Law firm partner’s profit share allocation was a reasonable exercise of discretion

15 July 2021

Most disputes between partners of professional services firms are settled either through confidential negotiations or arbitration.  A public resolution of the matter through a full hearing and reported judgment is a rare occurrence. A recent example of such a case involving an ex-partner of a law firm is a useful reminder that it is difficult to challenge profit share or bonus decisions as an irrational exercise of discretion.

What happened?

  • The Claimant, Mr Tribe, was a partner of the law firm Elborne Mitchell LLP and its predecessor for over 25 years, although his relationship with the firm soured over his last few years there.  He retired from the firm on 30 April 2016.
  • Regarding the distribution of profits, the LLP Agreement (the “Agreement”) provided that the amount the equity partners would receive in respect of each accounting period was based on:
    • a fixed amount of £75,000 each;
    • a “discretionary fund” formed out of remaining available profits (comprising up to 40% of the whole distributable profit) which would be distributed on the basis of recommendations made by the Senior Partner and then settled by a resolution of the equity partners; and
    • if the distributable fund was not allocated by a certain time it, together with any remainder of the profit, would be distributed based on lockstep points.
  • The Claimant’s claims were in respect of his profit share allocation for his last two years at the firm (i.e. the 2014/2015 and 2015/2016 financial years).
  • The firm performed particularly well in those years, principally due to certain work brought in by a fixed-share partner.  There were difficulties regarding the recovery of fees on some of the Claimant’s matters and the firm’s shipping practice (which he had run) ceased when he left.  These factors were among those taken into account by the Senior Partner in formalising his profit share recommendations.
  • In respect of 2014/2015, the Claimant strongly objected to the Senior Partner’s recommendation as to what the Claimant’s share of the distributable fund should be and threatened to bring proceedings.  Following a debate at a partners’ meeting, a revised split was agreed and a resolution signed by the partners, including the Claimant (though he claimed he reserved his position).
  • The following year, the Claimant again objected to the Senior Partner’s recommendation in lengthy correspondence and put forward an alternative proposal.  However, he did not attend the partners’ meeting at which the proposals were discussed and voted on.  The Senior Partner’s recommendations were adopted.
  • The Claimant claimed that the Senior Partner’s recommendations and the subsequent resolutions passed by the equity partners were not done in good faith.  He sought damages and a declaration of his rights under the Agreement.

Outcome & Comment

The Court held that the Senior Partner’s recommendations regarding the Claimant’s profit share were reasonable exercises of his discretion under the Agreement.  The partners’ subsequent resolutions on the matter were also lawful. 

In summary:

  • In contracts under which a party is permitted to exercise discretion, there is an implied term that that party will not exercise that discretion in an arbitrary, capricious or irrational manner.  That is a fact-specific question.
  • In the context of an LLP, a decision-making power must be exercised in good faith and in what a member considers to be in the best interests of the firm.  In making decisions, irrelevant matters should not be taken into account and relevant matters should not be ignored.  Further, the decision should not be one that is outside the range of reasonable decisions in the circumstances.
  • In this case, the discretion of the Senior Partner to make recommendations was a broad one, particularly because it involved a proposal to partners, rather than a decision.  Partners would be able to challenge his proposals and adopt an alternative allocation if they disagreed with them.
  • The ultimate decision of the partners should also meet the same test.  That is, it should not be outside the range of reasonable decisions that might be made in the circumstances. 

Since the Supreme Court’s landmark decision in 2015 in Braganza v BP Shipping Ltd there has been considerable interest among employment and partnership lawyers in the scope for successful legal challenges to discretionary decisions by employers and LLP firms.  As already seen in relation to bankers’ bonuses, this case suggests that proving that a discretionary decision on profit share allocation made by an LLP firm was irrational and unlawful will often be difficult, although every case will turn on its facts.  It remains to be seen whether there is greater scope to challenge discretionary decisions made by firms in respect of partner exits, expulsions and compulsory retirements. On one view, the court should set the bar of what amounts to a rational and lawful decision at a higher level when it comes to partner exit procedures and expulsions, than in mere partner profit share disputes.

FURTHER INFORMATION

If you would like any further information or advice about the issues explored in this blog, please contact Andreas WhiteÖzlem Mehmet or another member of our Employment team.

 

ABOUT THE AUTHORS

Andreas is a partner in our employment team.  He has substantial litigation experience, with a particular focus on complex and high value employment and partnership disputes. Andreas has a particular interest in international and cross border employment law. He is a former president of the labour law commission of AIJA.

Özlem is a Professional Support Lawyer in our Employment Team. Before joining Kingsley Napley, Özlem was a Tutor and Team Leader at BPP University’s Law School, teaching on the Legal Practice Course.  She taught the Employment Law, Business Law & Practice, Corporate Finance and Equity Finance modules of the course, as well as the skills modules of Interviewing & Advising and Professional Conduct & Regulation.

 

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