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The Perils of Partnerships
Practice Management and Business Skills| What area(s) of law does this episode consider? | Partnerships, including incorporated limited partnerships and limited liability partnerships. |
| Why is this topic relevant? | Partnerships are a unique type of business structure that has remained a popular choice for law firms and other professional services firms. In Australia, legal partnerships can involve as few as two partners and up to as many as four hundred. However, there are challenges and benefits to operating under a partnership model which practitioners should be aware of. |
| What legislation is considered in this episode? | Partnership Act 1892 (NSW) |
| What are the main points? |
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| What are the practical takeaways? |
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| David Turner:
1:00 | Hello and welcome to Hearsay, a podcast about Australian laws and lawyers for the Australian legal profession, my name is David Turner. As always, this podcast is proudly supported by Assured Legal Solutions, a boutique commercial law firm making complex simple. While the company limited by shares has been the legal entity of choice for businesses across a whole range of industries for many many years, it’s the partnership that’s remained a popular choice for law firms and other professional services businesses. And that’s true whether we’re talking about a two-partner law practice on the high street, or an international law firm with partners on five different continents. Why has the partnership endured the test of time? And what perils does partnership present for the unprepared practitioner? Joining us today again on Hearsay to talk about all things partnerships is Geoff Sutherland. Geoff thanks so much for joining us again in the Hearsay studio. |
| Geoff Sutherland: | It’s a pleasure. Good to be here. |
| DT:
| Now, Geoff, you’ve been a partner in law firms here in Australia and overseas, what makes partnership a popular model for law firms, and why has it endured for so long when incorporation has been popular in other industries and offers partners limited liability and greater convenience in terms of people entering and exiting the business? |
| GS:
2:00
3:00
4:00 | Partnerships are very ancient. They’re really the first form of joint commercial exercise. It goes back to Roman times. In the more modern times the first record of partnership seems to have been about 1350 in Florence, so they’ve been around forever and really were originally joint stock companies and corporations came along a lot later. TIP: Ok, so I’m not sure how much this will help you with Australian partnership law but I think this sort of stuff is fascinating, so let’s quickly look at the 14th century origins of partnership law. So, yes! Early forms of partnership structures were recorded in Renaissance Florence in the mid 1300s. They came to exist following the Ciompi Revolt of 1378. Basically following some changes to the Florentine tax system that were introduced after that revolt, the elite upper class decided to introduce partnerships as this new way to secure status and political power and combine financial interests, even more so than they were already doing through strategic marriages. And then partnerships, as a form of business organisation, spread throughout Europe as more and more people realised the organisational efficiencies of joining forces with others and similarly spread into the Middle East and Asia. A common feature of all of these early Medieval and Renaissance partnerships, and modern ones in fact, is the relationship between two or more people to trade and share profit. So, there you go. If you’re a bit of a history geek like me, that’s where partnerships come from. Now, today we’ll talk about partnerships in Australia that have some additional features that have developed through legislation and the common law and Geoff will talk more about those now. For law firms, it’s compulsory to operate as a partnership and I think in some other professions as well. And I think that the reason for that is that it’s sort of part of the social compact that if you’re given freedom and licence to advise people in companies on matters that are very important to them the authorities require that you stand behind your advice, as it were. Apart from the compulsion reason, there are other good commercial reasons for it. One is that profits flow through to the partners so you don’t have any double taxation dividend imputation issues, which were obviously a matter of significant discussion during the previous federal election. And with professional firms, the nature of the business I think is different. You’re going to a person. It’s not like buying steel, or it’s not like buying a product from a bank. It’s quite a different type of business to most businesses run by companies. |
| DT:
| That’s quite a good point. I think that the structure of the partnership kind of reflects the way that clients think about the law firm – that it is a collection of individual experts and those individual experts, as you say, are putting their own opinions and their own names and reputations on the line when they give their advice, they’re standing behind that in a personal capacity rather than in a corporate one. |
| GS: 5:00
6:00
7:00
