The Business Divorce Law Report

February 1, 2020

How a Law Firm Can Protect Itself From the ‘Grab and Go’?

Law firms should recognize that lawyer resignations and the loss of clients are inevitable in the modern law practice due to prohibitions on agreements that restrict competition.
Law firms can protect the interests of clients and the firm by adopting best practices that govern lawyer resignations.
Law firms should recognize the investments made in the firm’s intellectual property and adopt policies that limit misappropriation.

Law firms must survive in a world in which key employees are free to leave at any time and to take as much of the firm’s business with them as they can. Many lawyers, motivated by the financial incentives that are part of their separation, believe that there are no rules limiting their solicitation of clients, copying of key documents and compensation for their old firm. This view may be mistaken, but sorting it out after the resignation or withdrawal is expensive, time-consuming football-1717630_1280-1024x682 and threatens to draw off the time and attention of key managers.

The grab and go is the unexpected resignation without notice combined with the immediate unilateral solicitation of clients. Its corollary is the law firm lockout, in which a lawyer that has indicated his or her intention to leave is locked out of the firm and cut off from clients while the clients are intensely solicited by the firm.

Best Practices to Manage Lawer Resignations

Here is a list of some of 10 policies that a law firm should have in place before a key lawyer decides to move his or her practice. But first, the reality check. Lawyers will leave and lawyers will take clients. Not only that, but lawyers have a right to leave and take clients. The only issue on the table is managing the process.

Law firms, the individual lawyers that work there and the clients that we serve are better served by articulating a clear set of rules beforehand, by adopting key internal policies and by recognizing that resignation need not equate with conflict. Lawyers and their former law firms should remember that life goes on after the departure. But when one side tries to gain an unfair advantage over the other, however, life gets complicated and messy. Continue reading

November 12, 2019

Tax Treatment Alone Does Not Establish General Partnership

by Jay R. McDaniel, Esq.

Courts determine whether an individual has an equity interest in a law firm partnership by examining the financial investment and risk taken by the claimed owner, such as payment of capital and guarantees of obligations.
The rise of the non-equity partner in law firms management has changed the status associated with the title partner. Nearly half of all law firm partners are now classified as non-equity or limited equity.
The way in which the firm reports the income of a partner to the IRS in its tax filings are evidence of an equity interest in many cases, but describing an individual as an equity owner may not be conclusive.

The last refuge of the general partnership may be the law firm. However, the term “partner” in a law firm can have a number of different meanings and it often does not identify only the traditional equity owner of the enterprise. In many circumstances, “partner” is a title that indicates a senior attorney, usually at the top of the firm’s professional structure. It does not, however, provide a particularly reliable indication of either management responsibilities or a financial interest in the firm. partnership-526413_1280-1024x562

Not all partners are created equally. In fact, the rise of non-equity partner, those that do not share in the profits or capital of the law firm, is rising rapidly. Only 56 percent of the partners in law firms in 2018 were equity partners. (Above the Law, 3 Reasons to Embrace the Rise of Non-Equity Partners). That trend is a 250 percent increase over the past two decades. In 1999 the figure was 17.1 %.(Altman Weil, Inc. What Should Law Firms Do about Non-Equity Partnership).

Not surprisingly, the existence of an equity interest, or not, is not an uncommon area for dispute. In this post we consider here involving the effect of tax documents on the claim of an attorney that he held an equity interest in a well-known personal injury firm. Treatment for income tax purposes is invariably a key component of holding equity. Is it dispositive? In this case, no. Continue reading

August 12, 2019

Attorney Charing Liens in New Jersey

by Jay R. McDaniel, Esq.

Attorneys have common law and statutory security interests in the proceeds of recoveries of their clients, generally referred to as charging liens.
A statutory lien is created when a lawyer files a pleading with an affirmative claim for recovery and may be enforced by filing a petition in the underlying action.
Clients have an interest in the assertion of an attorney charging lien and must be notified of their right to have the amount of the fee determined by arbitration.

