Ethics Advisory Opinion 91-20
A law firm presently requires that new partners purchase an interest in the firm's accounts receivable upon admission to partnership in certain undescribed circumstances. Departing partners are presently allowed to share in accounts receivable at the time of departure.
The firm proposes to amend its partnership agreement to eliminate the requirement that new partners purchase an interest in the firm's accounts receivable. In addition, the amendment would "either partially or completely" eliminate a partner's interest in accounts receivable at the time of departure. The firm states that it is "merely adding a retirement benefit with no connection whatsoever to withdrawal." The actual present and proposed language of the partnership agreement has not been provided.
A. May partners in a law firm voluntarily limit or waive their right to receive a proportionate share of accounts receivable for service rendered before their withdrawal, regardless of whether those partners continue to practice law?
B. May a law firm, in its partnership agreement, provide for deferred compensation payments determined by reference to a partner's proportionate interest in accounts receivable as of a particular date to be paid to a partner who dies or withdraws from the partnership?
C. May a law firm, in its partnership agreement, limit a partner's right to receive a proportionate interest in accounts receivable in the form of deferred compensation payments only to instances of the retirement of the partner from the practice of law?
D. If the answer to question B above is yes, may the deferred compensation payments be determined by reference to a partner's proportionate interest in accounts receivable as of a particular date?
The proposed amendment to the partnership agreement that would prohibit withdrawing partners from receiving deferred compensation for services rendered before their withdrawal regardless of whether those partners continue to practice law does not appear to violate Rule 5.6 (a). An agreement which sacrifices a benefit due to the continued practice of law must be carefully tailored to come within the retirement exception to Rule 5.6 (a). Specifically, a partnership agreement should not violate Rule 5.6 (a) if withdrawal benefits are clearly specified, qualifications for retirement are specified and are similar to those found in other business settings, retirement benefits are in addition to withdrawal benefits, and expelled partners who retire from practice are entitled to retirement benefits.
The setting of the amount of deferred compensation by reference to a proportionate interest in accounts receivable as of a particular date does not necessarily changed the analysis. Cohen and other cases following it, however, make particular reference to the sacrifice of benefits already earned as a factor important to whether Rule 5.6 has been violated. In the facts presented, it could be fairly concluded that the interest in the accounts receivable has already been earned and could not be forfeited for competition without violating Rule 5.6 (a). Since the analysis is fact specific as to a partnership agreement as a whole, a more definitive answer is not possible without a copy of the agreement to review.
Rule 5.6 (a) of the South Carolina Rules of Professional Conduct provides that " (a) lawyer shall not participate in offering or making: (a) a partnership or employment agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement."1 The Comment to Rule 5.6 states that (a)n agreement restricting the right of partners or associates to practice after leaving a firm not only limits their professional autonomy but also limits the freedom of clients to choose a lawyer. Paragraph (a) prohibits such agreements except for restrictions incident to provisions concerning retirement benefits for service with the firm.
The facts presented do not constitute the typical restrictive covenant found in employment agreements which is prohibited by Rule 5.6 (a). See e.q. SC Bar Advisory Opinion 82-5 and ABA Formal Opinion No. 300 (1961). The concern here, however, is whether the financial arrangements of the firm for departing partners would, as a practical matter, restrict the partner's right to practice so as to violate Rule 5.6(a).
The proposed amendment to the partnership agreement treats all departing partners on an equal basis. A withdrawing partner receives the same amount whether he continues to practice law or compete with the firm. Law firms are generally free to choose their own method of diving assets as long as the method does not restrict a withdrawing lawyer's right to practice law. Almost any accounting method chosen for computing a withdrawing lawyer's rights to payments could work a financial disincentive to withdrawing from a firm. This potential in and of itself should not make the method unethical if it is not contingent in any way on the withdrawing lawyers' ability to practice law.
Although they did not specifically address whether the agreements ran afoul of Rule 5.6 (a) or prior DR 2-108 (a), several courts have upheld law firm partnership agreements that resulted in a smaller withdrawal payment than what would have been paid under alternative accounting methods. See Bailey & Williams v. Westfall, 727 S.W.2d 86 (Tex. Ct. App. 1987); Folsom v. Woodburn, Wedge, Blakely and Jeppson, Chartered, 683 P.2d 9 (Nev. 1984); Reina v. Hartenstine, 426 So. 2d 654 (La. Ct. App. 1982); and Cowan v. Maddin 786 S.W.2d 647 (Tenn. Ct. App. 1989).
The liberalization of allowing express agreements regarding the division of fees among lawyers also militates in favor of allowing lawyers generally to be free to agree to a division of fees receivable in the event of a withdrawal from the firm. See Rule 1.5 (e) South Carolina Rules of Professional Conduct.
The proposed agreement to prohibit withdrawing partners from receiving deferred compensation for services rendered before their withdrawal, applied equally to all withdrawing partners regardless of whether those partners continue to practice law, does not appear to violate Rule 5.6 (a).
