What to consider when negotiating a hire or merger

In previous generations, attorneys stayed at one law firm for the duration of their career. As law firms grow and expand and as attorneys develop specific, personalized goals for their careers, movement by attorneys between law firms is more common. The number of laterals changing firms has never been higher. In many situations, an entire practice group (as opposed to a single attorney or two) may be lured away by firms eager to grow numerically and geographically.

Firms can try to keep valuable partners by encouraging comradery and a sense of dedication to the firm. However, some firms are also starting to focus on what they can do within the boundaries of attorney ethics rules and existing laws to protect their investments in people and practices and prevent unexpected or unwanted departures. No firm wants to invest in the acquisition and development of attorneys or practice groups only to see them walk out the door just as they become profit centers.

The best protection, of course, is an economic and cultural environment that is preferable to the risks associated with change. Yet in today's portable practice world, sometimes even the best environments are not enough when other firms decide to expand, offering money in a loss-leader model to attract the necessary talent. To protect themselves, firms must anticipate and do more to protect their investment.

Unlike other professions, unique rules apply to the practice of law. Indeed, many traditional protections enjoyed in other areas are simply unavailable to law firm employers. Nonetheless, law firms are not weaponless in trying to protect themselves - especially in deciding to make a substantial investment in the acquisition of a new practice group or hiring of a new partner. Nothing is worse for the morale and economics of a law firm than to make a large investment in an acquisition or in hiring, only to see the attorneys move on shortly thereafter, leaving behind liabilities that are not easily shed.

Here are several options firms may consider when negotiating a new hire or merger. Each firm must review the relevant state's stance on these various mechanisms for protecting the firm's interests and consider the firm's own goals and preferences. However, the options provided below, along with the pros and cons set forth for each, should serve as a good starting reference.

No Competition

In the typical business setting, the most common tool to protect a business from departures of valuable talent involves a noncompete agreement. Through noncompete agreements, a person agrees that they will not compete against the employer after leaving, typically for a prescribed amount of time and within a prescribed geographical location. Similarly, these provisions include restrictions against working for a competitor or taking or soliciting business upon leaving.

The rules relating to the enforceability of such provisions are complex and often unpredictable. Such provisions are even more complicated as they apply to attorneys. Courts and bar associations view legal industry noncompete clauses with strong disfavor because they are viewed as infringing on the personal nature of attorney-client relationships and hindering client choice. Indeed, if an attorney is prevented from practicing in the same geographic area after leaving her or his law firm, it is the client who suffers because they cannot have their counsel of choice. As a result, many state bars and courts simply refuse to permit the use of such clauses or find them unenforceable.

For example, California's Rules of Professional Conduct Rule 1-500 prohibits an attorney from entering an agreement that restricts the rights of a lawyer to practice law after termination of the relationship, except in the case of retirement from the practice of law.

Notably, however, the California Supreme Court has interpreted its relevant rule of professional conduct to mean that a contract provision that imposes a reasonable cost on a partner who has decided to compete against former partners does not unduly restrict the practice of law. See Howard v. Babcock, 6 Cal. 4th 409, 419 (1993). The court explained that instead, it creates an economic consequence for an unrestricted choice to practice law. In contrast, the New York Court of Appeals has held that financial disincentives that in effect restrict the practice of law interfere with a client's choice of counsel and are improper.

Simply stated, the enforceability of such provisions varies from state to state. Rather than outright covenants not to compete, many law firms employ other tools to protect themselves. For example, "collars" or "golden handcuffs" are similar to noncompete agreements. They consist of financial disincentives or incentives that are structured to entice an attorney or practice group to stay at a firm.

Collars typically involve a provision in the partnership agreement providing that if a partner leaves with other partners in a group, then certain financial consequences attach. These can include either forfeiture of capital contributions, delay of the return of such contributions, or payment in receivables rather than cash.

Golden handcuffs often include bonuses or other financial incentives that have to be returned if an attorney leaves. Like other industries, where these incentives typically take the form of stock options, golden handcuffs require partners to remain at the firm to vest or become eligible for financial incentives in the future.

Rejecting Jewel Waivers

There are other tools that can dissuade mobility. For example, the Jewel doctrine requires partners who have left a firm that subsequently dissolves to return to the former firm those fees earned from cases started prior to the departure. See Jewel v. Boxer, 156 Cal. App. 3d 171 (1984). This liability for a departing partner can be avoided through a Jewel waiver. Whether to include a Jewel waiver in a partnership agreement generally depends on whether the firm is most interested in protecting the partnership or protecting the partners - a distinction with a difference.

Jewel waivers maximize mobility, permitting partners and practice groups to leave without fear the firm will seek to recover lost profits later should the circumstances so demand. Consequently, this waiver protects the individual partner's interest to the detriment of the partnership.

In contrast, law firms, especially those financially less stable, have generally focused on protecting the partnership and may not consider a Jewel waiver advantageous. Because these firms need more predictability of revenues and profits, the potential risk associated with losing monies associated with work started at those firms is too great. In those circumstances, Jewel waivers, while good for the individual partners, do not make sense for the partnership.

Moreover, Jewel waivers may be unenforceable if they are added to a partnership agreement just prior to a bankruptcy under constructive fraudulent transfer rules. See In re Heller Ehrman LLP, 2011 WL 1539796 (Bankr. N.D. Cal. Apr. 22, 2011); In re Brobeck, Phleger & Harrison LLP, 408 B.R. 318 (Bankr. N.D. Cal. 2009).

Notably, a solution may be found in a hybrid approach where partners agree to pay a percentage of profits earned if they depart while a matter is ongoing.

Before choosing whether to agree to a Jewel waiver or hybrid agreement, every firm must take a hard look at its financial position and long-term goals and decide accordingly.

In combination, restrictive covenants (where permitted), collars, golden handcuffs, and rejecting Jewel waivers may have meaningful impacts on protecting law firms from unexpected departures after substantial investments in new partners or practice groups.

The key is to carefully consider and evaluate the options and governing rules, and then determine the approach that best balances the interests of the partners and the partnership as a whole. It is only this balance that protects both the partners and the firm's investment in them.