Attorneys that provide services to clients with that yields a financial recovery to the client will typically have a security interest in that recovery to secure their fee. The lien may be statutory or, in some cases, the attorney may have a lien that is enforceable in equity. These two types of liens, statutory and equitable, have significant differences, but both types of liens provide the lawyer with a security interest in the proceeds of the case. Law Firm Business Divorce Attorneys

In this article, we will take a look at some of the mechanics of asserting and enforcing a lien. In a subsequent post, we will examine the manner in which courts have allocated competing claims for fees.

The Attorney Charging Lien

A lien is more than just a claim for fees. It is a secured interest in the recovery that a client achieves – through the lawyer’s efforts, of course — for the satisfaction of the debt. It may be asserted over all of the recovery and, therefore, even against the client. As a practical matter, liens are asserted when a lawyer is replaced or in rare instances when a client fires the lawyer in an attempt to avoid paying a fee. Continue reading

July 2, 2019

Shotgun Agreements and Other Methods to Break Deadlock

by Jay R. McDaniel, Esq.

Buy-sell agreements, like a shotgun sale triggered by a deadlock, are the principal means by which the owners of closely held businesses protect against the worst consequences of deadlock.
Commonly used shotgun provisions allow one party to set the price and allow the other party to decided whether to buy or sell at the offered price. Closely related to the shotgun is an auction that allows offerors a chance to sweeten their offers to buy.
The compelled sale of an equity interest triggered by a buy-sell agreement will be subject to the fiduciary duty of loyalty and the implied covenant of good faith and fair dealing.
Courts may apply shotgun or auction techniques when compelling the sale of a business as a going concern.

A well-drafted agreement between the owners of a business will address the issue of what to do in the event they become deadlocked. This is true of effective shareholder agreements or corporate by-laws, limited liability company operating agreements or partnership agreements.

Agreements that are intended to prevent or resolve a deadlock in most circumstances will contain language that in some circumstances will require the exit of one person from the business. This exit, in turn, requires payment of the value of the equity interest of the departing owner.

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In this post, the last in a series on deadlock in the closely held business, we look at buy-sell agreements as a means of breaking deadlocks without litigation and, in particular, a form of buy-sell often referred to as a shotgun. A buy-sell often avoids or greatly simplifies litigation between the deadlock owners of a business, sure. It also has the effect of avoiding deadlock in the first instance.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Shotgun provisions are a form of weapons control, like the mutually assured destruction that has – thankfully so far, at least – kept the world powers from global conflagration. Owners of a closely held business have an emotional as well as a financial investment in a business and triggering a process in which they may be forced to sell will be seen as a very unwelcome choice. In many cases, shotgun language in governing documents triggers compromise among the owners of a closely held business.

Buy-Sell Agreements Triggered by Deadlock

June 28, 2019

Dividing Fees in a Law Firm Business Divorce

by Jay R. McDaniel, Esq.

Business divorce disputes among lawyers will often require the division of contingent fees realized after the parties have separated their business interests.
An agreement between lawyers in a firm to divide fees in the event of their separation cannot function as a restriction on a lawyers right to practice and to compete with a former firm, but otherwise is generally enforceable.
Courts also use principles of quantum merit — ‘as much as he deserves – to allocate contingent fees between lawyers who once practiced togther.

The division of fees, in particular contingent fees earned after a firm is dissolved or the resignation of a rainmaker, are the catalyst for business divorce disputes in law firm breakups. These disputes involve some key issues: business-861325_1280-1024x768

Is there an agreement in place covering the division of fees?
If there is an agreement, is it enforceable?
If there is no agreement, how will a court divide the fees?

Agreements to Divide Fees

Lawyers practicing together in a firm frequently make agreements on how fees will be divided after the withdrawal of a lawyer. These agreements may be part of the firm’s partnership, operating agreement or corporation bylaws, or embodied in an employment contract or separation agreement. These types of agreements are generally, but not always, enforceable.

Getting the client’s consent to such a division is also a good practice and, in at least one jurisdiction, may be required.

June 26, 2019

Anti-Deadlock Agreements in Business Divorce Litigation

by Jay R. McDaniel, Esq.