8:00 | A partnership is a form of joint venture, as are companies, as are a lot of unit trusts in particular. The reason a company is not a partnership is because it’s excluded by legislation. What we call a joint venture, a lot of those don’t qualify as partnerships because of the definition of a partnership, so there’s the definition of a partnership which has been the definition since, I don’t know, the New South Wales Partnership Act is 1892, so it hasn’t changed since then, is ‘a relationship between persons carrying on business in common with a view to profit.’ A lot of what we call joint ventures are not partnerships because they’re not carrying on business. It’s usually a contractual arrangement for one project only. So they don’t qualify. The partnership is a contract. A partnership is not a legal entity separate from the partners. It’s quite unusual, it sort of sits out on its own as a commercial structure in many respects. TIP: Ok, let’s talk about the requirements of the Partnership Act 1892. Now, section 1(1) of that Act defines a partnership as ‘the relationship which exists between persons carrying on a business in common with a view of profit and includes an incorporated limited partnership.’ Ok, so that partnership definition can be broken down into, really, three key elements. First, the purported partnership has to be “carrying on a business”. The common law developed complex indicators for what “carrying on a business” means but a joint venture – pointed out by Geoff – might not actually qualify because it’s often formed for a singular reason or a transaction or a specific project rather than an ongoing business. More important is whether the business is systematised, regular, and continuous. That second element, the partnership has to be operated “in common”. This means that the partners have pooled interests, rights, and their obligations and a scary prospect for any partner can be liabilities they assume for the actions of their other partners. This unlimited liability is a defining characteristic of a partnership, though, and this is a point that Geoff’s going to touch on in a moment. Now, the third element of a partnership is it has to be formed with a “view to profit”. This element is perhaps the most self explanatory but it explains why we don’t have not-for-profit partnerships. Now, a company or association incorporated under the Corporations Act 2001 is expressly excluded from the definition of a partnership as is any other company or association that’s incorporated pursuant another Act of Parliament or Letters Patent or Royal Charter. Now, broadly, at the point of their enactment, partnership acts all across Australia were substantially just a transposition of the Partnership Act 1890 (UK), so similar definitions are included in all of that legislation – but take care switching between jurisdictions because there’s a couple of tiny little differences in operation. |
| DT:
| And as you say, because it’s not a legal entity in and of itself, it’s a collection of the individual legal personalities of the principals, or the partners, that means that those profits can flow through directly to those partners but it also means that some of those liabilities flow through directly to the partners. What are some of the exposures in terms of liability that partners in a partnership have? |
| GS: 9:00
10:00 | The partners are jointly and severally liable to all creditors of the partnership. And as far as a third party is concerned, any partner has ostensible authority to act on behalf of the partnership. It may be that within the partnership agreement there are limitations placed on it. So often you’ll have matters that are reserved by the authority of a chief executive officer as they’re now called, or to the board or things like that. But as far as the rest of the world is concerned each partner has authority to bind the partnership. And if one of your partners does something or commits the partnership to something, you’re bound by it and are liable for it regardless of what you might think about it. And of course, personally liable. TIP: Ok, so section 5 of the Partnerships Act outlines this power of a partner to bind the firm as an agent of the whole partnership, and section 12 states that partners in a firm are jointly and severally liable for the actions of the partners – along with some exceptions for limited or incorporated limited partnerships. So, in other words, jointly and severally liable, each partner for the whole of the partnerships debts. So let’s talk a bit about what an “incorporated limited partnership”, which we’ll call an ILP, what that is. An ILP is a unique type of partnership with tacks together some principles from partnership law and corporations law – bit of a business structures Frankenstein – which permits some – but not all – of the partners to limit their liability. Now, according to Part 3, Division 2 of the Partnerships Act, ILPs have to have at least one partner with unlimited liability (referred to in the Act as a “general partner”) and it can;t have more than 20 of these. Limited partners in an ILP can’t be involved in the management of the business. As ILPs are incorporated, they’re a recognised separate legal entity and can sue and be sued in their own name. It’s worth noting that ILPs are commonly used in Australia as a structure for venture capital, and it’s not a common structure for law firms or other professional services businesses though. |
| DT: 11:00
| And what are some of the challenges associated with that personal exposure, particularly where that personal exposure has come from the acts or omissions of one partner in a partnership of 200-300 partners? I mean, how do you manage that at a practical level? |
