Partnership Agreements Between Lawyers: The Essential Provisions

Jun 15

13 min read

A law firm partnership agreement is the instrument that decides, in advance, the questions on which partners are least able to agree once a dispute has arisen: who owns the clients, how profits are divided, what a departing partner takes away and what the remaining partners must pay. Many firms operate for years on a handshake or on a short document copied from another firm, and discover its inadequacy only when a partner retires, falls ill, is lured away by a competitor or is the subject of a regulatory complaint. By that point the parties' interests have diverged, and every gap in the document becomes a negotiating position.

Lawyers are in an unusual position in this respect. Practitioners spend their working lives drafting shareholder agreements, joint venture terms and partnership deeds for clients, and then neglect to apply the same discipline to their own firms. A law firm is also not an ordinary commercial partnership. Its principal assets are the goodwill attached to individual practitioners, the confidence of clients who are entitled to choose their own attorney-at-law, and a professional reputation that every partner can damage. It operates under duties of confidentiality, conflict avoidance and client money handling that no commercial partnership agreement addresses by default.

This article sets out the provisions that a well-drafted law firm partnership agreement should contain, explains the commercial reasoning behind each, and identifies the points on which practitioners most often differ. The law governing partnerships, limited liability partnerships and the professional regulation of attorneys varies between jurisdictions, and nothing here substitutes for advice on the statute and the regulator's rules that apply to the firm in question.

Why a law firm partnership agreement is not an ordinary commercial document

In most common law jurisdictions, partnership is governed by a statute that supplies default rules where the partners have said nothing: equal sharing of profits, equal rights in management, no entitlement to remuneration for work done, and dissolution on the death or bankruptcy of a partner. Those defaults were framed for general trading partnerships. They fit a law firm poorly. Equal profit sharing rarely reflects the contributions of a rainmaking senior partner and a junior partner who has just been admitted. Dissolution on a partner's death is commercially destructive for a firm whose value lies in continuity of client relationships.

The professional character of the business adds further layers. A partner in a law firm owes duties to clients that override loyalty to co-partners. The firm must hold client money in accordance with the accounting rules of its regulator. Each partner is exposed, in a general partnership, to liability for the professional negligence of the others. The agreement must therefore do two things at once: allocate economic rights between the partners, and construct a framework within which each partner can comply with professional obligations without being held hostage by the commercial dispute.

Choosing the vehicle: general partnership, limited liability partnership or company

The first decision, which the agreement should record, is the legal form of the firm. The options available depend on local legislation and on what the regulator permits attorneys to use.

General partnership

A general partnership is the default form and the cheapest to establish. Its drawback is unlimited joint liability of the partners for the firm's debts and, depending on the jurisdiction, for the wrongful acts of co-partners acting in the ordinary course of the firm's business. Where a general partnership is retained, the agreement should be paired with adequate professional indemnity cover and with internal indemnities between partners, recognising that an internal indemnity is only as valuable as the indemnifying partner's solvency.

Limited liability partnership

Where the legislation provides for limited liability partnerships and the regulator permits attorneys to practise through them, the form limits each member's exposure for the firm's debts and for the defaults of others, though not usually for the member's own professional negligence. An LLP is a body corporate with its own legal personality, and its agreement should address matters that a general partnership leaves to the statute, such as designated members, the filing of accounts and the consequences of a member ceasing to be a member. Practitioners should confirm whether the regulator imposes any conditions, such as minimum insurance, on the use of the form.

Professional company or incorporated practice

Some regulators permit incorporated practices, with shares held only by attorneys or by persons approved by the regulator. In that case the primary document is a shareholders' agreement and the articles of association, though the issues discussed below arise in identical form. The terminology differs, but the analysis of capital, profit entitlement, management, departure and valuation does not.

Capital contributions, work in progress and ownership of assets

The agreement should state what each partner contributes at the outset, in what form, and what happens to that contribution on exit. Law firms are not capital intensive, but they are working capital intensive: fee earners are paid before clients pay the firm, disbursements are advanced, and unbilled time accumulates as work in progress. A firm that has not agreed how this is financed will find that the partners with deeper resources fund the firm informally and then dispute whether those advances are capital, a loan or a prepayment of profit.

