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A structure to suit

Cover Story

Cite as: (2008) 82(9) LIJ, p. 30

Although the Legal Profession Act 2004 allows flexibility in law practice structures, there are often obstacles. Maintaining the partnership structure, but changing the way in which partnership interest may be held, is an option.

By Rohan Harris

The structure that law practices (other than sole practitioners) have typically been required to adopt historically and with which most practitioners are familiar is a partnership of individual practitioners. This changed significantly with the enactment of the Legal Profession Act 2004 (the Act) and further expansion of the concept of “law firm” under the Justice Legislation (Further Amendment) Act 2006 which amended the Act.

There are now several “law practice” structures allowed under the Act, and within this several types of permitted “law firms” by way of addition to the traditional partnership model: s1.2.1(1). One of the alternative categories of “law firm” is a partnership consisting only of one or more incorporated legal practices (ILPs) and one or more Australian legal practitioners (see para (d) of the definition of “law firm” in s1.2.1(1)), or a partnership consisting only of ILPs.

The Act recognises that any corporation (which would include a corporate trustee of a discretionary trust) may be eligible to be registered as an ILP: s2.7.6(1). An ILP is not itself required to hold an Australian practising certificate (s2.7.6(3)), but at least one of the directors of an ILP must be a qualified legal practitioner: s2.7.10(1).

A second, although not essential, element of this type of structure involves the appointment of a separate ILP to act as the nominee/agent of the partnership of individuals and discretionary trust ILPs. The nominee would typically adopt the name of the partnership. For example, if the partnership traded as ABC Law, the ILP agent or nominee would typically trade as ABC Law Pty Ltd. All transactions with clients and other third parties may then be conducted through the ILP nominee/agent, rather than directly by the partnership.

This structure may be illustrated as follows:

Why restructure?

The incentives to restructure will vary between firms and between individual partners. However, some of the potential benefits to be gained from this type of structure are as follows.

Individual choice

In multi-partner firms, the motivation to restructure may differ between partners. Partners who are perhaps approaching retirement may prefer to continue to hold their partnership interest and receive partnership distributions personally, whereas others may be more attracted by the potential long-term benefits of holding their interest and receiving profits in a discretionary trust vehicle. The benefit of this type of structure is that partners can make an individual choice whether or not to participate, based on their personal circumstances and preferences. This is not possible with other types of structures, including under a purely corporate model where the assets of the firm are held legally and beneficially by the ILP in its own right.

Asset protection

The major potential asset protection benefit of this structure derives from the ability to distribute profits of the partnership via the discretionary trust partners to different beneficiaries. These beneficiaries may have different risk profiles from that of a legal practitioner/principal who remains personally exposed to possible client negligence claims (to the extent not covered by insurance), and claims pursuant to financier guarantees or other personal undertakings required for the purpose of the business. A practitioner who is a legal practitioner director of the ILP nominee/agent or corporate trustee ILP also remains personally responsible for the proper management of the legal services provided by the ILP: s2.7.10(2).

Profit sharing

The retention of a partnership structure means that a significant degree of flexibility can be maintained as to the manner and proportion in which profits of the partnership are distributed to partners, having regard to factors such as any special admission arrangements, seniority and their respective contributions to the firm. This is difficult to achieve under a corporate structure. In addition, the Act specifically recognises that an Australian legal practitioner may share the receipts, revenue or other income arising from the provision of legal services by the practitioner with an ILP (s2.7.20), including as a corporate trustee of a discretionary trust, which in turn can be used as a vehicle to distribute that income to different beneficiaries in a more tax-effective manner, depending on the tax profiles of those beneficiaries.

Administrative convenience

If an ILP is appointed to act as the nominee/agent of the partnership, then all business can be transacted through, and all business registrations can be held by, that nominee/agent. There may be no need to vary or update those arrangements on the entry or exit of partners to and from the partnership.

There will also typically be potential barriers to or risks involved with any restructure, all of which should be identified and assessed case by case. In particular, there are significant taxation and accounting considerations that need to be dealt with before proceeding with any restructure. For these reasons, there is considerable merit in engaging independent legal, tax and accounting advisers, even if it is considered that sufficient expertise in these areas is available from within the firm.

What is involved?

As with any commercial transaction, there are steps that need to be taken and documentation that needs to be prepared, the exact nature and timing of which will again vary firm by firm. Some of these steps are explained below.

The significant time cost of having someone from your firm undertake such an exercise should also be borne in mind when considering whether to engage independent advisers.

Reviewing and amending the partnership deed

The partnership deed should be reviewed carefully to identify provisions that need to be changed to cater for the admission of ILP discretionary trust partners. The deed should also continue to personally bind the principal individuals associated with the new ILP discretionary trust partners insofar as personal restraint, professional performance and other covenants of a personal nature are concerned.

Modifications to the partnership deed can be documented by means of a supplemental deed of variation to the existing document, or a new agreement. However, there are risks associated with implementing a new agreement if there is a desire to ensure continuity of the partnership for taxation purposes.