| GS: | At a practical level you sort of make sure that they realise there’s going to be pretty serious consequences. Usually in the partnership agreement there would be provisions for some form of discipline or dismissal if people internally don’t comply. But if they don’t comply and a third party relies on it and has no notice or reason to suspect that that partner has no authority, then you’re stuck with it. |
| DT: | Can you tell us about a time that you’ve seen a partnership exposed to a liability because of one of the partners acting outside their actual authority but within what an external party would have would have thought their ostensible authority to be? |
| GS: 12:00 | There certainly have been examples in smaller partnerships where one of the partners has gone feral and, has for example, defrauded the trust account and has no resources of its own and the other partners are left holding the baby. In big partnerships, particularly with international partnerships, it can be a real problem. And one situation I knew about, one office thought about having new premises and signing up a long lease at extremely high rentals and thought that would be a good idea because they’d get great views and be in a great part of the city and all that sort of stuff. When the office wasn’t profitable, the rest of the partners were stuck with it. |
| DT: 13:00 | Oh dear. I mean that must be pretty nerve wracking. Some of our listeners will be partners in law firms on the high street, they might have some personal exposure through that partnership that maybe keeps them awake at night if it’s a particularly expensive office. But to be a partner in a partnership like that where you might be jointly and severally liable, and therefore theoretically liable for the whole lot of the rent payable on a Melbourne multi-storey commercial lease, that must be pretty nerve wracking for some of those partners. |
| GS:
14:00 | It is. And look, the two big expenses for virtually any business are premises and staff and premises you can’t really do anything about. You’re stuck with it. I mean you might be able to sublease part of the premises or something like that. The staff you have some control over, I know there are unfair dismissal rules and things like that, and in the nature of business staff come and go, so if some staff leave you might not replace them, so you can to some extent control your expenditure on salaries. But your expenditure on premises is really important and that is often the largest expenditure. TIP: Just pausing here to let you know we’ve got a few episodes of Hearsay that can help you to understand a bit more about your firm’s operating profit model. Now, if you’re looking for ways to better understand your business’ expenses, try episode 6 of Hearsay, ‘Microeconomics for Lawyers’ with Dr George Beaton and we’ve also got ‘Accounting for Lawyers’ with Nik Ahkin. That’s a good episode to listen to if you want to understand how to really measure financial performance in your law firm. |
| DT: | I suppose a lot of large law firms are also financed by debt, indeed smaller and medium sized law firm partnerships would also be financed by debt, how does that work in a partnership structure? |
| GS: 15:00
16:00 | Well, what happens now is that there’s really two types of debt that professional firms use and one is that the partnership borrows, I’ll say borrow but it might be other forms of financial accommodation, it might be asset financing or whatever it happens to be, but the partnership borrows and the balance of the capital comes from equity provided by the partners. And some time ago, back in the 90s, I worked with a financial advisor who advised a lot of the professional partnerships and we started what’s now a quite common product which is partner equity financing. So instead of a partner having to find the money to buy in for a share of the partnership, for the equity required for the partnership, you borrowed it. So there’s a sort of standard suite of documents which is used now so that the bank lends to the partner, the partner uses that borrowing to contribute equity to the firm or to lend money to the firm, can be done in different ways in different firms, but essentially the partnership undertakes to the bank that sufficient monies will go to that partner to enable the partner to pay the interest on the loan from the bank. And as an undertaking from the firm to the bank that if the partner leaves, the firm will pay the amount of the outstanding loan to the bank before it pays any monies to the partner. The partner agrees to all that, of course. So one way or another, the whole lot comes from lending. |
| DT: 17:00 | There’s clearly challenges associated with managing liabilities and personal liability in a partnership, whether that’s a large partnership or a small one, including that exposure to bank debt. But what about some of the challenges associated with managing a partnership? You’ve been in management roles in law firm partnerships in Australia and overseas, how does that differ both in terms of the task of management and I suppose the culture of the organisation and the culture of management from a company where you have a more clearly delineated director and employee and shareholder kind of role separation? |
| GS:
