Opinion: When is a partner not a partner?

Two non-equity partners are apparently suing Clifford Chance in Germany, ­following their removal in a recent firm restructuring. They are claiming that they were employees rather than shareholders and so were entitled to protection from unfair dismissal.

Clive Howard

Clive Howard

These events may be happening in another country but they serve as a timely reminder of the continuing uncertainty over the employment status of partners in UK law firms.

Many firms have slashed their ­partnerships recently, with non-equity partners among these cuts. In some cases, the non-equity partners may have held employee status, even if they were ­routinely described as genuine partners and taxed under Schedule D. The issue is complex and at the very least worth ­investigating.

If an individual is a genuine partner, they are not an employee and do not enjoy statutory employment rights relating to unfair dismissal and redundancy.

There are other crucial differences between the legal position of genuine partners and that of employees. For ­example, restrictive covenants are more likely to be upheld against genuine ­partners, who are considered to have equal bargaining power, than against employees. The duty owed between ­genuine partners of good faith is a higher duty than the duty of mutual trust owed between employer and employee.

When is a partner an employee? ­Historically, two factors are considered the most important.

  • Is there a sharing of profit and loss? It is a common misconception that by sharing profit an individual becomes a partner and not an employee. But that is not the case. It is a determining factor but other factors come into play, such as whether individuals have to make a capital ­contribution and the nature of the ­indemnity provided by equity partners.
  • What control and influence does the partner hold over the management and financial affairs of the firm? It is not unusual to see fixed-equity partners with minimal participation in management. For example, the combined vote of the fixed-equity group may equate to less than one vote of an individual equity partner. Such an arrangement does not suggest meaningful participation and decision-making and in turn strengthens the ­argument that such fixed-equity partners are not genuine partners and may have employee status

Increasingly, partnership structures can contain several different levels of ­’partners’ as firms make every effort to avoid spreading full equity. Structures with equity, fixed equity and salaried ­partners may be viewed as containing ­categories of individuals who are not ­genuine partners, not least because the structure, or a specific category of partner, could be regarded as a sham.

For example, the primary intention in the creation of the structure may have been to avoid or reduce tax and national insurance contribution liabilities. When considering the history of how and why a class of partners was introduced, if the ­primary reason was to minimise these tax liabilities, that is likely to be a material ­factor when ­considering whether an ­individual in such a category is a genuine partner.
Finally, it is worth stressing that the legal position does not change ­significantly when dealing with LLPs. Courts have confirmed that when ­considering the employment status of ‘members’ of an LLP, the same approach is taken as with partnerships generally, so LLP status does not remove the problem.