Key Issues to Consider When Updating Your Firm’s LLP or Partnership Agreement
A number of firms have been revisiting and updating their Partnership or LLP Agreements recently, having discovered that those agreements do not provide adequate powers to deal with underperforming partners or sufficient protection against former partners moving to a competitor and trying to take clients and colleagues with them. Others are reviewing their compulsory retirement age clauses for their partners to ensure they are fully justifiable. We highlight below some of the key partnership and discrimination law issues for firms to bear in mind when reviewing their partnership terms.
1. Reviewing compulsory partner retirement age clauses: Firms need to keep these clauses, and the reasons and supporting evidence for them, under regular review to ensure that partner retirement on the grounds of age, and at the specific age chosen, remain justifiable by the firm. It is not simply enough to be able to point to the fact that the firm has always had a retirement age of 60 or 65 throughout the years and that no one has ever challenged it.
If the firm’s partnership agreement has a retirement age of, say, 65, and that compulsory retirement is challenged by one or more older partners as unlawful age discrimination, the firm should have considered and prepared in advance the basis on which it will seek to defend itself against such a claim. Age retirement clauses are unlawful age discrimination (with the potential of substantial uncapped compensation) unless they can be objectively justified. In essence this means that the firm must show (with concrete evidence) that the requirement that partners retire at 65 progresses one or more specific social policy aims. These include by way of example, workforce planning (in our present context, including knowing when partner places will become available for others), staff retention (including retention of associates who may become disillusioned by lack of promotion opportunities and leave if older partners do not retire), intergenerational fairness (sharing of partnership opportunities between the older and younger professionals), and preserving dignity of older workers (by avoiding the perceived humiliation for older partners of being performance-managed out if their productivity declines with age).
The firm must then be able to show that having the retirement age clause, and specifically at the chosen age of 65, is a proportionate way of achieving those aims, having regard to the particular circumstances of that firm at the time. It will also need to show that there is no less discriminatory way of achieving the firm’s legitimate aims.
It would be advisable for firms when revisiting their partner retirement age clause to have detailed (and documented) discussions amongst all the partners as to the proposed justification for the clause and thereafter, if necessary, to amend the age at which it applies, or even to remove the clause all together if the partners conclude that it can no longer be genuinely justified in their particular circumstances.
2. Dealing with under-performing partners: Whilst most firms’ partnership agreements provide for partner expulsion on the grounds of gross misconduct, some still have no provision to ask a partner to retire without cause, such as for under-performance. Without such a clause, the firm will not normally be able to secure the removal of that partner without his or her agreement (or otherwise dissolving the firm). It is therefore essential that modern partnership agreements include the right for the firm to be able to ask a partner to leave without cause, either with a period of notice or a payment in lieu of notice, and to consider whether this should be a decision which requires a partnership majority vote or which should be devolved to senior management.
It is also worth considering whether to expressly build in a formal process to be followed before any such proposed expulsion without cause takes place, including: providing the right of the partner to know in detail the reasons for which they are being asked to leave, to make representations on those reasons and to be accompanied by a fellow partner during any related meetings. The purpose of such a formal process is to ensure best practice and transparency in partner exit arrangements, and fair and consistent treatment of the partner in line with any good faith obligations owed to him. It will also place the firm in the best position to show subsequently that the reasons why the partner was asked to leave are not connected to unlawful discrimination on grounds of one of the protected characteristics (which include sex, race, age, sexual orientation, disability, religion or belief), but rather are for genuine, non-discriminatory business reasons.
Firms who exit partners without an appropriate procedure and papertrail can leave themselves vulnerable to such a discrimination claim, as well as other claims. Providing for these procedures clearly in the partnership deed will ensure as far as possible that they are applied consistently and fairly.
3. Managing exiting partners under notice: It is more important than ever to ensure that firms have a very detailed garden leave clause which gives them the right, for example, to require that an exiting partner remains at home or at another office, undertakes alternative responsibilities, ceases to have contact with clients and colleagues, refrains from making or authorising announcements regarding their departure, and is cut off from access to the firm’s confidential information and its computer systems and email.
Equally, if the firm wants the partner to continue coming into the office and working during his or her notice period, it also advisable to retain the express right to be able to unequivocally direct and limit such partner’s client and marketing activities during that period, and to be able to require the partner to transition client and contact relationships to other partners as soon as the firm requires that he or she does so.