18:00 | Well, it’s an old well-known expression that managing a law firm is like herding cats, you spend your whole time trying to round them up. You’re dealing often with successful people, a lot of type A personalities. Unless you’re very careful there’ll be at least some who think they can do better than you. I was reading something the other day which reminded me that a partnership is a contract and so there are limits on people who can enter into a contract. So a minor, somebody under 18, can’t enter into a contract, and persons of unsound mind can’t enter into a contract, which I think a lot of people who have been partners in law firms will find interesting to think that people of unsound mind can’t be partners in law firms. |
| DT: | Yeah no, that’s not consistent with my experience. |
| GS:
19:00 | No, that’s right. The partners are owners. In many firms, partners are treated somewhat like mid-level managers but they’re not and they certainly don’t think they are. They are owners and as an owner of any asset you’re entitled to have a vote, to have a say, on what happens with the asset, in this case, what happens with the with the partnership, and they’re personally liable as well, so they’ve got good reason to have a say if they think that decisions are being made which are not in the financial best interests of the partners. In my experience, like other partners at other law firms have told me this, partners in law firms are certainly not shy about coming out and letting their opinions be heard during partners meetings. |
| DT:
20:00
21:00 | And I suppose that’s most unique at the big end of town, isn’t it? Because in SMEs in any industry, in any type of business, an SME even if it’s incorporated in practice the directors are also probably the shareholders, whether themselves or through a family trust or some other interposition, and they’re probably also personally on the hook for many of the company’s debts through guarantees, through borrowing against the family home to finance the business, and things like that. TIP: Now it’s not at all uncommon to see commercial lenders of business including personal guarantees as a standard part of their loan documentation, meaning that for the majority of small business owners there’s really no corporate veil for them – they’re personally liable if their company defaults on the loan. Now, as we discussed before, knowing that you’re on the hook for business failures can be pretty stressful, and nothing exacerbated those worries for small business owners more than the COVID-19 pandemic – which caused a huge amount of financial distress and a real suppression of demand and supply for a lot of small businesses. Now, some experts predicted that COVID would not just cause a wave but a tsunami of small business insolvencies but that tsunami never really arrived thanks to some really great government initiatives that helped businesses stay afloat like JobKeeper. While we’re on the topic of SMEs, let’s look at some quick stats on SMEs. In December 2020 the Australian Small Business and Family Enterprise Ombudsman (the ASBFEO) published a report ‘Small Business Counts’, which recorded approximately 2.3 million small businesses in Australia – that’s a lot of small businesses. 62.8% of these businesses were non-employing – which means they didn’t have any employees, the only people that worked in them were the owners – and then 97.4% of those businesses had between 0 and 19 employees, 2.4% with 20-199 employees, and just 0.2% of these small businesses having over 200 employees. At the smaller end of town, there’s probably little difference between personal liability and corporate personality because of those personal guarantees, because of that, co-location of the director and shareholder roles. But there’s very few very large businesses, like some of our large international law firms here in Australia, where the managers would still be the owners. I think that’s really the place where the partnership structure is at its most unique. |
| GS:
22:00
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| Yeah, I think you’re right David. You don’t get many corporations where you’ve got 10 people committing themselves in the way you described. Whereas for 10 partners in a law firm to do that is perfectly normal. There are restrictions on the size of partnerships. A corporation is a form of joint venture. It’s not a partnership because it’s excluded by legislation from being a partnership, but in the Corporations Act there is a provision, one of the early sections, that you can’t have a partnership for more than 20 people, more than 20 partners, but there are exclusions in the regulations for certain areas. So you can have an accounting partnership for up to 1,000 partners in Australia. A law firm partnership up to 400, and then lower numbers for architects and factories and other areas. TIP: Those limits on the size of partnerships can be found in the Corporations Regulations at reg 2A.1.01. That regulation sets out some limits on the number of partners in a partnership for different industries. So there’s a limit of 50 partners for all actuaries, medical practitioners, patent attorneys, sbrokers, stockbrokers, trademark attorneys, as well as partnerships or associations that have a primary purpose of scientific research. There’s a higher maximum partner limit for architects, pharmaceutical chemists and veterinary surgeons, though, they can have as many as 100 partners in a partnership. Now legal practitioners, aren’t we lucky, we can have as many as 400 partners in a law firm and accountants, well, the sky is the limit with a maximum number of partners in an accounting firm of 1,000. |
