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Understanding & Securing the LLP Shield in New York (Part 1)

June 2, 2015 • NYLER Archive

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By Goldy Gluzman & Susan Fortney

Introduction

“[T]he actions of a partner you don’t even know, working in an office on the other side of the country, could cost you your house and force your kids to go to public school.” See, Michael Orey, “The Lessons of Kaye, Scholer: Am I My Partner’s Keeper?” American Lawyer, May 1992, at 3, 81.

 

Whether or not one sympathizes with some lawyers’ fears of public schools, this passage reflects the concern that motivates firm lawyers to seek to limit their vicarious liability for the conduct of other firm partners or employees. More recently, another commentator shared this perspective when he stated, “The one thing that many partners fear most is being held personally liable for something they did not do and knew nothing about.” See, Randy Evans et al., “Three Steps to Shield Innocent Partners from Malpractice Liability,” The Recorder (2/24/2015), discussing “innocent” partners in the context of professional liability insurance (excerpt from California Legal Malpractice Law).

To shield themselves from vicarious liability claims, lawyers first sought protection by structuring their firms as Professional Corporations or Professional Associations under applicable state laws. Following the emergence of the limited liability company (LLC) and limited liability partnership (LLP) structures, lawyers around the country converted their general partnerships to LLCs or LLPs. Unfortunately, many lawyers jumped on the limited liability bandwagon without fully understanding the liability shield and the consequences of practicing in a limited liability firm.

This article seeks to fill that gap in two parts. Part 1 addresses the New York statutory requirements for LLPs and the liability protection provided. Part 2 discusses traps and unintended consequences associated with practicing in an LLP. Part 2, to be published in the next edition of the NYLER, also suggests an LLP “check-up” that firms may wish to annually complete. The hope is that these articles will help lawyers better understand the liability protection available under the New York Partnership Law, so that they can take steps to secure the shield without compromising client and public protection.

 

Birth & Expansion of the LLP Form

The seed for the LLP structure was first planted in a 21 attorney law firm in Lubbock, Texas. The firm’s lawyers, along with lawyers around the country, were monitoring the government litigation against numerous law firms implicated in the failure of financial institutions. This litigation troubled lawyers because the amount of damages exceeded available insurance and the government lawyers could use their large war chest to pursue the personal assets of all partners in a defendant law firm, regardless of whether they had been involved in the representations that were the subject of the lawsuits. In response to this risk, a senior partner in the Texas firm asked why general partners in law firms had to share joint and several liability for the acts and omissions of other firm lawyers. This question led to amendments to the Texas partnership statute. Under the amended provisions, firms could continue to function as general partnerships while limiting partners’ vicarious liability for malpractice.

Following the enactment in Texas, the LLP form quickly spread throughout the United States and thereafter to countries abroad. The protection provided expanded as the LLP form was adopted in all 50 states and the District of Columbia.

The availability of the LLP structure varies from jurisdiction to jurisdiction. In some jurisdictions, including New York, the LLP structure can only be used by professionals. Section 121-1500(a) of the N.Y. Partnership Law defines an LLP as a “partnership without limited partners each of whose partners is a professional.”

The scope of the liability protection also varies by jurisdiction. In the U.S., only nine states allow partners to limit their liability for malpractice-type claims only (partial shield statutes) and 42 jurisdictions have enacted “full shield” statutes that allow partners to limit their vicarious liability for all partnership debts and obligations, whether arising in contract, tort, or otherwise. See, Alison Martin-Rhodes et al., “Law Firms’ Entity Choices Reflect Appeal of Newer Business Forms,” Business Entities, Jul./Aug. 2014, at 16, 20–21. New York is in the latter group.

Largely driven by the motivation to limit potential personal liability, New York lawyers have embraced the LLP form. Based on 2011 survey data, LLPs were the second most popular choice among N.Y. firms. [Id. at 18.] As the size of the firm increases so does the likelihood that it will be organized as an LLP. See, Robert W. Hillman, “Organizational Choices of Professional Service Firms: An Empirical Study,” 58 Business Law 1387, 1401 (2003), reporting on findings from a 2002 survey. Survey data also indicated that the LLP has been more popular in New York, as compared to the totals for law firms nationally. Id. at 1398.

