“… Most UK professional practices operate a system of inherently discriminatory compulsory retirement of partners at a fixed age, regardless of ability or performance, on the assumption that this is legally justified …”

The case of Seldon v Clarkson Wright & Jakes is due to be heard by the Supreme Court on 17 January 2012 in a hearing estimated to last three days.

In summary the Justices (Lord Hope of Craighead, Lady Hale of Richmond, Lord Brown of Eaton-under-Heywood, Lord Mance of Frognal and Lord Kerr of Tonaghmore) will consider the correct approach to justification of prima facie direct age discrimination contrary to Regulation 3(1)(a) of the Employment Equality (Age) Regulations 2006.

The professional practices sector in particular has been awaiting the outcome of this long-running case with interest and perhaps some trepidation. Most UK professional practices operate a system of inherently discriminatory compulsory retirement of partners at a fixed age, regardless of ability or performance, on the assumption that this is legally justified by the need to encourage younger members of the firm by making room for them at the top, and to avoid arguments as to whether or not older partners are still pulling their weight (the “collegiality” argument).

Mr Seldon, a partner in Clarkson, Wright & Jakes, a firm of solicitors, was compulsorily retired following his 65th birthday in accordance with the terms of the firm’s partnership deed. He brought a claim for unlawful direct age discrimination.

The Employment Tribunal decided that Mr Seldon had suffered less favourable treatment as a consequence of his age, but that the deed was a proportionate means of achieving certain legitimate aims.

The Employment Appeal Tribunal upheld the Employment Tribunal’s decision except that it found that the aim of “collegiality” did not itself justify fixing the compulsory retirement age at 65. The Employment Appeal Tribunal decided to send the matter back to the Employment Tribunal for it to reconsider the question of justification. Mr Seldon appealed the Employment Appeal Tribunal’s decision to the Court of Appeal. The Court of Appeal dismissed the appeal. Mr Seldon appealed to the Supreme Court.

It is uncertain whether the Supreme Court hearing will resolve all of the issues in the Seldon case itself, as the Employment Tribunal may be permitted by the Supreme Court to reconsider the issue of justification as it applies to the facts of that case, as originally ordered by the Employment Appeal Tribunal. By whichever route the Seldon case is to be finally determined, we can only hope that the Supreme Court will take the opportunity to offer clear guidance of more general application to all age discrimination cases where justication is in issue.

It may well be that once the outcome of the case is known it will be necessary for there to be a root and branch reassessment by professional practices as to how they deal with the issue of ageing partners. Some firms may be reluctant to abandon their traditional retirement practices, for the same reasons that have supported the justification argument to date, and may try to find ways around any tightening in the law. The result may be that with the hoped-for clarification we will see an upsurge in age discrimination claims by older partners.

Professional practices will be well-advised to study carefully the outcome of this month’s hearing, once judgment is handed down. A new round of debate amongst partnership practitioners will no doubt be followed by careful consideration by practices with their partnership law advisers as to how to redraft their deeds to ensure compliance with the law and avoidance of substantial claims.

“… The classic example that is often given is where a firm has contracted to build a bridge, and dissolution occurs when only half of the bridge has been built …”

The recent case of Boghani v Nathoo [2011] EWHC 2101 (Ch) (judgment 2 August 2011) is a useful modern authority relating to the obligation and entitlement of partners to carry on the firm’s business following partnership dissolution.

At the date of dissolution the assets of the firm included two substantial but incomplete hotel developments. The partners were unable to agree how those developments should be disposed of in the winding up of the affairs of the firm, with one partner contending that following a three month marketing campaign the uncompleted hotels should be sold to the highest bidder, and the other partner maintaining that the hotels should be completed before being sold.

Expert evidence confirmed that the projects could each be sold within three months of commencement of a marketing campaign, whether or not the projects had been completed, but that the benefit to the firm of completing the projects was considerably more (some £65m more, net of the cost of completing the projects) compared with simply selling off the uncompleted hotels.

Section 39 of the Partnership Act 1890 states:

“On the dissolution of a partnership every partner is entitled, as against the other partners in the firm, and all persons claiming through them in respect of their interests as partners, to have the property of the partnership applied in payment of the debts and liabilities of the firm, and to have the surplus assets after such payment applied in payment of what may be due to the partners respectively after deducting what may be due from them as partners to the firm; and for that purpose any partner or his representatives may on the termination of the partnership apply to the Court to wind up the business and affairs of the firm.”

In other words, every partner in a partnership dissolution has the right to require that the assets of the firm should be sold and the proceeds used to pay the debts of the firm, with any surplus to be distributed amongst the partners.

However, section 38 states:

“After the dissolution of a partnership the authority of each partner to bind the firm, and the other rights and obligations of the partners, continue notwithstanding the dissolution so far as may be necessary to wind up the affairs of the partnership, and to complete transactions begun but unfinished at the time of the dissolution, but not otherwise.”

The classic example that is often given is where a firm has contracted to build a bridge, and dissolution occurs when only half of the bridge has been built. The contract to build the bridge is a “transaction begun but unfinished.” There are contractual “obligations” to complete the project.

In the Boghani case, the Court considered whether it was “necessary” to complete the projects in order to wind up the affairs of the firm, and what “complete transactions” meant in this context.

Both of the principal contracts governing the developments permitted the firm to assign the benefit of the agreements and novate its obligations if it could find another developer to take its place. In addition, both partners were willing and able to purchase the uncompleted projects. It followed from that that it was not “necessary” to complete the projects, as the winding up could occur through disposal of the hotels. The “transactions” (the outstanding contractual obligations) could be “completed” through assignment and/or novation.

