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Managing and Responding to Partner Exits Part Two: Checklist for Exiting Partners

Partners in professional services firms are not immune to the financial impact of the COVID-19 pandemic. An increasing number of professional services firms are taking protective measures across their entire workforce (including partners) to maintain profitability and ensure the firm’s survival during and after the end of the COVID-19 pandemic.

The protective measures in respect of partners include:

• Offering part time working and a pro-rated reduction in profit share

• Reducing fixed profit shares, units or points

• Reducing or suspending monthly drawings

• Deferring profit distributions

• Calls for additional capital contributions

• De-equitisation of equity partners

• Claw-back of awarded but unpaid bonuses or discretionary distributions

Partners who do not accept such measures may be left in dispute with their firm as to the extent to which the firm can nevertheless impose such changes on them under the partnership terms. They may face the prospect of being asked to leave the firm if they do not agree to such changes.

Other firms are moving directly to asking partners who are perceived as under-performing or as no longer being a good “fit”, to leave on an agreed basis or, if an amicable voluntarily exit is not possible and the firm has the constitutional power to do so, to compulsorily exit partners.

In any partner exit, whether on a negotiated  or compulsory basis, the starting point is to consider the 5 points in the checklist below.

1. Are you in fact a genuine partner?

The starting point is to establish whether you are a partner in the eyes of the law, or you are, in reality, an employee. This is important as your rights and the firm’s obligations will differ according to your true legal status. This news alert sets out the position for true partners (including genuine LLP members) only.

Salaried partners and some fixed share partners are often surprised to discover that they might in fact be an employee with employment rights (including the right to bring a claim against the firm for unfair dismissal, and with a potentially stronger basis for challenging the enforceability of post-termination restrictions against soliciting clients, colleagues and working for a competitor).

Your legal status will be determined on the reality of your situation, regardless of the job title given to you. Various factors will be relevant in determining your status. The key factors which may indicate a true partner include:

• An obligation to contribute capital to the firm

• A variable share of the profits of the firm (rather than a fixed share of profits, which is akin to an employee’s salary)

• Voting rights or participation in management

• Right to share in surplus assets on winding up of the firm

• An agreement to be bound by the partnership or LLP agreement

• Evidence that you and the firm’s intention was for you to be a partner

2. Has the correct process been followed?

In order to be compulsorily exited, the firm must have a contractual power to do so and must follow any agreed process. The power and process may be set out in a partnership or LLP agreement, partner policies, deed of adherence, side letter or partner resolutions. You should identify (or ask the firm to confirm) the basis for your exit and consider the following:

• Do circumstances exist to permit the power of compulsory retirement to be exercised? Firms usually have a power of summary expulsion if specified grounds (such as misconduct, an unremedied serious breach or, in some rare cases, under-performance) exist. Most modern partnership agreements however also permit a firm to exit a partner without cause, on a specified period of notice, where the necessary partner or management committee voting majority is achieved. Ensure you understand the basis on which you can be asked to leave and who has the authority and by what majority to secure your involuntary exit.

• Has the firm properly followed the process (for example, seeking and securing partner approval, serving a notice in writing, offering a right of appeal (where applicable) and complying with any time limits)? If you are resigning, is the firm allowing you to give the specified period of notice?

• If the firm has discretion to decide whether to force your retirement, has the decision-maker potentially acted in bad faith, arbitrarily or capriciously?

• Has the firm complied with its duty of good faith (if any) to you?

3. Is there any evidence of discrimination or unlawful whistleblowing detriment?

Consider whether your selection over other partners may have been influenced by:

• Any unlawful discrimination (on the grounds of your sex, age, race, disability, sexual orientation, gender reassignment, marriage or civil partnership, pregnancy or maternity, or religion or belief); or

• Any protected disclosure(s) which you may have made regarding potential wrongdoing, under the whistleblowing legislation (whistleblowing detriment protection applies to LLP members rather than partners).

Bear in mind that you will need to act quickly to protect your position as, in most cases, the time limits to commence the first mandatory steps in an Employment Tribunal claim by making a notification to ACAS in relation to discrimination and whistleblowing claims are very short. Generally, you will only have three months from the act of discrimination or detriment to make that notification.

This is an area worth considering, even where the relevant partnership agreement has an arbitration agreement, as such a provision cannot prevent partners from bringing discrimination and whistleblowing claims in the Employment Tribunal. If successful, such claims allow a claimant to claim uncapped compensation for actual and future financial losses. This may be fairly valuable in the current circumstances where you may find yourself dealing with the challenges of a contracted legal recruitment market at a time not of your choosing and as a result an extended period of potential losses whilst you search for a role in a new Firm, or perhaps even a new career entirely.

A Data Subject Access Request may also help provide some insights into the reasons for your exit, and whether unlawful discrimination or protected disclosures were an influencing factor.

4. Are there any alternatives to exit?

Consider if your exit is the only option. Alternatives which you can suggest to your firm include:

• Transfer to another department or role within the firm

• Profit share reduction

• Deferred or reduced drawings

• Part-time working

• Sabbatical

• De-equitisation if you are an equity partner

5. Can you negotiate favourable exit terms?

If you are being asked to resign through no fault of your own (such as the financial pressures of the COVID-19 pandemic), you may be able to negotiate more favourable exit terms than would otherwise be available. Key areas for negotiation include:

• Ask for earlier repayment of your capital or payment by instalments with interest (though, bear in mind that this may not be possible if the firm is facing liquidity and cash flow pressures but consider your repayment obligations under any partner capital loan from the bank).

• Ask for the release of your tax reserve. This is your money and you are responsible for the payment of your tax.

• Request that any drawings and distributions that you have already received are yours to keep and will not be subject to any clawback from the firm if a hole is later found in the accounts.

• Restrictive covenants for partners can be more onerous than those applicable to employees. This may be a good opportunity to ask for any restrictions on joining a competitor and acting for the firm’s clients to be waived (or at least partially relaxed) so that you can improve your prospects of securing a role at another firm (which will be especially difficult during the COVID-19 lockdown and economic pressures on all firms).

• Request your release from and an indemnity against any personal liabilities incurred as a partner (including overdrafts, directorships of service companies and personal guarantees).

• Ask the firm to cover your legal and any other professional fees (such as tax advice).

In summary, most exiting partners are looking for more time and as favourable a financial cushion as possible on exit, and having a clear understanding of the partnership law and employment law issues and best practice handling in these types of situations will place exiting partners in the best position to seek to achieve this.

If you are a firm considering the retirement of partners or you are a partner who is facing a proposed exit, please do get in touch with Clare Murray, Wonu Sanda, Zulon Begum or Sarah Chilton for guidance on your specific rights, responsibilities and potential liabilities.

CM Murray is Ranked Band 1/Tier 1 for Partnership by Chambers and Partners and Legal 500, and is recognised as having ‘one of the legal world’s strongest offerings in this area’. (Legal 500 UK 2019).

Unless specifically stated otherwise, we use the term “partner” in a colloquial sense to mean a partner in a general partnership or a member of a limited liability partnership incorporated in England and Wales.