“… the income of the firm may well diminish and/or partners may not account fully or at all for accrued WIP …”
Unless there is an express agreement between partners permitting retirement, no partner can retire from a partnership at will. The only way to bring about termination of the relationship is for one or more of the partners to give notice of dissolution to the other(s).
However, on notice of dissolution being given, a firm may not immediately cease to trade. Indeed, a firm may carry on trading for a considerable period. This is driven by two factors, firstly the duty to clients/customers to complete retainers/contracts, and secondly the benefit if any of continuing the dissolved firm as a going concern until it can be sold (possibly to one or more of its partners, or otherwise to an outside purchaser) or merged into another firm, or otherwise dealt with so as maximise the benefit to partners and/or minimise the potential downsides.
Whether or not the firm continues to trade, until the winding up of the firm is complete (and this can take many years, even if the firm does not continue to trade) the partners at the date of the dissolution notice (including the partner(s) who served it), remain as partners, with a continuing duty of good faith to one another, and a continuing ability to bind one another to contracts with third parties for the purpose of the winding up.
The principal downsides of partnership dissolution are normally as follows:
- The partners’ income tax is normally accelerated by a year, subject to any overlap relief to which individual partners may be entitled.
- Redundancy/lieu of notice payments may become payable to staff.
- Liabilities may arise from leases that cannot be assigned or can only be sub-let at an under-rent.
- Ongoing storage of files and papers (not underpinned by ongoing income).
- Costs of recovery of unpaid fees, or loss of unpaid fees, particularly where clients decide to try to avoid payment in the hope that a firm that ceases to trade may not bother to/be in a position to sue for fees and/or based on alleged breach of retainer arising out of cessation of services/inadequate service following the dissolution.
- In the case of a firm of solicitors, if there is no successor firm for insurance purposes (e.g. a firm with which the dissolved firm merges) then the dissolved firm must purchase (six years’) run-off insurance, typically at a premium of between two and three times last annual premium.
For so long as the firm continues to trade these downsides may not materialise, and can be avoided altogether at any stage if all of the partners agree to an (often back-dated) retirement of the partner who served the notice, or other form of acquisition by the “continuing” partners, thus bringing about a technical dissolution only, which does not lead to the downsides listed above.
In the absence of any such agreement the firm will be in what is known as general dissolution, and will have to be wound up, and the downsides listed above will occur.
As partners make plans to go elsewhere and/or as they physically leave the firm, the income of the firm may well diminish and/or partners may not account fully or at all for accrued WIP (preferring, dishonestly, to bill it in their new firm, where they may be able to retain 100% of its value for themselves). At the same time the outgoings (e.g. rent) may not diminish at the same rate or at all, and eventually a marginal position may come about in which it is not economic to keep the firm going, even in order to complete long retainers (for example to complete litigation) with the result that bills cannot be rendered and/or claims for repayment of fees or damages may be made by clients.
Along the way, partners will be looking for a safe haven in another business, and will wish to take clients with them in order to secure the best terms for themselves in their new business. Disputes may well arise between the partners in relation to who should take which clients with them (none or them being entitled to do so as of right, at least until the firm could no longer carry out the work and there is no prospect of anyone paying for the goodwill).
In the absence of an event such as a merger which prevents a general dissolution, other businesses may be put off recruiting partners of the dissolved business (and this potentially includes the partner who served the notice). Such businesses may fear that those partners may be saddled with personal liabilities arising out of the dissolution.
In the case of solicitors, other firms may be wary of taking on partners in such a way as to make the acquiring firm a successor practice to the old firm for insurance purposes. This can arise in many different ways and if it does arise the acquiring firm will be required to take out insurance at next renewal which takes into account the claims history of the dissolved firm, thus substantially increasing the premium.
Matters such as this tend to encourage settlement between the partners of the dissolved firm, in the form of an agreed retirement of the leaving partner. In the event of such a settlement, it is important to document it properly. There are many traps for the unwary.
Generally the only reason a group of partners will elect to wind up the firm, rather than agree to the retirement of the partner who wants to leave, is where the extent of the assets and/or continuing/anticipated future work are so outweighed by the actual or future liabilities that the partners do not want to release the leaving partner from his obligation to contribute to those liabilities and/or to release the leaving partner’s capital. In such circumstances they will insist on the leaving partner remaining as a partner in the dissolved firm (as he does automatically unless released by agreed retirement), sharing all of the liabilities.
In essence, when a partner gives notice of dissolution, his co-partners will need to consider what (if any) amount (in addition to the return of the “leaving” partner’s capital) they are prepared to pay for the benefit of the firm’s fixed assets, name and goodwill, whilst also taking on the liabilities of the firm. The balance sheet in the accounts will not provide the answer. The biggest elements taken into account in any settlement tend to be the value of goodwill (which is usually not reflected in the balance sheet), off-balance sheet work-in-progress, and sometimes off-balance sheet liabilities (often associated with leases), all of which can be difficult to value.
