Just a few weeks ago, I commented on a recent uptick in disputes centered on the breakup of professional services firms.  In those disputes, we expect that the demands of the legal, accounting, and medical professions draw individuals with keen attention to detail, focused on documentation, and prepared for all contingencies.  Less expected is the irony that many attorneys, accountants, and medical professionals fail to bring those attributes to the table when organizing their business relationships. 

The result of that failure is a tinderbox—poorly defined “partnership” relationships, mixed with high profit margins, difficult to value businesses, and type A owners willing to litigate their disputes.  The right spark triggers bitter and hotly contested litigation.  That part-legal, part-psychological phenomenon explains why business divorces of professional services corporations—especially law firms—can get complicated fast. 

Motivated by that uptick, Becky Baek and I were pleased to recently present a CLE on the complexities that arise in the dissolution or breakup of law firms.  Here are the highlights.

Partner or PINO?

The PINO, or “partner in name only” has seen a surge in popularity among the legal profession.  According to a 2019 Wall Street Journal article, more than half of the “partners” at Kirkland & Ellis were PINOs—not invited to the annual partners’ retreat and not expected to share in the record-breaking profits of the firm. 

While billed to clients and courts as “partners,” PINOs—unlike true partners—often have a fixed salary, no voting or management rights, no statutory ownership rights, and no obligation to share in the firm’s losses. 

The popular practice of calling attorneys “partners” to courts and clients, but not bestowing upon them the legal rights of partners inevitably leads to litigation over the circular question: when is a partner a . . . partner?  The answer rests on a highly fact-specific inquiry, with no one fact dispositive.  Here are some of our favorite cases addressing the partner/PINO dilemma:

• D’Esposito v Gusrae, Kaplan & Bruno PLLC, 44 AD 3d 512 (1st Dept 2007) (attorney who did not sign PLLC operating agreement but nonetheless received K-1s held not a partner);
• Barrison v D’Amato & Lynch LLP, 2019 NY Slip Op 30905(U) (Sup Ct NY County, April 2, 2019) (attorney who did not sign partnership agreement but received K-1s identifying him as a “general partner” held not a partner);
• Rosengarten v Guerrero et al., Index No. 6522241/2022 (Sup Ct, NY County) (attorney who signed partnership agreement, but did not participate in day-to-day business held a partner);
• Capizzi v Brown Chiari LLP, 194 AD3d 1457(4th Dept 2021) (attorney who shared in firm’s profits and losses but did not exercise control or management functions held a partner).

In my view, the interesting takeaway here is that each of these cases deals either with a partnership or a professional limited liability company.  The professional corporation seems less susceptible to disputes over ownership status.

The Choice at the Beginning Matters Most at the End

Upon a law firm’s founding, the attorneys will need to choose a corporate form.  In New York, they can operate as a Partnership (subject to New York’s Partnership Law), a Professional Limited Liability Company (subject to New York’s LLC law, including Article 12), or a Professional Corporation (subject to New York’s Business Corporation law, including Article 15).  The chosen corporate form will dramatically change how, in the absence of an owners’ agreement stating otherwise, dissolution or a buyout can come about. To generalize:

• A New York Partnership (i) is automatically dissolved upon a partner’s death or bankruptcy; (ii) is dissolved “by the express will of any partner when no definite term or particular undertaking is specified;” and (iii) can be judicially dissolved upon a Court’s finding that it is no longer reasonably practicable to carry on the business, or the business of the Partnership can be carried only at a loss (see Partnership Law 62, 63)
• A New York Professional Limited Liability Company can be dissolved (i) upon a vote of a majority of members (see LLCL 701); (ii) as provided for in the operating agreement; or (iii) when it is no longer reasonably practicable to carry on the business in conformity with the articles of organization or the operating agreement (that standard is explained here).
• A New York Professional Corporation can be dissolved (i) by majority shareholder vote (BCL 1103); (ii) upon a deadlock of shareholders (BCL 1104); or (iii) upon a finding that those in control of the corporation are guilty of oppressive or unlawful conduct toward at 20% minority (BCL 1104-a).

