As the recent travails of US-based global law firm Couderts demonstrate, even the strongest of partnerships can experience problems. This can happen to any business but, discovers Stephen Ward, law firms have particular idiosyncrasies that must be handled with care

Coudert Brothers is one of the largest and oldest law firms in the world, and a pioneer of going global, but after 152 distinguished years, Coudert’s management, partners and employees are going through a tough time.


‘After exploring various options, the partners of Coudert have authorised the firm to enter into combinations of offices and practice groups with other firms to reflect the strengths of the firm. Such combinations will be done in an orderly process and announced over the next several weeks,’ a terse statement says. Basically, the firm’s lawyers have all been given the green light to find themselves a new home.


According to Tony Williams, head of legal consultants Jomati, Coudert is at least going about breaking up the organisation in the right way. ‘The first priority is to make sure it happens in as orderly a way as possible,’ he says.


He knows that better than most, having been through the process in the most high-profile example in the UK of recent years. He was managing partner of Andersen Legal, which by 2001 was ranked the ninth largest law firm in the world by fee income. Then the Enron scandal affected the parent accountancy firm so badly that the law firm had to dissolve with it. Mr Williams managed the transition of various Andersen Legal practices to Ernst & Young as well as to independent status, and oversaw the successful winding-up of the English practice of Andersen Legal.


It may not happen to Coudert, but occasionally problems can evolve to dissolution. Douglas Preece, a partner in City law firm Fox Williams’ partnership law group, says: ‘We have acted in a number of dissolutions in the UK. They are not on that scale and they don’t make the press.’ But they happen.


As with a limited company that ceases trading, a partnership has to add up the assets and the liabilities, and use the former to pay the latter. That, as partnership law specialist Richard Linsell, head of the professions group at City law firm Mayer Brown Rowe & Maw, explains, is what happens in the case of a firm of solicitors, architects or any other partnership.


The main creditor is the bank. ‘The first thing the bank makes them do is draw up a list of the few assets and the many obligations. They meet and divvy it all up,’ he says. Partners will most commonly have to pay in proportion to the percentage of profit they draw annually. ‘The more they take out, the more they [now] put in,’ continues Mr Linsell. Usually there is no capital left to divide up and give back to the partners.


Each partnership has its individual terms of agreement which will govern exactly who gives and gets what proportion. ‘Sometimes the liability is in proportion to the amount each has invested,’ Mr Linsell explains.


The difference between a partnership and a limited company, as Mr Preece explains, is that the partners are liable for the debts if there is a shortfall, where the shareholders of a company are limited in liability to the money they have invested.


He says: ‘There have been cases in the UK where personal assets have come into play.’ The partners are jointly and severally liable. The creditor sues the partnership for the money and the partners sort out the individual liability between them according to the articles of association.


There can be minefields in this distribution of liabilities, Mr Linsell says. ‘It is terribly complex when one partner goes bankrupt and defaults, and that share of the obligation [to creditors] then transfers to the remaining partners.’ The result is a bit like the transfer of votes from candidates under a complex proportional representation system.


He says partners may find that the bank that is holding the firm’s borrowings knows exactly how solvent most of the partners are as individuals because they commonly have their personal accounts with the same institution. It may add to creditworthiness in normal times, but it means there is no privacy when there is a dissolution.


‘I remember one architects’ partnership where one of the partners had £200,000 in the bank, which may not be where he wanted it to be,’ Mr Linsell says.


Mr Williams says the lease on a building – a valuable fixed asset to a firm – can become a double-edged sword when problems set in. Mr Linsell adds that probably two-thirds of law firm leases are held by four named partners from among the many, who hold it in trust for the rest. ‘The law is that they are entitled to be indemnified by the other partners, but it is not an enviable position to be left with a liability, which may be six years at £200,000 a year.’


One way to restrict exposure is for the firm to be a limited liability partnership (LLP), points out Colin Ives, director of private client services at accountancy firm Smith & Williamson, and a member of the Association of Partnership Practitioners working party dealing with the Law Commission review of partnership law.


‘All the capital which partners have invested in the partnership is still exposed to creditors,’ he says. Beyond that, they may be individually liable if they personally have been negligent or breached a duty of care. They may not be liable even in those circumstances if the terms and conditions of engagement with the client make it clear that the LLP and not the individual is liable, but it will probably need courts to decide.


‘Up to now there have not been huge exposures for law firms in the same way as for accountants,’ he says. Law firms converting to LLPs are preparing for the worst-case scenario, and for vast transactions, the theoretical liability is also vast. He says: ‘The main driver for law firms converting is that new partners are more comfortable if they are not taking on unlimited liability.’


For more usual liabilities, such as the unexpired portion of the lease on the building, an LLP does remove personal liability from partners as long as the landlord has been happy to sign the lease with the LLP rather than requiring the guarantee of individuals.


