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ABSs and the potential lock-in of individuals
Monday 11 June 2012 by Miguel Pereira and Fergus Payne
The legal press is full of articles on the new alternative business structures (ABSs) and the so-called Tesco Law revolution of legal services. A number of major law firms have confirmed that they are seriously considering the option to converting to an ABS and we have already seen high-profile third-party investors coming into the sector. These developments are the first signs of how the legal landscape is changing following the liberalisation of the UK legal services market. For instance, QualitySolicitors is developing a national franchise network of law firms and earlier this year Quindell Portfolio acquired Liverpool-based personal injury specialist firm, Silverbeck Rymer. At the same time, the national firm Russell Jones & Walker announced it had been bought out by Australian outfit, Slater & Gordon.
Not much, however, has been reported on how these deals have been structured and what, in practice, it all means for the individual partners of the firms. Law firms are people businesses and therefore, before parting with any money, an external investor will want to ensure its investment is protected and that the firm’s human capital is to remain in place for the long term.
Third-party investors are unlikely to be willing to be used merely as a means of financing an exit for the owners of the firm. Their investment will be made with certain conditions, namely a requirement that partners, and more likely those partners who hold the relationships with key clients of the firm, agree to be locked in and remain with the firm for a period of time, usually three or four years. Such lock-in provisions may come in different forms and guises and therefore it is important for the individual partner to carry out his or her due diligence on the investor and go into the relationship with their eyes wide open. Three to four years may not sound like a long time, but it will feel like that if the relationship with the investor becomes strained.
Types of lock-in restrictions
- Lock-in: in its simplest form, a partner would agree to be locked-in for two to four years, in other words he or she cannot serve notice to retire for two to four years or else suffer a significant financial penalty if they leave within that period.
- Long notice periods: these can be expressed (i.e. 18-24 months) or be more subtle by providing that a partner can retire on giving “x” number of months notice which expires on the accounting year end. This, depending on the timings, could have the effect of making the notice period longer than thought on first reading.
- Waiting room or departure lounge provisions: these will typically limit the number of partners that can leave in a given period of time, usually the firm’s financial year or a calendar year. Such clauses help to prevent entire team moves. If a number of partners exceeding such limit want to leave at the same time they will need to wait their turn in the waiting room.
There is little case law on the above type of clauses and, as a result, it is unclear whether they will be fully enforceable. Each will certainly be caught by the restraint of trade doctrine and, therefore, the firm will need to show that the clause has a legitimate interest capable of protection and is not in excess of what is necessary to ensure that protection. Investors will undoubtedly point to the level of their investment as being a legitimate interest that requires protection and that any of the above clauses are no different to the restrictive covenants usually found in investment agreements in private equity deals where management are treated as being 'bad leavers' if they voluntarily resign too soon.
Certainly, there is commercial strength in that argument. It remains to be seen whether a strong case can be made for the more subtle variations of the lock-in clause. For example, if relying on a lengthy notice period, there is a risk a court may interpret the provision in its narrowest context and argue that no firm would need more than, say, 12 months to arrange for the retirement of a partner. There are no recorded cases in relation to waiting room provisions and much will depend on how such clauses are drafted and the size of the firm. Arguably a waiting room clause makes more sense in a firm with a smaller number of partners but, in larger firms, the same could be said for clauses which are directed to specific departments, teams or classes of members within the firm.
It remains to be seen how such provisions will be drafted and whether a visible trend will develop. What is clear, however, is that the senior partners in firms seeking external investment will need to stick it out for a bit longer before they can enjoy retirement.
Miguel Pereira is a partner in the partnerships & LLPs group at Lewis Silkin LLP, Fergus Payne (pictured) is a partner at Lewis Silkin LLP, and joint-head of its Partnerships and LLPs group
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