The provisions to consider are these:

the amount of fixed capital each partner contributes, and whether it is to be topped up as the firm grows or as partners' shares change;
whether capital carries interest, and if so at what rate and in priority to profit division;
how partner loans are documented, ranked and repaid, so that they are distinguished from capital;
how work in progress and unpaid disbursements are valued when a partner enters or leaves;
who owns the firm's name, domain names, precedent bank, software subscriptions and premises lease; and
the treatment of tax liabilities that fall on individual partners in respect of profits not yet received in cash.

The last item is easily overlooked. In a transparent entity, partners may be taxed on their share of profits whether or not the firm has distributed them. The agreement should provide for tax distributions or for a retention policy that does not leave partners with a tax liability and no cash to meet it. The relevant tax rules are for the firm's accountants, but the agreement is where the policy is fixed.

Profit sharing: the four principal models

Profit division is the provision most likely to produce friction, because it is a continuing referendum on each partner's worth. There is no correct model; there are only models whose consequences the partners understand and accept. The usual structures are summarised below.

Model	How it operates	Principal advantage	Principal risk
Equal shares	Each partner receives the same share of net profit	Simplicity and cooperation between partners	Resentment where contributions are visibly unequal
Lockstep	Share rises with seniority or years as partner on a fixed scale	Encourages mentoring and sharing of work	Rewards tenure over performance and may drive out high performers
Formula based	Share derived from measurable factors such as origination, billing and management work	Transparent and defensible	Encourages partners to optimise the metric rather than the firm
Discretionary or merit based	A committee or managing partner allocates shares periodically	Flexible and responsive to change	Opacity and disputes about fairness

Many firms use a hybrid: a fixed salary or drawing for each partner, a priority share to reflect capital, and a residual pool divided by formula or by committee. Whatever is chosen, the agreement should state how and when shares are reviewed, who decides, whether a partner may inspect the data on which the decision was made, and what happens to a partner whose share is reduced. A reduction that the partner regards as unfair should give rise to a defined process, not to an implied right to leave with clients.

The agreement should also separate drawings from profit. Drawings are advances on account of expected profit, paid monthly or quarterly. If the year ends with profit below drawings, there must be a rule for repayment or set-off. A common drafting failure is to provide for drawings without providing for the position when they exceed the share eventually earned.

Illustrative arithmetic

The following is illustrative arithmetic only and does not represent market data. Suppose a firm has three partners and a distributable profit of 300,000 in a given year, in whatever currency the firm uses. Under equal sharing, each partner receives 100,000. Under a model that gives each partner a fixed 20,000 priority share for capital and divides the remainder by a 50, 30 and 20 per cent split, the first partner receives 20,000 plus half of 240,000, which is 140,000; the second receives 20,000 plus 72,000, which is 92,000; and the third receives 20,000 plus 48,000, which is 68,000. The example shows how a modest change of structure moves the outcome materially, and why the agreement must set out the calculation in full rather than describe it in general terms.

Management, decision making and reserved matters

A partnership agreement should separate day to day management from decisions that require the consent of the partners. Without that separation, either every decision is made by committee and the firm cannot act, or a managing partner exercises powers that the others never intended to confer.

Matters ordinarily delegated to a managing partner or management committee include supervision of staff, approval of routine expenditure up to a stated limit, and the day to day administration of the practice. Matters usually reserved for a vote of the partners include admission or expulsion of a partner, a change of the firm's name or business, borrowing above a stated limit, the acquisition or disposal of premises, a merger or acquisition of another practice, the commencement or settlement of litigation by or against the firm, and any variation of the agreement itself.

The voting thresholds deserve care. Unanimity gives each partner a veto and invites deadlock. Simple majority allows a coalition to dominate the minority. A common compromise is a simple majority for ordinary reserved matters and a qualified majority, such as three quarters by number and by profit share, for fundamental ones. The agreement should state whether votes are counted per partner or weighted by profit share, since the answer matters greatly in a firm with one senior and several junior partners.