In New York, as noted, the limited liability structure provides individual partners vicarious liability protection for the debts and obligations of the partnership while allowing the firm to operate as a general partnership. Although a partner’s vicarious liability may be limited, the partnership continues to be liable for losses attributable to the acts and omissions of partners acting within the scope of firm business. Also members of an LLP can agree to make themselves personally liable for specific partnership debts. N.Y. Pship. Law §26(d).

 

New York’s Statutory Requirements for LLP Status

Under N.Y. Partnership Law, a general partnership may become an LLP. First, §121-500 requires LLPs to register with the N.Y. Department of State (DOS) by providing certain information on the registration certificate including the name of the LLP. The name of the LLP must contain “Registered Limited Liability Partnership,” “Limited Partnership,” “R.L.L.P.,” “RLLP,” “L.L.P.,” or “LLP.” [N.Y. Pship. Law §121-1501.] The registration should also contain the specified partners who are to be liable for specified debts, obligations, or liabilities of the LLP pursuant to N.Y. Pship. Law §26(d). §121-500.

Second, §121-1500(a)(II)(A) requires notice by publication of the certificate of registration in two newspapers, once a week, for six consecutive weeks, within 120 days of filing the certificate of registration. A certificate of publication must then be filed with the DOS. Id.

Finally, §121-500(g) requires the LLP to file a renewal statement with the DOS every five years containing information specified in the statute. If the renewal statement is not timely made or is revoked by the DOS, the LLP reverts back to being a general partnership. Id. An LLP has to file a certificate of consent in order to get back its revoked LLP status pursuant to the statute. Id. However, once the status is “re-obtained” the LLP’s liability shield is deemed to have been in effect during the disputed lapse period. Id. Based on legislation enacted in 2015, the Secretary of State and the Commissioner of Taxation and Finance may agree to allow LLPs to file their registration annually along with their taxes instead of separately, every five years, with the DOS. 2015 N.Y. Laws 32-34.

Unlike some other states, New York does not impose an insurance requirement on LLPs. New York also does not require that the LLP maintain specified minimum assets.

 

Full Liability Shield: N.Y. Partnership Law §26

New York Partnership Law §26(b) describes the liability protection for lawyers practicing in registered LLPs, as follows:

Except as provided by subdivisions (c) and (d) of this section, no partner of a partnership which is a registered limited liability partnership is liable or accountable, directly or indirectly (including by way of indemnification, contribution or otherwise), for any debts, obligations or liabilities of, or chargeable to, the registered limited liability partnership or each other, whether arising in tort, contract or otherwise, which are incurred, created or assumed by such partnership while such partnership is a registered limited liability partnership, solely by reason of being such a partner or acting (or omitting to act) in such capacity or rendering professional services or otherwise participating (as an employee, consultant, contractor or otherwise) in the conduct of the other business or activities of the registered limited liability partnership.

 

In New York, the purpose of the liability shield is to limit a partner’s liabilities to third-party creditors. Christine Hurt, et al., Bromberg and Ribstein on Limited Liability Partnerships, The Revised Uniform Partnership Act, and the Uniform Partnership Act 147 (2015 ed.), (hereafter, Hurt). This means that a creditor cannot get a judgment against a partner personally because of the partner’s status in the partnership. See, Regency Found. v. Robson, No. 101615/06, 2006 WL 3833656 (N.Y. Sup. Ct. 11/2/2006), dismissing claims against partners in a LLP stating that there can be no individual liability on the part of the individuals in the absence of any allegations in the complaint of acts on the part the individuals. This liability protection continues through dissolution, winding up and termination of the partnership. N.Y. Pship. Law §26(g).

