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Maintaining your stake in a partnership

While the political tensions persist in the medical profession between equity partners and salaried partners in dividing up the shrinking profit cake, it is interesting to see how other professions, notably the legal profession, have been round the houses with this and related issues.

Over a number of years the dwindling pool of practice profits combined with increased pressure on partnerships to promote the younger talent rising through the ranks has led to the creation of elaborate tiers of partners, with points, locksteps, fixed-share status, salaried status, tier one, tier two, tier three equity ranking and so on.

This in turn has engendered considerable debate about the legal nature of these hybrids. When times get tough internally for a particular ‘partner’, he finds himself faced with the decision of whether he ought to invoke the law of partnership (whether in a traditional or limited liability partnership) or employment law, in circumstances where either he is being pushed out of the practice, or he wishes to protect himself against being pushed out.

The nature of the individual’s stake in the partnership becomes a critical determinant of what should happen next.

There are at least two recent cases where solicitors, whose remuneration had been on a profit share basis, had chosen to seek umbrage for one reason or another in employment legislation. One was successful, the other not.

The problem is that there is no clearly defined litmus test. The starting point is always going to be the written agreement if there is one, but the courts will be interested in the following:

  • the way that remuneration is paid
  • whether the individual is liable to contribute capital from his own resources
  • whether he is entitled to be involved in a real sense in the management of the partnership
  • whether he is entitled to share in the surplus assets of the partnership on a winding up.

Additionally, there is intermittent pressure to push out those at the top to make way for new blood. The discrimination legislation applies to partners and employees alike.

In a recent Supreme Court case, a former partner in a firm of solicitors unsuccessfully challenged a decision that his compulsory retirement at the age of 65 pursuant to the partnership agreement had been lawful.

He argued that the decision amounted to direct age discrimination and that a notice clause (combined with a new partner in waiting to replace him) would be less discriminatory.

The Supreme Court said that the firm, in setting a retirement age, was entitled to pursue the legitimate aims of inter-generational fairness on the one hand (i.e. providing younger generations with the opportunity of partnership after a reasonable period) and dignity to the older partner on the other (by reducing the need to expel partners through performance management) – provided of course that the means were proportionate to the aims.

However all businesses would now have to give careful consideration to what mandatory retirement rules could be justified.

The other performance-management tool in active use against poorly performing partners in recent times has been the ‘compulsory retirement’ or ‘green socks’ clause.

It has on occasion provided an effective lever to de-equitise or vary the terms of such a partner’s engagement. But there is a huge caveat. It must be invoked for the right purposes and in the correct spirit. In the wrong hands and used for the wrong purposes, it has the capacity to wreak havoc on hitherto congenial business relationships.

A partner wishing to challenge an actual or proposed forced exit, or a practice seeking to make sure of its grounds for resorting to such drastic action, will need to consider three issues:

  1. Have the grounds relied on, if any, been made out?
  2. Has the proper procedure been followed?
  3. Has the practice acted in good faith and for proper purposes?

Martha Maher is a barrister specialising in partnership litigation at St John’s Chambers