Key contracts and business registrations

All key business contracts and business registrations held in the name of the partnership should be identified and reviewed to determine whether any consents or approvals may be required as a condition of the restructure. These may include client panel appointments or engagements, premises leases, banking facilities, insurance policies, business name registrations and major supply contracts.

Particular care needs to be taken to ensure that a restructure will not trigger default events or termination rights under existing contracts or arrangements. There may also be scope to renew these arrangements in the name of, or transfer these arrangements to, the ILP nominee/agent.

Incorporating and appointing the ILP nominee/agent

If the partnership is to appoint an ILP nominee/agent, then this entity needs to be incorporated. Ordinarily, the shareholders of the ILP nominee/agent would be the same as, or associated with, the partners of the partnership. As discussed above, at least one of the directors must be a legal practitioner – it is optional as to whether some or all of the pre-restructure partners, and possibly non-lawyers, are appointed co-directors.

The constitution of the ILP nominee/agent should include specifically tailored provisions having regard to the various requirements relating to ILPs under the Act. For example, the constitution should prohibit the appointment of anyone who is a “disqualified person” under the Act as a director of the ILP. Such an appointment would be an offence under the Act: s2.7.21(1)(a).

The ILP nominee/agent should also be formally appointed to that role, preferably by means of an appointment agreement between the ILP nominee/agent and the partnership. The agreement should (among other things) make it clear that beneficial ownership of the business and assets of the firm remains with the partnership, and should confirm the capacity in which the ILP nominee/agent will conduct its activities.

Establishing and admitting the new ILP discretionary trust partners

As with the constitution of the ILP nominee/agent, the constituent documents of the new ILP discretionary trust partners should include specifically tailored provisions having regard to the requirements of the Act concerning ILPs. For example, there should be an express prohibition in the trust deed on any “disqualified person” under the Act receiving a distribution from the trust. Such a distribution would be an offence under the Act: s2.7.21(1)(c).

The new ILP discretionary trust partners should be admitted to the partnership in accordance with the formal admission procedures prescribed by the partnership deed (subject to appropriate amendments being made to permit the admission of those entities). They should agree to be bound by the partnership deed and their admission should be appropriately documented and minuted.

Interests of outgoing partners

Partners in law firms typically accrue personal entitlements and liabilities under the partnership agreement apart from their entitlement to profit distributions (for example, a share in the partnership capital and assets, annual and long service leave entitlements, and debit or credit loan accounts in the partnership).

These need to be identified and appropriately treated, having regard to applicable taxation and accounting considerations. Any transfer or assumption of individual partners’ entitlements and liabilities should be formally documented and minuted on the resignation of outgoing individual partners to ensure a smooth transition.

Notices to Legal Services Board

The Act requires the provision of various notifications to the Legal Services Board (LSB) as a consequence of this type of restructure.

Any corporation intending to commence practice as an ILP must give the required notice of intention to the LSB before doing so: s2.7.7(1). This applies to the ILP nominee/agent, as well as each prospective ILP discretionary trust partner before appointment or admission.

Any individual who ceases to be a partner of a law firm, or who is appointed as a director of an ILP, must give notice of the event to the LSB, and any changes in the membership of the partnership must also be notified: s6.2.24.

Trust account requirements

The ILP nominee/agent will be required to open a new trust account, appoint an approved external examiner and provide notice of the new account to the LSB in the prescribed form and within the prescribed period: Part 3.3 Division 2. Appropriate transitional arrangements should also be implemented regarding the existing trust accounts of the partnership, in consultation with the LSB and relevant banks.

Professional indemnity insurance

Law practices must maintain the required level of professional indemnity insurance with the Legal Practitioners’ Liability Committee (LPLC). Details of insurance must be provided to the LSB at the same time as the notice of intention to commence practice as an ILP is provided. Given the multiple ILPs that need to be established under this type of structure, the LSB has specific requirements in relation to this insurance that need to be dealt with case by case in consultation with the LPLC.

Larger law practices will typically have “top-up” professional indemnity insurance coverage as well. These policies should be reviewed and updated as appropriate to ensure that coverage will continue post-restructure.

Communicating the change

As with most business restructures, it is important to plan and implement an appropriate post-restructure communication strategy for people and organisations (particularly clients) having a relationship with the practice.

Business letterhead and invoices should quote the name and ACN of the ILP nominee/agent, in addition to the ABN of the partnership.

From a liability perspective, the outgoing partners should no longer be referred to as “partners”. The desirability for consistency may also drive the adoption of a uniform title for all principal practitioners, even though some of them may continue to be partners in their own name. All business cards, letterheads, promotional material, precedents and other relevant items should be updated accordingly.

Conclusion

Partners and managers of law practices that may have rejected the basic corporate ILP model should seriously think about the alternative partnership of discretionary trusts model described above. The allowance for individual partner choice, and the potential benefits of this model for existing partners and future partnership candidates cannot be understated.

ROHAN HARRIS is a principal in the corporate and commercial group at Russell Kennedy, with expertise in law practice restructuring.

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