| DT: | And what’s the policy thinking behind those limits? Why limit the number of partners in a partnership? If there’s 400 partners, what difference does that make if there’s 500? |
| GS: 24:00
25:00 | The problem was that the regulatory authorities, say the Law Society, did not want to do away with partnerships as the commercial form for a law firm. And so the pressure came onto the government to legislate to expand the number. This went back to, originally, during the during the 80s when globalisation took place and Australian legal and accounting firms were expanding fairly rapidly and they were getting up to the stage where they had twenty partners, they had another 10 people in the wings who were ready to be partners, but they couldn’t bring them in. So the number has built up over time and as there have been mergers and there’s been a lot of mergers over time. If you go back to the early 80s, say, a law firm with 10 partners was a large firm. Then it expanded pretty rapidly after that. And an accounting firm with 20-25 partners was a large firm. They tended to be very state based in those days. The national firms hadn’t really emerged and certainly international firms hadn’t. But the pressure has come from the nature of business really, that business needed the resources that large firms could provide to them and in order to do that, you need to have a certain bulk to do so. |
| DT:
| You’ve mentioned the partnership agreement and that partnership is at its core a contract a couple of times now. What is the role of the partnership agreement in ameliorating or mitigating some of these challenges we’ve described around both management and managing liability? Especially for those of our listeners who might have got their partnership agreement when they set up their law firm out of a precedent book and haven’t really given much thought to its contents, what are some of the things that you’d recommend are included in a partnership agreement, particularly for a law practice? |
| GS: 26:00
27:00
28:00 | What’s really important at the outset is to work out what happens if things go wrong. Now you’re not getting into it because you think things are going to go wrong. It’s quite the opposite, but things do go wrong along the way. And particularly, for example, in a partnership, there can be a falling out between people for all sorts of reasons which you don’t expect. You might think when you’re 30 that you’re going to be in partnership quite happily until you’re 70, but you never know what happens along the way, and people can come under personal pressures or financial pressures outside the practice or just have a change of life and decide they want to go and sit under a tree or whatever it happens to be. And the time to address that is at the beginning, not when the crisis arises. So you build into the partnership agreement a structure, and there’s various ways you can do this, but a structure that provides exactly what’s going to happen. So what are the circumstances on which somebody can resign? How much notice do they have to give, for example? If they don’t give enough notice, what happens to them? Is there an easily assessable financial repercussion for doing that? What are the circumstances in which a partner can be dismissed? And how do you go about doing that? And, importantly, what happens with the paying out the equity of the partner? How is that determined? Who does the valuation? Is somebody going to purchase it? Because it just doesn’t evaporate as it were. If so, who? When does payment have to be made? Have all those things set out quite clearly in the partnership agreement. Because particularly if there’s a partnership dispute, you’re not going to resolve it while the dispute’s going on. It’ll just turn to buck really quickly and you’ll finish up in litigation and litigation between partners, is like a really bad divorce. It’s terrible. You don’t want to go there. |
| DT: | There’s certainly some stories of messy litigation between partnerships and within partnerships in the legal industry here in Australia. Can you tell us a story about a dispute within a partnership that you’ve seen? Perhaps not one that you’ve been involved in, but one that you’ve seen and how that played out. |
| GS:
29:00
30:00 | There was one I knew about where the firm had grown but had grown in sort of different directions from where the original partners of the firm were contemplating when they set it up. So one part of the firm had grown much faster than another part. And this wasn’t the actual facts in this case, but let’s say it was an insurance part of the firm, insurance practice, and it had grown rapidly, whereas the commercial practice had not. Now the cash flow for an insurance practice is quite different to the cash flow for a commercial practice, the margins are quite different, the hourly rates are quite different and they don’t necessarily go well together. And the insurance practice didn’t like the fact that the corporate partner was running the firm and it just wasn’t fitting. And that fell apart. And it was pretty ugly. It didn’t go to litigation, but it was pretty ugly and one of the problems in that case was tax. So you’re getting into issues of capital gains tax and stamp duty and those sort of things. And at the end of the day, I know in that case that the two sides had different tax advice. The resolution was they just decided to go their own ways and go along with their own tax advice and see what the tax office said. But that can really affect how you handle a separation. It’s different in a big firm if one of the, or a small group of, partners, is leaving. That can usually be dealt with. But in a smaller firm, it can be really difficult. And in a bigger firm it can be difficult if you have a large group of partners who want to leave, who want the firm, for example, to merge with another firm but not all partners do. And that can lead to a lot of animosity and disharmony and a dispute between the partners. |
