Understanding & Securing the LLP Shield in New York (Part 2)
By Susan Fortney
As Part 1 of this article suggested (see NYLER June 2015), many lawyers jumped on the limited liability partnership (LLP) bandwagon without fully appreciating the reach of the statute that enabled lawyers to practice in LLPs and the consequences associated with practicing in LLPs. To help foster understanding, Part 1 first addressed the statutory requirements for lawyers practicing in LLPs in New York and then discussed the nature of the liability protection. As explained, New York is a full-shield state, allowing lawyers in LLPs to limit their vicarious liability for all claims brought by third parties. Although this may sound good to lawyers concerned about their vicarious liability exposure related to the acts and omissions of other firm lawyers and employees, lawyers should not ignore the ethical issues associated with practicing in organizational settings, including LLPs. They should also recognize that the liability shield is not impervious.
This article, Part 2, considers select ethics concerns related to practice in LLPs and describes traps that lawyers should look to avoid in practicing in LLPs. Part 2 ends by urging lawyers in LLPs to periodically conduct a “LLP check-up” to identify and address concerns that may put the LLP shield at risk.
Prospective Limit on Liability
When states first adopted legislation permitting practice in limited liability firms, including professional corporations and limited liability partnerships, some questioned whether using such an organizational structure would violate ABA Model Rule of Professional Conduct 1.8(h) and state versions of that rule that prohibit a lawyer from making an agreement prospectively limiting the lawyer’s malpractice liability, unless certain conditions are met. Various ethics committee opinions including N.Y. City Opinion 1995-7, concluded that lawyers may ethically take advantage of the statutory provisions allowing lawyers to limit their vicarious liability. Opinion 1995-7 explained that the statutory provisions do not absolve the lawyer from liability for his or her own “individual” malpractice nor for that of anyone supervised by the lawyer, and thus the limited liability partnership and company statutory provisions are “completely consistent” with the provisions of the applicable Disciplinary Rule. Although Opinion 1995-7 analyzed the issue under the then-applicable N.Y. Code of Professional Responsibility, the disciplinary rule prohibition is comparable to the proscription set forth in Rule 1.8(h) under the current N.Y. Rules of Professional Conduct (RPC), so the opinion remains valid.
Designation of the LLP and Communications with Clients
Ethics opinions have also considered the LLP designation and communications with clients and third parties. Statutes creating limited liability entities specify that the firm include in the name a notation or reference to its limited liability structure. As noted in Part 1 of this article, a New York statute requires the initials “LLP” (with or without periods), Limited Liability Partnership, or Registered Limited Liability Partnership as the last letters or words in the partnership name. The New York statute also requires publication in two newspapers, once a week, for six consecutive weeks, within 120 days after the LLP’s registration date. N.Y. Pship. Law §121.1500(a).
Ethics opinions have also considered whether the initials “LLP” alone are adequate to make apparent to clients the restriction on the lawyers’ vicarious liability. In considering this issue the members of the ABA Standing Committee on Ethics and Professional Responsibility parted ways on the extent of disclosure necessary to inform clients as to the limitation on liability. Based upon “legislative approval of the use of initials and the relative unimportance today of the lawyer’s business form for clients,” the majority of the members of the ABA Committee concluded “that the use of initials, without more, is adequate to meet ethical criteria.” ABA Formal Op. 96-401 (1996). However, the opinion also cautioned that the Committee “cannot and does not express any opinion as to whether, as a matter of law, the use of initials is sufficient to shield the partners of a lawyer held liable for malpractice from vicarious tort liability.” Id.
The N.Y. County Lawyer’s Association Committee on Professional Ethics took a similar approach, concluding that including the initials “PC,” “LLC” or “LLP” in a law firm’s name, without more, provides adequate notice to clients of the limit of the lawyers’ liability. N.Y. County Lawyer’s Op. 703 (1994). Interestingly, the New York City Bar’s ethics committee generally agreed that initials will suffice, but the opinion added an important qualification:
While we agree that use of the abbreviations or phrases permitted by the LLC or LLP statutes will in most cases provide clients with sufficient notice, lawyers may wish to consider whether that is adequate in all circumstances. In addition, lawyers changing to the LLC or LLP form should be prepared to answer any client questions regarding the nature of the change and its ramifications. N.Y. City Op. 1995-7 (1995).