Furthermore, the projects required further financing to complete them. While there was no indication either way as to whether such financing would be available, the Court pointed out that financing would involve “further and new post-dissolution contracts.” That said, historically the Courts have recognised that where a firm has an obligation to finish a bridge, it can (post-dissolution) enter into new contracts to purchase the girders necessary to finish it. So there is a lack of clarity here as to how one distinguishes between the need to enter into new financing contracts and the need to enter into new contracts to purchase girders.

However, in the Boghani case, on the basis (principally I believe) of the ability to assign/novate the contracts, the Court found that it was not appropriate to order that the partners should co-operate in completing the projects prior to sale; instead the uncompleted hotels should be marketed and sold immediately.

The corollary of the above is that where a firm has both a contractual obligation and the ability to complete a project, and there are no “escape clauses” (for example, permitting assignment/novation, or indeed permitting termination of the contract altogether), and/or there are no third parties (or partners) willing to take over the incomplete project, partners are likely to be entitled to insist that their co-partners should co-operate in completing the project as part of the winding up process.

“… considerable profits have been made, and essentially it is worth fighting over …”

The recent case of Eaton v Caulfield & others (an unfair prejudice petition brought under section 994 of the Companies Act 2006, coupled with a just and equitable winding up petition under section 122(1)(g) of the Insolvency Act 1986) highlights the difficulties faced by LLP members who do not have an LLP members’ agreement setting out their rights and obligations.

All too often parties who wish to enter into business together incorporate an LLP, but are in such a rush to get started that they don’t think about or finish thinking about the precise basis on which they wish to do business together. They plunge into a business project only to find some time later that issues emerge, perhaps issues that were always there but had not been identified. By then the business has taken wing, there is considerable client/customer goodwill and/or considerable profits have been made, and essentially the business is worth fighting over.

Typically, one or more parties decide that it would be better for them to be doing business on their own or to the exclusion of one or more of the other participants, and they look for ways to exit the people they can no longer work with, or to walk away themselves, taking their capital and business connections with them.

Unfortunately, the default rules (contained in the Limited Liability Partnerships Regulations 2001) that govern the relationship between the parties in the absence of agreed terms are minimal and usually inadequate to deal with the sort of issues that often arise. In many cases where there is no LLP members’ agreement the participants discover that they cannot lawfully do what they want to do.

In the Eaton case the parties found themselves at trial arguing over whether one party had been entitled to expel the other and whether certain verbal exchanges were sufficient to override the default rule that in the absence of contrary agreement the profits and capital are to be shared equally.

The difficulty with not writing down the precise terms on which you are going to be in business together, and making it a term of that agreement that all variations have to be in writing and signed by the parties, is that the law recognises oral agreements and oral variations of written agreements.

So in the Eaton case the (no doubt very expensive) trial was concerned with what was said about expulsion in a management meeting and during an argumentative drinking session on a train journey, and what terms as to profit-sharing and ownership of capital were agreed in an exchange of emails.

It is always difficult in such cases to pull a clear statement as to what was agreed out of a morass of conversation and often casually-expressed correspondence.

The outcome was that it was found that there was no agreement permitting the expulsion of a member, so that Mr Eaton, by being “dismissed”, had been unfairly prejudiced and was entitled to wind up the LLP and receive an equal share of any surplus value in the business.

This outcome may well have been a disaster for all concerned, including the “winner”, as the value of any business’s goodwill would be bound to be severely damaged by entry into liquidation and consequent ceasing to trade. In such a case the parties may try to do a hurried deal to salvage such value as they can, that is if they can bring themselves at that point in time to negotiate with one another.

In effect in such cases the Judge writes the parties’ agreement for them, but the cost of that can typically be at least 100 times greater than the cost of taking professional advice at the outset.

Those who wish to use an LLP as their business vehicle should ensure that they have an LLP members’ agreement in place, before they open their doors for business.  Those who have omitted to do so should put one in place as soon as they can, before the honeymoon period is over.

The first in a new series of bite-sized FAQs on aspects of partnership and LLP law

Partnership dissolution FAQs: 

What is dissolution?

In the partnership context, “dissolution” describes both an event and a process :

• The event is a dissolution notice or court order (or arbitration award), or some other event prescribed by a partnership agreement or by statute that dissolves the firm (such as the death of a partner).  At that point in time the status of the firm changes so that the partners (or surviving partners) are obliged to wind up the firm.
• Sometimes the term “dissolution” is used to describe the process of winding up the firm, for example in the phrase “in dissolution”.  Winding up involves taking all steps necessary to realise all assets of the firm into money, pay all creditors, and distribute the balance (if any) to the partners.   There is often more to it than that, and the process can take many years.

There is a common misunderstanding that a dissolution notice terminates the relationship between partners completely and instantly.  That is not the case.

Dissolution can have far-reaching and unexpected consequences, and should not be embarked upon lightly.

What is a “technical dissolution”

In a technical dissolution there is no obligation to wind up the firm, which carries on as a going concern.  An example of a technical dissolution is where a firm is dissolved and some of the partners purchase the interest of the other partner(s) in the firm.  Or where a partnership agreement provides that when a partner retires the partnership between him and the other partners is dissolved, but that the partnership between the others continues, and that those others are entitled to (or automatically) acquire the interest of the retiring partner.

What is a “partnership at will”?

This is any partnership that does not contain an agreement to the effect that it cannot be dissolved by notice, for example, with certain rare exceptions, neither of the following are partnerships at will:

• a fixed term partnership
• a partnership in which it has been agreed that partners who want to leave must retire.

