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Managing Exiting Partners

Clare Murray

Article published in CIPA

Managing Exiting Partners

Softening the Blow For Exiting Partners

There is never a good time to exit a fellow partner. However, now more than ever, senior management are having to take tough decisions to address issues of long-term partner underperformance and to restructure the partnership to ensure the long-term future of their firm.  We highlight below some of the steps which firms may take to make the process of asking partners to leave less painful whilst still protecting the firm, and identify some of the issues which individual partners may wish to raise, and senior management may therefore anticipate, in typical partner exit discussions and negotiations.

Steps to protect the firm

From the firm’s perspective, the first step for senior management is, without question, actually to read the partnership agreement and understand the rights of a potentially departing partner – these are frequently overlooked or misunderstood.

Ensure you have a full understanding of the extent of your powers and obligations in relation to the proposed partner exit, and of matters such as the basis for selection for departure; the process and tactical options in terms of handling and achieving that exit; the options to seek to mitigate the effects of partner exits (such as considering alternatives to departure including reduction in profit-share entitlement, de-equitization or a consultancy arrangement); the reasons and information to be put to partners to secure an expulsion vote in the absence of agreement and the extent to which a partner should have a right of response to such proposed resolution; the extent to which exit discussions and related matters should be kept confidential; and the type of detailed terms normally contained in partner exit arrangements.

Put in place the internal paperwork to support the decision-making process whether it relates to the underperformance of a specific partner or, in the case of a wider partner restructuring, the need to make cuts in the partnership, where such cuts need to be made and why, and the basis of assessment of partners for potential exit, including the selection criteria and process.

In a partner restructuring, avoid adopting simplistic selection criteria, such as pure recent financial performance, which may disadvantage certain categories of partners and amount to unlawful discrimination.  In our experience pure financial performance-based criteria are most likely to affect partners who are on, or recently returned from, maternity leave and/or working part-time or flexibly due to childcare; older partners including (though by no means limited to) those recently returning to full time client work after stepping down from management; and partners who have had periods of sickness absence due to serious ill-health such as cancer.

Ensure all partners in the group to be affected by any restructuring are included in the selection pool and are assessed consistently against each other, with written assessment sheets in support; be prepared to provide a copy of that assessment sheet to the partner upon request.

Keep the number of people involved in this process to a minimum and impress on them the importance of keeping the proposed departures confidential whilst discussions are ongoing; confidentiality, agreed statements, non-disparagement and mutual co-operation for a smooth handover are key factors for both the firm and partner in protecting their respective reputations.  Get this wrong at an early stage and you potentially lose significant leverage in negotiations.

Prepare in advance a reasonable retirement package to provide to the individual partner on a confidential, without prejudice basis: heads of terms, followed by a more detailed retirement agreement once those heads are agreed.  Try to offer up front the two things that most exiting partners need:  as much time in the office as possible before departure to enable them to find another job – even more necessary now than ever before; and a sensible financial cushion to protect them if they simply are not likely to find another job at any time in the near future.

Think carefully about the damage that may be done to the partner’s career prospects by requiring an extended period of garden leave.  If the exiting partner is really such a threat to the firm and its client connections should the firm really be asking them to leave at all?

Keep the possibility of seeking a formal expulsion vote under the Partnership Agreement in your back pocket if negotiations do not proceed as planned, but in the meantime try to get agreement to an amicable settlement and allow a reasonable period of time to achieve this, sure in the knowledge that the confidential paper trail regarding business reasons and selection is already in place.

Ensure that those members of senior management who are involved in the exit process commit nothing to email or paper about the exiting partners which they would not wish to be seen.  Under the Data Protection Act 1998, partners can require certain personal data held about them by the firm, including in electronic format, to be provided to him or her within 40 days of submission to the firm of a subject access request and payment of £10.  Such a request often reveals ill-advised emails between partners commenting on the departing partner in terms which create potential difficulties for the firm.

Also bear in mind that the partner may also be entitled to call on the provision of information and documentation under the partnership or members agreement (depending on its terms).

Steps to protect partners and ways for the firm to help

For partners who find that their role is at risk, the process adopted by the firm will normally depend on whether the partner is, in reality, an employee (for example, a salaried partner with employment rights) or a genuine equity partner. Their rights and obligations will depend on such  status and so some thought should be given by both the firm and the partner as to whether they are in fact a genuine partner.  And being aware of the types of points and requests which a departing partner may raise in negotiations will assist any Managing Partner to consider and, where possible, address these in advance in any proposed retirement agreement.