Owners of a closely held business, be it a corporation, limited liability company or partnership, may enter into contracts that are triggered when the principals have become deadlocked.
Anti-deadlock provisions may provide for the appointment of an independent director, for alternative dispute resolution, or for the compelled sale of an equity interest.
The owner of a business that invokes the terms of an anti-deadlock provision, particularly when the sale of interest is involved, is likely to be subject to duties of loyalty and care.

After a closely held business becomes deadlocked, it is extremely difficult to push the parties toward some mechanism that might either break the deadlock or preserve the current management system, or event let the parties separate themselves on mutually agreeable terms.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Human nature stands in the way. The parties likely have financial and emotional positions that they are unwilling to compromise. These may range from the ability to control some aspect of the operations of the business to the payment of dividends or bonuses.

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Lawyers and their clients try to address the potential for future deadlock with these contractual provisions that are known by a number of descriptions, such as buy-sell agreements, shotgun

provisions, put-call terms. In the world of closely held limited liability companies, corporations and partnerships, a buy-sell agreement that is triggered by a deadlock is the pre-nuptial agreement of business divorce.

In this and the following post, we examine these contractual provisions that are used to break deadlocks. We consider first the scope of anti-deadlock provisions, when they may be invoked and whether they are subject to judicial controls. In a following post, we will look at buy-sell agreements in more detail and, in particular, shotgun language that is intended to keep a forced sale on terms acceptable to both parties. Continue reading

April 9, 2019

Direct or Derivative Lawsuits: Who Owns the Recovery

by Jay R. McDaniel, Esq.

When a shareholder, LLC member or partner sues to recover for damages based on wrongs committed against the business entity, the claim is derivative and the recovery belongs to the business. Derivative claims have special procedural rules.
Courts have discretion to allow the owners of closely held businesses to sue individually on a derivative claim when the plaintiff can show “special injury” or when the direct action is not unfair to the business, its creditors or other equity holders. The right to bring derivative actions is available to corporate shareholders, LLC members and partners in general and limited partnerships.
A shareholder may bring a direct claim to enforce rights that are contractual in nature or which enforce some right as shareholder, such as the right to vote or elect the directors.

It is not always easy to determine whether the remedy for the injury suffered as a result of some wrong among the owners of a closely held business belongs to the entity – whether a corporation, limited liability company or partnership – or instead belongs to one or more of the owners.

The distinction is both procedural and substantive, and may be fatal to the plaintiff’s claim. Some claims can belong only to the company. In addition, there are specific procedures in place for bringing a derivative claim in which an owner seeks to assert a right owned by the company. These procedural and substantive requirements can be fatal to a plaintiff’s claim.

But the line is often blurred in the context of the closely held business, and courts can ignore the distinction in some circumstances. In this post, we look at some recent cases in New Jersey considering the distinction, one involving a limited liability company and the other involving a closely held corporation. Although most of the case law has developed in corporate derivative actions involving shareholders, derivative causes of action may also exist in claims brought by members of a limited liability company or partners in a partnership.

Derivative Lawsuits Assert Claims that Belong to the Business

January 30, 2019

Dissolution and the Reasonably Practicable Standard

by Jay R. McDaniel, Esq.

Most limited liability company and partnership statutes make no mention of ‘deadlock’ as grounds to order the involuntary dissolution of a business.
Deadlock arises when the members or partners are no longer able to pursue the basic agreements on which the business was organized, typically an operating agreement or partnership agreement.
The key determination in an action to force the dissolution of a limited liability company or partnership is whether it is ‘reasonably practicable’ for the business to continue.

Courts examine deadlock involving a limited liability company or partnership through the lens of the operating agreement or partnership agreement. The fundamental question in these cases is whether the LLC or partnership can pursue its essential purpose. In this article, we primarily examine the elements of deadlock applied to limited liability companies. Deadlocked partnerships are a rarity, but the analysis should be similar if not identical.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

A limited liability company or partnership is more prone to deadlock because unanimous agreement is required in most states to act on a number of issues. The unanimity requirement is a core aspect of some of the central principles underlying unincorporated business associations (primarily partnerships and LLCs) – that the owners have unfettered discretion to pick their partners, that they cannot compelled to fundamentally change the business against their will and that they normally will participate in the day-to-day affairs of the business. Deadlock limited liability company | deadlock corporation | deadlock partnership