How do I dissolve a partnership at will?

By notice, which can take immediate effect or can be stated to have effect on a later date.   The notice should be in writing if the partnership is governed by a deed, otherwise it can be oral (though disputes sometimes arise as to what was said). Written notice is therefore usually to be preferred in all cases.

My partnership is governed by a partnership deed.  Can I dissolve the partnership by notice?

Whether you have a deed or not, a partnership will only be capable of being dissolved by notice if there is no agreement preventing dissolution.  Whenever parties have gone to the trouble of drawing up a partnership deed, it almost always makes provision for the business to continue to be run by the continuing partners when a partner leaves.  In such a case, no partner can dissolve the firm by notice.  But in certain circumstances a court might make an order dissolving the firm.

My partner and I have a partnership agreement that says that we are partners for life.  I no longer get on with him and wish to terminate the partnership.  He will not agree.  What can I do?

If you indicate to him that if necessary you are prepared to apply to the court to seek a dissolution order, you might be able to persuade him to reach an agreement with you, under which one of you buys out the other or you both sell to a third party.  Failing that, the Partnership Act 1890 sets out grounds on which the court can (if it thinks it appropriate to do so) dissolve the partnership, most notably if it is “just and equitable” to do so.   A dissolution order is often made on this basis where the relationship between the parties has completely broken down, to the extent that the business cannot function.  If one of the partners has caused the breakdown through his inappropriate conduct, the court is unlikely to make an order on his application, but might well make an order if the innocent partner applies.

I want to split from my partners and start my own business, providing a similar service.  I think our partnership is a partnership at will.  Should I serve notice of dissolution?

Ending a partnership is not as straightforward as that.  When a notice of dissolution is served the only thing that changes is that the partners now have an obligation to wind up the business, but in a manner that maximises its value, if there is any prospect of a sale.

So, following a notice of dissolution it is more or less business as usual.  There is a rule of thumb that partnerships in dissolution should not take on any new work or contracts, as the aim is now to close down the business.  But in order to maximise value on a sale of the business, the more existing work/contracts and turnover that can be demonstrated to a prospective buyer the better.  So far as existing contracts or other obligations are concerned, there is still an obligation to complete them.

Crucially, after dissolution, you are still in partnership with one another, and most of the rules governing partnership still apply, including the obligation not to compete.  There are ways and means to split from your partners, but dissolution is probably not the solution, or the preferred solution, or may be only part of the solution.

I am a “fixed share partner”.  Can I dissolve the partnership?

The term “fixed share partner” covers a number of different situations.  Normally (if there are no agreements between the partners which would prevent dissolution) a partner (no matter what his title) will be able to dissolve the firm if he has a right to a share of the assets of the firm in a winding up.  It is common for fixed share partners to have no rights to share in the assets of the firm on winding up, but this depends on a number of factors.  You are more likely to be able to dissolve the firm if you have invested capital in the firm, and conversely you are less likely to be able to do so if you have no capital invested in the firm.

But even if you have the right to dissolve the firm you should consider carefully what the effect will be and whether this will meet your objectives.

I think my firm is going bust and I want to get out now to avoid paying my share of its liabilities.  Would dissolving the firm and leaving assist me?

In a word, no.  In a dissolution all of the partners are liable for the firm’s debts.  But there are other methods by which you may be able to achieve your aims.

“… while nobody sympathises with a money-launderer or other criminal, not only is there the possibility of a damages claim from a client, but also regulatory sanctions in addition …”

Solicitors could inadvertently breach their obligations to certain clients by allowing their Solicitors Accounts Rules (SAR) auditors to view those clients’ files.

Solicitors and other professionals are all too aware of their duty to report clients and others to the Serious Organised Crime Agency (SOCA) if they come across or suspect money-laundering or other criminal acts committed by their clients or others.

Solicitors are in a unique position, namely that there are particular exemptions that apply to them in relation to privileged information and information that comes to their attention in the course of conducting litigation. Suffice it to say that quite frequently circumstances arise in which solicitors become aware of or suspect money-laundering or other criminality but are excused from making a report to SOCA when these particular exemptions apply.

More importantly, in the absence of a statutory obligation to report, their obligation of confidentiality to their clients precludes them from making such a report. They have a positive obligation to the client not to make such a report.

Individual fee earners should still, however, make an internal report to the money laundering officer in their firm.

Accountants are not in the same position. Legal professional privilege and the litigation exemption do not apply to them, it only applies to lawyers. Accountants have a duty of confidentiality, but this is overridden by their statutory duty to report suspected money-laundering.

Once a year solicitors invite their accountants in to review their accounts for the purposes of ascertaining whether the solicitors have complied with the SAR. The accountants then make a report to the Solicitors Regulation Authority (SRA).

The SAR accountants are entitled to look at any file, and in the course of an SAR audit they will look at quite a number of files. In doing so they may come across facts and matters that they consider they have a duty to report to SOCA. The information may be in the form of file notes, correspondence or documents placed on the file in the normal course of conducting the matter, or it might be in the form of the solicitors’ own internal communications constituting or concerning an internal report to the firm’s money laundering officer, copies of which the fee earner running the file may have chosen to keep on the file.

Either way, the accountants may come across the information and may quite properly make a report to SOCA.

This is not just a theoretical risk. Just as solicitors often declare to their clients in their terms and conditions that anti-money laundering reports may be made to SOCA, accountants are including in their terms and conditions provided to solicitors terms to the effect that they may make reports to SOCA arising out of matters that come to their attention in the course of carrying out SAR audits. They would not go to the trouble of including such terms if the issue never arose.

