partners should be allowed to work past mandatory retirement age only if they continue adding value to the firm. also: six agreement provisions that often are outdated.
by marc rosenberg
the role of the managing partner
when the managing partner’s job is discussed, their role in the firm’s partner agreement is rarely mentioned. perhaps in the overall scheme of things, it’s not as important as revenue growth, profitability and staff development, among many others. but it’s still critically important.
more: how long should it take to make partner? | how a good managing partner impacts profitability | how a great managing partner impacts firm growth | compensation is no way to manage partners | clarify partner expectations | exceptional managing partners offer their advice
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if there is one person in the firm responsible for safeguarding the firm’s assets – its clients, people, proprietary data and practices, reputation and value – it’s the managing partner. and the most important way he or she does that is by enforcing a solid partner agreement.
before we proceed, a note about terminology: this post uses the term “partner agreement” to describe the agreement for all legal entities, including c-corp, sub-s, partnership, llc and llp.
main governance issues partner agreements address
every firm is different, but these are the most critical firm governance issues addressed in partner agreements:
- authorities of the managing partner and governing bodies such as the executive and compensation committees
- voting
- rights, responsibilities, limitations and duties of the partners
- financial considerations such as partner income allocation, ownership percentage and capital
- how disputes are settled, including grounds for expulsion of a partner
- partner buyout
- how the firm admits new partners
- limitations on departing partners’ ability to take clients and staff with them if they leave the firm (noncompete and nonsolicitation agreements)
without these protections, the firm is at risk of having these issues decided in ways that are antagonistic, harmful and unfair to the firm and its owners. it’s the managing partner’s job to enforce the agreement and protect the firm and its partners from harm.
an overarching perspective on the managing partner’s authorities
tony kendall is the managing partner of mitchell titus, a large firm with offices in six major cities. he succeeded the firm’s revered founder in 2009. after several months on the job, he saw that his partners’ view of the managing partner’s job had to change. he told his fellow partners:
“i can’t manage this firm if i have to take a vote every time i want to make a decision.”
the managing partner section of your partner agreement should be written with that simple yet powerful governance technique in mind.
managing partner authorities commonly found in agreements
this preamble often precedes a list of specific managing partner duties:
the managing partner shall have general and active control of the management and business affairs of the firm on a day-to-day basis. the managing partner shall exercise general supervision and administration over all of the firm’s affairs, with the exception of those issues stipulated elsewhere in the agreement that require a vote of the full partner group. the managing partner has the power to make all contracts on behalf of the firm in its regular and ordinary course of business and shall see that all resolutions and matters approved by the partners are carried out.
these are common authorities granted to the managing partner in partner agreements. as with items in the managing partner’s job description, the managing partner is free to delegate any of these to other firm members:
- be responsible for the management duties and powers normally exercised by the ceo of a business
- have the right to delegate authority to others from time to time and recall the authority so delegated
- resolve questions and issues relating to ethics and professional standards
- determine the types of services provided by the firm
- hire and fire all employees, other than partners, and recommend compensation for employees
- create, adopt, enforce and supervise operating procedures, policies and processes for the firm
- pay all expenses and debts as they become due
- automatically serve on the firm’s compensation and executive committees; at virtually all firms, the managing partner chairs these bodies
- approve all admissions of partners (note: this is in addition to a vote by the full partner group)
- manage and administer the firm’s partner retirement system
- initiate preliminary, no-obligation discussions with merger candidates
keeping the partner agreement current
over time, provisions of partner agreements become outdated because of changes in the size of the firm and new governance practices that emerge from time to time. it’s the managing partner’s job to keep current on these potential reasons for changing the agreement. here are major examples of outdated or poorly written partner agreement sections that i find with alarming frequency.
- voting. perhaps when the firm was formed, there were only five or fewer partners. the agreement provided for voting to be done on a unanimous or a heavy supermajority basis (say, 80 percent). but as the firm increases in size, it is no longer workable to use such a high threshold to pass certain issues. in these cases, it becomes reasonable to require a smaller supermajority (perhaps two-thirds) or a simple majority vote to pass certain measures.
- buyouts. over the past 10 to 15 years, firms have tightened up the conditions and rules regarding partner buyouts. for example, instead of a buyout being virtually automatic, partners are now required to provide ample notice (usually 18 to 24 months) and proactive client transition assistance.
