The ABC’s of Law Firm Breakups
It’s been years, and through all the ups and downs your law firm has survived. But then one day, your partner announces that it’s time for a change: she’s leaving to join another firm. This is always an unpleasant surprise, even when the writing on the wall has been throbbing in day-glow colors for months. It’s been easier to just ignore the signs and concentrate on practicing law. But the damage is now done. What to do?
Sometimes there is no controlling agreement, or if there is an agreement it was penned years ago, not touched since, and it was written at a honeymoon time when the thought of a partner’s departure was far from everyone’s mind. Sometimes the subject of a partner withdrawal (or an expulsion) is addressed in an agreement. But even then there is fertile ground for disputes, and disputes are common. What you do, agreement or no, will depend upon perspective. The world looks very different depending upon which side of the table one is sitting.
The Law Firm’s Perspective
You have just learned that your partner is leaving, defecting, stabbing you in the back! Since you can’t stop him (her) from either leaving or competing (noncompete covenants don’t work with lawyers), it’s now all about damage control. Let’s assume that the departing lawyer generates profits for the firm (if he or she doesn’t, this is all academic). The loss of this lawyer’s fees is going to hurt. There are steps which can be taken to lessen the pain, and equally there are steps which shouldn’t be taken as tempting as they may appear.
In representing the departed firm, the first place to look is the governing agreement if there is one. In the lucky case, the firm has addressed in detail the eventuality of the loss of a productive partner, maybe even dealt successfully with a prior departure. Those are the easy ones, but they are rare. More often agreements (particularly LLC operating agreements) spend pages dealing with taxes, capital accounts and governance, but touch only lightly if at all on member withdrawal. Which is not surprising given that many LLC operating agreements affirmatively prohibit member withdrawal. So let’s assume that the governing document does not definitively address partner departure, or that it does so in an unhelpful manner.
The departing partner takes certain assets with him or her and leaves certain assets behind. No dispute here. Understanding where the line is: not so easy. The departing lawyer needs to live on something during the transition period creates issues. He leaves behind mature accounts receivable. These are the property of the firm and thus must remain with the firm. Work in process is a different matter, particularly in situations wherein the work being performed is contingent fee work. How does the firm navigate these treacherous waters?
Assume that the departing partner and the firm have observed their ethical obligation of offering active clients the options of remaining with the firm, leaving with the lawyer or finding new representation, and that a number of contingency fee clients have elected to follow their lawyer to his (her) new digs. There is an indistinct line between the firm’s right to a portion of any contingency fee ultimately earned (emanating from the fee agreement that the client signed with the firm) and the departing lawyer’s right to a reasonable fee. Case law gives us a starting point for allocating contingency fees earned post-departure between the firm and the departed partner. In re L-Tryptophan Cases, 518 N.W.2d 616 (1994) sets forth a list of criteria which is helpful in establishing a means of allocating post-departure contingency fees in a way which does not prejudice the client by hog-tying the departing partner who successfully completes the case. Courts may consider (1) the length of time each firm spent on the case; (2) the proportion of funds invested by each firm; (3) the quality of representation; (4) the result of each firm’s efforts; (5) the reason the client changed firms; (6) the viability of the claim at transfer; (7) the amount of recovery realized; and (8) any pre-existing partnership agreements.
Clients can choose their own lawyers, and contingency fee agreements last only as long as the client elects to continue the relationship. After the client walks, the contingency fee agreement morphs into a quantum meruit claim for compensation, sometimes bolstered by an attorney’s lien (a subject discussed in another article on this website). The L-Tryptophan criteria are helpful to formulate a bridge between the firm’s equitable right to compensation and the departing lawyer’s entitlement to a fee. What that bridge looks like is a matrix setting forth, case-by-case, an agreement for a percentage split between the firm and the departing lawyer of anticipated contingency fees.
If, for example, the case is new at the point of departure, then the percentage assigned to the departing lawyer would be high, 90% or more. The departing lawyer is taking on all the risk, and the client can rest assured that her lawyer is properly incentivized to aggressively litigate the case. If the case is on the steps of the courthouse, the percentage split would run the other way, in favor of the firm. The firm will want to negotiate the highest percentage allocation it can without disincentivizing the departing lawyer from working the file hard to maximize the recovery. There is no right or wrong answer in such an allocation exercise. In our experience, these arrangements work very well.
The firm will also normally insist that any costs it advanced prior to the point of departure be reimbursed. In the best case scenario, the departing lawyer will ‘buy out’ the costs at the time of transition. In the far more normal situation, agreement is reached that the departing lawyer will collect all advanced costs at the point of positive resolution of the case and remit the full balance to the firm.
The Departing Lawyer’s Perspective
An opportunity which could not be missed has arisen for you to move your practice to another firm. The difficult conversation with the firm partners has taken place, and agreement has been reached with regard to the sharing of future fees and reimbursement of costs. Now what?
There is much clean-up business to be attended to. There may be a line of credit on which the departing partner is a guarantor. The partner may have personally signed the office lease, or the copier lease. The departing partner may have deferred compensation owed to her, or a redeemable capital account. Social media needs to be changed. Protocols for new client inquiries to the departed firm must be put in place. These are but a few of the normal bumps in the road.
Regarding the line of credit, rarely will banks agree to release a guarantor, even if the line would remain adequately underwritten by the remaining guarantors. The solution if release is not in the cards, is for the departing partner to notify the lender that she will not consent to any additional advances on the line post-departure. The best of all worlds is for the line to be zero-ed out contemporaneously with the transition. But of course this may not be practical. In the parties’ separation agreement (yes, there should be one), the remaining partners are often willing to indemnify and hold the departing partner harmless from liability on that portion of the line which is unrelated to the partner’s financial responsibility to the firm for the debt.
Regarding office and equipment rental agreements on which the departing partner has personally signed, we have found more flexibility in landlords and lessors to release a departing partner. But where that is not possible, the same indemnity and hold harmless commitment to the departing partner is usually the best bet, and this is common because post-transition the departing partner does not benefit from these rental arrangements, whereas the firm continues to do so.
Regarding deferred compensation and redemption of capital, these are unique issues to every firm, and to the extent they are not definitively addressed in a shareholders’ or operating agreement, they can and should be resolved in the separation agreement.
Social media has become an integral part of lawyer marketing. Web pages and search engine optimization (SEO), Facebook, Instagram, AVVO, etc. all need attention to insure a seamless practice transition for the departing partner. Protocols for new client inquiries to the firm seeking representation by the departing partner must be put in place.
There is obviously much more to an efficient separation from a law firm than this brief article addresses. These are good starting points however. A fair and comprehensive separation agreement is the best guarantee that all of the unique aspects of the relationship are dealt with fairly, and costly and distracting disputes are avoided.