 

Exceptions to Third-Party Liability Protection

New York’s full liability shield contains three exceptions for the following: (1) direct liability; (2) supervisory liability; and (3) liability imposed by partnership agreement. Individual partners remain personally and fully liable for any negligent or wrongful act they themselves committed or that was committed by a person under their direct supervision and control. N.Y. Pship. Law §26(c). However, the first two exceptions do not render the partner liable for the debts of the partnership generally. See, Jacobs v. Altorelli (In re Dewey & LeBoeuf LLP), 518 B.R. 766, 778 (Bankr. S.D.N.Y. 2014), “Extending an individual LLP partner’s liability to liability arising from that partner’s wrongful conduct (including based on the conduct of someone the partner supervised) does not make that LLP partner liable for the debts of the partnership generally… .”

 

1. Direct Liability

First, Partnership Law §26(c) imposes liability on the partner for misconduct directly attributed to him or her. N.Y. Pship. Law §26(c) specifically states: “Notwithstanding the provisions of subdivision (b) of this section, (i) each partner, employee or agent of a partnership which is a registered limited liability partnership shall be personally and fully liable and accountable for any negligent or wrongful act or misconduct committed by him or her … .”

 

2. Supervisory Liability

Second, Partnership Law §26(c) imposes liability on the partner for the direct supervision and control of the person who committed the wrong or by any person under his or her direct supervision and control while rendering professional services on behalf of such registered limited liability partnership.

To hold a partner personally liable, it is not enough for a plaintiff to assert that an individual partner exercised general supervision and control. Rather the plaintiff must establish that the negligent or wrongful act was committed by the defendant or any person under the defendant’s direct supervision and control. See e.g., Salazar v. Fillas, LLP, 980 N.Y.S 2d 484 (N.Y. App. Div. 2014), concluding that a partner cannot be held liable unless the partner “directly supervised” the person who allegedly engaged in the misconduct.

In evaluating whether a partner in an LLP exercises direct supervision and control, the entire record, including the provisions of the partnership agreement, may be examined. In Cooke-Zwiebach v. Oziel, 962 N.Y.S.2d 64 (N.Y. App. Div. 2013), the court affirmed a summary judgment on behalf of a defendant-partner of the LLP. The court noted that the wording in the firm’s partnership agreement did not establish, as a matter of law, that the defendant-partner had supervisory control over the attorney who allegedly engaged in misconduct and that the record failed to conclusively establish that defendant-partner had knowledge or reason to know of the other attorney’s malfeasance. Id.

By contrast, in Connolly v. Napoli, Kaiser & Bern, LLP, 817 N.Y.S.2d 872 (N.Y. Sup. Ct. 2006), the court refused to dismiss claims brought by a discharged associate, alleging breach of an implied-in-law obligation due to his termination for refusing to violate a disciplinary rule. Id. The court indicated that the associate’s allegations implicated the partners in the misconduct personally or through direct supervision of the firm’s operations and were sufficiently stated to allow discovery. Id. at 879.

 

3. Liability by Agreement

Third, the statute imposes liability on the partner if the partner previously agreed to assume individual liability for the wrong or to the degree that a majority of partners vote to impose liability on the partner. As stated in N.Y. Pship. Law §26(d):

Notwithstanding the provisions of subdivision (b) of this section, all or specified partners of a partnership which is a registered limited liability partnership may be liable in their capacity as partners for all or specified debts, obligations or liabilities of a registered limited liability partnership to the extent at least a majority of the partners shall have agreed unless otherwise provided in any agreement between the partner … .

 

Under this provision, the majority of the partners can effectively contract away (or alter) the LLP shield for the liabilities of the LLP partners. Hurt at 13. As explained by the court in Ederer v. Gursky, 881 N.E.2d 204, (N.Y. 2007): “Partnership Law’s provisions are, for the most part, default requirements that come into play in the absence of an agreement. …Partners might agree, as among themselves, to limit the right to contribution or indemnification or to exclude it altogether.” Id. at 212. For example, partners may vote to guarantee the firm’s line of credit with a bank. Partners may also determine that it is advisable to provide more protection to certain partners who work in supervisory positions, such as partners who serve on an Opinion Review Committee. Rather than relying on the default provisions under applicable partnership law, firm partners should carefully consider the consequences of practicing in an LLP and enter a partnership agreement that spells out the partners’ rights and responsibilities.