In this way, privileged information belonging to clients, which the solicitors are obliged to keep to themselves, may “leak” out to SOCA, via an SAR accountant.

Every such “leak”, as well as being a breach of the duty of confidentiality to the client, will be a breach of the solicitors’ rules of professional conduct and may be a Data Protection Act breach. So, while nobody sympathises with a money-launderer or other criminal, not only is there the possibility of a damages claim from a client, but also regulatory sanctions in addition. Data Protection breaches have already led to professional firms being fined six-figure sums.

A common knee-jerk reaction on hearing about this issue is to make the assumption that if the client is a villian no court or regulator is going to punish the solicitor for an inadvertent breach. The matter is not, however, so clear cut. A large proportion of clients who are reported to SOCA may be innocent. What is being reported may be only a suspicion. In this instance there is not always fire when smoke appears. Even guilty persons are not always prosecuted, let alone convicted.

The consequences of a report for a client may be considerable. In the case of suspected tax evasion the client may be investigated by HMRC, and may have to incur substantial professional fees, even if in fact they owe no tax. In the case of many suspected crimes the suspect may be arrested and a receiver may be appointed over his or her assets, long before any trial to determine guilt (at which the client may be acquitted).

Solicitors may feel a degree of comfort in that the client may never discover that a “leak” from the firm of solicitors led to their financial losses. Though many firms might “get away with it”, such matters sometimes emerge, or clients determined to recover compensation will make an educated guess. Solicitors should not feel immune. Of course, solicitors will in any event wish to strive to comply with their obligations to their clients, not just hope that they will get away with failing to do so.

What then should solicitors do about this?

In the circumstances described above (suspected money-laundering but no obligation to report to SOCA), solicitors are entitled to, and in my view are obliged to, withhold a requested file from their SAR auditors if there is any risk that allowing the SAR auditors to read it might lead to a report to SOCA by the SAR auditors. It is not just internal reports that might be on the file that are in issue. Normal file documentation may contain the seeds of the original suspicion that led the solicitor concerned to make an internal report to his firm’s money-laundering officer. So keeping internal reports on a separate file, though very probably a good idea (so as to avoid future inadvertent and unlawful disclosure to the client), is usually not going to be a complete solution. Perhaps in some cases solicitors may feel entitled to weed files of suspicion-inducing materials before handing them over to SAR accountants, but that may depend on the extent of the materials, and in any event such a precaution requires a solicitor to be aware of the issue (of potential reporting by the SAR accountant) in the first place.

In many firms when the request for access to files is made by the SAR accountants, the files are collected by accounts staff or secretaries, in some cases perhaps without prior reference to the fee earner concerned, particularly if the file has been closed and archived.

Firms will already be keeping a list of files on which internal anti-money-laundering reports have been made. It would be wise to make it a part of the firm’s compliance regime to cross-compare the SAR accountants’ list of requested files with the internal anti-money laundering list.

Where solicitors decide that they have an obligation to their client to withhold a file from their SAR accountants, this will undoubtedly lead to a qualified report by the accountants to the SRA. The solicitors may well then wish (or be obliged) to explain themselves to the SRA. Otherwise unexplained qualifications may lead to an inspection by the SRA, taking up time and valuable resources in the case of all concerned.

“… most conduct that would have been sufficient to justify a discrimination or sexual harassment claim may well be oppressive and unacceptable and cause anxiety, alarm or distress …”

It is quite a common occurrence these days to find at the first meeting with a client that he or she has a perfectly good discrimination claim against the firm or LLP in which he or she has been a partner or member, but that the claim is barred by the very short limitation period (three months) applicable to discrimination and other claims in the Employment Tribunal. Such claims encompass discrimination on the grounds of age, race, nationality, religion (including the absence thereof), gender and sexual orientation, as well as sexual harassment.

It is pretty grim for someone who has a good claim under one or more of these heads, who has taken a bit of time to compose themselves after what may have been a traumatic ejection from their place of work, to find that they have no remedy in the Employment Tribunal because they have left it too long.

However, all may not be lost. The civil remedy under section 3 of the Protection From Harassment Act 1997 is often available to a potential discrimination claimant. The harassment cause of action has a limitation period of six years. Its ambit goes far beyond discrimination.

In order to establish such a claim against one or more partners or members or an LLP, the claimant has to prove the following:

1    The defendant(s) pursued a course of conduct (on at least two separate occasions) which:

a    amounted to harassment of the claimant; and

b    The defendant knew or ought to have known (an objective reasonable person test is applied) amounted to harassment of the claimant; and

2    The conduct was oppressive and unacceptable.

The above of course begs the question what is harassment.  Harassment means causing anxiety, alarm or distress.  Unlike a personal injury claim it is not necessary to demonstrate psychiatric injury (or negligence, or foreseeability).

Conduct includes speech, but the speech must go beyond “the ordinary banter and badinage of life”.

There is no requirement for other illegality.  Therefore the harassment does not have to be capable of amounting to a criminal act other than harassment, or another tort.

Harassment does require conduct outside the norm.  That said, most conduct that would have been sufficient to justify a discrimination or sexual harassment claim may well be oppressive and unacceptable and cause anxiety, alarm or distress.

Each case of course turns on its own facts, but as management regimes grow tougher in the poor economic climate, practices need to consider carefully what is and is not acceptable conduct in the drive to “incentivise” partners/members.

Few would doubt that what might be characterised as bullying of one sort or another does take place between partners in some firms, even in professional practices, whether by way of autocratic rule, offensive office banter, strategic manoeuvring, or opinion-shaping or other forms of “ganging-up”.