These observations are noteworthy in cautioning lawyers to consider whether the minimalist use of the legal shorthand “LLP” will effectively communicate to clients the lawyer’s intention to rely on the limited liability shield. My own research indicates that initials alone may not be sufficient. Based on a survey that I conducted of members of the Houston Chamber of Commerce, 85 percent of the respondents reported that they did not know how a law firm organizing itself as a limited liability partnership or organization affected the malpractice liability of firm lawyers. See, Susan Saab Fortney, “Professional Responsibility and Liability Issues Related to Limited Liability Law Partnerships,” 39 S. Tex. L. Rev. 399, 414-15 (1998). Although this survey was conducted many years ago, query whether the percentage would be much different today. Thus, lawyers who want to limit their vicarious liability should consider if it is prudent to communicate more, rather than less, with respect to the limited liability structure.
At a minimum, lawyers should avoid communications suggesting that firm partners will assume financial responsibility for losses caused by the conduct of any firm lawyer or agent. For example, beware of communications such as the one sent by a major accounting firm after it converted to a limited liability organizational structure. In a letter to clients, the accounting firms announced that firm partners would no longer risk personal liability as a result of actions in which they had no involvement and over which they had no control. Id. at 436–37, citing “LLP Announcements: Damage Control,” 83 Tax’n. 127,128 (1995). So far, so good. But with the announcement, the firm also sent a personally addressed letter that stated, “Let me reaffirm, however, that the Firm and the professionals who work with you will continue to stand fully behind our work.” Id. Evidently firm leaders sent this letter to put a positive spin on the conversion to the LLP structure and to allay concerns related to the accountability of the firm and its principals. Unfortunately, the communication may have confused the recipients more than it clarified the effect of the conversion.
This account illustrates how careless communications can dent the liability shield. An aggrieved client may point to statements by firm partners, arguing that equitable estoppel should prevent partners from denying liability. Using a similar rationale, clients may maintain that they reasonably believed that the firm and all its partners would stand behind work performed in the ordinary scope of firm business. Various courts have considered reasonable beliefs and expectations in determining both the existence and scope of the attorney-client relationship. Id. at 437–38. In the following passage, Professor Deborah A. DeMott considered client expectations when they retain lawyers in LLPs:
Clients may well expect members of the firm, individually, to monitor the work done under the firm’s auspices. They may expect that, by holding themselves out as a single firm, members of even a large multi-site firm warrant their belief that firm work meets at least minimal professional standards. Thus, clients may expect firm members to stand behind the quality of the firm’s work and to be accountable for lapses in that work’s quality. They may expect members of the firm, regardless of their organizational form, to have staked their professional reputations on the quality of their fellow professionals’ work as well as the quality of their own individual work. It is not evident by adding “L.L.P.” or “A Professional Limited Liability Company” to the firm’s letterhead should defeat those expectations. Deborah A. DeMott, “Our Partners’ Keepers? Agency Dimensions of Partnership Relationships,” 58 Law and Contemp. Probs. 109, 129 (1995).
In support of a “reasonable expectation” argument, a former client might point to statement made in firm communications, such as firm websites, newsletters, and brochures. Marketing materials often speak in glowing terms, referring to quality controls and teamwork. A partner in the firm well-versed in liability law should review firm marketing communications to determine if they create expectations that are inconsistent with the partners’ intention to rely on the LLP shield.
This evaluation of firm communications should include a review of form letters used by the firm. An example of a hidden risk can be seen in a specimen letter distributed by the ABA Section on Law Practice Management, which stated: “All legal work performed will be *** be monitored and approved by one or more partners in the firm.” Win-Win Billing Strategies: Alternatives that Satisfy Your Clients and You, 192 (Robert C. Reed ed., 1992). A plaintiff may point to such a statement as grounds for extending liability to the partner who purportedly supervised the legal services that are the subject of the legal malpractice claim.
