Charting an Exit From a Multi-Partner Firm

07/30/2013
by Edward Poll

This article was published in www.technolawyer.com, June 25th 2013

Every lawyer eventually leaves the practice of law. Some die during their career, but most stop practicing to retire or pursue a different career. Thus, law firm management consultant Ed Poll's new book — Life After Law: What Will You Do With the Next 6,000 Days? — has more universal appeal than other books about law practice. This explains why we asked him if we could reprint a chapter for today's issue of SmallLaw.

Ed's 215-page book consists of 11 chapters as well as 10 sample documents and other valuable information. It covers ethical issues, succession plans, transferring clients, teaching rainmaking to a successor, selling a law firm, retirement planning, and much more.

Below you'll find all of Chapter 4 — Charting an Exit From a Multi-Partner Firm (except for the section about large law firms). We'd like to thank Ed for giving us this exclusive. Life After Law is available in both print and electronic formats from LawBiz (Ed's company) and from Amazon.

Buy Life After Law directly from LawBiz — available in print, PDF, or ePub format, the latter of which works in iBooks on the iPad.

Buy Life After Law from Amazon — available in print or Kindle format.

Please Note: Any typos in the excerpt below resulted from OCR and don't exist in the actual book.

Chapter 4: Charting an Exit From a Multi-Partner Firm

As mentioned earlier, lawyers who are approaching retirement and practice in firms with multiple partners will need to delve into some issues separate from those faced by solos and the smallest firms. It is essential, of course, to develop a strategy for successfully transitioning client relationships and other responsibilities to other partners or qualified associates in the firm (as discussed in more detail in Chapter 5).

However, the first step in the strategy for those who work in multi-partner firms is to review their partnership agreement. Of course, this raises another threshold issue. Far too many law firms do not have a written partnership agreement — again, an example of the shoemaker and his children going without shoes.

But putting that issue aside for now, let us focus on understanding your rights and options as you begin to plan your exit from the firm — especially as this will have a significant impact on both the timing and the financial aspects of your retirement plans.

The Crucial Role of the Partnership Agreement

Too few lawyers understand their partnership agreement, having leapt at the chance to become partner but not actually reading the agreement itself. Or they read it years ago but do not remember pertinent provisions. Lawyers nearing retirement age in a multi-partner firm, however, should be able to answer certain questions about their partnership agreement.

You will need to first consider whether there is a buy-out provision for the firm's partners. Your potential movement into an "of counsel;' "counsel emeritus:' or equivalent position, or out of the firm entirely, will also be governed by such provisions in the agreement (or the statutory equivalent in the absence of a written agreement).

But, of course, there are other questions to ask about the partnership agreement's terms, so senior lawyers can know what the answers may mean for their financial future. Some key issues are:

  • How much did you actually pay to join the firm?

  • Does the firm consider there is goodwill for your interest in the firm?

  • Will you receive severance and a share of the firm's receivables when you leave?

  • Presuming there is a buy-out provision, will the money be paid to you in a lump sum, or in monthly or other increments?

  • Are you a personal signatory to the firm's line of credit or lease?

  • Would you have to pay anything if you left in six months? In one year? In five years?

  • Will you be able to continue your health, disability, or similar insurance coverage through the firm?

There are also other, broader questions to ask, particularly if the firm has been experiencing financial difficulties. For one, do you know if your up-front contribution has gone for the improvement of the firm, or is being split among the other partners? Do you know if there are only certain times of the year (for example, your anniversary date, or the last day of the fiscal year) when you can leave and get your full investment back? The partner who can't answer such questions is probably guilty of personal financial negligence — and may find that retirement plans need to be altered considerably.

Here's an important thing to note about the timing of the agreement's review, and why it is such a critical early step: A number of years ago, one of my clients, who was a founding partner of her small law firm, wanted to retire from the firm in order to take a position on the bench. I advised her to review the firm's partnership agreement before I started on a course of action to guide her in the transition. Nonetheless, she procrastinated on the review as I moved forward on her work, still urging her to review the agreement. It was only when my assignment was close to completion that she finally reviewed the details of her partnership agreement.

To her horror, she found that while the partners had agreed to take their proportionate share of the then existing accounts receivable upon their exits, it was only if the notice of termination came in December of each year. The reasons for this are irrelevant here; but the net result was that a move would have cost her several hundreds of thousands of dollars — a cost that effectively put an end to her opportunity to leave the firm for the bench at that time.

Assuming, however, that you review your partnership agreement and separation or termination is economically feasible, you can then announce your wishes to the remaining stakeholders and work with them to structure a specific timeframe for your departure. Importantly, this needs to include a mechanism to decide which remaining lawyers in the firm will be primarily responsible for the clients with whom you currently are the relationship — and billing manager.

This pass-off or transition will be essential for the firm's future health, a concern for you especially if you will be receiving payments from the firm over time.

What to Do if There Is No Partnership Agreement

In the event there is no partnership agreement that controls the buy-out of your interest in the firm, then you will need to broach the subject for consideration by the group as to how to deal with your interest, what the value of your interest actually is, and how to pay for your interest as it may be valued.