| DT:
31:00 | Yeah, I mean, I think that’s one of those situations that as you described, you’d really want to make sure that there’s a mechanism by which to make that decision, even if it’s an acrimonious one and it causes some feeling that there’s a mechanism to deal with it in the partnership agreement. I advise a lot of new businesses starting corporations and as you said, a shareholder’s agreement is very similar, but it’s not there to govern the company day-to-day. You’d want to have a more organic and more trust driven structure for managing the company day-to-day than a shareholder’s agreement. The shareholders agreement is there for exceptional circumstances and really only two of them: disputes between the shareholders and entry and exit of shareholders and I imagine the partnership agreement is much the same. TIP: Are you curious to know more about what happens with shareholder disputes when things go south in a company? Well, listen to episode 25 of Hearsay where I talk with Vince Pirina and Andew McEvoy from Ashton Chase and Jason Porter from SV Partners where we discuss how liquidators of solvent companies can help to resolve shareholder disputes. In that episode, we talk about the types of powers and duties that court-appointed liquidators have, and how that affects their ability to manage shareholder concerns and disputes and how that differs from an insolvent liquidation. |
| GS: 32:00
| The partnership agreement is not just the document that says partnership agreement, it’s a normal contract. The partnership agreement is whatever at any time, the partners agree on. So you’ll have a partnership meeting and the partners agree to do something or other. That becomes part of a partnership agreement, even though it’s not incorporated in the document that you call a partnership agreement. |
| DT: | And we’ve talked about a few of the downsides, a few of the challenges of partnership; personal liability, difficulty managing people, disputes, how to manage exits. What are some of the benefits of a partnership over a corporation? |
| GS:
33:00 | Tax can be a benefit in that you don’t run the risk of double taxation that you do in a corporation. The profits just flow through to the partners. There’s also the ability and most professional partnerships have what they call service companies. So that under the Legal Practitioners Act in New South Wales and whatever the equivalents are in other states, there’s a provision that certain parts of the business have to be dealt with by the partnership, so only the partnership can employ lawyers, for example. But the service company can rent the premises, can employ non-legal staff, all those sort of things. And that’s often used as a way to essentially syphon off part of the profit. And often it’s a unit trust and the units are held by family trusts and it flows out through that sort of thing. So you have the flexibility to do that sort of thing, which you wouldn’t often do in that way in a corporate structure. |
| DT: | I suppose, also those services companies are one way to limit the liability of partners while still having some of those tax benefits around direct receipt of income from the partnership. |
| GS: 34:00 | There’s also that your remuneration is linked directly to your performance. And in a corporation, there’s lots of other things that can come into play. Particularly in a professional services firm, your assets are your experience and your time, your knowledge and your time, and your ability to charge and get the invoices paid. And that will reflect directly onto your income and that of your partners. Also, partners owe fiduciary duties to each other and to the firm as a whole, which in a shareholders agreement you don’t have that. Directors have fiduciary duty to the company, of course. And there is this ability to admit or dismiss partners, which in a shareholders agreement you can’t sort of dismiss a shareholder as it were. And as the management side of things, you do, as a partner, have the ability to make or influence changes and decisions that affect the whole of the firm. |
| DT: 35:00 | I suppose there’s a more democratic element to it there, isn’t there? That a single partner in a 100 partner firm has substantially more clout than a shareholder of a single share in a 100 share firm. |
| GS: | Yeah, that’s true. If you’re in a 100-partner firm and you’re one partner, you’re not managing partner or something like that, then you have some say, but a limited say. But you certainly have the right to stand up in a partners’ meeting, which are held monthly or quarterly or whatever, and ask the CEO or the board pretty blunt questions. And so you have that ability, whereas in a corporation you’re not going to go into the CEO’s office and say ‘look CEO, I think you really mucked this up and this strategy’s wrong,’ you’ll just get sent back to your office and sacked. But you’re dealing with, say if there’s 100 partners, you’re dealing with 100 highly educated, experienced people, a lot of whomhave strong opinions and strong opinions about how good they are and why doesn’t everybody listen to me? |
