At the height of the financial crisis, the phenomenon of law firm partner de-equitization was also at its peak. This de-facto termination of older partners who may have had high billing rates but who brought in less business than their fellow partners was a purely financial strategy that had enormous human impact. Times of crisis led firms to take drastic action rather than hold on to partners who were once added for a reason.

We now appear to be past the peak of the de-equitization tsunami, but that doesn’t mean the phase-out of older partners has gone away at larger firms. The Wall Street Journal reported a variety of anecdotal examples early in 2013 to illustrate that de-equitization is not dead: a one-third partner reduction at a 200-lawyer Nashville firm, a Wells Fargo Private Bank survey saying that 15 percent of respondent firms will cut partners in the first quarter, a consultant’s claim that many big firm partners are billing 30 percent below the traditional standard of 1,900 hours a year.

The fundamental truth is that partners must contribute to the well-being of their firm. If they don’t, they will be terminated irrespective of their partnership status or equity interest. In other words, they must adhere to the basic formula of The Business of Law: P = R – E (profits for any firm equal revenues minus expenses). Or said another way, partners are now beginning to realize that the practice of law is a business, just as is every other service profession (and manufacturing and distribution sector). And the line between partner and employee is becoming narrower each day.

Economics

This is not necessarily an age issue. There are 70-something partners who are contributing to the bottom line of their firms and there are 40-somethings who are not. Those who do not contribute to the bottom line can be sustained in the firm for only so long before their weight drags down the firm’s financial performance. That is one of the primary reasons for poor performance and even failure of many large firms.

A recent book on large law firm economics, Declining Prospects by corporate attorney Michael Trotter, illustrates how many large firms made the management decision in recent decades to add hundreds or thousands of lawyers in an attempt to increase leverage and profits. They got the leverage (with ratios of 4-to-1 and more) but saw profits sag for a simple reason summarized in a Bloomberg Businessweek review of the book: “By bulking up so aggressively, law firms made themselves more vulnerable to economic downturns. Partners at many firms failed to appreciate that all those salaried employees needed to be paid every month, whether or not new business is coming in the door.” For this reason alone, de-equitization will continue.

Today, all lawyers at large firms can and should keep their eyes open and ask hard personal finance questions about how to cope with a potential dismissal. Did they save enough to afford retirement or did their standard of living increase over the years to match their income? Will they be able to get any equity at all out of their firms, and if so, how fair will be the price set by their former partners who are casting them away? Did they continue to service major clients effectively, positioning themselves as indispensable counselors that the firm dismisses at its peril? If not, de-equitized big firm partners may have no alternative but to sue their firms, alleging that they were merely “employees” who were thus covered by age discrimination laws. They may be right—but that’s not an ideal end to a professional career.

The simple fact is that de-equitization is normal business activity. When an individual lawyer stops being as productive as he or she used to be—whether bringing in new clients as a rainmaker or billing enormous hours for existing clients—de-equitization is a legitimate option if done according to specific performance metrics. If done simply to get rid of older lawyers because they are old, the result is harmful.

Discrimination

Several years ago, the Equal Employment Opportunity Commission accused Sidley Austin of firing a group of older lawyers strictly on the basis of their age. The firm contended that its action was based on decreased productivity, but still agreed to a reported $27 million settlement with the dismissed lawyers. There also was a recent lawsuit involving an older partner at the former Thelen Reid firm who refused to accept a downgraded status. The law firm argued that the lawyer breached his employment agreement by failing to produce sufficient billable hours. The lawyer argued that he merely had to be available to do work, that he did not have rainmaking responsibilities. The issues revolved around interpreting an employment contract, and the arbitrator found that the lawyer did seek billable work and was available. The contract did not otherwise require that he reach the firm’s billables benchmark.

A 2009 U.S. Supreme Court decision has direct implications for lawyers who have been de-equitized or laid off. The court, in its 5-4 decision in Gross v. FBL Financial Services, said that the burden of proving age discrimination lies solely with the plaintiff. In previous cases, the plaintiff merely had to prove that age was a factor, and then the employer had to show that there were legitimate reasons for the termination. How will plaintiffs be able to show that age was the primary factor? After all, the plaintiff was not in the room when the decision to terminate was made. Law firms are not exempt from the requirements to have a workplace free from discrimination. But the Gross ruling suggests that older partners who have been terminated or demoted will have little foundation to claim discriminatory intent on the basis of age.

Partnership Agreements

Of course, the point of exiting the partnership is well past the time to question the wisdom of joining it. Every partner should review the written agreement to determine specific answers to questions such as these, which would have a direct and substantial financial impact at the time of de-equitization:

• Was the “buy in” to the partnership at a value asserted by that partnership itself, or by an independent study?

