Law Partnerships & Agreements

About half of existing law partnerships does not have written partnership agreements. In older firms, precedents tend to take the place of formal signed documents, that is, when precedents can be remembered. The absence of a written agreement can give rise to serious disputes and gross inequities, especially inequities in payments to partners' widows or widowers.

In recent years, the rising expectations of younger lawyers and the trend toward larger organizations have convinced many firms to prepare written partnership agreements. While a single partnership agreement may cover all of the subjects necessary to regulate the relationship of a group of partners, a professional corporation requires a variety of instruments. Nevertheless, in both situations similar problems must be faced and resolved.


The fundamental consideration in drafting a partnership agreement is whether (1) the agreement should be annual and include the allocation of income in precise terms, or (2) the agreement should be so constructed that specific terms worthy of annual reconsideration can be handled by amendment or supplementation. Some firms seem to prefer the agreement that is rewritten annually. Such a process is time consuming. To renegotiate and retype a lengthy agreement each year or two is unnecessary. A more economical use of partner and secretarial time would be to have an agreement which, like a good constitution, requires only occasional amendment. Recurring matters, such as the admission or withdrawal of partners and the compensation of lawyers, can be handled through the adoption of the minutes of periodic partnership meetings and the execution of supplements or amendments to the basic agreement.

Income to the Firm

One of the fundamental questions to be answered by the documents of partnership (or the employment agreements of a professional corporation) is what constitutes income to the firm. Any adopted definition of income should apply to associate lawyers as well as partners.

Fees for professional services are, of course, the property of a partnership or the corporation, but what constitutes professional services when it comes to lawyers? Are directors' fees for service on a corporate board, or part-time salaries for teaching at a law school, or compensation for serving as a United States Commissioner or an assistant prosecutor to be included as firm income? Are fees paid to guardians and trustees legal fees? Suppose a partner receives royalties for writing a book?

There are different schools of thought on the subject of what is income. Some firms define fees for professional services narrowly and confine firm receipts to legal services which require a license to practice law. Other firms include in their firm's receipts all payments received by lawyers for the rendering of any personal service. Still others include all income except that derived from personal investments in securities, real estate, or other specified sources.

Generally law firms are counseled to use the comprehensive approach to avoid arguments at some later time. The performance of personal services, whether as a bank director or as its attorney, requires time and use of the firm's facilities. When partners and associates are entitled to retain certain types of payments, there is a natural conflict of interest. Lawyers seek to maximize personal extras. For example, a low-paying, part-time teaching assignment will become far more attractive if the teaching partner can personally retain all of the revenue. Even though this income may be retained by the attorney personally, he or she will use a secretary to type examination papers and will use the office photocopier to reproduce them, and probably will come to work a little later on the morning after teaching in the evening.

A situation involving two young associate lawyers brought the need for an income policy statement to the attention of a suburban law firm . The firm had never precisely defined "income to the firm." Consequently, various politically active partners were accustomed to pocketing the small remunerations they received for serving on the township governing body and for some other appointments. One year, two of the firm's three associates were appointed assistant district attorneys. These were part-time positions with salaries of $15,000 each per year. The positions required about half an attorney's time during the first two weeks of every month. The result of this lost time was a substantial reduction in the attention given to firm clients and in lower firm income. The associates expected to pocket the salaries, and they did. What was good for the goose was good for the gander.

Death or Withdrawal

In a partnership, the death or withdrawal of a partner terminates the partnership unless there is a specific written agreement to the contrary. In the event of termination, absent such agreement, a new set of books must be opened and a new firm formed. This is an expensive process. If a second partner terminates within a short period of time, fees collected must be apportioned among three sets of books. All of this can be avoided with a little forethought and a written agreement.

There is another advantage to including in a written agreement the financial arrangements regarding the death of a partner. A lawyer's widow or widower should know the entitlement from the firm in advance of the spouse's death. Professional corporations may, of course, pay the spouse or estate of a deceased employee a death benefit of up to $5,000, which is deductible to the corporation and not reportable as income to the recipient. For lawyers in a substantial income tax bracket this is a worthwhile benefit. It may be included as a matter of policy in a resolution of the Board of Directors and in the employment agreements of the corporation.