Warnings for Employee-Owners

Many professional corporations are structured so that their shareholders are also employees who receive their compensation as a salary/bonus and not as a dividend or distribution. In those corporations, disputes arising at the intersection of “employee” and “shareholder” can produce some harsh results.

For example, mere retirement does not entitle the retiree to dissolution or a buyout (Lubov v Horing & Welikson, P.C., 72 AD3d 752 (2d Dept 2010) (mandatory redemption provision of BCL 1510 does not apply to terminated shareholder).  This means that a retired shareholder of a PC (especially one holding less than 20% of the corporation) could be stuck unable to obtain any value for his or her shares.  But recall how the creative pulmonologists dealt with that dilemma in Wang v Schenectady Pulmonary & Critical Care Assoc., P.C., 79 Misc 3d 1210(A) (Sup Ct, Albany Co. 2023) (discussed here).

Second, PC shareholders must be cautious of the relationship between at-will employee and shareholder status.  Where a shareholders’ agreement contains a mandatory redemption clause upon the termination of a professional’s employment, a shareholder-employee terminated for any reason whatsoever will have little recourse to challenge the redemption of his or her shares (Laurilliard v McNamee Lochner, P.C., 79 Misc 3d 1220(A) (Sup Ct Albany Co 2023) (discussed here).

Valuation Issues Abound

Valuation of law firms presents some of the most complicated valuation questions I’ve seen in my career.  The basic principles can be stated with almost disarming ease:

• Pending hourly-fee cases are not “assets” of the law firm, since a law firm does not “own” a client or engagement (see In re Thelen LLP, 24 NY3d 16, 29 [2014]).
• A law firm that litigates a contingency-fee case obtains an interest in that case, and that interest is a firm asset—this means that if a departing partner takes a contingent-fee case and subsequently litigates it to settlement or verdict, the dissolved firm is entitled to the value of the case at the date of dissolution, with interest, or, “[s]tated conversely, the lawyer must remit to his former firm the settlement value, less that amount attributable to the lawyer’s efforts after the firm’s dissolution” (Murov v Ades, 12 AD3d 654, 656 [2d Dept 2004]);
• The goodwill of a law firm—its ability to attract clients as a result of the firm’s name, location, or reputation of its lawyers—presumptively is a distributable asset absent some indication that the partners intended otherwise.

In practice, these principles are difficult to implement.  And they often implicate major confidentiality and privilege concerns.  Valuing a firm’s interest in contingency-fee cases has spawned years of dispute in Capizzi v Brown Chiari (discussed here).  And, as SDNY Judge Koetl’s recent decision in Freedman Normand Friedland LLP v Cyrulnik, 21-CV-1746 (JGK) (SDNY May 15, 2024) (discussed here), demonstrates, even the most high-profile lawyers and experts can get tripped up on the complexities associated with valuing pending contingency-fee cases.

Best Practices

We’ve only barely scratched the surface of the complications that can arise when law firms break bad.  But that overview lends a fine opportunity to offer some general guidance that may prevent a bad breakup from getting worse:

• Have it in writing.  It’s an unusual irony that attorneys often are quick to advise their clients about the importance of a writing, but don’t heed that advice in their own affairs.  The profession would be wise to consider the words of Justice Crespo: “this dispute . . .  like many others between learned attorneys, ends with the familiar and constant admonishment: ‘have it in writing!’” (Cohen v Cohen [N.Y. Sup Ct, New York County 2009]).
• Consider the P.C. In a post not too long ago, I explained why all else equal, I’d prefer to be a minority shareholder of a corporation over a minority member of an LLC.  Those reasons ring particularly true in the law firm context.
• Avoid the valuation question ex ante.  Valuation of law firms is difficult.  Attorneys crafting owners’ agreements with buyout provisions would be wise to consider buyouts tied to other metrics, such as compensation or collections.

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