Supervisory Liability & Responsibility
As noted in Part 1, under New York Partnership Law, a partner in an LLP may be liable for the wrongs committed by a person under the partner’s direct supervision and control. As explained by the court in Salazar v. Fillas, LLP, 980 N.Y.S.2d 484 (N.Y. App. Div. 2014), a partner cannot be held personally liable just because the partner exercised general supervision and control. Rather, liability will ultimately depend on factual circumstances. This fact-specific determination creates uncertainties on the extent of the supervisor’s liability. This uncertainty may undermine partners’ willingness to participate in firm management and supervisory activities. For example, risk-averse partners may decline to serve as practice leaders or as members of law firm opinion committees.
To counter the reluctance of partners to get involved in supervision and management, firms could take a number of steps. The first step is for the firm to purchase adequate malpractice insurance so that a plaintiff will not feel compelled to pursue claims against individual supervisors. A second move would be for the firm to purchase a management liability insurance policy written to cover claims arising out of management services. A third possibility is to amend the partnership agreement to include a provision in which firm partners agree to indemnify managers and supervisors for losses related to their service in those capacities. A final strategy would be for a firm to compensate partners for the additional time, effort, and liability exposure associated with supervision and management activities. The bottom line is that the firm, its lawyers, and clients are better served if the firm makes up for the risk of supervisory liability by providing incentives to the firm’s lawyers to serve as managers and supervisors.
By taking steps to develop the firm’s management controls and ethical infrastructure, the firm partners discharge their responsibilities under various sections of the Rules of Professional Conduct. First, Rule 5.1(a) requires that a law firm make “reasonable efforts” to ensure that every lawyer in the firm complies with the RPC. In addition, Rule 5.1(c) specifically states that a “law firm shall ensure that the work of partners and associates is adequately supervised, as appropriate.” Failure to comply with the requirements of Rule 5.1(a) or (c) could subject a law firm to discipline under Rule 8.4. See, In re Cohen & Slomowitz, LLP, 116 A.D.3d 13 (2d Dept. 2014), citing In re Law Firm of Wilens and Baker, 9 A.D.3d 213, 216 (1st Dept. 2004).
Despite the very small number of New York cases involving firm discipline, partners should always remember the risk of firm discipline if their firms do not implement appropriate management systems to ensure that the firm lawyers comply with the RPC. Similarly, under Rule 5.1(b), a lawyer with management responsibility could be disciplined if the lawyer fails to make reasonable efforts to insure that other lawyers in the firm conform to the professional conduct rules. Lawyers who understand the affirmative obligations under various sections of Rule 5.1 should appreciate the importance of precautions and safeguards to counteract the tendency of lawyers to shirk management and supervisory responsibilities.
In a traditional general partnership, the partners shared profits and losses. The fact that partners are jointly liable for one another’s misconduct creates a Three Musketeers mentality of all for one, one for all. In a general partnership, each general partner has a vested interest in the firm itself (rather than the individual general partners) paying judgments and settlements. Otherwise, individual general partners may be personally liable. Because of this liability exposure, partners in a general partnership may be more inclined to continue as partners at the firm because they have a personal stake in the firm paying any malpractice judgment or settlement. A lawyer in an LLP, in contrast, does not risk personal liability for the misdeeds of other partners, and may thus feel free to walk away from the firm.
The financial protection provided by a general partnership may diminish even further if the firm uses an LLP structure that completely eliminates vicarious liability. When an LLP faces a large malpractice judgment or settlement that is not covered by firm assets or insurance, the partners who do not have personal liability may be more inclined to jump ship and change law firms than to stick around at a firm that is dealing with a malpractice judgment or settlement that must be paid. Of course, in situations involving highly publicized malpractice cases, firm partners may determine that it is desirable to leave the target firm because of the “reputational baggage” associated with the defendant firm.
