Believe it or not, law firm governance documents, and the process of creating them, are the key to successfully forming your law firm and building it into a stable and sustainable entity. Those partnership, LLC, LLP, operating agreements, bylaws and other formation documents are far more than “check-the-box” activities. They can be the source of success by influencing culture and by managing risk.
Join our panel of attorneys who advise law firms on culture, ethics, succession, risk management and a host of other issues that impact whether your firm struggles to survive or thrives. Sit back and enjoy the dialogue with:
MITCHELL: Where do you see value for law firms being more thoughtful and deliberate about creating their governance documents?
CHIVERS: When I am retained to assist with a law firm formation, I usually provide the founders with a checklist of common provisions in governance documents so that they can engage in an informed dialogue amongst themselves to identify common goals and potential areas of conflict that need to be resolved. I also have them discuss what kind of firm culture they want to develop and foster. Having partners engage in conversations to explore governance issues at the outset creates some incredible benefits. It helps set the direction for the firm and provides guardrails for how the firm will operate to achieve its goals. Their dialogue creates a road map for the partners and helps them clarify priorities.
ROSING: Risk management provisions in governance documents can bring significant strategic value to law firms. The practice of law is an inherently risky business and, when you bring multiple lawyers together in a firm, that risk can increase exponentially.
Risk in the law firm environment includes partnership disputes, employment law issues, legal malpractice claims, ethics compliance conundrums and licensing issues, not to mention a wide variety of more standard business risks. Because a law firm cannot completely eliminate risk and also hope to make money, the law firm must put in place tools and written structures to effectively manage risk.
There are a variety of questions that the leaders of law firms should be thinking about. How do you effectively incorporate risk management into your governance structure? What level of risk are you willing to tolerate? Are you managing your risk by taking steps such as securing adequate insurance, particularly in the malpractice and cyber arenas? Do you have adequate processes in place for case intake, training and supervision? Do you have mechanisms for securing engagement documentation and conflicts waivers from clients, and later avoiding fee disputes with clients? Do you have an adequately detailed partnership agreement so that everyone knows what their obligations and entitlements are? These are the types of questions that can be addressed in your governance documents and your attendant policies. In this manner, whether you are a partnership, professional corporation or professional limited liability company, your law firm leaders are on the same page in terms of how to effectively manage risk for the benefit of the people working at the firm, as well as the clients.
As has been publicized, there have been a string of seemingly successful law firms that have imploded over the years due to not only poor financial management, but because of inadequate processes to address risk factors in the firm environment. Failing to proactively tackle these matters can pose an existential threat to a law firm.
O’RIELLY: Having well-developed law firm governance documents, like an up-to-date negotiated partnership agreement, should be a competitive advantage for a law firm because it clearly sets the firm’s policies and, by extension, the firm’s culture.
The steady trend we’ve seen in recent years, especially in the period since COVID, has been that traditional law firm trappings have been devalued as a significant contributor to a firm’s identity. Fewer people care if you have, for example, a large law library when everyone works from their laptop computer wherever they happen to be. The shift toward remote work and virtual firms is further accelerating this trend. These things used to help a law firm set a firm culture: law firm offices, fixed resources and in-person work interactions used to be what largely defined a law firm.
But these things are less relevant now. That’s why consciously identifying, in the firm’s governance documents, the firm’s policies and unique practices is increasingly important. Firms stand out today because of their core ideas: How does the firm value its people? How does the firm approach work in terms of problem solving? How does the firm govern itself and its future? What are the firm’s long-term goals? Establishing and expressing the firm’s culture in its governance documents sets and guides those values. That helps clients, and attorneys and staff, differentiate between firms.
MITCHELL: Are there best practices when it comes to drafting law firm governance documents?
CRAIG: The key to great drafting is having all the hard conversations first. Lawyers tend to not have those conversations when they are setting up a firm. It is a honeymoon period, and no one wants to raise the difficult issues. Unfortunately, these are the issues that always come back and bite you in the end when problems arise.
Sometimes, these conversations are not what one would think they would be. For instance, can one partner tell another that they shouldn’t help train associates because they have tendencies to treat associates poorly? Can a partner tell another that they are not appropriate to manage the firm’s trust account because they don’t balance their own checkbook? Can we admit that once the firm is up and running and we are no longer concerned about keeping the lights on that one partner will want to move to an eat what you kill compensation model? Can partners admit that checks and balances are needed, and no one gets to operate completely autonomously? These are the questions that, if left unanswered, will defeat even the best drafted governance documents.
O’RIELLY: Regardless of what your firm’s plans may be there is a useful structure for law firm governance documents. We want our clients to consider all critical areas of their business in this process. Our agreements are responsive to ethics opinions, local rules and evolving case law on partnership and ethics issues on each of the core aspects of a law firm:
In our view, the process of creating governance documents is even more important than the documents themselves. We encourage our clients in the process to consider the firm’s identity, its goals and risks that it may face. Having these conversations helps us to create agreements that address the firm’s real needs. The process also helps to create a consensus and shared understanding of the purpose and direction of the firm.
