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You are one of the handpicked few who has been offered a partnership at a law firm. Your invitation to partnership is an impressive feat. But there are enormous financial, emotional, and practical ramifications to becoming a partner. Regardless of whether you have become a new partner at an eight-lawyer or an 800-lawyer firm, the most fundamental change resulting from your attaining partnership status is the fact that your existence at the firm will now be driven and defined in large measure by your contribution to, and impact on, the firm’s bottom line. The handsomely designed announcement circulated by the firm will no doubt present you to the world as a “partner,” without caveat or qualification. However, within the law firm itself, there may be great differences between your status and that of other partners. Indeed, your partnership may have an entirely different meaning than those of classmates who have just been made partners at other law firms, or even in the same firm. An equity partner is someone who is (1) assigned a percentage ownership in the firm and shares in profits and losses; (2) typically required to make a capital contribution which is to remain as investment in the firm until withdrawal, termination, death, or dissolution of the partnership; and (3) given a vote on matters relating to the firm’s governance. A non-equity partner (also known as a noncapital partner, contract partner, or income partner) is essentially a partner who (1) does not share in profits and losses but receives a fixed compensation, (2) makes no capital contribution, and (3) has either no voting rights or limited voting rights on firm matters. In some firms, non-equity status is a step to becoming an equity partner. In other firms, non-equity partnership can be permanent. Firms have also used non-equity status as the means to have a “look-see” at lateral partners before making an offer of equity partnership. What role a new equity partner plays depends largely on the culture and size of the firm. While equity partners participate in the firm’s governance and generally have a right to vote on firm matters and serve on management committees, in some firms, power is institutionalized in the hands of a few, and new equity partners in fact exercise little control. In other firms, great effort is made to bring new partners into the mix, with key assignments on important committees that can influence day-to-day management and long-range planning. Firm culture often determines how equity partners are evaluated and rewarded. It is usually some combination of factors such as business origination, billable hours, skill, areas of expertise, marketing success, management ability, interpersonal skills, and bringing honor to or enhancing the image of the firm. On the basis of one or more of those factors, a percentage of ownership is assigned to each equity partner, from which profits will be allocated. A few firms have a lock-step system, where those who entered the partnership in the same year will receive the same percentage. Most firms have a more individualized approach to profit allocation, where some or all of the aforementioned factors are weighted by a committee in order of priority based on the firm’s value system. Some use a formula for assigning shares of the earnings pie based on some combination of a percentage awarded to the client originator and a percentage to the servicing partner. There is even more variation in the role non-equity partners play and how they are defined. On one end of the spectrum, non-equity partners can be given a voice on firm governance that is nearly equal to that of an equity partner, with the general exception of voting on the election of new equity partners and the allocation of equity partners’ compensation. On the other end of the spectrum are non-equity partners who are given very little voice in the firm’s governance and are essentially partners in name only. OWNING THE BUSINESS As an equity partner, your rights and obligations have changed drastically from when you were an employee. You are an “owner” of a business. You are now personally liable for your share of the debts and losses of the partnership and each of your partners. You may be asked to sign on to the firm’s lease or bank loans. You receive a draw against future profits, not a salary. You are no longer subject to payroll taxes; instead, you must now make quarterly estimated tax payments based on the profitability of the firm and must pay what is effectively double what you had previously paid for Social Security and Medicare taxes (both the employee’s share and the employer’s matching share). Indeed, in some cases, if the firm’s profits do not exceed draws, you may have to pay back some of your draw. You owe significant fiduciary responsibilities to your partners, and generally are no longer protected by the employment laws. Instead, your rights are governed by applicable partnership state laws. Many jurisdictions, including Maryland and Virginia, as well as the District of Columbia, have adopted the 1997 version of the Revised Uniform Partnership Act (RUPA). The prescribed rules governing the rights and duties of partners are consistent among these jurisdictions. Some of the enumerated statutory rights include an equal voice in the management of partnership business, the power to elect or reject another person to the