In 2003, I raised this question in an article suggesting that the LLP structure could contribute to firms failing to meet their obligations and closing their doors. See, Susan Saab Fortney, “High Drama and Hindsight, The LLP Shield, Post-Andersen,” Business Law Today, Jan./Feb. 2003, at 47. In that article, I examined the exodus of partners at Arthur Anderson LLP following the Enron claims and contrasted it against the response of partners at Kaye, Scholer, Fierman, Hayes, and Handler following the claims brought by the Office of Thrift Supervision. To settle claims brought by the federal government, the Kaye Scholar partners agreed to personally pay millions. The multi-million dollar question is whether personal liability contributed to the partners’ willingness to contribute to the settlement, rather than switching firms. Id. at 48–49.
Although the connection between LLP structure and firm stability may be speculative, partners in LLP firms should seriously consider the extent to which the limited liability structure might contribute to lateral lawyer departures, asset insufficiency, and firm instability. Partners who are concerned about the effect of the LLP structure on partners’ commitment to the firm may address liability issues in their partnership agreement. Although the LLP partners may still avoid vicarious liability to third parties, the partners themselves can agree to indemnify one another in circumstances defined in the partnership agreement. That way, partners get the best of both worlds — the shield against liability to the outside world, and the right to mutual support from other lawyers inside the partnership.
The above discussion was intended to communicate possible unintended consequences and risks associated with practicing law in LLPs. The good news is that various concerns can be addressed once lawyers focus on them.
Conducting an Annual LLP Check-Up
If a firm is thinly capitalized or does not have adequate insurance to cover claims, a malpractice plaintiff may attempt to pursue claims against individual partners, as well as asserting a claim against the firm as an entity. With spiraling ad damnums in malpractice claims, this possibility is more likely than in the past. To improve the partners’ ability to defeat vicarious liability claims, they should understand both the requirements for LLPs, as well as the types of conduct that could contribute to firm partners inadvertently losing the statutory liability protection. Considering these concerns, a senior partner at the firm should conduct an annual LLP check-up.
In an article published more than a decade ago, Professor Roy Simon urged lawyers not to delegate to a support staff person the responsibility for monitoring compliance with LLP requirements. See, Roy Simon, “Law Firm LLPs Carry No Guarantees,” NYPRR Sept. 2003. Referring to the importance of a lawyer monitoring compliance, Professor Simon cautioned: “Don’t let your hard-earned assets be exposed to unlimited liability just because a clerical employee with no legal education and relatively little to lose does not understand or carry out the requirements for registering and maintaining the LLP.” Id. Rather, he suggested that lawyers personally read the LLP statutes so that they can intelligently monitor how the firm is fulfilling the statutory mandate.
The following suggests inquiries that a lawyer should include in the annual LLP check-up:
1. Is the firm in compliance with state registration, publication, and renewal requirements governing LLPs?
2. Does the firm’s partnership agreement clearly set forth the partners’ understanding with respect to personal liability of equity partners?
3. Determine if the partners want to agree to indemnify individual partners for losses they suffer in performing particular services for the firm, such as serving in supervisory or management positions or practicing in high risk, but lucrative, practice areas.
4. If firm lawyers practice outside New York, determine if there are particular steps to be taken to deal with issues related to the firm’s status as an LLP with lawyers practicing in other jurisdictions.
5. Review the firm’s marketing materials and website to determine if they contain statements that could be used by plaintiffs in arguing that they reasonably believed that all firms’ partners would be responsible for work performed by firm lawyers.
6. Confirm that the LLP designation is included on all firm communications and agreements.
7. Evaluate the firm’s liability insurance to determine if the limits and coverage are adequate. In addition to purchasing a professional liability insurance policy, determine if the firm should purchase employment and management liability policies.
As suggested by the last item above, the best move to protect against personal liability for tort claims is for the firm to maintain adequate levels of insurance for the different types of risks associated with the firm’s law practice. Adequate insurance not only protects lawyers and firms, but also provides a source of recovery — and justice — for persons injured by firm lawyers’ acts or omissions. Such insurance should help all lawyers sleep better, without the need to take cover behind the LLP liability shield.
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 firstname.lastname@example.org.
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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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