Whether a partnership provision limiting benefits, such as an interest in accounts receivable, to "retirement" violates Rule 5.6(a) depends heavily upon the terms of the particular agreement. An understanding of the issues can be gleaned by comparing the case of Miller v. Foulstein, Siefkin, Powers & Eberhardt, 246 Kan. 450, 790 P.2d 404 (1990) with Cohen v. Lord, Day and Lord, 551 N.Y.S.2d 157 (Ct. App. 1989) and its progeny. In Miller v. Foulstein, Siefkin, Powers & Eberhardt, 790 P.2d 404 (Kan. 1990), the Kansas Supreme Court enforced a partnership agreement challenged as violative of DR 2-108 by an expelled partner. The partnership agreement provided in part as follows:
"(N)o such deceased, retiring, withdrawing or expelled partner, or his beneficiaries ... shall have any claim of any nature or kind against the remaining partners or against the partnership including, but not limited to, any claims for work in process or uncollected fees, it being the intention hereof to limit such deceased, retiring, withdrawing or expelled partner's rights only to such rights as are expressly provided in the ARTICLE VII and in ARTICLE II relating to the firm name." Id. at 413. This provision precluded plaintiff's claims for significant attorney fees acquired by the firm in contingent fee cases in progress when he left.
The agreement provided retiring partners a greater benefit than withdrawing partners. Retiring partners were entitled to the following:
(i) Such partner's full drawing account for the month in which his death or retirement occurs.
(ii) Such partner's capital account as of the end of the month immediately preceding the month in which his death or retirement occurs.
(iii) An amount to such partner's share of partnership profits, as defined in Section 3 of ARTICLE VI, for either the fiscal year of the partnership first preceding the date of such death or retirement, or for the fiscal year second preceding the date of such death or retirement, whichever is greater, provided, however, that for purposes of this computation, there shall be excluded from partnership net profits that portion of any single fee paid within any such year which is in excess of $75,000.00.
Id. at 408. Withdrawing partners did not receive item number (iii). Id. at 409. Expelled partners who otherwise qualified for retirement benefits, including retiring from the practice of law, were treated as having retired from the firm. Noting that the agreement treated expelled partners the same as retiring partners (providing they both discontinue the practice of law), the court held that this provision fell within the retirement exception to DR 2-108. In the Cohen case, Lord, Day & Lord's partnership agreement provided that upon withdrawal of a partner from the firm, the firm would not be automatically dissolved pursuant to general partnership laws and also provided that withdrawing partners were to share in the firm's earned, but uncollected, profits. Id. at 157. The partnership agreement, however, conditioned payment of such earned but uncollected profits upon a withdrawing partner's consent to refrain from the practice of law in competition with the former law firm. When Richard Cohen, a twenty-year member of the firm and chief of the firm's tax department, withdrew from LD&L, he requested his departure compensation. The firm refused to pay, relying on the agreement's forfeiture for competition clause which stated: Notwithstanding anything in this Article TENTH to the contrary, if a Partner withdraws from the Partnership and without the prior written consent of the Executive Committee continues to practice law in any state or other jurisdiction in which the Partnership maintains an office or any contiguous jurisdiction, either as a lawyer in private practice or as a counsel employed by a business firm, he shall have no further interest in and there shall be paid to him no proportion of the net profits of the Partnership collected thereafter, whether for services rendered before or after his withdrawal. There shall be paid to him only his withdrawable credit balance on the books of the Partnership at the date of his withdrawal, together with the amount of his capital account, and the Partnership shall have no further obligation to him. Id. at 157-58. Cohen's initial court action succeeded on a cross motion for summary judgment where the trial court held that the clause violated DR 2-108(A) and was unenforceable. Id. However, the New York Appellate Division reversed and dismissed Cohen's suit, stating that "the clause was valid as a 'financial disincentive' to competition and did not 'prevent plaintiff from practicing law in New York or in any other jurisdiction.'" Cohen 551 N.Y.S.2d at 158 (citing Cohen v. Lord, Day & Lord, 534 N.Y.S.2d 161 (A.D. 1 Department 1988).
The New York Court of Appeals reversed the lower appellate court, holding that although the clause did not expressly or completely prohibit Cohen form practicing law, the monetary penalty exacted by the provision if Cohen competed with LD&L in fact constituted an impermissible restriction on the practice of law. Id.
The court addressed the question from the perspective of the interest of actual and potential clients rather than the incentives or disincentives provided a withdrawing partner. According to the court, a forfeiture for competition clause "would functionally and realistically discourage and foreclose a withdrawing partner from serving clients who might wish to continue to be represented by the withdrawing lawyer and would thus interfere with the client's choice of counsel." Id.
The forfeiture for competition clause restricted the withdrawing partner's right to practice law because it denied him benefits that would otherwise be his. Addressing the retirement exception of DR 2-108(A), the Court found that it did not apply. Id. at 159. The court reasoned that if financial penalties were not restraints within the meaning of the rule, the retirement exemption would have been unnecessary. Id. In the LD&L agreement, retirement benefits occupied a separate section of the agreement and referred withdrawing partners to the forfeiture for competition clause. Also, the limited time for payment of departure compensation was entirely different than the lifetime retirement benefit. Finally, the court considered the treatment of departure compensation as a retirement benefit as inverting the exception into the general rule, thus undermining the prohibition against restrictive covenants. Id. at 159. Similarly, the court also rejected the defendant's argument that forfeiture of departure compensation was necessary to maintain the economic viability of the remaining firm. Id. at 160.
