Until a claim do us part: Does your partnership agreement address the event of a claim against the firm?

October 1st, 2017
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By Thomas Harban

In the article by the Prosecutions Unit of the Attorneys Fidelity Fund ‘Liability of directors of an incorporated law practice’ (2017 (July) DR 18), a number of questions arose regarding the extent to which the risks associated with more than one practitioner practicing in partnership (whether in an incorporated entity or not) are appreciated and addressed by attorneys. Of particular interest for current purposes is the extent that these risks can be addressed by attorneys in either their partnership agreements or other founding documents of a law firm. (In this article, I use the term ‘partnership’ in the generic sense to refer to a firm where more than one attorney practice together as partners or directors, this will include those attorneys practicing in incorporated practices.)

A partnership of practitioners (as with any other partnership) is based, inter alia, on good faith between the participants in that relationship to the achievements of the objects of the partnership. In addressing attorneys in various forums, I have often likened the partnership agreement entered into by practitioners to an antenuptial contract (ANC) entered into by parties about to enter a marital relationship. All the terms of the relationship should be carefully set out so that, in the unfortunate event of a dissolution, the rights and obligations of the respective parties to the ‘fruits and the spoils of the union’ are clearly recorded. I surmise that for so long as the partnership relationship peacefully persists and all the parties thereto are deriving the associated benefits, it would be improbable that any of the participants would feel the need to regularly have regard to the contents of the underlying agreement. (I suppose that, similarly, a married couple would hardly find a need to refer to their ANC contract while their union is a happy one.) However, when the relationship ends, or faces the threat of termination (whether, for example, in the unfortunate event of the demise of one of the partners or the threat of a claim against the partnership), the parties may suddenly then find a need to have careful regard to the contents of the agreement. At that stage it may be too late to seek to address any gaps in the agreement.

The cases referred to in the article by the Prosecution Unit of the Attorneys Fidelity Fund raise a number of questions, which practitioners should consider addressing.

What if, for example –

  • a claim against the partnership arises only after the partnership has been dissolved;
  • a claim is made against the partnership, but the underlying circumstances of the claim arose when the practitioner concerned was part of a previous entity; or
  • one partner, facing a claim, either joins the other(s) or institutes action against them for a contribution?

A response that ‘we simply did not consider these questions’ may not assist when the partnership is faced with a claim.

My suggestion to practitioners is that it would be prudent to address issues relating to professional indemnity (PI) claims and other forms of potential liability in the partnership agreement. A claim for PI, misappropriation of funds or some other liability may arise after the partnership has been dissolved. In many instances, practitioners moving between firms may take the files they have worked on (or are currently working on) with them. What will happen in the event that there was breach of mandate, while the practitioner was still with the previous firm? Against which firm will the claim lie? In many partnership agreements, substantial emphasis is placed on how the financial rewards will be shared between the partners/directors but little (if any) attention is paid to how liabilities will be addressed.

The Attorneys Insurance Indemnity Fund NPC (the AIIF) is often notified of claims against firms, which no longer exist in the form they had existed, when the circumstances giving rise to the claim arose. In some instances, the relationship between the former partners has degenerated to the extent that they are belligerent towards each other.

The applicable legislation

It is trite that the partners in a firm of practitioners are jointly and severally liable for the debts of the firm. In the case of an incorporated practice, the provisions of s 23 of the Attorneys Act 53 of 1979 will apply. The applicable provisions of s 23 provide that:

‘Juristic person may conduct a practice –

(1) A private company may, notwithstanding anything to the contrary contained in this Act, conduct a practice if –

(a) such company is incorporated and registered as a private company under the Companies Act, …, with a share capital, and its memorandum of association provides that all present and past directors of the company shall be jointly and severally with the company for the debts and liabilities of the company contracted during their periods of office;

(b) only natural persons who are in possession of current fidelity fund certificates are members of the company or persons having any interest in the shares of the company;

(c) ….

(2) Every shareholder of the company shall be a director of the company, and only a shareholder shall be a director thereof.’

(The references in the Attorneys Act are still to the repealed Companies Act 61 of 1973 and thus still refer to a Memorandum of Association rather than to a Memorandum of Incorporation (MOI) as provided for in Companies Act 71 of 2008 (the 2008 Companies Act)).

The corresponding section in the Legal Practice Act 28 of 2014 (LPA) (s 34(7)) provides that:

‘(7) A commercial juristic entity may be established to conduct a legal practice provided that, in terms of its founding documents –

(a) its shareholding, partnership or membership as the case may be, is comprised exclusively of attorneys;

(b) provision is made for legal services to be rendered only by or under the supervision of admitted and enrolled attorneys; and

(c) all present and past shareholders, partners or members, as the case may be, are liable jointly and severally together with the commercial juristic entity for –

(i) the debts and liabilities of the commercial juristic entity as are or were contracted during the period of office; and

(ii) in respect of any theft committed during their period of office.’

It will be noted that the LPA expressly provides that there will be joint and several liability by the shareholders, partners or members with the commercial juristic entity for any theft committed during their term of office.

Section 8(2)(c) of the 2008 Companies Act provides that a profit company is ‘a personal liability company if –

(i) it meets the criteria for a private company; and

(ii) its Memorandum of Incorporation states that it is a personal liability company.’

Who is a partner/director of the firm?

It is the prerogative of the practitioner(s) in a firm to decide who to appoint as a partner/director and this will be dealt with in terms of the internal arrangements and founding documents of the firm. It is, however, important to note that holding a person out to the public as a partner/director will have implications for the PI cover afforded under the AIIF policy. The AIIF policy defines a ‘Principal’ as a ‘sole practitioner, partner or director of a Legal Practice or any person who is publicly held out to be a partner or director of a Legal Practice’ (clause XXIII). The level of cover (limit of indemnity) available under the AIIF policy and the applicable deductible are calculated with reference to the number of principals (partners/directors) that made up the Legal Practice on the date that the cause of action giving rise to the claim arose. Queries have been made with the AIIF whether, insofar as the policy is concerned, there is any difference between a ‘salaried partner’ and an ‘equity partner’. No such distinction between partners is applied in the AIIF policy provisions.

The deductible is the first amount payable in respect of a claim under the AIIF policy. Attorneys may also consider addressing the issues around the payment of the deductible in their partnership agreements.

In the event of the claim amount exceeding the available limit under the AIIF cover and there is no top-up policy in place to cover this amount, the partners/directors will be liable for the amount in excess of the AIIF cover available. Practitioners should also consider addressing these circumstances in their partnership agreements.

Insurance cover

Firms may also consider purchasing appropriate insurance cover in the open market to cover themselves in the event of claims. In addition to purchasing top-up PI cover, firms must also consider purchasing other types of cover such as –

  • misappropriation of trust fund insurance;
  • fidelity guarantee cover;
  • directors and officers liability insurance (for incorporated practices see also ss 77 and 78 of the 2008 Companies Act); and
  • what is also commonly referred to as ‘key-man cover’.

The partnership agreement could also include provisions addressing the payment of the premium for the insurance cover(s) taken out by the firm.

Conclusion

While some may consider the questions raised in this article rather uncomfortable, it may be best to deal with these questions as partners while the relationship between the principals is cordial. Attempting to deal with these questions after the relationship has broken down or where the firm is already faced with a claim may be difficult, if not impossible.

Thomas Harban BA LLB (Wits) is the General Manager of the Attorneys Insurance Indemnity Fund NPC in Centurion.

This article was first published in De Rebus in 2017 (Oct) DR 14.

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