So who's afraid of partnership liability?

The recent Binder Hamlyn decision has prompted partnerships to register in Jersey

“DOOMSDAY ACTIONS”, where firms face bankruptcy and disintegration from litigation, are now as much a threat to lawyers as they are to accountants.

Actions have certainly grown in size and frequency against law firms in the fall-out from pre-recession takeovers, even though the real targets may often remain the auditors and financial advisers.

In the light of the business sector's mounting hostility, both in terms of bid practice and the growing taste in suing professional advisers, urgent questions arise over the future of unlimited liability.

Meanwhile, the principle of joint and several liability, which can cause serious injustice to lawyers and accountants alike, has ensured that even those advising on a minor aspect of a big deal can pick up the whole tab if it goes belly up.

Alasdair Neil, senior partner at Simmons & Simmons, said: “Every single law firm is facing law suits. The trend seems to be for more and larger actions, although a lot are 'deep pocket' actions.” But a potential solution is in sight in the form of the limited liability partnership (LLP) for accountants and, possibly lawyers too.

Tom Scott, Linklaters & Paines' tax partner, said LLP could be the answer. “We and the other large law firms are all looking at the possibility of limiting liability in the 'Armageddon' situation, like a Binder Hamlyn-type claim which can wipe out assets of individual partners.”

Neil said: “It's something that law firms would look at, although there would be complex questions about how it would affect firms.”

Garth Pollard, Clifford Chance executive partner, added: “I would have thought all firms would watch this.”

In the last two years known multi-million pound claims have been made even against firms whose names are synonymous with excellence. The cases, all strongly contested and some dropped, still highlight the precarious nature of the lawyer's job in the 1990s.

Nabarro Nathanson was sued by Bradstock Trustee Services, as trustees to the collapsed Clearmark Group, claiming negligence after directors invested surplus pension funds in the company (The Lawyer 14 December 1993).

Simmons & Simmons was sued by Banque Bruxelles Lambert in a £50 million action over allegations concerning registration of a property in January 1994.

Linklaters & Paines was sued for £115 million damages with bankers SG Warburg over allegations of negligence in due diligence by Irish company Yeoman in connection with a business acquisition, also in January 1994.

Clifford Chance was sued by BZW for negligence in relation to information provided to banks about British & Commonwealth, again in January 1994. Commentators then speculated on the “death of the gentlemen's agreement”.

And Lovell White Durrant and Jeffrey Green Russell were sued by Bank SBG Holdings and an insolvent property company alleging negligence in relation to drawing up certificates of title for a property (The Lawyer 14 February 1995).

Accountants have had an even tougher time, and were stunned by the recent actions against Ernst & Young in the Lloyd's litigation Merrett case.

The firm has been roped in with other defendants to the £300 million award, and the Binder Hamlyn action, where an award of up to £110 million to company ADT is expected to bankrupt Binders' partners.

Recent talk has focused on incorporation. While KPMG, the UK's biggest accountancy firm, is incorporating its audit practice, full incorporation is thought to have many drawbacks. These include an additional tax burden and the loss of partnership culture.

But now the accountancy profession is taking the initiative, offshore style.

“Big six” firms Ernst & Young and Price Waterhouse are assisting the States of Jersey in drawing up a Limited Liability Partnerships law.

The aim is to protect partners' personal assets from litigation while maintaining the partnership structure and culture.

The “Jersey Law”, as the accountants call it, would be far superior to the UK's own Limited Partnerships Act 1907, which, even today, excludes any partner remotely involved in managing the practice and is left largely for 'sleeping partners'.

Under the proposed law, the firm's partnership would remain totally liable for all its debts. But individual partners who have not been responsible for a particular “negligent act” would have their personal assets protected from any debts arising from that negligence.

Jersey's Finance and Economics Committee says all the LLP assets would be available to creditors. Each LLP would be required to make a £5 million financial provision for judgments against the partnership.

Each LLP would be required to have at least one general partner. This would be a legal mechanism for forfeiting the deposit and which could, unlike general partners under the UK's 1907 Act, be incorporated.

LLPs would register in Jersey for a fee.

A draft Bill is expected to be debated in the Island's Parliament, the States of Jersey, in early 1996. If approved and sanctioned by the Privy Council, it could be enacted before the end of the year.

Ian Brindle, Price Waterhouse senior partner, said: “The legislation is aimed at providing a level playing field. Under current UK law, which dates from Victorian times, partners can be pursued quite literally for their shirts…This is something the proposed Jersey Law would prevent.”

Nick Land, Ernst & Young senior partner, said the firm had “had useful discussions with the authorities in Jersey. We support this initiative and will be considering seriously with all our partners whether adoption of the LLP model is appropriate for Ernst & Young.”

Land said that only the partner(s) found liable for the negligent act would be fully liable. Ernst & Young would extend protection to cover this by indemnifying individual partners.

“The guy deemed negligent would still be able to call on the full resources of the firm. The whole concept that sits behind partnership will still exist,” said Land.

“Partners could lose their capital, which in Ernst & Young's case is in excess of £50 million; they could lose their business, but they would not be made bankrupt,” he said.

Land expects his partners to vote on LLP in June 1996.

Linklaters' Tom Scott said lawyers are watching the accountants' moves closely, and not only for how LLP would benefit them. “If they take it up, it could accelerate the idea that lawyers are the last deep pocket to go for. And it's hard to see why the rules should be different for lawyers,” he said.

But the devil is in the detail. Simmons & Simmons' Neil said: “I'm sure any legal partnership would have to look carefully at the implications for day-to-day working relationships between partners, and be very clear about the knock-on effects.”

Right now, top City partners were chewing over the options for forming “an entity which gives limited liability to partners which is fiscally transparent,” said Scott.

There are three: LLPs, incorporation, and contractual capping – where clients accept limited liability in their terms of engagement. “Incorporation and LLP only protect you from Armageddon. Only capping would reduce the average indemnity bill,” said Scott.

“We will wait with very keen interest for further details of the Jersey legal reforms,” he said.

More bleakly, a partnership law expert said some medium-sized firms suffering both inadequate insurance cover and large personal debt might need the LLP solution.

“Quite a lot of law firms are running debits on their internal accounts, where partners actually owe the firm money. If there's a good claim against them the plaintiff might be facing a lot of impecunious partners,” he said.