Partnerships: Cut out the clashes

by Barney Leaf, Laytons Solicitors

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27 Jul 2012

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Clash

THE DOWNTURN has magnified the importance of the strategic issues that all businesses face and, in turn, given rise to an increase in disputes within the management teams of accountancy firms.

Does the firm have the right people to compete in a changed market? Is the organisation top heavy and/or under-resourced in lower-level fee earners that the current market requires?

The increased pressure to deliver fees is another powerful dynamic. Within accountancy, and most other professional practices, it is the main criteria by which all partners are ultimately measured. Fluctuations in fee income can create disputes about unequal contributions and therefore each partner's share of the profit. It's also true that, even in a downturn, swords will still be sharpened by personal ambition – especially when it is thwarted.

Yet of all these flashpoints, nothing has quite the same ability to create disputes as a merger. The review of operations that takes place when two firms join forces can be relied upon to magnify any problems or resentments that already exist, never mind the new disputes that such a change can create.

Issues which may have festered are suddenly brought out into the open. People tend to find themselves in circumstances where straws break camel backs. That's because a merger takes away personal control and replaces it with uncertainty. Everyone is going down the same route but inevitable differences of opinion emerge, which can end up as legal disputes.

Mergers also tend to cast light where there have been shadows. People who have been hiding get found out. Underperforming departments get scrutinised closely by the potential new business partners.

The way they are conducted depends on the firm's structure. In the situation of a simple partnership where there is no formal partnership agreement, there is very little flexibility and a partner can leave, potentially forcing the partnership to be dissolved. There are no restrictions on who deals with which clients. Without a pre-agreed set of ground rules governing how you go your separate ways, you simply have to try to negotiate your position at a time that emotions will already be high.

Firms that do have a partnership agreement will still have major issues to resolve. Whether the scenario is people wanting to leave, or the firm itself wanting to remove an individual, there's often an assumption that the negotiations will be all about what is the worth of anyone's part of the partnership.

In fact, in a professional services partnership this issue can be relatively straightforward and come down to what your capital account is worth. The more important point for debate is how and when do you get your money out. The organisation needs to be able to fund your exit.

Of course, a great deal of value rests in client relationships. Partners who have been in the firm for a long time may well have an expectation that the clients are ‘theirs' as opposed to belonging to the firm. This is a problem of perspective: both sides believe they are absolutely right.

Someone plotting an exit may well entertain the fantasy of approaching clients and asking them to come on board with the new organisation. While this happens all the time, partners do have a legal obligation to act in good faith towards the firm, and breaching this covenant is potentially actionable.

Partners are usually bound by restrictive covenants which, if you are leaving, set out to stop you approaching existing clients for a period of time. These covenants are a key area for all concerned and reflect a second problem: both parties in a dispute have to accept that clients don't want to become embroiled in your dispute.

So they may well walk away from both of you if the issue is handled badly. One option is to try to find some middle ground. It may be agreed that the exiting partner can approach a limited number of clients and stay away from others.

At the same time, certain clauses in a partnership agreement can become areas of manipulation. For example, the document will probably make it clear that the partnership has to meet your tax liabilities after your exit. The reality is that both sides often stop making their payment obligations in a serious dispute.

Firms operating as Limited Liability Partnerships are governed primarily by the Limited Liabilities Partnerships Act 2000 and the Companies Act 2006, which means partners (or members) have a written set of duties and liabilities, in addition to their common law ones. This adds a greater level of accountability to the partners of an LLP than that which would apply to the other forms of partnership.

In general terms, the larger the partnership, the easier it is to get rid of someone. Large firms may have executive committees which can just vote you out. In a small partnership, this process is much more reasonable because the balance of power tends to be much more even – not least in order to attract partners to join the partnership in the first place.

Potential collateral damage needs to be considered and thought given in advance of it occurring. People at any level of the firm will be affected by the uncertainty that a recession or merger can bring. They need to be communicated with and to be reassured that they are valuable and that their views are respected.

It is especially important that the communication is at all levels of the business as professional services businesses are more of a "people " business than many other types of business. While many senior partners see themselves as owning the client relationships, it is often the up-and-coming staff who actually do most of the client work. These junior staff will often leave if they cannot see their future career path well mapped out for them.

It also goes without saying that a senior management team engaged in a serious internal conflict is at risk of being distracted from its true business and damaged both financially and emotionally.

It would certainly be wrong to underestimate how petty and personal disputes can become. In one case I dealt with, a partner was asked to pay for a 20-pence contribution to one of the medical kits in the practice. The partner refused and this lead to an exchange of correspondence between the solicitors who were acting, at a cost of about £30 per letter. I also handled another case where a partner who was leaving a firm was duped into paying a £1,000 bill for a staff night out. His partners subsequently refused to reimburse him because they felt his financial contribution to the rest of the practice left something to be desired.

Disputes more often than not just become about degrees of losing – no one really wins. Keeping a level, practical and commercial head is vital. Try to remove any emotion from the dispute as this will cost time and create more stress. Most parties in a dispute want to feel they have "won". Avoid this attitude, and instead focus on ending the dispute and moving on.

Barney Leaf is a partner at Laytons Solicitors

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