Personal damages (for anxiety, etc) and actual financial loss can be recovered, and there is no limit.  The usual requirements of mitigation apply, but subject to that it is open to partner and LLP member claimants to recover very substantial sums.  In one of the leading cases, which was an employment case involving long-term bullying, which resulted in two nervous breakdowns, the recovery was in excess of £800,000 plus legal costs.

In many cases there may well be a cross-over or overlap between harassment and the duty of good faith.  However, in many LLP environments the duty of good faith may well not apply, even by implication, and in others it may be expressly excluded under the members’ agreement.  Also, breach of the duty of good faith is unlikely to give rise to the ability to claim damages for non-financial injury (at least not without establishing psychiatric injury).  There may be types of conduct which arguably engage only one of these causes of action, so unless there is good reason to do otherwise one should consider pursuing harassment and breach of the duty of good faith in tandem.

“… If someone is completing on Friday it does not help them if their solicitor ceases to practise on Thursday …”

Some legal practices are only now, with one week to go, receiving premium quotes for their 1 October 2010 professional indemnity insurance renewal. It is nail-biting for them as they may have only one quote – it is “take it or leave it.”

There is talk of practices being quoted premiums in excess of 400% of last year’s premium, with no discernible reason other than that they fall into a particular “demographic” (for example, being a practice with four or less principals).

There is much less capacity and a lot more caution in the insurance market, following the withdrawal of Quinn (which insured 10% of the market).

And it does not help that the number of legal practices in the Assigned Risks Pool (ARP) has swollen to over 400, compared with typically less than 30 in better times (28 in 2007/8).  Insurers who insure the solicitors’ profession have to pick up the tab for claims against practices in the ARP, and thus naturally seek to recoup their losses through higher premiums across the board.

In the past, practices in the ARP were usually there because they were otherwise uninsurable, in other words the risk of substantial losses arising is so great that no insurer with half his marbles would insure them.

Such practices are still in the ARP, but there is a new breed of potential ARP entrant, that is the perfectly good practice that in previous years has been insured for a premium that is a reasonable proportion of their turnover, which has led an exemplary existence and “deserves a break”, but is not getting one in this year’s renewal season.

Faced with an unaffordable premium, such practices have the unenviable choice between entering the ARP (and paying an unaffordable premium) or ceasing their practice before 1 October 2010 (or, if they are confident of obtaining a better quote before the end of October 2010, relying on the 30 day “grace period” - firms which put insurance in place within that period are treated as though they never entered the ARP).

But cessation at short notice is not as straightforward as such practices might hope. There are obligations to clients to give them reasonable notice to enable them to find a new home for their work. If someone is completing on Friday it does not help them if their solicitor ceases to practise on Thursday. Such conduct risks breach of contract claims and disciplinary proceedings, and in a bad case possibly Solicitors Regulation Authority (SRA) intervention. Solicitors who have been so cavalier as to, in effect, abandon their practice may find that they are uninsurable in the future, even if the SRA and/or the Solicitors Disciplinary Tribunal do not pull the plug on them.  Others may simply have to accept that they are insolvent and have an obligation to creditors to cease to trade, whatever the consequences may be.  In such cases, it may be “cavalier” to trade on.

If cessation can be achieved before the renewal date there will be a run-off premium for the obligatory six year run-off policy. That will typically come in at 250% or more of the current year’s premium. Still, reasons to be cheerful, that is better than more than 400% (with an additional sting in the tail – see below) for only one year if the practice continues.

Those trading behind the firewall of an LLP might not be personally liable for the run-off premium, but even if they are not their LLP will probably go into insolvent liquidation, and they might face clawback or other claims from a liquidator or even be at risk of being disqualified for wrongful trading. They will also risk disciplinary proceedings for being in “policy default”.

So closing down carries certain difficulties with it. If the partners decide to continue in practice, there are finance deals out there to finance the unaffordable premium, or failing that the practice can go into the ARP (which runs its own instalment scheme). Either way, the practice is now committed to a premium that it cannot ultimately afford to pay, much like a house buyer with a NINJA* loan which will assure him a few months in a mansion before it is repossessed.

The ARP premium may be as punishing as (or worse than) the premium offered by the insurance market, and if in due course the practice ceases whilst in the ARP without a successor practice (see below) then there will be an ARP run-off premium.

If the practice continues without going into the ARP, but subsequently ceases without a successor practice, its run-off premium will be based on its premium for the year of cessation, so if it ceases in 2010/11 the run-off premium will be be 250%+ of its 400% (of the previous year’s) premium for the 2010/11 year.  That means that having paid a premium of say £50,000 in 2009/10, the total cost of professional indemnity insurance incurred in 2010/11 could be say £700,000 (2010/11 premium of £200,000, plus run-off premium of £200,000 X 250% = £500,000, total £700,000).

One option may be to try to keep the practice going at least as long as it takes to get the best value for goodwill, preferably on a merger, even if that only means the partners being credited in the books of the merged firm with the value of their capital in their current firm.  At the other end of the scale, preserving goodwill may only result in being able to get a job (not necessarily a partnership) at another practice on the back of the book of work that individuals can bring with them.

In the latter case, taking work away from a failing/ceasing practice needs to be done in a structured way by mutual consent of the partners.  If one partner “does his own thing” and takes away a group of clients without a “by your leave” then the others would have grounds to recover the value of that work from the partner concerned.

(And partners seeking a merger or new position must be careful to ensure that they are not moving from frying pan to fire.)