Salaried Partners

Salaried partners put at risk in a partner restructuring should try to find out as much as possible about the restructuring process; there are steps which the firm should follow, including identifying objective criteria to select those at risk, providing those criteria and the partner’s own individual assessment and identifying whether there are any suitable alternative roles available. The individual should be given an opportunity to challenge the criteria during individual consultation meetings if they are unfairly weighted or biased.

Salaried partners who are being exited for underperformance should be put through a performance management process which identifies their shortcomings, provides appropriate assistance and resources to address those shortcomings and allows the individual time and opportunity to improve against set targets or objectives.

Firms which do not satisfy these substantive and procedural requirements are likely to face potentially successful claims for unfair dismissal by their salaried partners.

Equity Partners

Equity partners who are notified of a proposal that they exit the firm will normally consider the following:

They too will need to read the firm’s partnership agreement and obtain advice on the circumstances and required vote on which they can be expelled, whether they have any right to respond or object to the proposed expulsion and what their notice period and financial entitlements are likely to be on retirement from the firm.

They will need to consider whether the firm has acted in accordance with any duty of good faith owed relating to the planned departure, and also whether their selection over colleagues may have been influenced by any element of unlawful discrimination, including sex, age, race, disability, sexual orientation or religion or belief.  Bear in mind that the partner will normally have only three months from the act of discrimination to commence the process of bringing a claim to the employment tribunal, by triggering early conciliation through ACAS.  The partner will need to act quickly if they wish to raise this as an issue and to submit a subject access request.   Often neither the partner nor senior management are sufficiently aware of these issues and the tight timescales that apply; this can occasionally have a dramatic effect on negotiations.

Exiting partners too will need to consider if departure is the only option. As indicated, there may be other alternatives which can and should be suggested to the firm.

Typical key issues in the partner exit negotiations

If the partner is in discussions with their firm regarding the terms of an exit agreement, there are a number of key commercial areas on which both sides may want to focus to assist an early resolution, including the possibility of early return (or repayment to the bank) of capital, early release of tax reserve and acceleration of outstanding profit share payment – possibly with agreement to fix the amount of profit share to provide certainty for the partner and an incentive to agree early exit.

Some partners request in negotiations that any drawings and profit share they have received to date are theirs to keep, and cannot be subject to any subsequent demand from the firm to return money if a hole is later found in the accounts.  They may also request the right to participate in release of bad debt/liability provisions in the accounts if they are eventually distributed to partners.   It will be a commercial matter for the firm as to whether it wishes to agree to any of these items.

Restrictive covenants are more likely to be binding on partners than employees – as the firm is asking the partner to leave because it no longer needs their services, the partner may ask for any restrictions to be waived or at least varied to improve their  prospects of securing a role at another firm. The firm should think carefully about the extent to which it needs and wishes to enforce restrictions, and what it can offer in this regard in negotiations to encourage early settlement.

Agreement should also be sought on the content and timings of internal and external announcements, including to clients, and to agree the terms of a reference. If senior management gives thought to and prepares helpful drafts in advance of opening discussions with the partner, this can go a long way to speeding up the exit negotiations. Including confidentiality and mutual non-disparagement provisions in the draft agreement are usually advisable too.

Consideration should be given to the extent to which the exiting partner is protected from liabilities as a partner in the firm; for example, they may be an LLP member now (which gives some significant protections), but if they were previously, pre-LLP conversion, a partner in the general partnership, the partner will need to understand, preserve and, if necessary, seek to extend indemnities against any remaining liabilities. They will also usually request their prompt release on departure from and indemnity against any personal liabilities incurred as a partner, or LLP member, such as in relation to overdrafts, other bank borrowings, directorships of service companies and premises etc.

An exiting partner may request a mutual waiver of claims as far as possible and this will be a commercial matter for the firm as to whether it is willing to agree to this and an exiting partner may also request that the firm cover or at least contribute to their legal and any other professional fees.

There may of course be additional requests from individual partners in negotiations but a little forward planning by senior management, to take account of the needs of the firm and also the rights and likely expectations of individual exiting partners, is likely to ease the burden, maintain morale amongst continuing partners and result in a better solution for all.

Clare Murray is Managing Partner at law firm CM Murray LLP, which specializes in Partnership and Employment Law.  Clare can be contacted at clare.murray@cm-murray.com or on 020 7718 0100.  

More information about Partnership Law issues can be found  in The  Little Book of Partnership Law  at https://www.cm-murray.com/little-books/little-book-of-partnership-law/