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Almost five years after the New Jersey Supreme Court adopted a rule allowing law firms to register as limited-liability companies, few New Jersey firms have opted for the tax and liability advantages that LLCs boast. New Jersey joined 47 states when it passed the Limited Liability Company Act in 1993, allowing LLC formation, codified in N.J.S.A. 42:2B-1 et seq. In 1996, the state supreme court adopted the provisions in a new Court Rule 1:21-1B and 1C, which specifically gave lawyers the right to form LLCs and LLPs (limited-liability partnerships). But as of 2001, only 60 firms are registered as LLCs, according to listings in the Martindale-Hubbell Law Directory. That’s 3 percent of the New Jersey firms listed in the directory. Only 187 firms, or 8 percent of those in Martindale-Hubbell, have chosen the LLP route. Of the two, the LLC seems to be a no-brainer. The benefits include limits on personal liability, greater flexibility in management and relief from double taxation. Like a Subchapter S corporation, the LLC is treated as a mere conduit, and its shareholders pay taxes only on their own income. Why, then, the reluctance to switch to the limited-liability structure? Some firms fear that switching from a partnership to an LLC could undermine their clients’ trust in them. “They feel that their clients may view it as some sort of maneuver on their part to absolve themselves of responsibility for wrongdoing,” says consultant Ward Bower, a principal of Altman Weil Inc., of Newtown Square, Pa. Another reason some have not changed from general partnerships to LLCs may be plain inertia. “For what it takes to do it, which is next to nothing, there’s probably no reason why a partnership should not be an LLC,” Bower says. Uncertainty about the court’s treatment may also play a role. “It’s a new animal,” says Stuart Pachman, a partner with Roseland, N.J.’s Brach, Eichler, Rosenberg, Silver, Bernstein, Hammer & Gladstone. In the mid-1990s, he recalls “a lot of judges would not know what they were talking about and they would get it confused and call it a limited-liability corporation and there’s no such thing.” “Commentators around the country have suggested that one concern with limited-liability companies is uncertainty due to their newness,” says Timothy Glynn, professor of business associations at Seton Hall University School of Law. “We don’t have a lot of case law to show how courts are going to treat limited-liability companies for the purposes of piercing.” He adds that a court may be more likely to pierce an LLC if it is set up more like a partnership than a corporation because a partnership confers liability on all the partners, Glynn says. Courts are gradually coming to understand LLCs, judging from a handful of decisions nationwide, Pachman says. “By now, courts have become more knowledgeable about LLCs and we’ve seen a couple of decisions where courts have respected the ‘corporateness’ of LLCs,” he adds. One of those was in New Jersey, though it did not address the issue of liability under an LLC and did not involve a law firm. So far, most of the firms that have taken advantage of the LLC designation have been small and midsized practices. Forty-seven of the 60 LLC firms in the state have no more than 10 attorneys. Six firms have up to 25 lawyers, five have up to 50 lawyers, and two have more than 50. Phil Chapman, managing partner with Roseland, N.J.’s Chapman, Kessler, Peduto & Saffer, says that switching to an LLC from a general partnership in 1999 was the best choice for the firm, which had rejected the idea of incorporating. “There is a greater flexibility in allocating the income in an LLC than there is in a corporation,” he says. In addition, the transformation was simple and didn’t require large amounts of paperwork. However, Chapman acknowledges that his eight-lawyer litigation firm has not yet created a written operating agreement setting forth the rights, responsibilities and compensation of its members. The agreement is the most difficult part of converting to an LLC, Chapman says, because it requires lawyers to deal with sensitive matters of how compensation and power are allocated. Even so, most large firms are more likely to be professional service corporations, since that option has been available for years, says Pachman, who served on the ad hoc committee of the New Jersey State Bar’s Corporate and Business Law Section that helped craft the court rule authorizing LLCs. There are fewer advantages in switching from a corporation to an LLC, among them less paperwork and fewer formalities, he says. One of the earliest LLC opters was John Curley, who heads a three-lawyer firm in Hoboken, N.J. “I considered forming a professional corporation and made the decision that that was too burdensome,” Curley says. “An LLC is the closest thing that you can get to having the financial setup of a corporation … . You don’t have to respect all the corporate formalities.” Pachman has one word of advice for any firm converting to an LLC: Notify clients about the change in a conspicuous manner. He points to a decision by the Colorado Supreme Court, Water, Waste & Land Inc. v. Lanham, 995 P.2d 997 (1998 Colo.), which held LLC agents liable for breach of contract when they failed to notify the other party of the LLC status. Although New Jersey’s court rule only requires a law firm to include the suffix “LLC” in its name, letterhead and documents, Pachman says all firms should send a special notice to clients so that they will be aware of the change.

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