Clients of course are entitled to exercise their own judgement in the matter and may not co-operate in being moved across to wherever partners can find new berths.

Even if transfer of goodwill (and obtaining some value for it) can be achieved, there may well be difficulties such as lease liabilities and claims from redundant staff.  Even in a merger, such claims are likely to remain as liabilities of the old pre-merger practice (which will continue a separate existence for the purposes of being wound up, either in dissolution or liquidation).  

In some cases transfer of a book of work can amount to a TUPE transfer, with the result that potential acquiring practices may be cautious. They will want the partner and his work but not the entire team.

To add to these difficulties, practices acquiring partners of ceasing practices and/or their goodwill may wish to be very careful to ensure that they do not automatically become a successor practice to the ceasing practice. If they do they will become responsible for insuring the risk of future claims arising from the ceasing practice’s past work. This is a minefield that can be traversed, but only with the “right equipment” (an in-depth analysis of the proposed course of action, with a copy of the succession rules at your side, tweaking the proposal as required to avoid succession).

With effect from 1 October 2010 the succession rules themselves have been tweaked, with the result that a partner or partners joining one or more new practices will be able to elect to pay a run-off premium rather than bring the burden of succession with them to the practice that they are joining.  This will make obtaining a job easier (especially for sole practitioners who are closing down their practice) but leaves the job-seeker with the run-off liability.

The best solution may be not to close down the practice but to look for “birds of a feather” – good practices in similar difficulties (brought about by the catastrophic insurance market, not poor business stewardship or poor claims history) with whom to merge.  Being “in the same boat”, such firms will not be as “picky” about succession and other issues. Such a merger will be too late to affect the premium that each practice (or the merged practice) has to pay this year, but at least being a larger practice next time round in 2011 might give rise to a lower premium, especially if there is a focus in the meantime on better preparation for next year’s renewal, for example putting better risk management processes in place which will be attractive to insurers.  And in the meantime economies of scale may be achieved.

This avoids a run-off premium or an ARP premium and/or an ARP run-off premium.

In any event, practices in this predicament may well have to find ways to reduce their partner numbers so that the increased premium leaves the remaining partners with enough profit to live on.

Poorly-performing partners may be given the choice of leaving with an indemnity or remaining in the practice and sharing the burden of greatly reduced profits and large potential liabilities if cessation occurs in the future. Some partners may regard the opportunity to leave as a “Get out of jail free card”, indeed those managing the process may be trampled in the stampede towards the exit. It is important to get the balance right with a view to retaining the most effective partners.

Faced with many different options, the partners in a practice facing a difficult insurance renewal would do well to prepare a number of different spreadsheet models, to enable them to ascertain and compare the possible outcomes.
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*No INcome, Job or Assets (sadly for aspiring mansion owners these loans are no longer available).

“… It is possible inadvertently to throw away these defences in the course of the process leading up to administration, a PVA and/or IVAs …”

This article describes the run-up to a professional partnership insolvency, and the choices faced by the partners who control the partnership. It then goes on to identify particular issues faced by salaried and fixed share partners, and the opportunities open to them to try to avoid personal liability for the firm’s debts.

The primary driver behind the swathe of LLP conversions during the last ten years, namely the risk of insolvency brought about by a catastrophic negligence claim in excess of the limit of a practice’s professional indemnity insurance, has not really come to pass. In these hard times many firms are instead sinking under the weight of their trading losses, brought about by decreasing turnover, and sometimes aggravated by partners who have seen the writing on the wall and have left, taking clients with them.

Most commonly, salaried and even fixed share partners are not involved in management, and they have either no idea or only a faint perception as to how badly things are going for their firm. The first they may know of a problem is when the equity partners tell them that they are proposing to put the practice into administration and/or pursue a partnership voluntary arrangement (PVA), and/or in some cases individual voluntary arrangements (IVAs). It is quite common for the salaried and fixed share partners to be asked to co-operate in these processes. This invitation needs to be approached with extreme caution.

Very often the equity partners will have had their heads in the sand, hoping for an upturn in work that never comes and/or compassion and time to pay from a growing roster of creditors, who may have become increasingly impatient. A final demand from HMRC in connection with failure to pay PAYE and/or VAT is commonly what prompts the equity partners to consult an insolvency practitioner.

Administration is usually only going to be possible and worthwhile if the firm has a decent business which someone is willing to buy. Client loyalty is a big issue here. In the case of a professional practice, given regulatory issues and the practical point that a professional practice in administration will rapidly lose its clients and goodwill, any administration is almost certainly going to have to involve a “pre-pack”, in other words a sale will have to be agreed with a buyer prior to and be triggered by the commencement of the administration.

Even if a buyer can be found, an administration may provide only very temporary relief for the partners, as they will still have unlimited personal liability for the debts of the firm. The evil day when they have to face up to their liabilities may have been briefly deferred, and the sale of the goodwill of the practice may well have provided some much-needed additional funds, but in most cases there will still be a substantial rump of indebtedness that the partners will have to address (whether or not the firm goes into liquidation).

A PVA may be standalone or may follow an administration. Whether or not preceded by an administration, IVAs may also be required if creditors are trying or threatening to pursue individual partners into bankruptcy. Indeed sometimes, especially in the case of smaller firms, interlocking IVAs are used instead of a PVA. Consideration has to be given as to how the partners’ professional regulatory body will react to a PVA or IVAs, in particular whether that body will permit the partners to continue in practice after a PVA and/or IVAs are in place. Clearly this is crucial and a decision of the regulator must be sought before any steps are taken, otherwise the PVA (and any associated IVAs) will have achieved nothing, particularly if (as is common) they include, as part of the proposal to creditors, a contribution from ongoing profits of the firm over a number of years (with the result that the PVA and/or IVAs fail, and the final outcome is liquidation and/or bankruptcy).