The Minority Veto Contributes to Deadlock

We see the “pick your partner” principle reflected in disputes over the admission of new members or partners, the unanimity requirement for amendments to an operating agreement, and in the rights of members to be free from interference in the management of the business by creditors. It is also demonstrated in many states by the requirement that mergers and other transactions outside the ordinary course of business have the approval of all of the members. Continue reading

January 25, 2019

Understanding Deadlock in Limited Liability Companies and Partnerships

by Jay R. McDaniel, Esq.

Deadlock in a limited liability company or partnership occurs when the members can no longer pursue the purpose of the business as agreed in an operating agreement or partnership agreement.
A ‘minority veto’ occurs when a minority member or partner uses the unanimity requirement to block the will of majority.
Actions outside the ordinary course of business are likely to require unanimous consent, including the admission of a new member or partner, amendment to the operating or partnership agreement, a merger or sale of substantially all of the business’ assets.

Deadlock among the members of a limited liability company, or among the partners in a general partnership, involves the inability of the company to make decisions that are material to the continued operation of the business. It is not an infrequent occurrence. The direct participation of the owners in the day-to-day affairs of the LLC or partnership and the requirement that — in most circumstances — the most important decisions require a unanimous vote make it important that an LLC or partnership is able to reach consensus on the most important decisions.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Because LLCs and partnerships are unincorporated business associations, they are typically quite different in structure than a traditional corporation. And while deadlock among the members of a limited liability company or partnership involves many of the same principles that one finds in the closely held corporation, there are significant differences as well.

New Jersey | New York | Deadlock limited liability company | deadlock corporation | deadlock partnership

In this article, we look at some of the differences between deadlock in corporations, which are generally governed by statute, and deadlock in unincorporated business associations (primarily partnerships and limited liability companies), which are governed primarily by principles of contract. In many cases, the results are not very different, but there are some key distinctions.

In later posts, I will examine some of the circumstances in which the courts have been asked to resolve deadlock disputes through lawsuits seeking involuntary dissolution actions or the expulsion of a member or partner.

Deadlock Occurs When Contracts Fail

Unlike a corporation, which conceptually is a creature of statute, deadlock in a partnership or limited liability company usually does not involve any specific statutory provision that is intended to address the problem of deadlock. In fact, neither the Revised Uniform Limited Liability Company Act (RULLCA) nor the Revised Uniform Partnership Act (RUPA) specifically mention deadlock. Rather, because the limited liability company and partnership are fundamentally creatures of contract, the focus is not on the statutory criteria but the nature and scope of the express and implied agreements that exist between the owners.

October 15, 2018

Valuation Clause in Operating Agreement Controls Buyout Price of Medical Practice

by Jay R. McDaniel, Esq.

A limited liability company operating agreement may be amended informally by oral agreement or by a course of conduct.
The party that claims amendment of an operating agreement by a course of conduct must establish the clear and mutual intent of the parties to agree to the amendment.
A clear and unambiguous provision in an operating agreement that governs how the limited liability company will be valued in the future is an enforceable contract.

attorney for medical practice valuation A retiring member of a limited liability company was unable to convince a trial judge that the parties had amended the operating agreement through their course of conduct to adopt a new valuation approach.

Certificate of Agreed Value Required by Operating Agreement is not Updated for 17 Years

The opinion in the Chancery Division dismissed on summary judgment the plaintiff’s claim that sought to order the majority owners of a medical practice organized as an LLC to use a fair market value determination of the value of the interest of a retiring member, rather than to rely on an outdated “Certificate of Agreed Value” prepared in March 2001.

Law firms should recognize that lawyer resignations and the loss of clients are inevitable in the modern law practice due to prohibitions on agreements that restrict competition.

Law firms can protect the interests of clients and the firm by adopting best practices that govern lawyer resignations.

Law firms should recognize the investments made in the firm’s intellectual property and adopt policies that limit misappropriation.

