Solicitors in Partnership: Three Mistakes that Lawyers make in relation to their own firms…

Over the next three weeks, my partner Susanna Heley and I will be considering some of the most common repeat problems that we see in our dealings with solicitors — Susanna will be considering these from a regulatory perspective and I will be looking at the disputes and commercial litigation side of partnership issues. These are problems which crop up time and time again and are often the result of solicitors assuming that their own relationships can be taken on trust.

So, from my perspective, what are the top three issues which regularly rear their heads when a potential dispute is brewing within a partnership?  For the purposes of this article, that includes “old fashioned” partnerships (“Partnerships”) as well as their corporate embodiment, Limited Liability Partnerships (“LLPs”).

1. Get a written Partnership Agreement in Place!

I wonder just how surprised most non-lawyers would be if they knew that it is far from unusual for solicitors not to record the basis on which they want their business to be run in a binding, written, agreement, or not to tailor and update any agreement they may have started with.

It’s worth remembering that, absent agreement to the contrary, both Partnerships and LLPs are subject to default regimes — the rules that apply to Partnerships and LLPs if nothing is agreed to the contrary.  Those regimes provide for matters such as each partner’s entitlement to profit share, to participate in the exercise of control over the business and in many other fundamentally significant respects. Both regimes can be displaced by agreement. In their unmodified form, the default regimes don’t present a terribly attractive basis for managing a commercial business, which may need less parity and more clarity about how to break a deadlock, something that arises with a fair degree of regularity and which I deal with in this article.

Solicitors who are too busy, or not sufficiently versed in corporate governance — or simply too trusting — may overlook or choose not to obtain a formal written agreement, although they often live to regret it. Things are fine while everyone is getting along but, when relationships become strained and everyone wants to know where they stand, it’s sub-optimal, to say the least, to be scrabbling to establish that you are not on an unsatisfactory default regime — or to learn, conclusively, that you are!

It is easier than you might think to fall into this trap, because even if a firm starts off with a solid agreement, changes over time can give rise to unintended consequences, including my next common issue…

2. Get All the Partners to Sign the Agreement

In this, not uncommon, scenario the good news is that your firm has a lovely, watertight, Partnership or LLP agreement. Everything is crystal clear and every aspect of the relationship between the partners is provided for. The bad news?  New partners have joined the firm without signing up to the agreement or, in some cases, have left without following the formalities required. What are the consequences of that? Well, if the new partners who have joined have not been given notice and expressly, or implicitly, agreed to the existing Partnership or LLP agreement, then the likelihood is that the terms of that agreement have been superseded by the relationship that arises between partners by default. The firm is back to square one, as above. Worse, there is a risk that a change in the legal composition of a partnership could cause a firm to be in breach of its authorisation requirements.

The consequence is that departing partners, who might otherwise have found themselves bound by an effective Partnership or LLP agreement, are instead able to operate from a position where they may be able to dissolve the partnership or depart with no notice and free of any restrictions that might otherwise have prevented them from soliciting work from or acting for clients after they had departed; the default provisions for Partnerships and LLPs do not provide for any such restrictions.

That can be a very inconvenient truth for the firm, leaving it facing the prospect of considerable disruption unless terms can be agreed with the departing partner. The balance of power in any exit negotiations may be significantly affected by such oversights, and a law firm is unlikely to attract much sympathy from a court if it has not managed its own governance with the same care it would advise clients to exercise.

3. Failing to Deal Properly With the Duty of Good Faith

Partnerships and LLPs are unusual creatures. The relationship that they give rise to is so strong that, unlike most agreements in a commercial context, the obligations between partners can continue even where one of the partners acts in a way that is fundamentally different from that agreed between them — assuming there is, in fact, an agreement to displace the default provisions I have mentioned above.

What that means is that, even if your partners “do the dirty” on you, you may still be required to hold up your end of the Partnership agreement. You may want to leave immediately when faced with poor treatment, in breach of your Partnership or LLP agreement but, unfortunately, that simply may not be an option — no matter how badly you have been treated.

What a departing partner may be able to do, however, is argue that they have been treated in a way that is inconsistent with the duty of good faith that is owed between them — the obligation to treat each other fairly and honestly and which, according to the venerable case of Helmore v Smith is the cornerstone of the partnership relationship. That can give rise to a claim in damages for the losses caused by the breach.

It’s worth noting that no reported case has ever successfully excluded the duty of good faith from a Partnership. However, LLPs differ in this respect as no duty of good faith is implied under the relevant default provisions. These days, the duty is more often than not expressed not to apply in well written LLP agreements.

Commonly seen problems arise:

• In Partnerships, because the duty is so wide and, frankly, somewhat difficult to pin down with absolute accuracy. The best way to reduce the scope for argument is to ensure that any mechanisms for exercising control and decision making are clear and adhered to. If there is a procedure and precedent for allocating profit share for instance, then sticking to that will go a long way to refuting a claim that the duty of good faith has been breached. Once again, it’s all about using a well drafted Partnership agreement to remove as much risk as possible.
• In LLPs, where (sometimes as an historical holdover resulting from the transfer of a business from a Partnership to an LLP) the duty of good faith is expressly stated to apply. If voluntarily adopted by the partners in an LLP, then those in charge of the LLP have far less freedom to conduct themselves as they might otherwise wish to. In that scenario, one of the management benefits of adopting an LLP as a vehicle for your business (no duty of good faith) is cast away.

These issues are fundamental, and taking steps to avoid them represents a solid first (but far from last) step towards avoiding real problems in your business as a solicitor.

Next week, Susanna Heley looks at some of the regulatory problems that crop-up most often and suggest how those can be mitigated.