Sometimes therefore, depending on the profession concerned, the equity partners may have to accompany their PVA with a “merger” with another firm, in which they can be “supervised” in their professional work by partners who are not the subject of an insolvency regime (this is particularly common where the practice needs to hold client money).

I put “merger” in inverted commas as more likely than not the partners of the insolvent firm will not be granted much if any status in the firm with which they are merging, often becoming salaried partners or consultants or indeed accepting a lower rank, just to generate income to live and to enable them to make any agreed ongoing contribution to their PVA/IVAs.

Whether the firm has to “merge” or not, salaried and fixed share partners will no doubt wish to consider their prospects for advancement (and their continuing exposure to future liabilities) in a firm that has suffered such trauma and/or in which some or all of the partners may be paying off creditors for some time. Particularly if the firm is able to continue without “merging”, salaried and fixed share partners may wish to consider whether they should (a) ask to be given another title and not be held out as partners going forward, or (b) find a job elsewhere. Either way, the purpose will be to avoid incurring potential liability for further debts that may arise in the future. In order for this to work, effective notice has to be given to everyone who has dealings with the firm, and there is a right and a wrong way to do this.

A PVA with or without IVAs may, depending on the terms proposed, put an end to the salaried and fixed share partners’ exposure to liability for the firm’s debts. But creditors may not accept the PVA/IVAs, or if they do the PVA/IVAs may fail because the firm and/or the partners may be unable in the final event to comply with the agreed terms.

One way or another, salaried and fixed share partners may well be exposed to creditor claims.  Although they may well not be true partners (which can only be determined after a careful review of their precise rights and obligations) they may be liable to creditors anyway under section 14(1) of the Partnership Act 1890 (holding out). Such liability depends not only on whether they have been held out as partners but also on whether the creditors concerned have relied on them when advancing credit to the firm. This is a very important potential defence. By adopting the right strategy it is possible to use this defence to keep creditors at bay for a long time or indeed to deflect them entirely.

Other technical (but nonetheless highly effective) defences are likely to be available to fixed share and salaried partners against HMRC and landlords.

It is most important therefore that salaried and fixed share partners do not do anything that will jeopardise these defences. It is possible inadvertently to throw away these defences in the course of the process leading up to administration, a PVA and/or IVAs, and salaried and fixed share partners should therefore obtain specialist and independent legal advice at the very first intimation of the firm’s insolvency, otherwise they may be at risk of falling into a number of traps which will result in them being dragged along by the equity partners into personal insolvency that might otherwise have been avoided.

“… after a few hours of tight-lipped civility, one or other of the parties … cannot stop himself telling the other party what he really thinks …”

There are a number of factors which distinguish partnership disputes from other types of commercial dispute.  In consequence, different methods are sometimes required to achieve settlement.

In this article I include in “partnership disputes” any dispute between proprietor managers of a small business, be they disputes between partners in a traditional partnership, or members of a limited liability partnership (LLP), or boardroom disputes between director shareholders of a limited company.  The unifying factor is proprietors who have worked together shoulder to shoulder to build and run a small business.  In this article I refer to all of these scenarios when I refer to “partners” and “partnership”.

Like all groups of people who face challenges together, partners must adapt to each other’s strengths and weaknesses, relying to a very great extent on mutual support and having trust and confidence in one another.  That trust and confidence is taken as a given, usually not even considered on a day-to-day basis.

But any breach of that trust will take centre stage.  Anyone charged with resolving such disputes must understand and take account of the emotional issues which often predominate.

I have repeatedly come across a willingness of sophisticated businessmen to walk away from the settlement process because of financially insignificant issues.  Partners who are not offered appropriate treatment for their emotional wounds are often willing to abandon settlement efforts and proceed to resolve their dispute in the much more expensive and uncertain forum of court proceedings or arbitration.  The costs and risks will greatly outweigh the commercial value (often £nil) of the issue which their head tells them to move on from, but which their heart will not let go of.

Examples of things which are sometimes very important to partners, but which have little or no financial value, are demonstration of remorse, admission of guilt, apology, thanks, and recognition of contribution.  In some disputes this emotional “currency” is more valuable to a party than any financial currency they are likely to be offered.  Going into a mediation, they may not even realise that this is the case.

Most importantly, the expression of remorse, apology, etc must be genuine, or at least perceived to be genuine.  It is difficult to fake a genuine apology, or put another way, it is very easy to spot a contrived apology. 

This creates an impasse.  While it is difficult for some parties to compromise without receiving some emotional currency as part of the deal, equally it can be very difficult for their opponent to reach deeply enough into his or her emotional pocket to find enough of this genuine currency to hand over.

In some mediations, after a few hours of tight-lipped civility, one or other of the parties becomes overwhelmed with anger or a sense of injustice and cannot stop himself telling the other party what he really thinks, what damage has been done, and how he feels about it.  Voices can become raised and the mediator has to assess how far he should allow the parties to go before stepping in. Sometimes this breaking of the emotional tension benefits both parties as it enables them to “move on”.

Though mediation is not as predictable as physics, it can be the case in mediation that for every action there is an equal and opposite reaction.  The anger, pain, distress and vulnerability that is communicated subliminally to an opponent in an uncontrolled emotional outburst is often the trigger for the opponent to find it in himself, just as spontaneously, to offer the genuine apology or other emotional currency that the other party is looking for. 