MITCHELL: What provisions would you like to see more firms include in their governance documents?
MONTGOMERY: I’d love to see provisions that very clearly and specifically set forth what happens when a partner leaves the firm. Specifically, addressing how clients will be handled. This would include notification provisions, how client information will be managed and the like so that both the departing lawyer and the law firm have agreed in advance on all these issues.
This would go a long way to stop some of the inappropriate behavior we sometimes see from departing lawyers and the obstructionist behavior some firms engaged in as they try to make it very difficult for a client to exercise their right to choose their lawyer.
ALI: I would take Sari Montgomery’s idea one step further and include a sample departure letter that includes a timeline for the entire notification process as well as specific language to be used in client communications by both the departing lawyer and the law firm.
CHIVERS: An annual time to review their governance documents would help firms keep their practices consistent or highlight the need to update those documents. Simply requiring a review at an annual partnership or board meeting is generally sufficient to cover most challenges. It is incredible how many law firms haven’t looked at their governance documents in many years!
MITCHELL: Compensation policies are often one of the most important and yet divisive parts of governing agreements. What makes them so problematic and what can a leader do to make it better?
CHIVERS: One of those conversations that you need to have at the beginning of forming a firm is how do the partners view the compensation structure. What didn’t they like at their old firm? What is it that they want to express through the compensation system? Is the focus entirely on origination or do other factors come into play, such as marketing efforts, leadership positions in the legal community and other intangible contributions to the firm, like mentoring, committee involvement, spearheading firm initiatives, etc.
I’ve seen firms experiment with a guaranteed minimum salary for a set number of years when they start out. That provides some psychological relief to partners who are not necessarily big rainmakers. It also allows partners to plan and take some risks. The guarantee is obviously dependent on the firm meeting its budget. To cover budget shortfall, salaries are reduced on a pro-rata or other agreed-upon basis.
MONTGOMERY: Compensation policies are a key reason lawyers leave a firm. They typically feel like they aren’t being compensated fairly and vote with their feet. This is an accelerating trend as we see concentrated wealth at the top of many firms. Partners who are working very hard often don’t see a path to move up in the firm and that forces them to look for options elsewhere.
O’RIELLY: When we talk to client firms about compensation, we are really thinking about incentives. We encourage our clients to determine what their firm values so that individual equity partners can determine how they should prioritize their efforts.
Incentivizing making money is important at any law firm, but it’s not the only important goal. If the firm rewards people for management roles, training, firm administration and professional development, for example, then lawyers will dedicate efforts to those critical firm functions. If the firm doesn’t reward those things, eventually it will be very difficult to get people to take on those roles.
ROSING: I have a lot of thoughts on compensation because I was also the shareholder in charge of our finances before I became the CEO. I have served on our compensation committee for many years and have seen the issue from the vantage point of the many law firms I have represented over the decades. Compensation structure is a big deal in law firms. Lawyers work very hard, and they want to know that they are being compensated fairly, commensurate with their efforts and their ability to attract clients. Unfair or illogical compensation structures can lead to the demise of a law firm.
In my experience, there is no perfect or even standard compensation system. Almost every law firm has unique structural components, so no one compensation model will work across all firms. I tend to favor a formulaic approach that reflects what the law firm and its partners value. The formula may not only consider hard metrics like revenues, profit and origination, but efforts in the areas of leadership, mentorship, training, pro bono work, etc.
Having the formula concisely described in the governance documents gives lawyers the ability to set and work toward personal compensation goals. For example, a lawyer may choose to work more hours to positively impact their compensation. Similarly, they may turn down a low-rate case that will negatively impact their compensation. This approach can be very empowering and lead to long-term retention.
MITCHELL: Why is it so important to capture all these ideas in the governance documents? Isn’t it enough to have conversations about these issues?
ROSING: I think it can be hard to stay organized or focused as a law firm unless you have written down who you are, what you want to do and how you want to get there. Collaborative efforts resulting in documentation that describes the vision of the firm ensures that the partners are the same page and that there are collective goals. It allows leaders to know if they are doing their jobs.
Having a strategic plan, which is a type of governance document, means you can go back to it, revisit it and track your progress. This provides accountability and can also be a lot of fun. The firm can know whether it is on pace to achieve its goals––or whether it is off track.
CRAIG: Well-thought-out and clearly written governance documents are critical to managing inevitable disputes. When parties are in conflict, they are often fighting mad. Memories of what they agreed to may fade as emotions escalate. Having specific ways to handle disputes in writing is necessary because, even in anger, lawyers pragmatically understand that they will use the agreed-upon approach for resolving these disputes. Agreeing up front about how to manage conflict about pivotal issues like financial distributions and budgeting, the purchase and/or sale of large assets, withdrawal from the firm and other contentious issues will result in an easier road to resolution. Some parties may not like that at the time of the dispute. But it's too late—the parties have already agreed to it.