Client money, indemnity insurance and regulatory compliance

Because the regulator, not the partners, sets the rules on client money, the agreement should defer to those rules and assign operational responsibility. It should identify which partner or partners are responsible for supervising client accounts, require compliance with the applicable accounting rules, and require that every partner cooperate with inspections, audits and any investigation. It should provide that a partner who breaches those rules bears the consequences, including contribution to any shortfall that the firm must restore, and that the other partners may suspend that partner's authority over client accounts without waiting for the regulator.

The agreement should also deal with professional indemnity insurance. It should specify the minimum cover the firm maintains, who selects the insurer, who is responsible for renewal and for making notifications of circumstances, and how the deductible or excess is borne between the firm and any partner whose conduct gave rise to the claim. Practitioners should also consider run-off cover. When a firm closes, or a partner retires, claims may emerge years later for work done during the partner's tenure. Where the policy is written on a claims made basis, the agreement should say who pays for extended reporting cover and for how long.

Conflicts of interest and confidentiality belong here as well. The agreement should oblige each partner to disclose conflicts promptly through the firm's conflict checking process, and should acknowledge that information barriers, where required, take priority over the partners' ordinary rights of access to firm information.

Restrictive covenants and the ownership of client relationships

No provision attracts more litigation than the one governing what a partner may do after leaving. The legal and ethical context is distinctive. Clients are free to instruct the attorney of their choice, and many regulators take the view that a covenant which prevents a client from following their chosen attorney offends professional principles. Courts in a number of jurisdictions therefore scrutinise restraints on lawyers more closely than ordinary commercial restraints, and the enforceability of a given clause depends on local law. Drafters should not assume that a covenant that would be enforced against the seller of a business will be enforced against a departing attorney.

Within those limits, firms commonly seek to protect their position through provisions of the following kinds:

a notice period during which the departing partner remains bound by duties of good faith and continues to be paid;
a prohibition on soliciting the firm's staff for a stated period;
a prohibition on actively soliciting the firm's clients, as distinct from acting for those who choose to follow;
a protocol for joint communication to clients, so that the client receives a neutral notice setting out the options of staying, moving or appointing another attorney;
an agreed procedure for the transfer of files, the retention of copies and the payment of the firm's outstanding fees and lien rights; and
an acknowledgement that the client's instructions, not the firm's preference, determine where the matter goes.

A protocol of this kind is often more valuable than a wide covenant. It is enforceable in practice because it is consistent with professional duty, it protects the client from a bruising contest for their file, and it supplies evidence of good faith if a dispute follows. The agreement should also state who holds the firm's records and how confidentiality is preserved when a partner leaves with permission to act for a client.

Retirement, expulsion, death and incapacity

An agreement should anticipate each way in which a partner may cease to be a partner, since each raises different questions.

Voluntary departure and retirement

The agreement should specify the notice a partner must give, the age or conditions at which retirement is permitted, and whether the retiring partner may continue to receive income for a transitional period in return for assisting in the handover of clients. A glide path, in which a senior partner's share reduces over a defined period as client relationships are transferred, serves both the individual and the firm. Without one, the firm risks losing clients at the moment of retirement.

Expulsion

The agreement should list the grounds on which the other partners may expel a partner, which usually include serious professional misconduct, suspension or striking off by the regulator, conviction of a dishonesty offence, bankruptcy, persistent breach of the agreement and a prolonged failure to contribute. It should state the voting threshold, whether the affected partner votes, and the procedure, including notice and an opportunity to respond. An expulsion clause that is exercisable without cause is unusual and carries a greater risk of being challenged as an abuse of power.

Death, incapacity and loss of practising status

The agreement should provide that death or incapacity does not dissolve the firm. It should specify whether the estate is entitled to a payout, how that sum is calculated, and over what period it is paid. Many firms fund this through partnership assurance policies, which should be addressed expressly in the agreement. A partner who loses the right to practise, for example on suspension, should be treated separately from one who retires, because the firm may have to remove that partner from client matters immediately. The agreement should empower the other partners to do so and to arrange the supervision of the affected matters.