Many partnership agreements provide that a multiple of the average earnings of two to five years prior to withdrawal or death shall represent the payout for the interest of a withdrawing or deceased partner. Other firms calculate the value of receivables at the time of death or withdrawal and make payments in the proportion of a partner's interest to the total receivables.

The capital account of a partner is always payable to him or to his estate upon death or withdrawal. A few agreements provide for forfeiture of the capital account if a partner is disbarred or expelled for other serious offenses.
In corporations, a shareholders' or stock purchase agreement must provide for recapture of the shares of stock held by a withdrawing stockholder. It is generally best to trade the stock of a professional corporation at the book value (the depreciated value of the corporate assets and its earned surplus) in order to avoid the multiplying effect of capital gains on successive sales.

Disability

Some firms have paid huge sums to disabled partners over many years because of the absence of a specific agreement. Once a partner has become disabled, it is too late to negotiate an equitable arrangement.

Any disability clause should limit the term over which payments must be continued. In some agreements, a partner is declared to be permanently disabled if he has been away from full-time work as a lawyer for six months. Other agreements require medical verification. Once permanent disability is established, some firms continue to pay a former partner for a certain period, generally at a reduced rate of pay.

Most importantly, any firm should require that its attorneys be insured under disability insurance programs such as those available through most bar associations. Larger firms can negotiate their own group plans, sometimes at a considerable saving. By providing insured income during long-term or permanent disability, a firm is relieved of the continuing responsibility to provide for a former partner or employee.

Retirement

Law firms are often reluctant to come to grips with the problem of partner retirement planning. There is a natural conflict of interest between the younger and older partners of the firm with respect to this matter and delay is often the way out.

[1]-Compulsory Retirement

Opinions differ sharply on the subject of compulsory retirement at any specified age. There are certainly some individuals who perform brilliantly past the age of seventy or eighty. Other lawyers decline sharply in their capabilities before they reach sixty. Industry has generally required executive retirement by age sixty-five. But law practice, unlike most businesses, can be a part-time occupation for the elderly anc) lends itself to a longer working life. Certain factors need to be taken into account in debating and formalizing a policy on retirement:
 

1. A part-time lawyer carries a higher overhead cost per billable hour than a full-time individual. For example, the lawyer who can bill 1,400 hours per year can spread the rental cost of an office over many more hours than the older lawyer who records only 800 hours. Consequently, compensation for the older lawyer must take this factor into account.
2. Any plan which does not provide for a compulsory maximum retirement age is hardly a plan at all, since most firms find it difficult to face up to the actual expulsion of a member because of failing faculties.
3. The absence of any assurance that the "old lawyers" will retire at a certain time is discouraging to younger lawyers and may cause turnover problems. However, a policy of retirement from leadership in the firm (management responsibility) rather than retirement from legal work may solve this problem.

A Retirement Program

A firm should strive for some flexibility in considering the need to retire those who fail early, by striking a balance against the contributions which others can make at a greater age. For example, a retirement program may include these provisions:
 

1. Early voluntary retirement, possibly starting between the ages of fifty-six and sixty.
2. At age sixty lawyers gradually reduce their working hours and their compensation.
3. Lawyers past the age of sixty or sixty-five would not actively manage the firm or its components.
4. A mandatory retirement age, such as age 70 or 75. Consideration should be given to making mandatory retirement flexible by including a requirement that lawyers who are past age 65 may continue to practice only if invited to do so by the annual meeting of the partners (or directors). The 1978 and 1986 amendments to the Age Discrimination in Employment Act (U.S.C. 623) prohibit mandatory retirement. Exempted are employees employed in a bona fide executive or a high-policymaking position, who are entitled to a pension of at least $27,000 per year, and have reached age 65. The law generally applies to employers of 25 persons or more. It is probably inapplicable to partners, but may apply to professional employees of a professional corporation.
5. There should be a provision for "of counsel" status for retirees who wish it. Under such arrangements they can be paid for work done or business obtained up to any age.