MITCHELL: There are a lot of benefits to having well-designed governance documents. Why don’t many firms make this a priority, so they don’t find themselves with inadequate or inappropriate out-of-date documents?
ALI: The focus on practicing law means many firms don’t make this a priority. Client work takes precedence. When they decide to act, instead of retaining counsel, they pull up a document online that applies to general partnerships and not specifically law firms. This means the form doesn’t consider their local ethics rules including the supervision requirements found in most jurisdictions.
MONTGOMERY: Many firms consider clients to be their “property.” This can lead to the inclusion of provisions that violate ethics rules around departing lawyers communicating with a client, restrictions on access to client files and other resources necessary for representation and a host of other provisions that are meant to protect the firm but are not consistent with the ethics rules or in the client’s best interests.
CRAIG: Problems arise even with well-drafted documents. I see firms ignore their governance documents for years instead of reviewing and updating them as needed. Then a dispute arises, and it heads to litigation. The firm points to specific language in the governance documents. The adverse partner points out that the firm has never actually followed any of those provisions and argues that the documents do not apply. That can become an issue of fact that has to be litigated at great cost of time, emotion and expense. Even if the documents ultimately prevail, the expense of litigating the issue is not necessary and could easily be avoided.
O’RIELLY: Developing and drafting robust law firm governance documents is an important task for any law firm, but it usually is not seen as an urgent task. Lawyers have many demands on their time and client work must come first. So, despite their best intentions, many firms don’t follow through on proactive planning, maintaining the status quo by default.
Even if the firm does create governance documents, business changes over time, meaning what was useful 10 years ago now may not be applicable or, worse, can do harm to the firm’s business prospects. Firms that commit to proactive planning, which for any law firm includes updated governance documents, generally do much better over the long term. The law firm graveyards are full of defunct firms that ignored important planning for their business.
MITCHELL: What areas do you often see firms neglect to address adequately in their governance documents?
MONTGOMERY: A rational process to handle lawyers leaving the firm. When this happens firm’s immediately think “how is that going to affect our bottom line? How much money (i.e., clients) will they take with them? How can we minimize that loss?”
Often noticeably absent is any thought about the impact on the client. “Who is the best lawyer to handle these client matters? Is it the lawyer who’s leaving and has been working on this case for the past two years? Is it the law firm that has provided the resources for the lawyer to do all that work?” These are the questions that law firms should, but often don’t ask.
A firm cannot truly consider itself as “client-centric” in the absence of a well-designed, client-focused, process to handle a partner exit.
ALI: I’m an ethics attorney so I look at problems that I see show up time and time again. One of the biggest concerns is leadership and supervision. Supervision includes supervising lawyers in the practice of law, which is required by every jurisdiction. It also includes supervising those people who make decisions for the firm in everything from hiring practices to marketing. It also includes supervising staff. This is an area where firms often assume they have it covered––and they do until a problem arises!
MITCHELL: Any final thoughts for law firm leaders aspiring to use their governance tools more effectively?
ALI: Interaction between people is key to a strong culture. People who are not engaged don’t feel like they are part of the team. If you don’t have in-person interactions or the casual watercooler talk, sometimes you do not feel connected to your firm. Leaders need to focus on how to consistently create an organization that fosters connection and supports all its people. Memorialize this in your documents and then consistently carry out those provisions.
MONTGOMERY: Law firms often see their people and their clients as little more than revenue streams. It becomes a battle of the dollars. That's dehumanizing for everyone. Your colleagues are human beings and while your clients may be a legal entity, they are comprised of human beings. In drafting governance documents, focus on the people, both clients and employees. The dollars will come and, more importantly, are much more likely to stay.
CHIVERS: Do you want to start a law firm that is different from your former firm? It's doable to start your own firm. While it takes a lot of hard work, if you're very thoughtful from the beginning now is one of the best environments ever in which to start a new law firm.
Technology is creating advantages for scaling and leverage. There are myriad business models that create flexibility and even more opportunities. Intentionally focusing on what you want to create in a law firm increases the likelihood you will make it happen.
CRAIG: Taking the time to have these critical conversations is so important. The answers to your questions may tell you that partnering with this person doesn't work, because the way they see and value money is very different from how you see it. It is better to walk away from a potential partnership before it begins rather than after you’ve invested a lot of time and money in it.
ROSING: There are a lot of things to consider when you are forming a law firm. One stands out for me: always make sure you know who you're letting into the partnership because, at the end of the day, a law firm is nothing more than a collection of people who want to be together to practice law. My other advice is to make sure that you do not lose the forest for the trees. I have seen many law firms with governance structures that are too complex or don't make sense, or firms that have policies that don't promote the values of the firm, or firms that become too bureaucratic. While governance documents are a must, always make sure that the big picture is top of mind and come back to that big picture when important decisions must be made about the future of the firm.
O’RIELLY: If you believe that long-term, proactive business planning for your law firm is not a priority, that’s a choice you can make. But your competition is doing it!
