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How to Protect Your Firm’s Goodwill with Partner Restrictive Covenants – Part 3 in our Key Building Blocks of an LLP Agreement Series

Following a brief summer hiatus, we return with the third instalment in our series on the Key Building Blocks of an LLP Agreement.

In the second instalment, Securing Long Term Stability of Your Firm Through Your LLP Agreement, we discussed the tools that can be incorporated in to your LLP Agreement to “lock” partners into your business as far as possible. However, even if you include the most sophisticated lock-in type provisions in your LLP Agreement, partner departures are still an inevitable fact of life. It is therefore crucial that you safeguard the firm’s goodwill following a partner’s departure by ensuring that any restrictive covenants applicable to the retiring partner are fully enforceable.

The Privy Council decision in Bridge v Deacons [1984] 2 All ER 19 remains the leading authority on the enforceability of restrictive covenants against partners. The partnership agreement in Bridge v Deacons included a five year restriction preventing former partners from acting for any client of the firm. However, given the passage of time and market developments since Bridge v Deacons, it is possible that if a similar case were decided today, the court would find such a restriction unreasonable.

In order for any restrictive covenants to be enforceable against a former partner, the firm will need to establish that the covenants in the LLP Agreement are sufficiently limited so that they are no more than reasonable and necessary to protect the firm’s legitimate business interests. If the covenants are too wide they run the risk of being unenforceable.

When reviewing each of your covenants and their enforceability, the three key aspects to consider are (i) duration (if it is too long it could be deemed unenforceable), (ii) type of restriction (some are more difficult to enforce than others) and (iii) scope (if it is too wide it could also be unenforceable).

Duration 

When settling on the duration of any covenants, a firm will need to demonstrate that the period is reasonable and necessary to protect its legitimate business interests, for example to allow it sufficient time to consolidate client and staff relationships in the wake of a partner departure.

Typical restriction periods for professional services firms range from six months to up to two years (the latter being less common) (indeed, five year restrictions (as in Bridge v Deacons) are relatively unheard of).

Where there are two or more classes of partners in a firm, a shorter period is commonly applied to the junior tier(s) (e.g. six months) whilst a longer period is applied to senior partners (e.g. 12 months).

You may also wish to consider whether any period spent on garden leave should be deducted from the restriction period so that a partner is only locked out of the market for a maximum period of (for example) 12 months (which would include both his/her garden leave and restrictive covenant period).

Types of restrictions

Most professional services firms LLP Agreements include “non-solicitation” covenants preventing a former partner from poaching clients, staff and introducers.

It is increasingly common to also include “non-dealing” covenants preventing a partner from acting for a client (even if the client approaches him/her) or employing/going into business with staff or other partners (regardless of whether the relevant employees or other partners were encouraged to leave the firm).

Non-compete covenants are relatively unusual in the professional services sector (although more common in some professions such as financial services and accountancy) and the most likely to be challenged as unenforceable. If you do have a non-compete covenant in your LLP Agreement you should consider whether it should be for a shorter duration that the non-solicitation/non-dealing covenants and whether it is sufficiently narrow in scope (see below) in order to maximise the likelihood of the covenant being enforceable.

Professional services firms are increasingly using sophisticated covenants which seek to prevent team moves by partners and employees. Whilst such provisions are yet to be tested in court, a carefully drafted team move covenant can be a significant deterrent to partners contemplating a team move. It could also place the firm in a much stronger position to negotiate a commercial settlement with the departing partners and potentially also the firm they plan to join (who may be joined as a party in any proceedings).

Scope of restrictions

The scope of your restrictions should be aligned with the size and nature of your business. If you are a relatively large firm with multiple offices in numerous locations/jurisdictions, covenants restricting a partner from soliciting or dealing with any client or employee of the firm may be deemed unreasonable. A similar restriction for a small single office firm would be more likely to be enforced.

Restrictions should be sufficiently narrow in scope, for example by reference to a specific geography (e.g. the area/jurisdiction in which the partner is based) and clients with whom a partner has had personal contact with or access to their confidential information. Similarly, non-solicitation of colleagues can be narrowed to specific categories of employees and those based within the partner’s team.

Keeping your covenants under regular review

Departing partners often challenge the enforceability of the restrictive covenants under the firm’s LLP Agreement as a tactical stance when negotiating exit terms. To avoid being wrong-footed by claims of potential unenforceability, it is important that you keep your covenants under regular review to ensure that they remain reasonable in the context of the firm’s business and in accordance with general market practice.

The next edition of this series will consider the typical profit-sharing and partner appraisal structures for professional services firms.

If you have any questions or would like advice regarding your LLP Agreement or any of the issues discussed above, please contact Zulon Begum or Clare Murray.

Click the following links for further information about advising partners and firms on restrictive covenants.

Read the first and second installments in this series.

Click here to read our Little Book of Partner Exits and Team Moves.

Click here to watch a short video of our Managing Partner, Clare Murray, discussing Partner Restrictive Covenants.