PARTNERSHIP: An Introduction to UK-wide

PRACTICE AREA OVERVIEW 

PARTNERSHIP: CONTENTIOUS 

Author: Fox & Partners Solicitors LLP 

The world of contentious partnership law is evolving. Partnerships and LLPs remain the structure of choice for many businesses, particularly professional service firms. They are put to increasing use in the financial services sector. While these industries typically favour privacy (with much being resolved by arbitration or negotiated settlement), pressure for greater transparency in decision-making and COVID-19 induced economic pressures have created an environment ripe for increased litigation in this area. What many firms did at the height of the crisis to conserve cash will now be under review, underlying deficiencies are likely to have been exposed and, in a lot of cases, there will be less profit to go around.

Financial services partnerships disputes are on the rise. In tough economic times, individuals naturally look to safeguard what they have worked hard to earn and will earn in the future, even if they are looking to exit their employer or firm. Similarly, where a senior individual is on the way out, either voluntarily or involuntarily, firms are likely to want to ensure that they are not paying out any more than necessary and will seek to reserve any surplus for the talent they wish to retain. In sectors where an equity interest comes to fruition at a point in the future subject to certain conditions, and such interest is potentially extremely valuable, the stakes in respect of those conditions are high for both parties. In economically unstable times, the prospect of replacement of any lost value in a new role is reduced. In short, the value is worth fighting for.

Contentious partnership work also appears to be mirroring issues widely reported in the press, with a stark increase in the number of discrimination, whistleblowing, bullying and sexual harassment allegations, possibly on the back of the #MeToo campaign and increased willingness of individuals to speak up. If allegations are sufficiently serious they usually now lead to a detailed independent investigation, often carried out by a third party. Competing stakeholder interests often creates an environment rife with conflict. The move towards a culture of speaking up has been supported by the pressure for transparency and personal accountability in firms. The availability of creative funding solutions and potential for group litigation have started to chip away at the structural barriers which may have historically prevented a challenge to the gender pay gap and discrimination.

The law relating to the exercise of discretion remains a hot topic in the partnership law space and we are likely to see increased challenge as discretionary decisions around exits and profit share are made. The law remains in a state of flux with uncertainty as to parameters. It is likely to be the case that, even if there exists a clear, express right for a firm to make decisions about the firm and the people in it, their use of this power is unlikely to go unchecked. Good faith will be implied into any exercise of discretion. The decision reached must not be exercised in a way that is objectively irrational, arbitrary or capricious or be so outrageous that no reasonable decision-maker could have reached it. A proper process and communication is key but often overlooked.

Tighter regulatory obligations (from both the Solicitors Regulation Authority (SRA) and the Financial Conduct Authority (FCA)) have meant clients are keen to seek advice at earlier stages in what is evidently a changing attitude towards risk. We have seen the FCA’s review of firms’ whistleblowing arrangements, and increased focus on personal accountability with the extension of the Senior Managers & Certification Regime (SMCR) to all FCA-regulated firms including asset management firms and hedge funds. The SRA has continued to flex its muscles. The prospect of regulatory action has become an increasingly prevalent consideration in contentious partnership work.

In professional services firms, we are likely to see an increasing number of exits over the coming months: those who are underperforming and are asked to leave; those who are not satisfied or are not thriving where they are and want more; and those who have developed the taste for more time at home and have chosen to retire. Firms will want to be ahead of the curve, predicting the next growth area and continuing to incentivise those who are valuable to the firm. In a recessional climate, inefficiencies will no doubt be exposed and if firms are over-staffed with partners, this will need to be addressed. Remote working means that maintaining identity, culture and a common purpose when most people are working from home is more challenging than ever.

Pressure on costs may result in increased capital calls from members in LLPs. Whilst LLP members often “buy in” at the outset of their membership, typically financed by third party borrowings, it is less common to require further capital contributions during the life of the LLP. LLP members may have mixed feelings in doing so and some may refuse if they feel they are disproportionately contributing to the firm’s financials at that time and consider that the capital injection may be at risk.

In smaller entrepreneurial firms, founders may find themselves under pressure in a climate that is putting a strain on costs and margins; firms may find that they must adapt and reshape and, potentially, create a more agile and flexible workforce.

We are likely to see more team move activity. In financial services firms, if bonus potential, long term incentive or carried interest is significantly reduced (or even wiped out to be built up again over time), teams may decide that they are as well jumping ship to establish spin-offs or to join competitors and start over, potentially in breach of restrictive covenants and fiduciary duties. Professional firms may wish to acquire teams in growth areas who are disillusioned or feel under-rewarded elsewhere, and those teams may be willing to take a risk that their previous firm does not have the headspace or financial means to fight them in the courts.

With partner moves, enforceability of post-termination restrictive covenants in relation to LLPs comes under the spotlight. Current thinking is that the law relating to restrictive covenants in traditional partnerships, in which partners are deemed to have equal bargaining power, would be likely to be applied to LLPs. A lack of case law around restrictive covenants in the LLP context remains. In reality most members of LLPs have no influence over or input into the terms of the LLP agreement, so having greater bargaining power than employees often doesn’t stack up. With so much uncertainty around the approach to restrictions in an LLP context, this area is ripe for review, particularly with the likelihood of increased movement in the legal and financial services markets in the short term.

An uptick in partnerships disputes and litigation is almost certainly on the horizon.