March 18, 2021
How Savvy Law Firms Protect their Firm from Partner Departures
Partner departures typically are very disruptive to law firms. In the near term, partner and group departures can create short term revenue shocks, create holes in the firm’s expertise, foster uncertainty for those who remain, and damage morale, to name a few effects. In the long term, departures can have serious negative effects on the firm’s bottom line, which can feed a vicious negative cycle. Law firms have a range of options to reduce the likelihood of partner departures and to react when they occur.
Attorneys and groups move to new firms for various reasons, and that is not something that the firm can or should try to stop entirely. Nevertheless, a law firm should have a coordinated set of policies that make it less likely that partners will want to leave, and less likely that they will benefit from leaving. The best place to start implementing these policies is in the firm’s partnership agreement itself. The best run firms coordinate partnership agreement provisions — regarding notice, disincentives to leaving, return of equity, compensation, and information sharing — to serve the policy of retaining top partner talent.
Notice Provisions. Notice provisions set the minimum contractual amount of time required for a partner to give notice to the firm of a departure. A reasonable notice period can provide the firm with sufficient time to compete fairly for the clients who may be at risk of departure, to manage the staffing and personnel changes necessary when a partner or group departs, and to manage the logistics of client matters that will stay and that will go. Client interests always come first, but these firm interests are valid, and properly drafted notice provisions typically will be honored, and enforced, with these firm goals in mind.
Excessive notice provisions, with long periods of required notice, should be avoided. These resemble unlawful restraints on attorney mobility and competition, and they tend to be less effective in any event, since client interests are likely to require a partner to move sooner rather than later. (See ABA Formal Opn. 489; Cal. Bar. Formal Opn. 2020-201) Draft notice provisions with a connection to the firm’s valid and protectable interests, but also with client interests in mind, not as a punishment to partners who choose to leave.
Disincentive Provisions. Restraints on attorney mobility that seek to prevent competition generally are void in California as against public policy. But California courts have made clear that disincentive provisions in partnership agreements, which hold departing partners responsible for reasonable costs associated with their departure from the firm, are valid and will be enforced. There is a fine line between provisions that prohibit or unreasonably restrain competition, which are not permitted, and provisions that compensate the firm for reasonable expenses incurred because of a departure. Properly drafted disincentive provisions create the right protections for the firm without running afoul of California’s public policy in support of competition and attorney mobility. These provisions are more critical in smaller or mid-sized firms since the departure of a partner or group can have an outsized effect on the firm’s proportional overhead load and profitability.
Return of Equity Provisions. The departure of an equity partner or group of equity partners should not, and need not, create a cash flow crisis at the firm. It is likely that the firm’s overhead commitments will continue, at least in the short term, despite the departure of one or more equity partners. Your office lease, for example, won’t lower monthly rent based on how many attorneys you have in those offices. The partnership agreement can account for this with a properly drafted, reasonable, return of equity provision that sets an orderly return of the departing partner’s equity contribution. This might include a return of equity over time, or in installments, such that the firm’s cashflow can recover before it must make those payments to departed attorneys. The provision might even be related expressly to cash flow, or to offsets for reasonable expenses related to the departure.
Avoid using this type of provision as a sort of penalty for partners who leave, dragging out the return of their money. The best-run firms draft these provisions with an eye toward the effects on firm cash flow and link the provisions to the firm’s reasonable financial needs.
Compensation Provisions and Information Sharing Provisions. In our experience, compensation shocks will raise the risk of attorney departures. Like anyone, law firm partners have expectations about compensation, including draws and distributions, that are based on real life: mortgage payments, car payments, school tuition, groceries, and things like that. This is even more likely for the highly-compensated partners: those vacation homes don’t pay for themselves. Making less money tends to be unwelcome, and can cause wandering eyes, even during a pandemic when many firms had to make temporary adjustments to compensation. But to be more precise, the real risk for inciting departures comes from compensation decisions perceived as arbitrary, and from compensation adjustments that are unexpected. The partnership agreement can and should minimize the likelihood of both.
Your partnership agreement should provide as much detail as possible as to how the firm intends to pay its partners and to distribute profits. This sounds elementary, but many law firms tend to avoid details in this area for fear of committing to payouts that they cannot honor. But the compensation provisions don’t have to require guaranteed payments (and shouldn’t, based on how those have worked out for some firms). They also don’t have to be overly complicated, and shouldn’t be. They should simply lay out in clear terms, and in as much detail as possible, how partner compensation will be calculated, and when, or in what order it will be paid.
Similarly, the partnership agreement should include information sharing provisions that lead to meaningful financial reporting to partners. It can significantly reduce the risk of unexpected adjustments when partners are receiving regular updates on the firm’s financial situation.
Taken together, if properly drafted, these provisions can provide substantial protection to the firm in partner departures, and they can reduce the overall likelihood that any partner or group will see a departure from the firm as necessary or beneficial.
Dena M. Roche
O’Rielly & Roche LLP