The giver of the apology may have been suffering from a niggling doubt about his own moral integrity, and through his genuine expression of remorse the weight of this doubt about his own conduct may have been lifted.  Often it is not as clear-cut or one-way as that, because both parties could have done better and both need to apologise or give recognition in some way.  Either way, all appropriate emotional “payments” having been made, and both parties having got things off their chest, they are ready to focus on the financial or other commercial terms of a settlement, and to make the concessions that will be required if a compromise is to be reached.

“… the income of the firm may well diminish and/or partners may not account fully or at all for accrued WIP …”

Unless there is an express agreement between partners permitting retirement, no partner can retire from a partnership at will.  The only way to bring about termination of the relationship is for one or more of the partners to give notice of dissolution to the other(s). 

However, on notice of dissolution being given, a firm may not immediately cease to trade.  Indeed, a firm may carry on trading for a considerable period.  This is driven by two factors, firstly the duty to clients/customers to complete retainers/contracts, and secondly the benefit if any of continuing the dissolved firm as a going concern until it can be sold (possibly to one or more of its partners, or otherwise to an outside purchaser) or merged into another firm, or otherwise dealt with so as maximise the benefit to partners and/or minimise the potential downsides.

Whether or not the firm continues to trade, until the winding up of the firm is complete (and this can take many years, even if the firm does not continue to trade) the partners at the date of the dissolution notice (including the partner(s) who served it), remain as partners, with a continuing duty of good faith to one another, and a continuing ability to bind one another to contracts with third parties for the purpose of the winding up.

The principal downsides of dissolution are normally as follows:

•  The partners’ income tax is normally accelerated by a year, subject to any overlap relief to which individual partners may be entitled.
• Redundancy/lieu of notice payments may become payable to staff.
• Liabilities may arise from leases that cannot be assigned or can only be sub-let at an under-rent.
• Ongoing storage of files and papers (not underpinned by ongoing income).
• Costs of recovery of unpaid fees, or loss of unpaid fees, particularly where clients decide to try to avoid payment in the hope that a firm that ceases to trade may not bother to/be in a position to sue for fees and/or based on alleged breach of retainer arising out of cessation of services/inadequate service following the dissolution.
• In the case of a firm of solicitors, if there is no successor firm for insurance purposes (e.g. a firm with which the dissolved firm merges) then the dissolved firm must purchase (six years’) run-off insurance, typically at a premium of between two and three times last annual premium.

For so long as the firm continues to trade these downsides may not materialise, and can be avoided altogether at any stage if all of the partners agree to an (often back-dated) retirement of the partner who served the notice, or other form of acquisition by the “continuing” partners, thus bringing about a technical dissolution only, which does not lead to the downsides listed above.

In the absence of any such agreement the firm will be in what is known as general dissolution, and will have to be wound up, and the downsides listed above will occur.   

As partners make plans to go elsewhere and/or as they physically leave the firm, the income of the firm may well diminish and/or partners may not account fully or at all for accrued WIP (preferring, dishonestly, to bill it in their new firm, where they may be able to retain 100% of its value for themselves).  At the same time the outgoings (e.g. rent) may not diminish at the same rate or at all, and eventually a marginal position may come about in which it is not economic to keep the firm going, even in order to complete long retainers (for example to complete litigation) with the result that bills cannot be rendered and/or claims for repayment of fees or damages may be made by clients.

Along the way, partners will be looking for a safe haven in another business, and will wish to take clients with them in order to secure the best terms for themselves in their new business.  Disputes may well arise between the partners in relation to who should take which clients with them (none or them being entitled to do so as of right, at least until the firm could no longer carry out the work and there is no prospect of anyone paying for the goodwill).

In the absence of an event such as a merger which prevents a general dissolution, other businesses may be put off recruiting partners of the dissolved business (and this potentially includes the partner who served the notice).  Such businesses may fear that those partners may be saddled with personal liabilities arising out of the dissolution. 

In the case of solicitors, other firms may be wary of taking on partners in such a way as to make the acquiring firm a successor practice to the old firm for insurance purposes.  This can arise in many different ways and if it does arise the acquiring firm will be required to take out insurance at next renewal which takes into account the claims history of the dissolved firm, thus substantially increasing the premium.

Matters such as this tend to encourage settlement between the partners of the dissolved firm, in the form of an agreed retirement of the leaving partner.  In the event of such a settlement, it is important to document it properly.  There are many traps for the unwary.

Generally the only reason a group of partners will elect to wind up the firm, rather than agree to the retirement of the partner who wants to leave, is where the extent of the assets and/or continuing/anticipated future work are so outweighed by the actual or future liabilities that the partners do not want to release the leaving partner from his obligation to contribute to those liabilities and/or to release the leaving partner’s capital.  In such circumstances they will insist on the leaving partner remaining as a partner in the dissolved firm (as he does automatically unless released by agreed retirement), sharing all of the liabilities.

In essence, when a partner gives notice of dissolution, his co-partners will need to consider what (if any) amount (in addition to the return of the “leaving” partner’s capital) they are prepared to pay for the benefit of the firm’s fixed assets, name and goodwill, whilst also taking on the liabilities of the firm.  The balance sheet in the accounts will not provide the answer.  The biggest elements taken into account in any settlement tend to be the value of goodwill (which is usually not reflected in the balance sheet), off-balance sheet work-in-progress, and sometimes off-balance sheet liabilities (often associated with leases), all of which can be difficult to value.

I will return to these and other aspects of dissolution in future posts.

This article may also be helpful.