Including express powers which give the firm the clear right to limit and direct the activities of the partner both whilst on garden leave and while they are still in the office is invaluable to ensure the firm can protect its business interests and avoid being held to ransom by an exiting partner who does not want either to hand over his clients immediately on request or cease his marketing activities prior to his departure.
4. Ensuring partner restrictive covenants are enforceable: As the market becomes ever more competitive and the need to protect client and introducer relationships becomes even more important, it is essential that firms ensure that their partner restrictive covenants which apply after the partner retires from the firm, are up-to-date and as potentially enforceable as possible.
Although partnership case law does make it more likely that restrictive covenants which would not otherwise be enforceable against employees would nevertheless bind partners, firms still need to be able to show that the partner restrictive covenants in their partnership deeds are sufficiently limited so that they are no more than reasonable and necessary to protect their legitimate business interests (including confidential information, client (and potentially introducer) relationships, and maintaining a stable workforce). If they are too wide they run the risk of being unenforceable against exiting partners, and indeed many firms only discover this once they try unsuccessfully to enforce them in response to the competitive activities of a particular former partner. The impact of failed enforcement of restrictive covenants on the firm’s business and also on the conduct of other partners who may also be considering joining a competitor, can be significant.
Most modern, professional partnership restrictive covenants are drafted to last for up to 12 months (and more rarely, 18 months to 2 years) from the date of retirement. The duration chosen by the firm should have regard for example to the period of influence which partners are likely to have over clients and colleagues etc, and how long it will typically take for the firm to consolidate its position with such clients and colleagues. There may be a reduction in the period for any time spent by the partner on garden leave. Restrictions will sometimes include a shorter non-competition clause preventing the exiting partner from working within a limited geographical area during that restricted period if most of the firm’s clients are based locally.
Restrictions on soliciting work from or doing business with the firm’s clients are common but a number of firms still have outdated provisions which fail to identify and limit the restricted clients by reference for example to personal contact with the client or access of the partner to their confidential information. Restrictions on soliciting or offering employment to restricted categories of colleagues for a specific period are similarly common (though non-employment provisions are more open to potential challenge on current case law).
Some modern partnership agreements also include detailed provisions which seek to prevent team moves by partners and associates. Whilst as yet untested by the courts, a detailed and carefully limited team move clause can have a significant psychological deterrent effect and also can place the firm in a much stronger negotiating position to require a commercial settlement from the exiting partners in the team and potentially also the firm they plan to join (who may be joined as a party in any proceedings).
5. Responding to HMRC’s proposed review of Fixed Share partner status of LLP Members: HMRC recently undertook a consultation on whether to remove the presumption of self-employed partner status for LLP members for tax and NIC purposes. They also consulted on whether or not they should automatically treat fixed share or salaried members who fail to satisfy certain proposed criteria (which go far beyond the normal employee status tests) as employees for those purposes. This may have a significant impact (and associated cost) for firms which have a number of fixed share partners who may be nearer to employee status rather than genuine partners. If HMRC makes the proposed changes, firms will need to consider carefully the partnership terms which apply to those fixed share (and salaried) members to see whether it is appropriate to continue with that status or if the terms require adjustment to ensure as far as possible that they are treated as genuine partners for tax and NI purposes rather than employees.
The above are just a few of the key issues that firms should be considering when reviewing their partnership and LLP agreements. There are others worth considering too, such as whether the agreement adequately addresses the position of a partner on long-term sickness absence. The agreement should ideally ensure this is addressed in profit sharing, permanent health insurance, medical examination and records, medical suspension and (subject to disability discrimination law issues) expulsion provisions which all hang together properly to protect both the firm and the individual partner.
Other areas for consideration include maternity, paternity and flexible working provisions; and review of profit and loss sharing arrangements to ensure appropriate and clear allocation provisions are included. In terms of lockstep systems, these should be revisited generally for age discrimination purposes and specifically to see if the firm wants to take advantage of the 5 year service benefit provisions which make the arrangement automatically exempt from age discrimination; lockstep systems which require longer than 5 years’ service to reach the top of the profit share ladder will otherwise need to be justified by the firm.
Finally, consider whether the voting requirements in the partnership terms are still realistic or whether these need to be reduced (and potentially certain powers devolved to senior management) to allow faster and more responsive strategic decisions by the firm in key areas.
The most important thing though is to review these issues proactively and in advance, so that instead of being on the back foot in extreme circumstances, the firm can be confident that it will be able to respond quickly and effectively to close down major threats to its business.