 

Liability to Other Partners

New York’s statutory liability shield for LLPs limits a partner’s liability only for third-party debts and does not limit a partner’s liability to account to other partners. As explained by the N.Y. Court of Appeals in Ederer v. Gursky, N.Y. Partnership Law §26(b) “does not shield a general partner in a registered limited liability partnership from personal liability for breaches of the partnership’s or partner’s obligations to each other.” Id. at 205. In Ederer, a partner who had withdrawn from the firm sued the partnership and its partners for an accounting under the withdrawal agreement. The sued partners argued that the liability shield under Partnership Law §26(b) eliminates the liability of a LLP partner for “any debts’ without distinguishing between debts owed to a third party, the partnership or each other. The court rejected this argument, noting that the phrase “any debts” is part of Article 3 of the N.Y. Uniform Partnership Act governing “Relations of Partners to Persons Dealing with the Partnership” rather than Article 4 which governs “Relations of Partners to One Another.” Id. at 211.

 

Liability for Distributions in Bankruptcy

In Jacobs v. Altorelli (In re Dewey & LeBoeuf LLP), 518 B.R. 766 (Bankr. S.D.N.Y. 2014), the Bankruptcy Court of the Southern District of New York addressed the interplay of the LLP liability shield and bankruptcy law in determining the liability of former partners in Dewey & LeBoeuf LLP. The proceeding involved the Liquidating Trustee’s attempt to recover amounts paid to the former partners while the firm was insolvent. The court concluded that for the purpose of the clawback provisions governing conveyances of partnership property, partners in New York LLPs should not be treated any differently from partners in general partnerships. Id. at 783. As explained by the Bankruptcy Court, N.Y. Debtor and Creditor Law §277 applies to a New York LLP such as Dewey and the strict requirements of §277(a) apply to its partners. Id. at 772. The court noted that §277 was needed to fill a gap in the partnership law which failed to address the issue of the fraudulent conveyance of an insolvent partnership’s assets to its partners. Id. at 780. Thus, the Bankruptcy Court concluded that partners of an LLP should be treated as general partners for purposes of §277(a). Id. The court dismissed other claims asserted by the trustee, concluding that for the purpose of Bankruptcy Code §548(b) a New York registered LLP should be treated as a corporation, not a partnership. Id. at 778.

 

Conclusion

Partners practicing in LLP firms should not assume that the LLP structure provides an impervious shield. Rather LLP partners, as well as those dealing with and suing LLPs, should understand the statutory protection and applicable case law. As discussed above, the liability shield provided by the limited liability partnership is not absolute and may be altered by agreements, such as guarantees signed by partners. In addition, practitioners should recognize that they risk vicarious liability if statutory requirements are not met. Part 2 of this article will discuss traps associated with practicing in LLP firms and steps that can be taken to help preserve the liability protection available under state law.

 


Goldy Gluzman is a May 2015 graduate of the Maurice A. Deane School of Law at Hofstra University where she concentrated in business law and completed an externship with the Departmental Disciplinary Committee for the Appellate Division of the First Department in New York. Goldy can be reached at goldygluzman@gmail.com. Susan Fortney serves as the Howard Lichtenstein Distinguished Professor of Legal Ethics at the Maurice Deane School of Law at Hofstra University. She can be reached at susan.fortney@hofstra.edu.

 

Get CLE Credit for this month’s articles (June 2015).

 

DISCLAIMER: This article provides general coverage of its subject area and is presented to the reader for informational purposes only with the understanding that the laws governing legal ethics and professional responsibility are always changing. The information in this article is not a substitute for legal advice and may not be suitable in a particular situation. Consult your attorney for legal advice. New York Legal Ethics Reporter provides this article with the understanding that neither New York Legal Ethics Reporter LLC, nor Frankfurt Kurnit Klein & Selz, nor Hofstra University, nor their representatives, nor any of the authors are engaged herein in rendering legal advice. New York Legal Ethics Reporter LLC, Frankfurt Kurnit Klein & Selz, Hofstra University, their representatives, and the authors shall not be liable for any damages resulting from any error, inaccuracy, or omission.

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