Keogh Act

Law firms must provide for the financial security of lawyers following retirement in order to make retirement possible and attractive. It is almost impossible to enforce retirement on a partner who cannot live without current working income from the firm. The Self-Employed Individuals Retirement Act (Keogh Act) has provided a vehicle for retirement savings to partnerships. Tax sheltered retirement fund plans are available to professional corporations. However, partnerships and professional corporations are now subject to similar pension provisions. The 1986 Act places new restrictions on pension plans, continuing the steady denigration of the private pension system by Congress. The 1986 Act has provisions squarely aimed at the individual pension plan of a one-lawyer P.C. when that P.C. is a partner in a larger firm. Such plans must generally be terminated before 1989, thus providing a disincentive to continue the P.C. vehicle.

When it comes to the negotiation of retirement plans and provisions, the rule is "the earlier, the better." When the "senior" members of the firm are in their forties, it is easy to talk about the subject. Once the head of the firm is nearing sixty, such a discussion may be taken as a personal affront. Quite often, when retirement plans are formalized in firms having older partners, the older lawyers are exempted from the newly negotiated provisions.

Expulsion

Most law firms provide for some protection to a partner whose expulsion is proposed. Generally, such action can be finalized only by a vote which is greater than a simple majority.

Life Insurance

The payments due a partner on death or withdrawal (or the repurchase price of shares, or other obligations due a shareholder in a professional corporation) can be funded by life insurance. When life insurance is used, an agreement may tie the cash value of policies to an early withdrawal.

In a corporation, disability insurance and group life insurance of up to $50,000 may be a deductible business expense which does not result in taxable income to the employee. Such plans must, however, cover all regular employees, by class. There are certain tax advantages to coverage obtained through a corporation in amounts greater than $50,000.

Further, part of the funds deposited in a corporate profit sharing trust can be used for the purchase of life insurance for the members of the trust. This procedure can provide substantial life insurance with before-tax dollars.

A partnership agreement or the shareholders' agreement of a professional corporation should provide that the parties shall undergo the required physical examinations and that they will complete the application forms for insurance required by the firm. Further, such agreements should have provisions with regard to payments of premiums due in the event that the firm fails to make payment in time.

Ownership, Capital Interests, and Voting

The names of a few law firms have real value in themselves. These are firms in which the names of long dead founding fathers have persisted. In many cities and towns, the firm name changes as the members change and the identity of the firm as a "name" becomes less valuable. For the vast majority of lawyers practicing privately, the firm name has only a transitory value and may be disregarded in calculating the value of the firm.

The capital interests of partners usually amount to a small fraction of the annual earnings of the lawyers. Capital interests are important in the daily life of a firm only if voting power is tied to them or if earnings are related thereto. This can be true in some law partnerships, but is not often so.

The capital invested in a law firm consists of the un-depreciated value of its hardware (library, typewriters, furnishings, carpets). Capital accounts of partnerships may also contain cash left in the firm on which personal income taxes have been paid. If voting rights or percentage interests in income are tied to contributed capital, then its amount must be limited by pre-agreement.

In a professional corporation, un-depreciated hardware is also a part of the firm's capital. In addition, a corporation may have a cash surplus which it has not distributed as dividends.

Some partnerships require equal capital contributions from all partners. Some establish two or more classes of capital interests. Still others have non-capital partners. One large professional corporation known to the authors has issued equal amounts of stock to each of the lawyers who were formerly partners. These lawyers range in age from about thirty years up to seventy. Individual earnings from the firm are quite different from share interests.

The voting power of each partner is also a matter for agreement. Many small firms give each partner an equal vote, regardless of earnings or paid-in capital. Some firms provide for extra voting power after an individual has been a partner for a specified number of years. Progress from one class of partner to another, junior to senior, may require a second "admission" process.

