Why Your Firm Needs a Written Partnership / Shareholder Agreement

We know the adage about the shoemaker’s children running barefoot.  In the law firm the equivalent is a firm built on a handshake and nod, without the benefit of a written agreement.  The result?  Just as dangerous as those shoemaker’s children running around barefoot on a bed of broken glass and rusty nails.  Aw comeon, you’re thinking, we’ve operated that way for years and it’s working just fine.  Hey, good for you.  The problem is what happens when you’re not getting along just fine.

The time to agree about things is when everyone is feeling agreeable.  When times are good.  That’s when people are most likely to be reasonable.  And that’s when you should nail down details that will be vital should things devolve into something less agreeable.  Let’s be honest, we are seeing a decided uptick in law firm dissolutions, defections, implosions, explosions, and outright financial failures.  Without a written agreement which spells out some critical actions, you will likely end up in court, or at least in the newspapers.

For example, read this recent article from the ABA Journal Law News Now entitled “Suit Claims Former Partners of Dissolved Law Firm Won’t Leave.”  I admit I laughed out loud when attorney Ronald Minkoff, a partner at Frankfurt Kurnit Klein & Selz who represents lawyers in partnership disputes, was quoted as saying that it is “unusual in this day and age” not to have a partnership agreement.  Ok, remember back in law school when you were told to look to your left, and to your right, and realize that by the end of 3 years only one of you would be remaining and passing the bar?  Same exercise, only this time it’s less than one of you will have a written agreement with your business partners.

You may be wondering what the big deal is . . . we’ll just go our own way, right?  Nope.  In all likelihood it will be getting nasty fairly quickly.  You may find yourself in the headlines.  You will certainly lose tons of time and energy which could be better used transitioning your clients to a new practice with you.  It will cost you legal fees in addition to emotional trauma.  And you may wind up with disciplinary issues and/or malpractice claims to boot.  Need examples of the issues which crop up the most?

Malpractice insurance coverage after the lights go out. 

Many of you immediately recognize we’re talking about “the tail” or what is otherwise known as an Extended Reporting Period Endorsement.  Malpractice insurance policies for lawyers are almost exclusively written on a “claims-made” basis.  This means that if you don’t report a claim within your policy period, or an act, error, or omission which you know about which may reasonably give rise to a claim in the future, you will have no coverage if a claim arises after the policy period expires.  For many lawyers, it is a rude awakening to find out that their new law firm home may have a policy which excludes prior acts coverage.  If you wind up on your own, you may not be able to afford a policy with full prior acts coverage.  The best policy for all concerned is to require the dissolving firm to purchase the tail, in order to protect everyone going forward.  However, absent a written requirement, I can assure you that it rarely happens, as those departing refuse to pay their fair portion of the premium.

Retention and disposition of remaining client files.

This is a complex and problematic area.  Just because a law firm closes doesn’t mean the firm is relieved of its obligation under Rule 1.15 [Safekeeping Client Property].  In fact, those obligations continue and can — and have in the past — impacted even former partners of a dissolved firm with disciplinary action if ignored. 

A few years ago I read about a dissolving New York firm which could not get the partners to agree to pay for a storage facility for all the closed client files.  The debate became heated.  No one wanted to pay to store files for former partners, let alone their own former clients.  Eventually, the few partners who stayed behind, responsible for winding things down, became sufficiently disgusted and literally threw away all the files. Ultimately, all partners who had left files behind, even those who had departed before the closing of the firm was announced, were disciplined for failure to properly safeguard client property. 

On top of these issues, firms must be concerned about discovery and possible accusations of spoliation if client records are dealt with inconsistently.  When it is left to individual attorneys to determine what gets saved and what gets destroyed at a given interval, every inconsistency becomes suspect under the bright glare of litigation discovery.

Future liabilities and audits.

When a firm winds down, unpaid liabilities can rear their ugly head.  While not every nuance can be anticipated, you want to make sure that any departed partners remain liable for their share of any back taxes, penalties and interest, defaulted loan payments, unpaid vendor bills, or whatever later arises from a period in which they were a member of the firm.  Gone should never mean off the hook for these obligations.  Look to your partnership or shareholder agreement to make this obligation clear.

These represent just three examples off the top of my head of what can — and frequently does — rear its ugly head in the absence of a written partnership agreement, when a firm dissolves.  If I didn’t have a backlog of work calling my name right now, I’d delve even into how a firm’s ability to nimbly realign and implement change in response to an evolving marketplace can be seriously hampered when there is no partnership agreement spelling out how decisions get made.  If you’re relying on 100% consensus to accomplish everything, you better hope you never disagree.  Because when you do (notice I didn’t say if) you will be thwarted by decision paralysis.

If you’re not convinced, search Google News for past headlines regarding law firm dissolutions and the thorny and ugly issues which emerged. You will find a common theme in most — the lack of a written agreement between members of the firm.  Don’t let your future follow a similar path.

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