The draftsman's contract
26 September 1995
13 October 2014
7 January 2014
9 May 2014
20 March 2014
9 December 2013
Michael Simmons is partner at Finers and a consultant on professional practice problems.
It is surprising how many firms of solicitors are prepared to leave the regulation of their own affairs to chance, or to the lottery of that ancient statute the Partnership Act 1890. Yet no self-respecting lawyer would advise their client to establish a business with anybody else without seeking to regulate the relationship in a written, binding form.
Who wants to be a member of a partnership at will? Any partner who wants to leave can do so by giving immediate notice to the others. There is, therefore, an innate lack of continuity in such a partnership.
Furthermore, any departure triggers off a dissolution unless an agreement is reached to the contrary. Because of the nature of the preceding year basis of taxation, coupled with the profit pattern which so many firms have experienced recently, the Inland Revenue will be able to take an extra slice of tax.
If there is no express provision in a partnership agreement to that effect, partners cannot expel an unproductive member. All they can do is dissolve the partnership. A partnership at will does not restrict competition from former partners. The outgoing partner could set up next door and compete vigorously, damaging the first firm's goodwill. Is this the intention?
The absence of any express provision for goodwill leaves the position open. For some firms it is still a valuable asset.
Many partnerships make one of their members produce a draft agreement, but somehow the partners never manage to execute it. This is frustrating for the draftsman and can create problems if a break-up occurs.
Are we dealing with a true partnership at will or are the partners bound by an agreed draft, albeit unexecuted? It will always be a question of fact. If the partners have enjoyed the benefits under such a draft, they should equally be bound by the burden.
However, it can often be shown that the draft, although passed around the firm, was never actually agreed. And if it has been amended on its rounds, it may be even harder to prove such an agreement.
Worse than no partnership agreement at all is one which fails to address the important issues which often arise when there is a conflict. It is true that the partnership agreement, once executed, can be relegated to a bottom drawer until it is needed. Its existence, if it deals with all relevant possibilities, may be sufficient to ensure that it will never be needed.
Often the draftsman has taken the easy way out and adapted a near-Victorian precedent. This is likely to focus more on the partners' obligations to the outside world than their rights and duties to each other. Is it necessary to express the fact that partners must be just and faithful to each other when that premise is clearly set out in partnership law?
A modern partnership agreement should resemble the memorandum and articles of association of a registered company. It should be expansive in relation to the rights and obligations of partners to each other. Time and effort should be spent dealing with clauses relating to practice management.
Is unanimity required for any decisions? As partnerships become larger, this provision is tending to die out. There will be matters of substance which require the equivalent of a special resolution and a substantial voting majority.
However, a large number of day-to-day decisions can be settled by a simple 51 per cent majority. Each partnership will give different weight to those matters which require a special resolution, but some obvious ones are the addition or expulsion of a partner, the opening of a new office or merger, changing the firm's bank or auditors, or matters involving unusually large expenditure.
The agreement should consider the method of management. Is the firm to be managed by the partnership as a whole, a committee or series of committees, or a managing partner? How much power is to be devolved to each, and what are the checks and balances? Such a document is unlikely to be off the peg but is more likely to be tailor-made for the particular quirks of the firm in question.
The profit sharing, remuneration and drawings' policy of the partnership needs to be agreed and recorded.
Is the division of profits set in stone, or is a formula stated for moving to equality? Is there a provision for a bonus pool, variable profit sharing and, if so, on what basis? While there are industry standards for all three profit systems, individual variations are the norm rather than the exception. Partners need regular monthly drawings. In good years there should be a provision for a top-up at the end of the year if cash flow allows. Conversely, in a bad year, there needs to be a provision to claw back overdrawings.
Expenses and their treatment, especially in relation to cars, are the source of endless debate. Does the partnership provide cars for the partners? If so, what are the financial limits and renewal terms? On the basis that the car debate can overshadow all other issues, it is often better to leave partners to purchase their own.
Drawings may or may not be linked with capital contributions. Again, it is important to set the initial capital of the firm, who contributes what, and who makes the payments if more is needed.
