The Pitfalls of Partnership

The Pitfalls of Partnership

All that glisters …..

For many young solicitors, the ultimate goal to which to aspire is that of partnership or membership of an LLP. However, as many a duped or defrauded junior partner will testify, careful thought should be given to the move to becoming a partner and appropriate legal and financial advice sought.

Often partnership is a reward for loyalty and a genuine invitation to share in the prosperity of the firm by participation in equity profits. In other cases it is a sensible business arrangement designed to encourage valued solicitors to remain with the firm, increase its perceived size or bring much needed capital into the practice. However, prospective partners should not assume that such positive reasons will always exist.

It is not unknown for firms to invite solicitors to become partners for less altruistic reasons including:

  • spreading impending liability over a larger number of people,
  • avoiding the need to pay a regular, known salary,
  • encouraging acceptance of a lower income,
  • seeking a capital contribution to benefit existing partners, or
  • having a scapegoat to leave behind when the other partners engage in professional misconduct or leave the country with the client account.

Too often gullible, vulnerable or simply overly ambitious young lawyers are left in the position of having to pay creditors for debts they neither incurred nor knew about, take a dramatic drop in earnings because their partnership drawings are inadequate or even face the prospect of being suspended or struck off because they unwittingly became involved in the fraudulent activities of their fellow partners or did not ask enough questions about what was going on.

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Solicitors should make sure they do not make a wrong decision because they are flattered by the offer of partnership or simply want to see their name on the headed notepaper. With partnership comes responsibility and it may be responsibility they would be better without. Offers of partnership should be treated in the same way as they would treat any other business decision.

Equity v Salaried Partnership

Partnerships tend to be two main types – equity and salaried. At its simplest, an equity partner is one who shares in the net profits of the firm whilst a salaried partner is paid a fixed sum by way of a salary. However, more often than not the key difference will lie not in the method of remuneration, so much as in the extent to which the partner has a say in the running of the business and access to partnership accounts and meetings.

All prospective partners should be aware that just because they have no share in net profits, nor a say in the running of the business, does not mean they will avoid sharing the firm’s liabilities. Usually they will have been held out as partners to third parties and so will be equally liable as the equity partners for the debts or transgressions of the firm. For example, the Solicitors Regulation Authority regard salaried partners as being equally liable for the professional misconduct of their fellow partners, even where not entitled to access management accounts or attend partners’ meetings.

Thus, the salaried partner may find himself or herself liable for matters of which they were entirely unaware and could not have influenced even had they known.

The message is think hard about the benefits and potential pitfalls and ask:

  • Why am I being offered a partnership?
  • What safeguards exist to ensure that you I not be liable for debts for which I should not be responsible?
  • Do the benefits justify the risks?

Even an indemnity from the other partners will only operate against them and will not exclude liability to third parties. Safeguards are only of use when honoured and are only as good as the financial standing of the equity partners. If the equity partners have no assets, or have left the country, then there will be nothing to be compensated from.

In particular, solicitors must be aware of being set up. Often partnerships are offered because the equity partners want to spread the burden for outstanding liabilities or to regulatory problems. Occasionally it will be a preparatory step to leaving the country with the contents of the client account. Other reasons have included:

  • wanting to bring in a relative (for example a son or wife) as an employee into a firm where there is insufficient income to pay another employee. Offering a lower partnership share to an existing employee is one way in which this can be achieved,
  • having someone in place in the firm to do the work whilst the other principal effectively retires,
  • setting someone up to run the less profitable or problem cases in one firm whilst the good cases are transferred to another firm, or
  • bringing in capital to finance debts or unlawful borrowings from client account,

Alternatives to partnership

Before accepting a partnership, every prospective partner should ask the question “Is this what I really want?”

Don’t assume the only way forward is through partnership, and ask whether the responsibilities of partnership are what you want as a solicitor. If being a lawyer is about practising law and not managing a business, then the duties which come with partnership may not be what you want.

Think about career/life balance. Weigh up the additional responsibility of partnership a life outside of business.

Think about moving in-house. The opportunities for in-house lawyers continue to grow and the additional benefits and lack of management responsibilities are an attractive package for many.

Asking the right questions

If, despite all this a solicitor is still determined to become a partner then he or she should at least make sure they go into the arrangement with their eyes open and aware of the potential problems.

Look carefully at the firm, its financial stability, the existing partners and the reasons why a partnership is being offered. Do you know the person who is offering a partnership? Do you have any reservations about their motives? If you do not know them, ask around other people to see what they know about the person or the firm.

Ascertain the precise nature of the partnership:

  • is it equity or salaried?
  • how will it be remunerated?
  • how will advancement within the partnership occur?
  • what ancillary benefits will be offered?
  • what are the arrangements for sickness and long-term illness/disability?
  • will there be a capital contribution and if so how will it be paid?
  • what pension provisions exist?
  • what family cover is provided in the event of death in service?

Above all, the potential partner should ensure they will have access to business information including the accounts and business plans. Find out about attendance at partners meetings and responsibilities other than fee-earning.

Ask to see the accounts and have them looked at by an accountant who will be able to advise as to whether there are any potential problems with cash-flow or funding. In particular:

  • are there outstanding liabilities to which the partnership is likely to become subject? If so, seek an indemnity from the existing partners;
  • ensure the firm is not subject to, or likely to be subject to, disciplinary or regulatory actions from the Solicitors Regulation Authority. Think about getting a written confirmation of that from the existing partners if you have any doubts whatsoever; and
  • find out if there are outstanding complaints against the firm and the effect they might have if upheld.

And finally remember – if it seems too good to be true then that’s probably because it is!

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