Best Practices to Manage Lawer Resignations

Courts determine whether an individual has an equity interest in a law firm partnership by examining the financial investment and risk taken by the claimed owner, such as payment of capital and guarantees of obligations.

The rise of the non-equity partner in law firms management has changed the status associated with the title partner. Nearly half of all law firm partners are now classified as non-equity or limited equity.

The way in which the firm reports the income of a partner to the IRS in its tax filings are evidence of an equity interest in many cases, but describing an individual as an equity owner may not be conclusive.

Attorneys have common law and statutory security interests in the proceeds of recoveries of their clients, generally referred to as charging liens.

A statutory lien is created when a lawyer files a pleading with an affirmative claim for recovery and may be enforced by filing a petition in the underlying action.

Clients have an interest in the assertion of an attorney charging lien and must be notified of their right to have the amount of the fee determined by arbitration.

The Attorney Charging Lien

Buy-sell agreements, like a shotgun sale triggered by a deadlock, are the principal means by which the owners of closely held businesses protect against the worst consequences of deadlock.

Commonly used shotgun provisions allow one party to set the price and allow the other party to decided whether to buy or sell at the offered price. Closely related to the shotgun is an auction that allows offerors a chance to sweeten their offers to buy.

The compelled sale of an equity interest triggered by a buy-sell agreement will be subject to the fiduciary duty of loyalty and the implied covenant of good faith and fair dealing.

Courts may apply shotgun or auction techniques when compelling the sale of a business as a going concern.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Buy-Sell Agreements Triggered by Deadlock

Business divorce disputes among lawyers will often require the division of contingent fees realized after the parties have separated their business interests.

An agreement between lawyers in a firm to divide fees in the event of their separation cannot function as a restriction on a lawyers right to practice and to compete with a former firm, but otherwise is generally enforceable.

Courts also use principles of quantum merit — ‘as much as he deserves – to allocate contingent fees between lawyers who once practiced togther.

Agreements to Divide Fees

Owners of a closely held business, be it a corporation, limited liability company or partnership, may enter into contracts that are triggered when the principals have become deadlocked.

Anti-deadlock provisions may provide for the appointment of an independent director, for alternative dispute resolution, or for the compelled sale of an equity interest.

The owner of a business that invokes the terms of an anti-deadlock provision, particularly when the sale of interest is involved, is likely to be subject to duties of loyalty and care.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

When a shareholder, LLC member or partner sues to recover for damages based on wrongs committed against the business entity, the claim is derivative and the recovery belongs to the business. Derivative claims have special procedural rules.

A shareholder may bring a direct claim to enforce rights that are contractual in nature or which enforce some right as shareholder, such as the right to vote or elect the directors.

Derivative Lawsuits Assert Claims that Belong to the Business

Most limited liability company and partnership statutes make no mention of ‘deadlock’ as grounds to order the involuntary dissolution of a business.

Deadlock arises when the members or partners are no longer able to pursue the basic agreements on which the business was organized, typically an operating agreement or partnership agreement.

The key determination in an action to force the dissolution of a limited liability company or partnership is whether it is ‘reasonably practicable’ for the business to continue.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

The Minority Veto Contributes to Deadlock

Deadlock in a limited liability company or partnership occurs when the members can no longer pursue the purpose of the business as agreed in an operating agreement or partnership agreement.

A ‘minority veto’ occurs when a minority member or partner uses the unanimity requirement to block the will of majority.

Actions outside the ordinary course of business are likely to require unanimous consent, including the admission of a new member or partner, amendment to the operating or partnership agreement, a merger or sale of substantially all of the business’ assets.

A Series Examining Deadlock Among the Owners of Closely Held Corporations, Limited Liability Companies and Partnerships

Deadlock Occurs When Contracts Fail

A limited liability company operating agreement may be amended informally by oral agreement or by a course of conduct.

The party that claims amendment of an operating agreement by a course of conduct must establish the clear and mutual intent of the parties to agree to the amendment.

A clear and unambiguous provision in an operating agreement that governs how the limited liability company will be valued in the future is an enforceable contract.

Certificate of Agreed Value Required by Operating Agreement is not Updated for 17 Years