Compensation orders against company directors: a new way around Limited Liability?
Various stories have hit the headlines recently of law firms holding departing partners to lengthy notice and garden leave periods. While this may have advantages from a cashflow perspective (as it enables firms to hold on to partners’ capital contributions for longer), it is rarely advisable from an HR, morale or partnership law perspective.
This article suggests a practical way forward for firms faced with partner departures. It also offers tips for recruiting firms on how to avoid disputes with new partners’ former firms.
There are a number of arguments that departing partners typically use to negotiate an earlier exit from their current firms than that contemplated by their LLP members’ or partnership agreement. These include:
Most LLP members’ or partnership agreements include a garden leave clause. Some firms place departing partners on garden leave if they are concerned that partners may, during their notice period, misuse confidential information or try to encourage clients, employees or other partners to move to the new firm.
Other firms typically use garden leave to prevent departing partners from having contact with clients so that they can use this period to firm up their relationship with those clients or introduce them to other key partners who can take over management of the client relationship.
But, garden leave is not usually an attractive option to be deployed by a departing partner’s current firm, as the departing partner will continue to receive a full profit share, even though he will not be generating any fee income for the firm. It can also create extra client and team uncertainty.
Most restrictive covenant clauses state that the length of the post-termination restriction will be reduced by any period during which the departing partner is on garden leave. Even if the restrictive covenant clause does not specifically state this, it is a valid argument that a departing partner can raise, or the effect is that the restrictions will apply for an additional period (i.e. the period during which the partner is on garden leave, as well as for the restricted period post-termination).
Restrictive covenants are usually viewed as being unenforceable, as they are in restraint of trade. They are only deemed to be reasonable and enforceable by the courts if they exist in order to protect a legitimate business interest,
such as confidential information, client connections or stability of the workforce, and if they are no wider than is necessary to protect those legitimate business interests.
In an employment context, the courts tend to try to interpret restrictive covenants in favour of the employee. Many fixed-share equity partners are in effect employees and, therefore, may be able to argue that that any restrictive covenants are too wide to be enforceable against them.
However, in a partnership context and certainly in relation to full equity partners, the courts tend to view restrictive covenants differently on the basis that partners are deemed to have equality of bargaining power. This is despite the fact that even full equity partners who are members of large law firms with several hundred partners don’t have any real negotiating power in relation to their contractual restrictions. The courts are typically more willing to uphold covenants given by partners than those given by an employee for the benefit of his employer.
In practice, firms should not set great store by trying to enforce restrictive covenants, unless in extreme circumstances. Injunctions are expensive to obtain and a very public and time-consuming way of resolving disputes, especially those concerning clients. Questions should be asked of the firm’s management team’s abilities if disputes concerning restrictions cannot be settled amicably via negotiation.
Most departing partners usually try to reach an agreement with their current firm about which clients they may be able to act for during the restricted period. In particular, there may be certain clients whom the departing partner introduced to the current firm and which have only come as a result of a personal relationship or the departing partner’s professional reputation and expertise, and who are likely to want to continue to work with the departing partner at the new firm. It is rare that the current firm will object to this, since it is unlikely that they would wish to involve a client in court proceedings were they to pursue the departing partner.
There are often instances where agreement can be reached in respect of clients common to the departing partner’s current and new firm, particularly if the departing partner’s current firm can continue to service the client in relation to specific areas of law in which the new firm lacks capability (for example, if the new firm is a US firm which does not yet have a full-service offering in London).
In short, a user friendly, reasonable approach to restrictive covenants usually pays dividends in the end in terms of departing partners and client relations.
If the departing partner’s current firm has varied the terms of its LLP members’ or partnership agreement in respect of previously departing partners (for example, by agreeing shorter notice periods or arrangements in relation to certain clients) then this constitutes a variation of the LLP members’ or partnership agreement by conduct and consent.
The practical difficulty for most departing partners is that deals reached with former partners are confidential and only the management team are aware of the exact retirement terms, rather than all the full equity partners. However, if departing partners were to test their treatment in a court of law, there is a legitimate argument that they should be treated consistently with other
Law firms should exercise extra care if the departing partners are fixed-share equity partners, who in reality are likely to be employees from an employment law perspective. If they find their notice periods or restrictions onerous, they could argue that their current firm has acted in fundamental repudiatory breach of the terms of the LLP members’ or partnership agreement, or the duty of good faith, such that they cannot rely on any contractual terms (such as the restrictions against the departing partner).
There are a number of team moves in the legal market where lawyers and secretaries want to follow partners to their new firm. If the departing partner and team members tender their resignations in such a way that their respective notice periods all expire on the same date, this usually indicates that there has been collusion between the partner and employees and that the partner has acted in breach of his duty of good faith and/or contractual obligations to the current firm. The question for the current firm is then whether to legally pursue the partner, team and/or new firm.
Staggered departures, of course, make proof of collusion more difficult. It could be that employees have responded to news reports of the partner’s new position and team expansion plans at the new firm. It could be that headhunters have made an approach rather than the departing partners themselves to entice the team members to the new firm.
In such situations, as long as the newfirm can show that it was able to ascertain the relevant employees’ information without recourse to confidential information belonging to the previous firm and without the departing partner having revealed the names and identities of the target employees to the new firm (or a headhunter), then the former firm will be pretty powerless.
There is ample scope for dispute on both sides when partners leave their firms.
The partnership has many tools at its disposal to make life difficult for departing partners. However, using such tools can make it appear overly defensive and insecure. Partners themselves will also be highly accomplished at finding loopholes, wiggle room and ways of securing a speedy exit.
But, it is never advisable for departing partners and their former firms to burn bridges. In a highly competitive market in which law firm mergers are increasing, their paths may cross again. The best approach often comes down to a compromise that both parties can live with commercially.
See our blog, 'Top tips for law firms recruiting teams and partners', for further information.
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