| DT: 36:00 | Yeah, absolutely. And I suppose that’s a drawback of the democratic nature of the firm as well, that you might have a greater capacity to have a voice if you want to be heard for benevolent reasons. I suppose you also have a greater capacity to be heard from malevolent reasons or for self-interested or just egotistical reasons as well. How do you manage that as a managing partner where you’ve got all of those competing interests and voices, legitimate voices in the sense that they’re entitled to be heard, but not always pulling in the same direction as you say a bit like herding cats, what are some of the strategies that you use to manage that? |
| GS: 37:00
38:00
39:00 | Well I suppose different people have different ways of doing things as always. I think that whatever you do, communication is crucial, and not just a broadcast email like you get in a large corporation, you get a personal email to everybody from the CEO. You actually have to be sitting down and talking, having a sandwich with them, whatever it happens to be and getting to know each other. You can work in a large corporation without really knowing the people that you’re working with. But when you’re in this position of joint and several liability with someone, you want to know them and they want to know you. My view is culture always comes from the top, so it’s incumbent on the CEO to create the communication, to make sure that people are communicating with each other as well as with you. And it’s not just formal communication in meetings. And if there’s some significant issue coming up or opportunity or whatever it happens to be, my view was that you talk to people and talk them through it. And often you would find that you would get buy in on the decision. And half the time they think it was their idea in the first place, which is a great thing, that’s what you want. And so you have to use communication. Most partnerships have partnership retreats of one sort or another. Partnership meetings, they might go for two or three days and they are really important. And like a lot of those things, it’s not just for the technical sessions, but it is the opportunity for partners to mix and play some tennis or go for a walk or whatever it happens to be. But do so away from the normal daily pressures where everybody is filling in timesheets and sending out bills and going to court and all those sort of things. I should also say I have a strong view that a CEO of a law firm should be a lawyer. I know there have been some firms that have tried having accountants and all sorts of other people as the CEO, but I don’t think that works because as I said the culture comes from the top. And I think to run a law firm, you’ve got to be a lawyer, just as I think to run a bank, you’ve got be a banker. |
| DT: | To have that kind of first-hand industry knowledge. You know what you described there in terms of getting buy in from partners before meetings, discussing these decisions privately and sort of almost engendering this thought that, ‘well, this is my idea in the first place’ in the other stakeholders, there’s a term for that in Japanese business culture called Nemawashi, which is ‘to go around the roots.’ And there’s kind of this ingrained cultural practice there, speaking to everyone who’s going to make a decision in a business meeting before the meeting to privately find out what their decision is going to be and influence it so the meeting is a bit of a formality and it’s that private communication and that respectful consultation that’s really where the decisions are made. And it sounds like that’s exactly what you’re describing in terms of how you manage a partnership. |
| GS: 40:00 | Yeah, it’s like anything else, you have your management team and it’s important for the operations of the firm that the management team is allowed to get on and manage. You have buy in from partners and they ask questions and that’s all important but there’s an old expression: ‘you don’t buy a dog and do your own barking.’ If you vote somebody in as CEO, you let them be CEO. And most partners will do that. They’ll let you know what they think, but can’t have two people managing the place. |
| DT: | Now, we talked a bit about liability and partnerships before and you mentioned limited liability partnerships. Can you tell me a little bit about that and whether that’s a structure that’s available or common in Australia? |
| GS:
41:00
42:00 | I don’t know how common it is. It’s available. How a limited liability partnership works is that you have general partners and limited liability partners. TIP: Now, we’ve mentioned limited liability a few times in this episode, but what does it really mean in the context of a partnership? So, earlier I told you about incorporated limited partnerships, which we mentioned before are a special type of limited liability partnership. That’s the one where the general partners have unlimited liability and the limited partners have limited liability. It’s a common business structure for venture capital firms but not so much for professional services firms like lawyers and accountants. Now in a limited liability partnership, unlike a traditional partnership, partners aren’t jointly and severally liable, and aren’t liable for the actions of their other partners. Like incorporated limited partnerships, limited liability partnerships also have to have at least one general partner who is unlimited in their