Shareholders vote their stock interests in a corporation. Their function may only be to elect a board of directors (with or without cumulative voting), or the by-laws or shareholders' agreement may specify that the shareholders shall have broader powers, such as control over the sale of shares to existing shareholders or new shareholders.

New Partners

More than a simple majority is usually required for the admission of new partners. In some firms, a unanimous vote is needed to invite an individual into the partnership. The rule of unanimity is justified in the smaller firm, but is difficult to defend in large organizations. As a firm grows, the partners must begin to rely on the evaluation of colleagues as to the qualifications of a prospective partner. There is not sufficient contact between the departments of some large firms to enable every partner to know each candidate for admission personally.

Some firms require a vote of the partners before engaging the services of a new associate lawyer. This practice also depends on the size of the firm.

Ownership of Clients and Files

The ethics of the legal profession provide that a client is free to stay with or leave a lawyer at will, but files are firm property. The partnership agreement (or the employment agreement) should specify that legal files are the property of the firm and that they will remain in the custody of the firm until a client has paid the firm in full and has discharged the firm. Only the client may then direct that his legal file be turned over to another attorney.

Management

The agreement between the members of a law firm should make clear by whom important decisions are to be made, and on what basis. To illustrate, the arrangements could provide that:
 

1. New members will be admitted by a two-thirds vote (or a unanimous vote) of all owners (or stockholders).
2. Members can be expelled only by a three-fourths vote of all the voting interests, excluding the voting rights of the member under consideration.
3. The firm (corporation or partnership) may be dissolved only on a two-thirds vote of interests , any number less than the two-thirds having only a right of withdrawal.
4. A merger of the firm with another shall require a unanimous vote in the affirmative.

In larger firms, decisions of lesser importance than these may be delegated to an executive committee, to a senior partner, or to a group of committees. In professional corporations, the relative authorities of the shareholders, directors, and officers are defined in the articles and bylaws. It is often better to describe the management structure in general rather than in very specific terms, and to use occasional policy statements or minutes to define it precisely.

Disputes

The settlement of disputes between lawyers are generally covered by provisions written in one of two ways:
 

1. Interpretation of the agreement is conclusively based on majority vote, or
2. Impartial arbitration is made available to any party or the successor in interest of any party.

In the latter instance, the standard type of clause promoted by the American Arbitration Association may be used.

Outside Activities

The firm should have some control over the activities of its professional members and staff. If the partner of a law firm gains favorable personal publicity, it will almost invariably inure to the rest of the firm. Similarly, unfavorable publicity will adversely affect the whole firm.

It is a good premise that all of the working energies of lawyers belong to their firms. These energies cannot be simultaneously applied to heading the regional organization of the Girl Scouts, the school board, March of Dimes, or the Board of Regents of State University, as well as to the legal problems of clients. There is a limit on how much an individual can do. It is only fair and proper, therefore, that the partnership agreement (or employment agreement) require pre-approval of any project, office, chairmanship, or committee assignment which will take a substantial amount of time, either during the day or the evening.

This is not to say that lawyers should not be active in community affairs, but rather that the degree of involvement of each individual and of the firm should be the subject of careful consideration and continuing evaluation.

Expenses

Some firms become wracked with ill feelings and disputes because of the expense accounts of some partners. Individual lawyers incur a number of expenses relating directly or marginally to professional practice, expenses which can either be borne by the firm or expensed individually. Since the 1986 Tax Act sets a threshold on deductibility of personal business expenses of 2% of adjusted gross income, more and more firms are likely to pay for business expenses, rather than ask individuals making the expenditures to take them as personal deductions.

Any firm should have an understanding regarding the dues for membership in professional organizations, such as the American Bar Association, the Association of Trial Lawyers of America, and local and state bar organizations. The number of memberships paid for each lawyer may be included in an agreement. More properly, the agreement should establish the principle of control, and annual policy should determine the amount.

Consideration should also be given to the following items of expense:
 

1. Dues of business and country clubs at which clients are entertained
2. Unreimbursed client entertainment
3. Attendance at continuing legal education sessions
4. Parking