Valuation and payout on exit

Valuation is where goodwill, work in progress and capital meet, and where the absence of an agreed method is most costly. A departing partner will argue for a high valuation; the continuing partners will argue for a low one. The agreement should therefore fix the method, the date as of which it is applied and the identity of the valuer if the figure cannot be agreed.

The principal components of a payout are usually the partner's capital account, any undrawn profit for the period to the date of exit, a share of the value of work in progress and, if the partners have agreed to pay for it, a share of goodwill. Many professional firms decline to pay for goodwill on the basis that it is personal to the practitioners, and instead compensate the departing partner only for capital and earned profit. Others pay a formula based amount, for example by reference to recurring fees from clients who remain with the firm. Each approach is defensible; what matters is that the choice is deliberate and written.

The agreement should also provide for the timing of payment. A firm cannot normally fund a large exit payment from a single month's cash flow, so the usual solution is payment by instalments over a stated period, with security or acceleration events if the firm is sold or ceases to trade in the meantime. It should state whether interest accrues on the unpaid balance and whether the continuing partners may set off sums that the departing partner owes the firm, including any liability arising from negligence claims. Where a partner leaves under a cloud, the agreement may allow the payout to be retained, in part, until the firm's exposure for that partner's matters is known. Such a retention should have a long stop date, otherwise it operates as a de facto forfeiture.

Dispute resolution and deadlock

A partnership agreement should assume that the partners will, at some point, disagree, and should channel that disagreement into a process that does not destroy the firm. A tiered clause is a sensible model: direct negotiation between the partners, then mediation before a mediator agreed in advance or nominated by a named body, then arbitration or litigation as a final step. Arbitration has the benefit of confidentiality, which matters to firms whose internal disputes would otherwise become a matter of public record and a source of reputational harm.

The agreement should address deadlock in a two partner firm or in a firm split into equal blocks. Options include a casting vote for a named person on defined matters, referral to an independent expert on financial questions, and a buy-sell mechanism under which one partner states a price at which they will either buy or sell, leaving the other to choose. A buy-sell clause is effective only where the partners are of broadly similar financial strength; otherwise it favours the richer partner and should be used with caution.

The agreement should also provide for interim relief. Even when the dispute is to be arbitrated, a party may need to approach a court urgently to protect client files, prevent the removal of funds or restrain a breach of confidentiality. The dispute clause should preserve that right.

Practical next steps

A firm that has no agreement, or an agreement that is out of date, can improve its position in an orderly way:

Establish the current facts: the legal form of the firm, the identity of each partner, the capital contributed and the shares actually being paid, which may differ from anything recorded.
Obtain the statute governing partnerships and the regulator's rules on the form of practice, client money and covenants, and list the points on which the agreement may or may not depart from them.
Hold a structured discussion among the partners on each of the topics in this article, recording their positions before any draft is prepared. Differences discovered at that stage cost far less than differences discovered during a dispute.
Retain independent advice for any partner whose interests differ materially from the majority, so that the agreement is not later impeached on the ground that one partner signed without understanding it.
Have the draft reviewed by the firm's accountants for tax consequences and by its insurance broker for consistency with indemnity cover.
Sign the agreement formally, store the executed original securely and diarise a review at a fixed interval, for example every two or three years, and on any change in the partners.

The firm should also keep a register of the matters that must be revisited whenever a partner is admitted or leaves: schedules of capital and profit shares, the list of authorised signatories on bank accounts, notifications to the regulator and insurer, and updates to the firm's letterhead and website.

How practice management software supports the partnership

A partnership agreement is only as reliable as the data used to apply it. Origination records, billing figures, work in progress and client account balances are the inputs to profit sharing and exit valuation, and disputes are far easier to resolve when those inputs are held in one auditable system with a clear history. A cloud practice management platform such as Legalytech, which holds matters, clients, documents, billing and a contract repository in one place, allows partners to retrieve the executed agreement, track the data on which shares are calculated and demonstrate who acted on a matter and when, and its pricing per firm with unlimited users means that adding a partner or fee earner does not alter the cost of the system.

This article is provided for general information only and does not constitute legal advice. Practitioners should consult the rules of their own jurisdiction and regulator.