PracticeAccounting FirmsPartnership agreements need a health check

Partnership agreements need a health check

Partnership agreements require regular checkups to mititgate against fatal flaws, says Miguel Pereira

IF YOU’RE A member of an LLP or a partner in a partnership, the firm’s members’ agreement or partnership agreement may be gathering dust in a drawer. You may have only read it once, whether when starting up your own firm or joining an existing one.

However, if your agreement has not been reviewed in the last few years, then it may be a good idea to get it looked at. It may require updating, particularly if you want to avoid difficulties enforcing certain provisions in the agreement, ensure that the firm’s goodwill is adequately protected or, simply, bring it into line with the firm’s actual practices and customs.

Over the last few years, it has become increasingly common for partnership or members’ agreements in larger firms to give a majority of the partners the right to expel an individual partner without cause. This right is a valuable one for management, particularly when dealing with performance issues, but also when having to operate in difficult economic conditions.

However, taking such steps is obviously aggressive and a gentler way of dealing with performance concerns would be to introduce the ability to de-equitise non-performing equity partners or to re-allocate their profit sharing points.

A departing member will be entitled to have his capital repaid and possibly an amount equivalent to his share of goodwill. A firm may have difficulty funding such payments if it is contractually obliged to make the repayment promptly but cashflow concerns may be eased if the payment can be made over a longer period of time and even in phases.

Anti-embarrassment clauses

A related issue, and one that has received attention lately, is the use of “anti-embarrassment” clauses. The purpose of this would be to ensure retired partners share in the benefit of any sale of the business or injection of external funding following their retirement. The rationale behind an anti-embarrassment clause is to ensure that partners who have contributed to the creation of value benefit rather than miss out entirely through the timing of their retirement. The benefit could last for a limited number of years following retirement with the individual partner’s entitlement decreasing over that period.

Furthermore, firms have more recently started to use their right to suspend or put partners on gardening leave as a means of protecting their businesses, particularly as partners are now more likely to move between competitor firms. A firm will not have this right unless it has been specifically written into its partnership or members’ agreement.

Firms commonly employ restrictive covenants as a means to protect themselves, however the related case law continues to evolve and it is possible that restrictive covenants drafted several years ago may no longer be enforceable or adequate to protect a firm’s business. Restrictive covenants are considered to be a restraint on trade but can be enforced if they are judged to constitute reasonable measures necessary to protect a firm’s goodwill. They tend to be more enforceable against partners than employees but cannot be excessive; one to two years in duration is currently considered to be about the right period of time.

The other constituent limbs of a restrictive covenant should also be considered in detail, for example geographical extent and the scope of any client solicitation provisions. For instance, it may be unreasonable to restrict a partner from acting for all clients of a firm if that partner only carried out work for a smaller number of clients.

Make your way to the departure lounge

There have been cases of entire teams of partners resigning at the same time and joining a competitor. This can clearly have a severe impact both on a firm’s image and future viability. To mitigate against such an eventuality, firms can insert a “departure lounge” clause in their agreement. Such a clause serves to limit a set number of partners, say one or two, to giving notice to retire over a defined period.

Other considerations must also be taken into account, for example the agreement may not contain appropriate parental leave or remuneration provisions and any existing clauses may fall foul of sex discrimination laws.

It is also possible that the firm’s retirement or remuneration policy for partners could be challenged as being discriminatory, particularly in light of recent age discrimination laws.

In a recent case involving a partner of a law firm, Seldon v. Clarkson Wright & Jakes, the Court of Appeal found that a default retirement age of 65 was discriminatory but in this instance a proportionate means of achieving a legitimate aim, i.e. succession planning. A firm must therefore justify any compulsory retirement age or any other provisions which could breach age discrimination legislation.

Don’t favour long-servers

Remuneration structures which deliberately favour longer serving members may also be discriminatory. Supporting provisions, such as voting or decision making, may also require periodic overhauls, particularly if the firm has grown considerably, but certain matters still require unanimous consent.

Whilst this may have worked whilst the firm was small, it may now be more practical for the firm to have a management board/committee, perhaps even with non-executive members, to manage day to day matters, leaving only big points for the members or partners to decide. Your agreement may then require amendment to describe what constitutes a major or minor decision.

Finally, the resolution of disputes is also an important point to consider. If you and your partners become deadlocked on an issue or fall out over something, you may wish to keep the dispute private and avoid going straight to court. A form of alternative dispute resolution will help, whether it is arbitration or mediation.

The longer you leave your review, the more issues you will have to face when updating your agreement and the greater the risk of your business not being as adequately protected as you had thought, or even falling foul of the law. So, dig it out and give it a good dust down.

Miguel Pereira is a partner at Lewis Silkin LLP

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