Once a dissolution in the UK has begun, then under section 38 of the Partnership Act 1890 firms are not allowed to take on any new business, a clause which was intended in the late 19th century to protect partners from becoming even further exposed, but which makes it, in the 21st century, hard to sustain equilibrium for long.


Not only is a dissolving firm unable to accept new work, but it will find the work it already has is under threat too. ‘Once a client knows a firm is going to dissolve, he will take his business to another firm,’ Mr Linsell says. This makes book debts precarious from this stage on.’ When you send your bill for work already done, he will refuse to pay, saying he expected continuity of service.


Mr Preece agrees. ‘Book debts become very hard to realise from the moment a dissolution is announced,’ he says.


Law firms are a peculiarly fragile form of business when looked at as assets and liabilities. Mr Linsell says: ‘Law is a profession where there are few assets other than the people. If you took [away] all the people making Mars bars, they could still continue to make Mars bars because you wouldn’t own the brand, and you wouldn’t have the production line. In a law firm, once the lawyers have gone, there is not much left.’ He says an investment bank has a similar structure, but even there the residual value of the brand is probably higher.


‘Even in the music business, if somebody signs Coldplay and pays an enormous amount to them for their next album, the existing record company keeps the rights to the back catalogue,’ he says.


Mr Williams says the most satisfactory way to pursue the orderly break-up of a law firm is to keep it as intact as possible: ‘Ideally offices go as entire offices, or groups of offices, or if not that, then as big teams. If people go in large groups, there is far more chance they will keep the business and stop clients switching, and fees for work done will be more easily recoverable. It will minimise the redundancy costs, and the new firm may well take over the real estate cost as well.’


Although it is not necessarily dissolving, this is a strategy that Coudert is trying to fulfill. A week after announcing that staff could leave, it reached an agreement with fellow US firm Orrick Herrington & Sutcliffe to transfer all of Coudert’s China practice in Hong Kong and Shanghai and a substantial portion of such practice in Beijing.


Orrick expects to take six partners in Hong Kong, one partner in Shanghai and two partners in Beijing, with a total complement of approximately 40 lawyers. Coudert said a memorandum of understanding signed by representatives from both firms calls for Coudert and Orrick to negotiate details for the orderly transfer by the end of September.


‘We are dedicated to making sure our clients are served in a seamless fashion during and after the transfer,’ the two firms said in a joint statement. ‘We also will make every effort to make the transfer smooth and orderly for our lawyers and staff in China.’


Mr Ives says it is easier to manage an orderly disposal for smaller law firms, when they are making losses or there is a lack of communal spirit remaining between the partners, or there has been a mass departure. ‘In one firm it was used as a threat where there were two partners with drink problems, and the rules only allowed one partner to be voted off by the others.’ Only by threatening dissolution could both be persuaded to leave, he explains.


If this process is carried out efficiently and successfully, the eventual reckoning of assets and liabilities becomes more or less a formality after a well-managed series of disposals. When another firm takes the people and the work in progress, the dissolving firm will always try to make them take the obligations such as the lease on the offices as well, as part of the package.


Mr Linsell says: ‘Mostly it is like a controlled demerger. Most actual dissolutions come only at a late stage when everything has been disposed off, as a sort of formal last rites.’


Partners and other fee-earners do not, unfortunately, always wait for an orderly disposal in the best interests of the firm. Mr Linsell says: ‘I can’t emphasise enough how in every partnership I’ve seen, there are always people looking after their own interests.’


Mr Ives says there is a cultural tradition in the US that clients are seen as belonging to the partner rather than the law firm, so they are more likely to follow that partner when the lawyer leaves. Another factor that means meltdown can go more quickly in the US is that partners can leave after 30 or at most 90 days, while in the UK they are often limited by the rules of the partnership to stay six months or a year.


Mr Ives says the pressure on the lawyers below partner level to look around for a new job rather than hanging around hoping to be retained as part of a package, knowing the firm is dissolving, is also great. ‘The effect on non-partners is enormously unsettling,’ he says. At the same time the less-easily employable may choose to stay until dissolution, at which time they become eligible for redundancy pay (at the expense of the partners).


Mr Williams says the margin of safety for a law firm is not that great, because its assets are in its people and work in progress, because it is a partnership so it will have distributed profits to partners each year, and because lawyers and clients are far less loyal and more prone to switch than in the past.


‘Size doesn’t make you immune,’ he says. The costs of employees and premises are fixed in the short term; ‘if you lose 10-15% of the business, it is serious’. If three or four rainmakers go, a firm can lose business quite fast.


‘After that happens, the future of the firm depends on the quality of the management in the decisions they take. It also crucially depends on the support the partners give them do what they need to do,’ he says. Most law firms work on broadly 30% of turnover distributed as profits – if 10% of turnover goes, profits are hit hard.


In addition, a partnership does not have reserves the way another form of business might. ‘The partners have put in their capital, but the profit is taken out,’ Mr Williams says, so the earlier the management recognises issues at an early stage, the more options they have.


Stephen Ward is a freelance journalist