Bring me equity

Michael Gerrard looks at the role of salaried partners and asks whether the profession will ever take them as seriously as the equity elite

When is a partner not a partner? When he is paid salaries and bonuses rather than a portion of profits, may be the answer - at least if a case currently causing a stir in the US is anything to go by.

One of the world's largest law firms, Sidley Austin Brown & Wood, is currently under the gaze of the US's Equal Employment Opportunity Commission (EEOC) in an ongoing case which raises the question of whether salaried partners are the real deal.

The EEOC has ordered the firm to hand over partnership documentation as part of its investigation into the demotion of 32 partners three years ago at the pre-merger Sidley & Austin (see [2002] Gazette, 14 November, 6).

The case has thrown up several issues - not least the employer or employee status of non-equity partners, who do not share in the profits and instead rely on salaries and bonuses for their income.

The difference is crucial, because employers are not covered by US anti-discrimination legislation.

Sidleys asserts that the 32 were partners and employers.

It also claims the demotions were triggered by shortcomings in performance.

Traditionally, there was a defined view of what constituted a partner - a person who owned some equity in the firm and drew a percentage of any profits rather than gaining remuneration through a set salary.

As Richard Dedman, senior partner at Barlow Lyde & Gilbert and a professional negligence specialist, puts it: 'The major difference is that an equity partner is a stakeholder in a firm, whereas a person who is on a salary is much closer to the status of employee.'

Indeed, this is a view generally taken by the Inland Revenue, which usually regards partners on a straight salary paying tax on a PAYE basis as employees for tax purposes, however they are presented to the outside world.

To this basic equity concept has been added over the years the concept of lockstep, where the percentage of profits a partner accrues is based on that lawyer's seniority in the pecking order.

Under this now widespread scheme, profits are divided on the basis of points, with partners gaining more points as they proceed up the lockstep ladder.

Further refinements have been added, such as the US merit-based idea of 'eat what you kill', where a partner only benefits from the work he himself brings in.

But over recent decades, as firms have ballooned in size and changed in character, so has the concept of partnership.

With more lawyers to satisfy, the idea of the salaried or non-equity partner was born.

And those who make it, even though everyone knows they are salaried, claim that the change in status is a major help; where before an associate could not get things done, or was not listened to, suddenly the salaried partner can and is.

The situation has been brought into sharp focus by the fashion for de-equitising lower-earning partners in an attempt to make the average profit per equity partner better, thus making a firm look better in profitability statistic tables.

This factor and the Sidley Austin case has helped re-ignite the debate in England and Wales as to whether a partner on a fixed salary is really no more than a glorified employee.

According to this argument, such partnership status is a useful promotional tool to make a firm's letterhead look impressive (although a few firms call such people 'associate partners').

Others will argue that salaried partners are just that; indeed, even though they may not be entitled to the greater benefits given to full equity partners, they are still capable of being held liable for firms' losses under partnership law.

Naturally, this debate has strong adherents on both sides, though few firms are keen to speak openly about how their partnerships are structured.

Several firms, not least the likes of Freshfields Bruckhaus Deringer and Slaughter and May, continue to operate full equity partnerships and these firms profess strong reasons for eschewing the salaried or non-equity partner route.

Birmingham giant Wragge & Co is another such firm, and its managing partner Quentin Poole is a strong supporter for traditional equity partnerships.

He expresses many of the usual misgivings concerning salaried partnerships even though a proliferation of partners can aid a firm financially.

He says: 'If you can give a whole lot of people the title of partner when they are not really a partner, then you can get clients to pay a lot more money at partner rates.'

Such salaried partners are treated by the outside world as partners, when they are not paid as such, he notes.

He and others from traditional partnership firms maintain that the introduction of salaried partners can lead to divisions and encourage these 'junior' partners to act in their own, not the partnership's, interests.

He says: 'When you make a person a full partner, it signifies to them that you are making a long-term investment, and they don't need to worry about their practice development in the short-term.

'Whereas salaried partners are encouraged to think and act short-term and worry about climbing on everyone else's head to advance to equity partnership.'

But even among firms which prefer the traditional approach, there is an appreciation that, in certain situations, a partnership level below full equity can be a useful tool.

Mr Dedman argues that when taking on a lateral hire from outside the firm, putting someone on a salaried partnership enables a firm to test someone out to see if they work well within a firm and are worthy of full partnership.

His firm has in the past had non-equity partners, but now argues that such a system brings with it pressures to promote people from associate level who may not have the qualities for full partnership.

Mr Dedman adds: 'If one only has full partners, there is likely to be a more rigorous attachment to the quality ethic.'

But other firms that do employ a system of salaried/non-equity partners bridle at the charge that they are pulling the wool over the public's eyes.

To them a partner is a partner, even if some are more equal than others.

London commercial firm Collyer-Bristow has 26 partners of whom only nine have full equity status, but the firm's chief executive Jonathan Fox claims that sensible handling can avoid divisions.

He says: 'There is a blurring at our firm between the equity partners, who are the owners of the business, and the non-equity partners - we have a head of department who is a non-equity partner.'

He agrees that in some firms, salaried partners might well to all intents and purposes be employees, but that such situations can be avoided by trying to involve them actively in the business and decision-making processes.

But rather than employing some tender, loving care, other firms have come up with the idea of ostensibly doing away with salaried partners altogether and replacing them with a fixed-share partnership, which they generally claim means that all partners are then included within the equity.

Under this system such partners, sometimes referred to as junior equity partners, are allocated a fixed share of profits, a specified monetary figure which, unlike a lockstep, means their salary will not alter as they progress in seniority.

In effect, they are still on something very much akin to a fixed salary, though different tax conditions may apply.

Those that have adopted this system, as with firms with salaried partner systems, admit efforts have to be made to bridge the two levels of partnership.

London firm Kingsley Napley's senior partner David Speker says: 'I would not deny that some junior equity partners may feel that they are employees, but I would say that we have done a lot here to try and bridge the gap.'

That said, he admits a distinction is always likely to remain between senior equity partners who own the firm and their fellow partners - though the latter could sometimes benefit.

He points out: 'There could actually be years when their guaranteed salary could make them better off than senior equity partners reliant on profits.'

Non-equity partners may be suffering in the prestige stakes - but like the super-salespeople who earn more than the chief executive, they do have something to sugar the pill.

Michael Gerrard is a freelance journalist