Comparing this to a solo practitioner's options, it comes very close (if not exactly identical) to selling a law practice. But major differences between the two processes are as follows:

  • Solos who, short term or long term, are unable to sell the practice can continue to operate until a sale does eventually occur, or they can close the practice on their own terms and at their own pace. In a partnership, in contrast, if you can't agree on the elements of a buy-out, including the value of your interest, there may be no easy way to vacate the premises. And your liability to creditors (most importantly to the bank on a line of credit and to the landlord on a lease) may do more than haunt you; it may substantially affect your net worth. Some lawyers in this situation find themselves chained to their desk for several years until the liabilities dissipate or get renegotiated without them. They may also find themselves now working among lawyers with adverse interests.

  • A sale agreement is prepared after the major terms of a transaction have been negotiated. In a buy-out, with no plan already in place, a negotiation must begin among partners who are still in a fiduciary relationship with one another — and who may have to "walk on eggs" to create a workable resolution while still together practicing law, representing clients, and seeking to be as profitable as possible for the benefit of all. Emotionally, this can be very trying, with tempers perhaps on edge and ready to explode at any moment, depending on the relationship among the principals and the others' reaction to the reasons for the desired departure by the one partner.

  • As mentioned, a sale will be negotiated and documented at the end of the practice's life. A buyout, if there is an agreement on the entrance of each new partner, is set in place at the very beginning, or at the time of entry of each new partner. Assuming the partnership continues for years after such an agreement is created, a departing partner may have second thoughts about the low value of the interest in the partnership to which he or she is entitled. Plus, the remaining partners may have second thoughts about how high the price is for the departing partners interest, and how they will be able to both run the ongoing operation and incur the new cash flow drain to pay the departing partner. After all, this payment is not one covered by insurance, as is the case in death with a key-man insurance policy in place. And rarely is any agreement drafted with the deftness of the U.S. Constitution. Thus, there must be a mechanism for periodic review and possible modification for this to be seen as fair to all parties over time.

Compensation for Phaseout Periods*

Another issue to consider within a partnership is whether you might transition into something less than full-time work for a given period, as part of preparing to retire from the firm full-time. This is something you will need to discuss thoroughly with your partners, of course. The conversation should include the value that you have brought to the firm over the years, as well as the ways in which you plan to continue contributing to the firm should you step into an of counsel or similar position.

A gradual step-down process frequently makes more sense than a sudden shift in time commitment. Remember as well that part-time can mean more than one thing. It could mean a reduction in the number of hours worked and billed each day, working fewer days per week, working certain hours remotely, or working fewer hours annually overall.

With a change to part-time status may come changes in other aspects of your role with the firm,such as moving from an equity to a non-equity status, or leaving a position of firm governance. Take these things into consideration as you weigh options. You may also want to change some of the ways in which you spend your time. If part of your value to your firm is your longterm client relationships, or your known expertise in a given field, for example, you might be able to generate additional clients for your firm through increasing the time you spend on business development activities that eluded you when you were billing significantly greater numbers of hours. Or, you may choose to spend more of your time supervising the work of others than doing the work itself once you move into gradual step-down mode. If you consider these tasks part of your exit strategy — and part of your legacy — you may find unexpected energy for them.

Firms have a wide variety of compensation systems, of course, but logically, reducing your time commitment with the firm in some way will probably reduce your take-home pay. So be sure to consider your firm's pay structure in advance and estimate how you believe this should be adjusted based on a reduced role. You will need to look at how long your client origination fees will be in force, and how your plans to turn over responsibility for client relationships will affect your remuneration during the phaseout period. This may already be spelled out in a partnership agreement, but those terms may be less than specific, if they even exist.

The financial aspects of a potential retirement may be different based on your firm and what you can negotiate with your partners, with or without an existing partnership agreement. But the one constant is that the issues involved cannot and should not be ignored, as lawyers tend to do. Even transactional lawyers typically are not known for personal financial foresightedness, as they — like most of their peers — focus much more on the immediate practice matters at hand than on financial matters in the future. At minimum, whether in a large or small firm, lawyers nearing retirement age have some important financial issues that must be considered, the sooner the better.

An Additional Issue: The Pension Fund

If you are a partner in a firm that has a pension fund program (albeit these seem increasingly rare), you will want to look closely into the details of the fund's current status. In an analysis conducted by the American Lawyer, as reported in a March 2012 ABA Journal article ("Unfunded Pensions Are BigLaw 'Elephant in the Room,), American Lawyer looked at pension plans of large U.S. law firms. It appears that a number of the country's largest firms have pension plans that are unfunded. In other words, these are firms with pension plans, but without the money to pay the obligations of those plans as their lawyers retire.

This may or may not be true of your firm, but be aware that the profession will increasingly see firms with the bulk of their lawyers leaving the practice for retirement with only the hope and prayer that the remaining partners will be willing to fund the firms' obligations. We will also see situations where the younger lawyers in such firms will find it to their economic advantage to torpedo the existing firm's pension obligations in exchange for creating a new firm with no pension obligations, since doing so would give them the opportunity to take on more of the revenue that is produced by their efforts.

Thus, partners nearing retirement age are well advised to review the status of their pension plans — and use their partnership status to demand answers on what the plan's funding and future payment prospects are.

* Special thanks to Wendy Werner for contributing her insights to this section.

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