New Definitions of Partnership

New Definitions of Partnership

The typical lawyer’s career track changed dramatically about 25 years ago. Until then, it was usual for a lawyer to join a firm upon graduation from law school, work hard as an associate for five to seven years, and then, in most cases, become an equity partner, staying until retirement or death. In the late 1980s, the partnership track for large firms extended to nine or ten years, and over time other layers of attorneys were added between the ranks of associates and equity partners. Now, there are all sorts of categories of law firm lawyers, including senior counsel, of counsel, special counsel, career associates, and so forth, with the title and criteria for each set by the particular firm.

It’s now common for law firms to have at least two tiers of partners: equity partners who share directly in the profits of the firm; and nonequity, income, or contract partners who, in most cases, receive a base salary plus bonuses usually dependent upon their personal production. Equity partnership involves shared liability for the debts of the firm, a capital contribution, voting rights regarding the affairs of the firm, and compensation based on a share of the profits. Historically, once an associate spent a certain number of years working for the firm, he or she was considered for partnership. That associate either was elected to full equity partnership status, or turned down. If “passed over” the associate was expected to leave the firm within a reasonable period of time. This one-tier partnership and “up-or-out” system began eroding in the 1980s as the increasingly competitive legal marketplace required new approaches to the traditional partnership system.

As partners began moving laterally between law firms, more flexibility was needed for their addition and, if necessary, removal if they didn’t meet expectations. Rather than offering lateral partners full equity status, which could pose difficulties in their admission to and removal from the partnership, law firms sought a structure which ­allowed for a probationary period. Thus, partners were hired on a contract or nonequity basis with provision for full equity consideration at a stated time, usually within one to two years. Often, their hiring agreement contained certain benchmarks regarding business generation and billable hours ­requirements. A lateral partner’s compensation depended upon individual performance rather than the profits of the firm. Those who didn’t prove themselves within the specified probationary period could receive an extended probationary contract or be asked to leave the firm without the more stringent procedures required for removal of a full equity partner.

In the increasingly competitive environment, not all senior associates are up to the challenge of full partnership at the time of their consideration for promotion. While they may possess excellent legal skills, they aren’t ready for the additional responsibilities of equity partnership such as generating and managing client relationships, supervising and training associates, and handling firm management duties. Creating a second probationary tier of nonequity partnership allowed firms to give these valued associates a promotion while permitting them to transition into full partnership duties over a period of a few years. Many firms don’t set a specific deadline by which lawyers in the nonequity partnership tier must demonstrate their readiness for equity partnership; instead, lawyers may remain in this tier for an indeterminate period. For some lawyers, the nonequity tier is a path to making equity partner within a few years rather than leaving the firm under an up-or-out policy; for others, it’s a limbo from which they never emerge.

In fact, some associates prefer nonequity status to full-equity partnership. While still attaining the title of partner and the ego boost of promotion, they needn’t shoulder all of the burdens of firm ownership. Some associates turn down offers of promotion to equity partnership in return for reduced pressure. They don’t want the extra responsibility of developing new business, taking on management and administrative responsibilities, putting in more hours and working harder, and making a huge capital contribution (or sign on for a loan to cover it) just when their law school loans finally are under control. Nonequity partnership also permits lawyers to better balance family and law firm obligations while still appearing to the outside world as a partner.

Voting rights for nonequity partners vary between firms and even between tiers of partners in the same firm. There also are differences regarding whether nonequity partners attend partnership meetings or receive the firm’s financial information. Although nonequity partners publicly look the same as full partners, they are, in reality, employees of the firm. The advantages for law firms of showing a larger percentage of their lawyers as partners include justification for higher billing rates and stronger relationships with clients that prefer working with partners only.

Some firms employ a “mixed-tier structure” where “fixed-income equity partners,” occupy a kind of hybrid equity/nonequity status. They contribute capital to the firm, like equity partners, but don’t receive a portion of firm profits as part of their compensation. Instead, their compensation is in the form of fixed annual salary and/or a performance-based bonus. These partners seldom vote as equity partners, thus possess little or no governance authority.

An important consequence of a multi-tiered partnership is the concentration of risk in a smaller number of full equity partners who are on the line for leases, debts, malpractice exposure, capital contributions, and so forth. Furthermore, if no part of the nonequity partners’ compensation depends upon firm profitability, there’s no incentive for them to contribute to the firm’s benefit as a whole. In other words, if the bonus component of nonequity partners’ pay depends only upon individual production, it’s against their interests to spend valuable time on firm management, associate training and mentoring, or other activities not tied to their personal bottom lines. And, finally, there may be a negative impact on morale if a firm’s partnership tiers give rise to a situation where partners who aren’t in full equity position are considered second-class citizens.

Traditionally, the “of counsel” title was reserved for senior partners of the firm who were semi-retired. Now, that title connotes ­almost any nonpartner/nonassociate relationship between a lawyer and a law firm. Some law firms give their semi-retired partners the title of “senior partner” or “partner emeritus,” differentiating them from other “of counsel” types. Even more confusingly, lawyers can serve as of counsel to more than one law firm at a time.

While there are distinct advantages to multi-tiered partnerships, the practice of deequitizing under-productive partners, or designating under-performing lawyers as nonequity partners or as permanent associates often only delays the inevitable. In many cases, these lawyers lack some essential ingredient for advancing within the firm. Unless they improve or continuously justify their existence from a business perspective, the firm eventually should let them go. Too many of-counsel and nonequity partners clog the advancement pipeline for those below them, preventing the firm from growing at lower levels and grooming potential new partners.

Valerie Fontaine

Telephone: (310) 839-6000

E-mail:  info@seltzerfontaine.com

2999 Overland Avenue, Suite 120

Los Angeles, CA 90064