partnership, access to partnership books and records, and rights regarding dissolution and dissociation. These rules, however, are subject to change by a partnership agreement, and many partnership agreements limit the rights to which you would otherwise be entitled under state law. The rights generally addressed in a firm’s partnership agreement are (1) your interest in the firm; (2) how compensation is determined and paid; (3) firm governance; and (4) your rights if you leave the firm, whether by withdrawal, expulsion, retirement, death, or disability. Realistically, most new partners will not have substantial influence over firm governance. The typical partnership agreement vests control in an executive or management committee. Allocation of partnership shares and compensation may be vested in either the executive committee, a compensation committee, or both, and may or may not be subject to a vote by all of the partners. If the partnership agreement vests power and sets procedures for allocating profit, the decision by the requisite partnership vote generally is final and enjoys the type of protection from challenge akin to corporate decisions under the Business Judgment Rule, which presumes that “corporate directors act on an informed basis, in good faith and in the honest belief that their actions are in the corporation’s best interest.” Black’s Law Dictionary 192 (7th ed. 1999). Your ultimate exposure with respect to firm liabilities will depend upon whether your firm is a general partnership or a limited liability partnership. In an LLP, liability is limited to each partner’s share of the partnership net assets, except for personal misconduct (in which case the responsible partners are still liable to the full extent of their personal assets). Recently, a law firm’s potential exposure to liability has increased with the spate of shareholder lawsuits, such as in the Enron fiasco, in which plaintiffs have named law firms as defendants. Even before Enron, there had been a trend toward reorganizing as LLPs, which will undoubtedly continue. NON-EQUITY RIGHTS The rights and obligations of non-equity partners are less clear. Indeed, some firms may have more than one class of non-equity partner, each with different rights. If the rights and obligations of a non-equity partner are spelled out in an agreement, it will generally control. Agreements between law firms and non-equity partners usually address compensation, conditions of employment, termination, and severance pay. In typical partnership agreements, the equity partners indemnify the non-equity partners. That, however, merely governs the relations among the partners. Creditors may be able to sue to recover law firm debt from non-equity partners on the grounds that they and the firm have held them out to be partners. See RUPA §308. This is generally a question of fact to be determined case by case. Where there is no agreement addressing non-equity partners’ rights, the legal landscape is generally uncertain as to whether the non-equity partner is a partner entitled to rights under the partnership laws or an employee protected by the employment laws. The only guidance gleaned from the scant case law is a consistent effort by courts to look at the totality of the circumstances, examining all of the indicia of partnership in addition to ownership interest, to determine the legal status of a non-equity partner in the specific context in which the issue is raised. As the Supreme Court noted in Clackamas Gastroenterology Assocs., P.C. v. Wells, 123 S. Ct. 1673, 1678 (2003): “Today there are partnerships that include hundreds of members, some of whom may well qualify as ‘employees’ because control is concentrated in a small number of managing partners.” Compensation and taxes may also differ depending upon whether non-equity partners are treated as partners, employees, or a combination of both. Without any interest in the capital or profits of the partnership or liability for a proportionate share of the losses, even non-equity partners with substantial managerial input will likely be classified as employees. Given the dramatic differences in consequences, it is critical to understand the category into which the unique combination of rights which make up non-equity partnership in your firm is likely to place you — partner or employee. Whether a court would hold that you are a partner has little practical effect on how you live your everyday life in the firm and what it means to be a partner there. Because a law firm is at its essence a business, as a new partner, your success will now be measured by your impact on the firm’s bottom line. However, different firms measure partners’ contributions differently. By now, you should have some sense of your firm’s value system, which is not likely to be spelled out in any partnership agreement. As important as it is to know your legal rights and obligations as a partner, it is equally important, but more elusive, to find the myriad ways in which you can contribute to your particular firm’s bottom line and receive due recognition for your contribution. Geri S. Krauss, a partner at Herrick, Feinstein, specializes in law firm partnership issues. Marianne Yen, an associate at the firm, helped prepare this article. A version of this article previously appeared in the New York Law Journal, an American Lawyer Media daily newspaper.

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