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The Key Building Blocks of an LLP Agreement Part 2: Securing Long Term Stability of your Firm through your LLP Agreement

The Key Building Blocks of an LLP Agreement Part 2: Securing Long Term Stability of your Firm through your LLP Agreement

The success and stability of any professional services firm will often depend on its ability to retain its best people. There are of course many “push” and “pull” factors (some of which will be outside the firm’s control) that will determine whether some partners remain committed to a firm. Whilst it is impossible to force people to stay, it is possible to optimise the firm’s position under its LLP Agreement so that it is not wrong-footed by partner departures.

In this second article in our series on The Key Building Blocks of an LLP Agreement (see the first edition on Decision-Making and Management here) we explore the various tools that can be included in an LLP Agreement which are designed to protect the stability of an LLP’s business in the face of potential partner exits.

Partner duties

Partners owe various implied and express duties to their firm, including (in certain circumstances) a duty of good faith and obligation to act in the firm’s best interests as well as the duty to provide full information to the firm regarding matters which are likely to have a significant effect (e.g. information regarding clients, partners or employees who are planning to leave).

Partners are often not aware of the extent of their implied duties under law. From the firm’s perspective, it can be helpful to specify these obligations in the firm’s LLP Agreement as this can have a psychological deterrent effect for partners who, for example, are considering a team move.

Useful express obligations which are designed to prevent partner departures include:

  • a requirement to notify the firm if a partner receives a job offer;
  • an obligation to notify the firm if a partner knows that other partners or employees are contemplating a move;
  • provisions preventing partners from encouraging other partners or employees from moving to another firm; and
  • detailed provisions safeguarding the firm’s confidential information.

Notice periods

One of the obvious points to consider when reviewing your LLP Agreement is whether the length of notice for partner voluntary retirement remains appropriate for your business and aligns with general market practice for your industry.

For the professional services sector, notice periods generally range between six to twelve months. Firms with different tiers of partners (e.g. fixed share and equity partners) typically have a shorter notice period for the junior tier (six months) and a longer period for the senior tier (twelve months).

When reviewing your notice period(s) you should think about:

  • the length of time it might take you to transition the client relationships of a departing partner to other partners/fee-earners in the firm; and
  • how long it would take you to recruit a replacement for a significant partner if the need arose.

Waiting Lounge

Multiple and simultaneous partner departures can seriously de-stabilise a firm and result in a significant capital outflow. A “waiting lounge” provision is designed to tackle this potential problem by preventing more than a certain number or percentage of partners from retiring in a given period.

Waiting lounge provisions are still relatively uncommon in LLP Agreements for professional services firms, however, given that it is particularly useful in deterring team moves and a mass exodus in a distress situation, it is highly recommended for any people business.

Garden leave 

Robust garden leave provisions will enable you to lock a partner out of the business during their notice period whilst allowing you the space and time to consolidate client relationships.

If your garden leave provisions are drafted properly, retiring partners can be prevented from making any comments or announcements regarding their departure, contacting clients, staff and introducers, accessing confidential information and the firm’s computer systems/emails and attending the firm’s offices, unless approved by management.

Ideally, your garden leave provisions should be relatively detailed and all-encompassing to avoid any dispute as to what a departing partner is required to do or not do during their garden leave. You should ensure that your garden leave provisions require departing partners to co-operate to facilitate the handover of clients and matters.

Good/bad leaver

Good/bad leaver provisions are the classic “carrot and stick” approach to discouraging partners from breaching their obligations to the firm or joining a competitor when they depart. It can work particularly well if your firm operates on a “goodwill” model, i.e. if partners have an interest in the equity of the firm that can potentially be realised when they leave.

A share in equity can be a considerable incentive for partners to remain committed to the firm and to contribute to its ongoing success. Conversely, the threat of being treated as a bad leaver and therefore losing equity or anti-embarrassment rights (i.e. a right to share in the proceeds of a capital event that occurs after a partner retires) is a very useful “stick”.

If your firm operates as a traditional tenancy model partnership, bad leaver provisions can still be used as an effective deterrent. For example, a longer deferral of current and capital account balances can be applied to bad leavers. However, you will need to ensure that any deferral of capital dovetails with the firm’s undertaking to the bank in respect of the repayment of any partner capital loans.

Restrictive covenants

In addition to locking in partners as far as possible, the key to safeguarding a firm’s goodwill following a partner’s departure is ensuring that any restrictive covenants applicable to the partner are enforceable. We will discuss restrictive covenants in detail in next week’s edition.

Tips for lateral partners

If you are a lateral partner on the receiving end of some of the provisions discussed above, you may be concerned about how you can extricate yourself in a way that does not seriously impede your future practice if, and when, you decide to move on. It is key that you seek advice on these issues prior to signing an LLP Agreement or approving amendments that seek to restrict your ability to leave.

Depending on your relative bargaining power, it may be possible to agree:

  • a shorter notice period in certain circumstances (e.g. within the first two years of joining the firm);
  • your exclusion from the waiting lounge requirements;
  • bespoke good/bad leaver arrangements; and/or
  • the carve out of certain clients/employees from restrictive covenants.

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.