- what ownership percentage means. when firms are small, partner agreements are often written to use ownership percentage to decide five significant financial and operating privileges for partners (listed below). the common concern of all five areas is this: ownership percentage is almost never a fair indicator of what the partners have done to earn the benefit. therefore, ownership percentage should not be used to determine these individual benefits or privileges.
impact of ownership percentage on partner agreements
| area of impact | misguided use of owner %; usually found in smaller firm agreements | how the area should be handled |
| new partner buy-in | 100% on owner percentage times the firm’s value | the firm should decide on a statutory buy-in amount independent of ownership percentage; $50,000 to $150,000 is common, depending on firm size |
| partner compensation | biggest factor in allocating income or a major factor | income should be allocated based on relative partner performance; some firms have a small income tier based on each partner’s capital in the firm |
| partner retirement/ buyout | biggest factor in calculating buyout or a major factor | benefits should be determined based on what the departing partner contributed to create the firm’s value and overall success |
| distribution of proceeds of a firm sale | 100% on owner percentage | should be the same as relative, accrued retirement benefits. |
| voting | 100% on owner percentage | 1. very few votes should be taken.
2. most votes are 1 person, 1 vote. 3. crucial issues (e.g., mergers and partner admissions) should be voted on a supermajority basis.
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- retirement/buyout provisions.
- onerous terms such as excessive goodwill valuations and enormous payouts to founding partners (usually put in the agreement by the founding partner)
- inadequate vesting or, amazingly, no vesting whatsoever
- non-solicitation agreements:
- no provision whatsoever
- no prohibitions on taking staff
- provision for management committees (aka, management by committee). there is no place in firms for these committees, so they should not be provided for in the partner agreement. instead, there should be an executive committee or a board.
- insufficient grounds for partner expulsion. the consequence of this is to greatly limit a firm’s ability to dismiss a partner who commits egregious acts.
enforcement issues managing partners should be alert for
almost all agreements and contracts have prohibitions against certain actions. the tricky part is being able to detect when these violations occur.
here are some important agreement violations that partners have been known to commit. managing partners should be alert to these violations:
- partners and staff leaving the firm and taking clients and/or staff
- failing to provide services requested by clients
- getting involved in side businesses or otherwise failing to spend full time on the firm; this includes (a) receiving compensation for personal services other than from income reported in the firm’s financial statements and (b) being an active owner of a side business
- investing in client deals in violation of the agreement
- accepting gifts from clients that are beyond minimal
- holding public or civic office without the firm’s approval
- serving as a trustee, director or executor without the firm’s approval
- committing “bad acts” such as fraud, embezzlement, criminal acts, tax evasion and any severe public conduct that damages the firm’s reputation
- engaging in substance abuse
- treating staff abusively
client transition for retiring partners
as discussed in the beginning of this post, one of the managing partner’s duties is to safeguard the firm’s assets. arguably, the firm’s biggest financial asset is its client base. whenever a partner retires or otherwise leaves the firm, loss of clients is a risk. firms need to adopt policies to retain clients when partners leave the firm. the managing partner is responsible for enforcing these policies.
one of the weakest areas of many firms’ partner agreements is the client transition requirement for retiring partners. hundreds of firms have no client transition requirements or have such a weak provision that it’s effectively nonexistent. two things are needed to add teeth to this provision:
- be very specific, in writing, about the transition procedures required of a retiring partner
- specify penalties for failure to comply with these transition requirements
it is the managing partner’s responsibility, not the retiring partner’s, to control the process. the biggest mistake managing partners make is to leave it up to the retiree to lead the transition process. retirees’ involvement and input into the process should be encouraged, but ultimately decisions must rest with the managing partner. retirees often take a very passive role in transition if it is left up to them.
as a retiring partner transitions his or her work to others, the retiree will likely have less than a full-time job, especially toward the end. nonetheless, the firm should maintain the retiree’s full-time compensation during transition. this is an incentive for the retiree to make the transition process as successful as possible while doing what is in the firm’s best interest. it’s also the fair thing to do.
“retired” partners who wish to continue working. at many top 100 firms, if mandatory retirement is 65, then usually, partners’ last day at work is in the year when they turn 65. but at most firms below $15 million or so, more than 90 percent of all partners wish to continue working in some capacity beyond mandatory retirement age. these firms have invented a new definition of “retirement” as the age at which partners are required to stop being equity partners but after which they may continue to work.
it should be up to the firm, not retiring partners, whether they are allowed to continue working and what the terms of their work arrangements are. the key is this: partners should be allowed to work past mandatory retirement age only if they continue adding value to the firm. it’s the managing partner’s job to lead on assessing this value.
here are four very common requirements for a partner to continue working past the mandatory retirement age:
- the partner must provide value to the firm. it should not be an inalienable right to continue working as a perk for prior years of hard work.
- it’s up to an annual vote of the partner group, or alternatively the managing partner or the executive committee, to allow the partner to continue working past mandatory retirement.
- at a minimum, these partners give up their equity ownership.
- no buyout payments are made to partners working past mandatory retirement age if they continue to control clients.
the conditions of the work arrangement for retired partners should be put in writing and address the following:
- full-time or part-time
- how many hours they can work
- compensation
- the nature of the work they are allowed to perform
- the extent to which they are allowed to control clients
- office arrangements, including support
- how many years the arrangement will be allowed to continue
the managing partner is responsible for taking the lead in setting and enforcing these conditions.