As a result of the invalid restraint on the practice of law, the court held that the forfeiture for competition clause was unenforceable. The court did, however, expressly limit its decision to those instances involving "entitlement to earned uncollected fees during the tenure of the partner as a working member of the firm" -- not to future distributions. Id. The court cautioned against a categorical interpretation or application of its opinion.
Recently, in Spiegel v. Thomas, Mann & Smith, (Tenn. Sup. Ct. April 15, 1991), the Tennessee Supreme Court followed the Cohen rationale and held that a professional corporation, operating as a law firm, could not condition the payment of deferred compensation to a withdrawing stockholder on the complete cessation of the practice of law by that stockholder. The court held that such an agreement was against the public policy embodied by DR 2-108(A). Id. at 6. The court cited Cohen's statement that a "'forfeiture-for-competition provision would functionally and realistically discourage and foreclose a withdrawing partner from serving clients who might wish to continue'" his representation. Id. at 7 (citing Cohen, 551 N.Y.S.2d at 158). According to the court, "The financial disincentive in leaving either Thomas, Mann & Smith or Lord, Day & Lord to practice law elsewhere works an impermissible restriction under DR 2-108." Id. at 8.2 See also Dwyer v. Jung, 336 A.2d 498 (N.J. Super. Ct. Ch. Div), affd. 348 A.2d 208 (N.J. Super. AD. 1975) (agreement between partners to divide clients among them upon dissolution of the firm held invalid); and Hagen v. O'Connell, Govak & Ball, 683 P.2d 563 (Or. Ct. App. 1984) (court invalidated an agreement imposing a 40% penalty on stock valuation if withdrawing attorney refused to sign a non-compete agreement).
The Cohen and Spiegel decisions cited for support the case of Gray v. Martin, 663 P.2d 1285 (Or. Ct. App. 1983), wherein the Oregon Court of Appeals held invalid a provision of the partnership agreement precluding a withdrawing partner from collecting certain partnership benefits if he were to resume the practice of law within designated counties. The court reasoned that such an agreement clearly restricted an attorney's right to practice law. Id. at 1290. Also, the plaintiffs, in answer to the withdrawing partner's counterclaim, contended that the agreement was a condition to the payment of retirement benefits. The court rejected this argument holding that under such a rationale, every termination of a relationship between law partners would be a retirement, and agreements restricting the right to practice would always be allowed.
In Anderson v. Aspelmeier, Fisch, Power, Warner & Engberg, 461 N.W.2d. 598 (Iowa 1990), a law firm attempted to deny a withdrawing partner his full financial interest in the firm by contending that his withdrawal constituted as act detrimental to the firm; therefore, he forfeited his remaining interest in the firm. The firm cited the following detrimental acts: (1) Anderson remained in competition with the firm; (2) he took an associate and two secretaries with him; and (3) retained a substantial amount of the firm's business. The firm argued that the "detrimental act" provision in the partnership agreement simply enabled the partners to protect the financial integrity of the firm. However, even though the court recognized the merit of this goal, it could not sanction the results of the implementation of the rule. The court reasoned that if none of the firm's clients had left with Anderson, he would have been paid in full share.
The above cases make it clear that the retirement exception found in Rule 5.6 (a) is rather limited and that an analysis of the language of all of the relevant terms of a partnership agreement is necessary to determine whether the agreement violates Rule 5.6(a). The retirement exception must mean something, but it does not sanction making all withdrawal benefits contingent upon the termination of the practice law.
The agreement enforced by the court in Miller gives some guidance as to what may be appropriate under Rule 5.6(a). Specifically, a partnership agreement should not violate Rule 5.6(a) if withdrawal benefits are clearly specified, qualifications for retirement are specified and are similar to those found in other business settings, retirement benefits are in addition to withdrawal benefits, and expelled partners who retire from practice are entitled to retirement benefits.
The setting of the amount of deferred compensation by reference to a proportionate interest in accounts receivable as of a particular date does not necessarily change the analysis. Cohen and other cases following it, however, make particular reference to the sacrifice of benefits already earned as a factor important to whether Rule 5.6 has been violated. In the facts presented, it could be fairly concluded that the interest in the accounts receivable has already been earned and could not be forfeited for competition without violating Rule 5.6(a). Since the analysis is fact specific as to a partnership agreement as a whole, a more definitive answer is not possible without a copy of the agreement to review.
1 DR 2-108 (A) of the prior South Carolina Code of Professional Responsibility contained essentially the same language: (A) lawyer shall not be a party to or participate in a partnership or employment agreement with another lawyer that restricts the right of a lawyer to practice law after the termination of a relationship created by the agreement, except as a condition to payment of retirement benefits.
2 Spiegel also considered and rejected the argument that the provision fell within the retirement exception to DR 2-108 (A).