Pushing out your partners: What issues must partnerships consider when cutting partner headcount?

November 28, 2009

Jobless partners may once have been a rarity, but just as the days of a job for life have long gone for employees, being a partner is now no bar to being sacked. The scale of the reduction in partner numbers proposed by professional services firms over the past 18 months has been staggering. Some law firms are known to have cut at least 15 per cent, of their partners by going through what is effectively a redundancy selection process. However, many firms fail to realise the extent of the pitfalls when expelling partners and we are seeing an increasing number of claims against partnerships from aggrieved former partners.

What does your Partnership Agreement say?

Before removing a partner, the first thing to do is to double check the requirements of your Partnership Agreement. Different provisions are likely to apply depending on the reason for expelling the partner, with many Partnership Agreements applying separate requirements and procedures for dismissals "for cause" and for dismissals "without cause". Often a firm will want to "de-equitise" a partner rather than expel them from the firm entirely, but we regularly see Partnership Agreements with no express provision which allows the firm to do this and changes to a Partnership Agreement invariably require unanimity.

Generally, Partnership Agreements say that a partner can only be removed from a firm following the vote of the partners or the resolution of the elected management committee. In smaller partnerships, the issue of a quorum often arises: will the partnership be able to hold a meeting with the requisite number of partners in order to properly vote on a partner’s expulsion? Management must ensure that they have authority to remove a partner before doing so, otherwise they could be acting in breach of the Partnership Agreement and in breach of their own duties as a partner.

Is there is a risk of discrimination claims?

Many firms operate under the misapprehension that employment law does not apply to the partners and so they take less care when removing a partner from the business. All partners, whether members of an LLP or partners in a traditional partnership (i.e. formed under the Partnership Act 1890), are protected from discrimination (including harassment and victimisation) on the grounds of their age, sex, race or nationality, religion or belief, sexual orientation or disability. A firm will have significantly greater prospects of successfully defending a discrimination claim if it has sound business reasons for expelling a partner which are carefully documented and not linked to the protected characteristic.

Is the partner also an employee?

Earlier this year the Employment Appeal Tribunal decided in the case of Kovats v TFO Management LLP that a member of an LLP could also be an employee. This decision was a stark reminder for LLP's that they faced possible claims of unfair dismissal when expelling partners.

Mr Kovats entered into a members' agreement with the LLP to become its Chief Investment Officer. He received a fixed distribution as a draw down against the future profits of the business and he was paid gross. Although Mr Kovats was unsuccessful in persuading either the tribunal or the EAT that he was an employee of the LLP, the EAT clarified that someone is not precluded from also being an employee merely because they are a member of an LLP.

This means that when LLP's expel certain members the firm must have a fair reason and follow a fair process otherwise it risks a successful complaint of unfair dismissal. It will be necessary for LLP's to asses the risk of a particular member having employment status. Factors to be analysed include but are not limited to:

  • the extent of the individual's role in the management of the firm (can they attend and vote at partners' meetings? Are they able to make important decisions which bind the firm? Can they sign cheques on behalf of the firm?);
  • whether or not they share in the profits and losses of the firm (a salaried partner is more likely to be an employee than a full equity partner, although it is not conclusive);
  • whether or not the individual has made a capital contribution to the firm;
  • whether they are held out as being a partner in the firm (for example, by having their name on its letterhead); and
  • the tax treatment of their remuneration.

The same criteria used for members/employees would also determine whether a partner in a traditional partnership is a genuine partner or an employee.

What is the reason for termination?

It is crucial that a firm considers its reasons for expelling a partner, carefully. Not only can the reason dictate the process which must be followed under the Partnership Agreement, the firm should also ensure that its reasons fall under the potentially fair reasons for dismissal contained in the Employment Rights Act 1996 if there is a risk of the partner having employment status and therefore gaining protection from unfair dismissal.

Other considerations

There are some other issues which might affect the way the firm handles partner terminations, including the following:

  • Duties - Partners in traditional partnerships owe a duty of good faith to each of their other partners whereas members in an LLP owe a duty of good faith to the LLP itself. In addition, firms should be aware what other duties are owed to partners pursuant to the written Partnership Agreement.
  • Unfair prejudice - It is also worth checking whether a member in an LLP has a potential claim that they have been a victim of unfairly prejudicial conduct (s994 of the Companies Act 2006). This right is routinely excluded in members agreements, but is raised on occasion where a member feels singled out by his partners.
  • Goodwill – A partner in a traditional partnership may have an entitlement to share in the goodwill of the firm when they leave it. Goodwill can be very valuable, but difficult to quantify. Generally this is dealt with in the Partnership Agreement, but if it is not then the default provisions of the Partnership Act 1890 and associated case law will apply.

 Aron Pope is a Senior Associate in the employment department of Fox Williams LLP. He is also a member of Fox Williams’ Partnership Law Group. Aron can be contacted on 020 7614 2640 or at apope@foxwilliams.com.


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