Tuesday, October 8, 2013

Forming a Law Partnership – The Partnership Agreement

A law partnership can be very much like a marriage.  My law firm partner and I bought a place together (our office in San Jose, California), furnished it and acquired dependents (a.k.a. employees).  We also share a bank account and plan for retirement together (through 401(k) and profit sharing accounts).  And, we often spend more time talking to each other than we do with our spouses.  When you get married young, there is often little need for a pre-nuptial agreement.  This was the case for our law firm partnership – we both brought very little, except our books of business, to the partnership, and therefore a very simple limited liability partnership (“LLP”) agreement sufficed.  However, almost ten years later we have built up significant assets and goodwill in our law firm, the dollars we split up at year-end got much more substantial, we had more attorneys involved, and we felt the need for a more detailed LLP agreement.  Similarly, experienced lawyers leaving established firms to start new law firm partnerships often have a lot to risk, and have strong ideas as to how the partnership should be managed and the money divided.  A well thought-out partnership agreement is a must.

In my experience representing law firms in drafting and negotiating their partnership agreements, if you are considering forming a firm with other attorneys, there are a few major items the partners should agree to before starting to draft an agreement:

  •    The Name.  Will you use the names of the partners (and in what order?), or will you use a name different from the names of the partners?  I have seen firms go through significant expense to change their website, letterhead, branding, etc. when a partner leaves or a new partner joins.  
  •    The Money.  This is probably the biggest area of contention amongst partners, and the terms you agree on in your partnership agreement can often have unintended consequences as to how the partners interact going forward.  For instance, be careful about creating a purely formula-driven system that could result in partners fighting over origination credit for each new matter brought into the firm.  On the other hand, it is very rare for a partnership to survive more than a couple of years with an agreement that says the partners share everything equally. Also, make sure the partners are all in agreement up front about what the partnership will do if it needs additional capital.  Will each partner have to put in funds to cover low periods?  Are you willing to borrow money to fund a contingency case?  Are you willing to borrow money to fund partner draws?  What happens if a partner is not pulling her weight with revenue?  Discussing these concerns in advance and drafting for them can result in better clarity and less disagreement when such situations arise.  In larger firms, a compensation committee is often created to address some of these issues as they arise.
  •   Management.  The management terms vary greatly depending on the size of the partnership.  Smaller partnerships can give all partners a voice in management, while larger partnerships must have clear rules for choosing the manager(s) and their levels of authority.  Think carefully about what the management committee in your partnership can and cannot do without the vote of the partners.  For instance, does the management committee have the authority to approve or disapprove new clients/matters?  Create policies/procedures?  Amend the partnership agreement?  Add new partners?  Expel a partner?  Does the management committee need to create and stick to a budget?

Once you and your potential partners can come to an agreement on these three items, you can move on to the more detailed specifics of the partnership operation.  If you cannot come to an agreement on these preliminary matters… think carefully about whether you might be better off with solo practices and an expense sharing arrangement.  It could save you an expensive and time-consuming business ‘divorce’ later. Of course, if partnership law is not in your areas of practice, it may be helpful for you and your potential partners to engage a partnership attorney to help form the law firm and provide suggested terms for the partnership agreement.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.

Tamara B. Pow is a founding partner of Structure Law Group, LLP in San Jose, California. (408) 441-7500, www.structurelaw.com

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