Attorneys come to us when contemplating the creation or expansion of their firms, when they want to leave their firm, or are dealing with the fallout of another member leaving.  While many law firms have taken advantage of the protections of a limited liability entity, attorneys are not always aware of the risks involved when the members of the firm do not enter into an agreement or enter into an incomplete or “boiler plate” agreement in forming those entities, risks that sadly only come to light when embroiled in a dispute between the members

And, yes, limited liability entities – in New York, registered limited liability partnerships (LLP), professional limited liability companies (PLLC) and professional corporations (PC) – have allowed attorneys to practice relatively free from concerns of personal liability for law firm liabilities and obligations, or for the malpractice of other members of the firm.  Recently, those liability protections allowed former partners of Dewey & LeBoeuf LLP to avoid personal liability under the bankrupt firm’s office lease. 1301 Properties Owner LP v. Abelson, 51 Misc.3d 1207(A) (Sup.Ct. New York City. April 1, 2016). The personal liability that remains is limited to any malpractice committed by the attorney and any individuals that he or she directly supervises or controls – for which professional liability insurance is maintained – and to any firm obligation that is personally guaranteed by the attorney – such as lease or line of credit guaranties.

But what about partner down the hall?  How will the withdrawal or death of that partner impact the finances of the firm, and those of the remaining partners?  Without an agreement in place that provides for member withdrawal procedures and payments, and dispute resolution by mediation or arbitration, (a) a firm will be stuck with the “default” provisions in the applicable statutes that were never agreed to; and (b) may endure a partnership “divorce” that can become as ugly and emotional as the end of a marriage, without any of the privacy/confidentiality protections afforded under matrimonial law. 

Agreement by Default

Without a partnership agreement providing otherwise, under New York Partnership Law the “disassociation” of a partner from the partnership is a “dissolution” of the partnership – the partnership is not terminated but continues for the purposes of winding up the business.  Of course, plenty of partnerships continue to operate after a partner’s withdrawal.

But the courts have found that the continuation of a “partnership at will” – one where there is no partnership agreement – is technically a “new” partnership with the same name created as of the date of dissolution.  The withdrawing partner – or his or her estate – can bring an action for an accounting, and payment of his or her interest, as if the firm dissolved on the date of withdrawal.  Similarly, a partnership agreement that provides for a partner’s death, retirement or expulsion, but fails to include a voluntary withdrawal of a partner, provides an opening for the withdrawing partner to insist on an accounting of his or her interest.

In contrast, the New York Limited Liability Company Law provides that the withdrawal of a member for any reason does not dissolve the LLC.  But a member cannot withdraw until the LLC dissolves.  Absent an operating agreement, this sets up a situation where no one can relinquish their membership interest and be bought out unless the members agree to dissolution or the member seeking to withdraw can establish the grounds for a judicial dissolution. 

And the standard for judicial dissolution of a LLC in New York is the more stringent that those for a partnership or corporation – dissolution is warranted only when “it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.”  New York Limited Liability Company Law §702. An attorney who believes that dissolution will be granted because the members are deadlocked or can no longer work together may be in for a rude awakening.  If the court determines that the firm is conducting its business – servicing clients, receiving income, paying expenses, etc. – the fact that the members do not like each other will not result in dissolution.

Now this has not been played out in the courts for a legal PLLC, where arguably the inability to withdraw may be a restriction on the right to practice in violation of the ethical rules (e.g., New York Rules of Professional Conduct Rule 5.6).  But in the meantime, a judicial dissolution proceeding can turn into a free for all of every petty grievance between the members played out in publicly accessible pleadings. 

Which leads to a recent hot topic – succession planning.  There have been a lot of articles and CLEs lately concerning succession planning.  And rightly so.  A recent study found that in 63% of law firms, partners aged 60 or older control at least one quarter of the total firm revenue.  But only 31% of those law firms have a formal succession planning process. Altman Weil, Inc., 2015 Law Firm in Transition: An Altman Weil Flash Survey (2015).  That study further concluded that addressing compensation and other retirement issues in light of retirement of Baby Boomer partners is critical.  Without prior planning and consideration of the applicable default statutory provisions, the retirement or death of a partner or member with a significant ownership interest – and expectation of a large payout – could wreak havoc on the firm and the remaining members.

The bottom line is to enter into a comprehensive partnership or operating agreement – the law firm “pre-nup” – sooner rather than later, before tempers and expectations get out of control.  We would not advise our clients to skip a written agreement.  Should we want any less for ourselves?