• Can the sale of a partnership interest be only under very restricted terms and at a value determined by a formula different than the formula used for the “buy in?”

• Must the partnership interest be sold back only to the partnership, not to a third party?

• Are there only specific times of the year (for example, the end of a financial quarter) when a partnership interest can be withdrawn?

A final note is necessary regarding departure from a firm where a lawyer may have held management responsibilities. Managing partners and practice group chairs often have not been compensated for management duties. Severance packages for lawyers serving in management positions are also minimal and rare. Lawyers at a senior level who hold leadership positions and are uncertain about the prospect of de-equitization should require that the firm provide a written statement of compensation, pension, bonus and other remuneration due if the lawyer is terminated while still holding a leadership title.

Receivables

Accounts receivable may be the most fluid asset that a law firm has—and the most important, apart from its human capital (i.e., its lawyers and staff). Consequently, if a partner faces being de-equitized, that partner should know exactly what his or her amounts in receivable are, and know how much the firm is depending on them to bring in the receivables before departure. Partners should ensure that there are incentives in their personal financial interest to collect the receivable before being asked or forced to leave the firm. Here are some suggestions to help any lawyer facing de-equitization address this issue:

• Ensure that time sheets are current.

• Prepare billings to clients but do not send them off pending the firm’s assurance that financial elements of the termination are negotiable.

• Do a peer review of your files to confirm that there can be no claim of negligence by the firm alleging faulty client service in the final months/years of service—allegations that can support reductions in pensions or severance.

It is essential that the client hear from the law firm when a senior partner is leaving, and for the firm the goodwill of the partner is important to collect the money owed by a client who may have worked with the departing partner for years. It would be most appropriate to send a joint letter (firm and partner) to the client indicating the partner’s departure, but this gives the partner considerable leverage on the preparation of such a letter. It can be made the subject of negotiations that can enhance the partner’s retirement package.

Other Liabilities

De-equitization is not the only partnership risk in today’s economy. Irrespective of individual termination risk, partners typically will be jointly and severally liable for the debts of the law firm in the event of the firm’s collapse. Moreover, consider what happens if a lawyer “escapes” from a firm nearing bankruptcy with the understanding of retaining clients and “unfinished business” from the old firm. Law firms that go into bankruptcy must collect funds to pay their creditors by selling off assets, and it has been argued that billables that walked out the door with a failed firm’s former lawyers belong to the originating firm and its creditors.

Deciding who gets the benefit from departing lawyers’ receivables is likely a battle that will be fought for years in the courts. The reality of our world is that anyone can sue anyone else, even without justification. In the meantime, the largest pool of cash available to the trustee in bankruptcy for a defunct firm is the new firm that the defunct firm’s lawyers went to—and, perhaps, those individual lawyers themselves. Be aware of that prospect when leaving a “sinking ship” to avoid de-equitization.

Pensions

In a 2012 analysis of pension plans of large U.S. law firms, it appeared that a number of the country’s largest law firms have pension plans that are unfunded. In other words, these are firms with pension plans, but without money to pay the obligations of those pension plans as their lawyers retire. What is increasingly likely is law firms with the bulk of their lawyers leaving the practice for retirement with the hope and prayer that the fewer remaining partners will be willing to fund the firms’ obligations. There may also be situations where these younger lawyers will find it to their economic advantage to torpedo the existing law firm and its pension obligations in exchange for creating a new firm with no pension obligations. Doing so will give them the opportunity to take on more of the revenue that is produced by their efforts. Partners nearing retirement age, even if not facing de-equitization, are well advised to review the status of their pension plans and use their partnership status to demand answers on what the plans funding and future payment prospects are.

An Afterword on Entitlement

Invariably, at some point lawyers often feel entitled to get what they’re getting, that by virtue of being in a larger firm their compensation should continue regardless of the fortunes of the firm. If those fortunes sag a bit, even if the lawyers are not so productive, they still want their compensation. According to some accounts, that was precisely what happened at the now-bankrupt Dewey & LeBoeuf, a firm that hired many lawyers with very high compensation guaranteed for a number of years. When the fortunes of the firm sagged, many of the highest paid and most economically viable lawyers left, their former partners (often unaware of financial promises that had been made) stayed, and the firm died. At least one former partner has sued, calling the firm’s compensation structure nothing but a Ponzi scheme. And it may have been.

But if the issue is firm survival, de-equitization of some partners is preferable to pretending that nothing is wrong…until there suddenly is no more firm. For that reason alone, de-equitization will continue and no partner should feel entitled or tenured. The only reasonable alternative is to be aware of the potential dangers—and keep eyes wide open.

Ed Poll, principal of LawBiz Management, is a coach, law firm management consultant, and author. He can be reached at edpoll@lawbiz.com.