liability and personally liable for all of the debts of the partnership, and there’s a further requirement that at least one of these general partners has to reside in Australia. Now, this limited liability partnership typically is used in Australia for professional services firms like law firms and accounting firms, but it originally came about from the US in the early 90s when limited liability partnerships were gaining steady popularity and started popping up all over the developed world as a top choice for professional services firms. Importantly, in Australia, a limited liability partner cannot take part in the management of the partnership. Now there’s a difference somewhere between management and administration I guess. But I would think that would mean that a limited liability partner, for example, could not attend partners meetings. So it’s a limited value really. I’m not sure why it was introduced, there’s a couple of reasons, one is that for sort of project financing stuff you might have a partnership where you have a passive investor, sleeping partner, it could have been for that. Or else it might have been looking at the issue with salary partners, what are called salary partners, or I prefer to call them fixed share partners, and that’s always been an issue since they first appeared on the scene. |
| DT: 43:00 | Do you find even in non-limited liability partnerships, that there’s a tension in the management dynamics of the partnership between equity and fixed drawal? |
| GS:
44:00 | Yes, usually fixed share partners are new to the partnership. So you come in at that level and then after time you’re offered equity and then you build up your equity. Usually new partners are relatively quiet because they’re still learning all the who’s who and what you can say and what’s going on, and that takes a few years to come to grips with. And certainly if you’re not an equity partner, there’s not quite the same incentive to have your voice heard. The difficulty for fixed share partners is that they’re still liable, they’re a partner, they’re still jointly and severally liable. So they have the downside really without the upside. They do have an indemnity. The partnership agreement should provide that they have an indemnity from the other partners for any liabilities. And it may also provide that in the event of a dissolution of the firm that they get paid any monies owing to them before any monies are distributed to the equity partners. But it’s important for anybody who’s a salary partner to understand that you’re on the hook to third parties. I don’t think there’s any question about that. |
| DT: | If there’s a listener listening to this episode, who’s a partner in a firm or perhaps has been offered or is considering partnership and maybe grappling with some of these challenges around the way a partnership is managed, or the way personal exposure in a partnership is managed, what would be your piece of advice to that person? |
| GS: 45:00 | If you’re looking at going into a new partnership, firstly make sure you got all the financial information, see your accountant. Do work out what the position is with premises, what the rent is, is the rent going to go up by 25% next year. Premises, as I mentioned earlier, are difficult. They are important in partnerships. My view is that law firm partnerships inevitably almost have either too little or too much space, usually as the firm grows there’s about 3 days on the way through where you have the right amount of space. But what are they planning to do with the premises? Is there major expenditure coming up? Are they going to refit the office? Things like that. So you need to do basically some due diligence on the partnership, because they will have done due diligence on you, that’s for sure. |
| DT: | Absolutely. Well Geoff, thanks very much for joining me today on Hearsay to talk about partnerships! |
| GS: | It’s been a pleasure. |
| DT: 46:00
47:00 | As always, you’ve been listening to Hearsay the Legal Podcast. I’d like to thank my guest today, Geoff Sutherland, for coming on the show. Now, I mentioned a couple of other episodes during the show that you could listen to after this one; ‘Accounting for Lawyers’, ‘Microeconomics for Lawyers’, ‘Shareholder Disputes’. But you know, Geoff actually has another episode of his own all about strategies when acting for commercial borrowers. So, if you want some more Geoff in your life, listen to that episode of Hearsay now. If you’re an Australian legal practitioner, you can claim one Continuing Professional Development point for listening to this episode. Now, as all of you well know whether an activity entitles you to claim a CPD unit is self assessed, but we suggest this episode entitles you to claim a practise management and business skills point. More information on claiming and tracking your points on Hearsay can be found on our website. Can you believe it’s nearly March? Remember, your friends can get 25% off a Hearsay subscription with the code referee2022 at the checkout. That’s referee2022. Hearsay the Legal Podcast is brought to you by Lext Australia, a legal innovation company that’s out to change how you experience the law and legal services, including CPD. I’d like to ask you a favour though, listeners, if you like Hearsay the Legal Podcast, please leave us a Google review. It helps other listeners find us and that keeps us in business. Thanks for listening and I’ll see you in the next episode of Hearsay. |
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