Absences for sickness and other reasons need to be covered, especially in relation to pregnancy. How long is a partner entitled to be away without suffering a financial penalty? A balance needs to be struck between fairness to the partners who share the extra burden, against the fact that many of these events, except for pregnancy, can affect anyone.
Expulsion and retirement provisions usually occupy a disproportionate part of the agreement. The former have to be drafted with care so that their use is fair. The latter usually provide for goodwill to accrue automatically to the remaining partners and allow a partner to retire on notice, which is considered sufficient for the firm as an ongoing entity, while not binding in a partner unfairly who wishes to leave.
The financial considerations of a departure, whether involuntary by death, bankruptcy, expulsion or otherwise, or voluntary as a result of notice can require subtle drafting.
The outgoing partner, or his or her estate, will want to be paid out as quickly as possible. The continuing partners will be mindful of the firm's cash flow and may want to phase such payments over a period of time. A balance has to be struck.
The components of the payout also have to be considered carefully. A number of firms insist on departure only at their year end. Are the normal accounts sufficient? Is it necessary to produce special retirement accounts where assets and liabilities are revalued? What about work-in-progress or debtors in a firm which draws up its accounts on the cash basis? If accounts have to be drawn up at any time other than the firm's year end, who pays for them? A distinction will have to be drawn between an outgoing partner's current account, which will have any undrawn balance of profits added to it, the capital account, and reserves for partnership taxation. There may be some useful ways of mitigating tax by use of pension contributions.
Interest needs to be paid on any outstanding balance, and an accelerator clause, in the event of failure to pay promptly, is not unknown.
Are the continuing partners bound to provide any kind of pension to an outgoing partner? Annuities for retiring partners used to be popular. However, the need not to burden future partners probably militates against them.
The modern partnership provides for each partner to arrange his own pension during his lifetime by way of personal pension premiums. Some partnership deeds lay down the amount and frequency of these provisions.
In order not to put temptation in the partners' way, the partnership secretariat will often have instructions to make payments directly to pension providers on the individual partners' behalf.
The underlying principle is that widows and orphans are not welcome once the bread-winner has died. Mutual and life insurance cover is another possibility. All are expensive, and many are not tax-efficient. Each partnership needs to decide which are the best ones for them. Similar considerations apply to medical and permanent health insurances.
The continuing partners will want to ensure an outgoing partner does not unfairly compete. What is 'unfair' is relative for every partnership. The clause in question must stand up to the usual tests in law.
How many solicitors in their anxiety to preserve goodwill forget this and go over the top?
Either time or space limitations are sometimes overlooked, or are oppressive. An absolute bar for a reasonable period of time and space may be valid. The partners may consider this too harsh when the outgoing partner was responsible for introducing a great number of clients. If the covenant is strictly enforced clients may not stay with the firm and will have to seek representation from a third set of lawyers. This shows little commercial sense.
A clause providing for a commission payment on clients removed by an outgoing partner for a reasonable period of time may make economic sense. The firm's culture and objectives need to be considered.
The outgoing partner needs to be bound to execute a continuing election for income tax, if required. Against this, he or she needs to be indemnified against any increased tax payable as a result.
In addition to expulsion clauses, partners need to consider whether they want the power to suspend one of their number. If so, is it necessary to spell out the occurrences which can give rise to such suspension or is it sufficient to give overall powers to management?
One firm will be able to adopt standard clauses, because it operates in a standard way. Another firm's governance is unusual, and exceptional remedies will be required.
The draftsman needs to be experienced, adaptable and sensitive to the partnership's requirements. An outsider is often best able to get the 'feel' of the partnership and produce something acceptable. And if partners are paying for their services, they are more likely to take advantage of them and pursue the matter to signature. Often when there is an incomplete agreement, one of the partners has been side-tracked while doing the work, and failed to pursue the matter to completion.
Incorporation may be round the corner for solicitors. Until that time no firm should be without a properly drawn partnership agreement which fits its particular idiosyncrasies.
No commercial agreement, and a partnership deed falls into this category, can cover every eventuality, especially if the parties are consumed by ill-will towards each other.