independent firms, organized as alliances between lawyers. So, you may have a couple of lawyers with a thriving practice in IP set up a little protection racket, "Nobody’s going to mess with us! We’ll take on anybody that challenges us; we’ll protect our territory," and so they offer alliances to any lawyers that don’t want to be bothered by all that pesky administrative and management work. You now have a multi-office firm consisting of these lawyer alliances, without an ownership structure and thus other lawyers can come and go as they see fit. Such models share some problems with closely held 80/20 firms. They are vulnerable to exploitation from lawyers without much loyalty to the group, who join the firm for easy, low-cost access to its administrative resources but leave the first time that it appears advantageous to do so.