The Law Firm Merger – Should I Stay or Should I Go?
The main driver for law firm mergers tends to be financial – primarily to drive revenue or to cut costs in an increasingly competitive legal market, and this presents the biggest pressure point for firms to get right. Marrying firms with different strategic objectives, cultures, profitability and profit-sharing arrangements, billing rates, quality and service standards, and management and decision making structures – often across borders – brings with it a host of additional business and cultural issues to resolve and realign.
So where does that leave the partners in the firms which are planning to merge? Many will face an uncertain future in the newly merged entity, unclear as to whether the proposed merger will achieve the merger objectives and improved profitability, having to vie with existing and new colleagues for key positions in the new structure, and some having to jostle to maintain their practice areas and client relationships. Others may face involuntary exit in preparation for or shortly after the completed merger, with the prospect of having to find a role elsewhere. Having acted for a number of such exiting partners in cross border merger situations including a UK LLP or partnership structure, we have yet to meet anyone who was not able to move on to and thrive in another suitable role elsewhere: one door closes, another one opens.
For each of these law firm partners, important decisions need to be made about their professional future. Merger discussions by their very nature are unsettling and the affected partner who has been offered a role in the new merged entity will have to make a decision whether to hold the course and put their faith in the merged entity, or whether to pursue alternative opportunities outside the merged firm.
Should I Stay..?
The likely changes ahead
The key considerations for the partner will most likely be the financial viability of the merged firm going forward, their own position and profit share arrangements in the new entity, any new restrictions on their ability to leave in due course, and the cultural fit.
Further, the firm as the partner knows it will disappear in the then-current form, and the newly merged entity may be relocated to different premises; relationships and allegiances which potentially were built up over a number years may disappear or change. There is thus invariably also a sense of loss by the partner concerned for the firm of old and internal structures familiar and known to them.
There will be a new partnership agreement to sign up to, usually with a number of new, more restrictive provisions and in cross border mergers often resulting in different jurisdiction and choice of law provisions to the partner’s home location and with the inclusion of an arbitration clause. There can further be a possible minimum lock in period; a long(er) notice period (with potential waiting room provisions to defer the effect of multiple resignations in any financial year); garden leave; tightly drafted restrictive covenants (including prohibiting team moves as well as usual client and colleague non-solicitation and non-dealing/hiring provisions); and set-off/clawback provisions against partner balances for any breach by the partner of their obligations. This may represent a much more restrictive regime than the partner has been subject to hitherto and requires careful consideration and negotiation.
By way of recap, restrictive covenants are more likely to be binding on partners than employees in a number of jurisdictions, including the UK. Although partnership case law does make it more likely that restrictive covenants that would not otherwise be enforceable against employees, may nevertheless bind partners, firms still need to be able to show that the partner restrictive covenants in their partnership deeds are sufficiently tailored so that they are no more than reasonable and necessary to protect their legitimate business interests – including confidential information, client (and potentially introducer) relationships, and maintaining a stable workforce. If they are too wide they run the risk of being unenforceable against exiting partners.
The period of post-merger integration must also be carefully managed to ensure the success of the new merged entity. It is essential that actual and potential barriers between the different entities are recognised and addressed from day one following the merger and that a joint culture and identity can flourish across all areas and at all levels of the firm. The danger of an underlying ‘them’ and ‘us’ culture between the merged entities, and a silo culture in teams and offices, cannot be left unchecked if the merger is to prove a success in the medium and longer term.
…Or Should I Go?
The challenges of leaving
For a partner considering leaving and trying their luck elsewhere, return of capital, payment of outstanding profit share and tax reserve, and preservation of indemnities will be key issues. There will be express, implied and potentially fiduciary duties owed to the existing firm which have to be considered carefully when pursing opportunities elsewhere. When going through an interview process and preparing a business case for the new firm, there is a significant risk that confidential information regarding clients, team members and billings may be disclosed which will place the partner in breach of the duties which they owe their existing firm. These issues require very careful consideration.
In the context of a merger careful thought should also be given as to whether restrictive covenants in the partnership agreement of a pre-merger firm remain enforceable post-merger against the former partner, either by any remaining entity or the new merged firm.
Team move departures in the wake of a merger are increasingly common and this is likely to expose the lead partner or partners (as well as key team members potentially) to the risk of injunctive proceedings or potential claims including (without limitation) for damages or an account of profits earned unlawfully as a result of partner breaches. They may also be at risk of forfeiting their various partner balances including current account, capital and tax reserve balances. Although the majority of law firm team moves typically result in some form of commercial resolution, the risk for the partners who act in breach of their obligations, and for their new firm (which may face allegations of procuring and inducing the partner breaches, conspiracy and other potential claims) is significant and should not be underestimated.
Due diligence on the potential new firm
And of course what of the new firm – what due diligence should a potential lateral hire undertake in respect of their potential new home to ensure they are not jumping out of the frying pan into the fire?
As a first step, it is essential to ask for a copy of the up-to-date partnership agreement(s) to understand the full extent of the applicable obligations and rights; and a copy of the firm and departmental business plans. Also request copies of the accounts for the last three years and up to date management accounts, the budgets for the coming year and a clear statement of how partner drawings and profit shares are determined. It will also be critical to establish both exactly what capital contribution is required – and the arrangements in place with the firm’s bank in order to finance it – and the provisions which govern the extraction of that capital on exit. For example, some firms permit withdrawal by lump sum shortly after departure, whereas others permit only instalments over an extended period, and may include extended deferral, clawback and forfeiture provisions (among others).
The financial position of any new firm will naturally be crucial. Any moving partner would be well advised to make enquires as to the speed at which the firm turns over its work in progress and debtors; whether the drawings policy is appropriate and takes account of the firm’s actual cash flow and liabilities; and whether there is any possibility that a partner may be asked to provide guarantees, or assume any personal liability. In addition, partners should consider the future position of a new firm: can the firm’s projected earnings cover its premises costs? Will those costs impair the firm’s ability to compete on a long-term basis?
It is essential that difficult questions are broached at this stage, rather than becoming the source of more complicated and serious disputes down the road. A partner may be used to a certain level of professional indemnity cover and this should be checked against the new firm’s policy, along with the firm’s record and potential liabilities which they may face.
Most notably, a moving partner should give consideration to any provisions which may affect their exit. For example, what notice would be required if they want to leave, or if the firm requested the partner to leave; would any removal by the firm be by a partnership or executive committee decision, for example? In case the new firm turns out not to be the right place for a partner and their client base, then any potential partner should also consider what gardening leave and restrictive covenant provisions might restrict his or her future movements.
A leap of faith or better the devil you know?
The decision whether to remain with the merged entity or to leave and find a new home will have to be made on the information available at the time and some key issues will be unknowable. Often it will be a question of personal instinct – is this firm likely to be the best long-term home for the clients and for me?
That brings us to the most important piece of the merger jigsaw puzzle, so often overlooked or underestimated: the clients, what they want and what is best for them, because whether the client decides to stay or to go will ultimately be the determining factor in the success or failure of any law firm merger.
CM Murray LLP is a London based law firm can provide law firm partners and law firms with English legal advice and support in the context of law firm mergers, firm exits and teams moves, including strategic and practical advice on managing risks and achieving sensible commercial outcomes. Please contact Bettina Bender at bettina.bender(at)cm-murray.com would like more information.