Home / Your Practice / Law firm management liability on the rise

Law firm management liability on the rise

Law firms are coming under increasing fire from their own members as lawyers become more mobile and firms emulate corporations.

“Claims of management liability are definitely on the upswing compared to five or 10 years ago,” said Rebecca Lamberth, a partner at Alston & Bird in Atlanta who practices professional liability defense.

The term “management liability” covers a broad spectrum of potential claims, explained Robert C. Minkoff, a partner at Frankfurt Kurnit Klein & Selz in New York.

“There are standard partnership disputes, where a partner sued the firm for ousting him improperly or not paying him properly, there are third party claims like wrongful poaching or tortious interference with contract, and there are claims that fall under the traditional legal malpractice rubric, such as inadequate supervision,” he said.

As law firms pay increasing attention to the bottom line and lawyers increasingly play musical chairs with their firms, liability risks have increased. The phenomenon has even spawned the introduction of management liability insurance to cover claims against the directors and officers of a firm, according to Jonathan Kurens, a vice president at AON Risk Services in New York, whose company began offering coverage in 1999.

“Firms should absolutely consider management liability coverage, no matter what their size,” Kurens said.

Lawyer mobility changes the profession

Law firm recruitment used to be akin to a marriage commitment, lasting forever, but today nobody expects a lifetime of loyalty, according to UC Davis School of Law professor Robert Hillman, an expert on lawyer mobility.

“Law firms just don’t have the stable cast they once did,” he said.

Coupled with the increased corporatization of law firms, “risks are growing,” he added.

Conflict of interest situations are the most common result of lawyer mobility.

“A single lawyer who fails to perform an adequate conflict check to see if his new firm conflicts with existing clients can cause a serious problem,” said Hillman. And this is only exacerbated if more lawyers – like an entire practice group – are added to the situation.

And the relatively recent increase in mobility means a limited amount of case law on what is appropriate and what isn’t when a lawyer or practice group leaves a firm.

“In this era of increased mobility, any law firm that wants to be successful wants to be open to lawyers coming from other firms and also to be free to go shopping for other lawyers,” said Lucian Pera, a partner at Adams & Reese in Memphis, Tenn. “But compared to other professions, lawyers don’t have a body of learning about how to handle mobility.”

Pera, who counsels and represents lawyers and law firms in the area of lawyer ethics, professional responsibility and malpractice, said he can provide much more specific advice to a stockbroker switching firms than to a lawyer – or a law firm that is recruiting an outside lawyer.

“Increasingly, law firms are asking how to protect themselves, like when can they find out who the prospective lawyer’s clients are? Or can they get financial information about that lawyer’s practice – and if so, when?” he said. “This is a treacherous, grey area.”

Minkoff agreed.

“It’s shocking how undeveloped this area of case law is,” he said.

With less emphasis on firm loyalty, lawyers are less hesitant to bring claims against their former partners and firms. Kurens said more lawyers are filing claims because they haven’t gotten proper credit for a client relationship or failed to receive the financial rewards they deserved.

“There used to be a hesitation in bringing claims against fellow partners, but firms are in essence corporations now, and lawyers see themselves as part of that corporate process,” Kurens said.

Lamberth cautioned that professional liability claims are also being tacked onto traditional legal malpractice claims.

“We have seen [more cases in which lawyers use] potential management liability as an ingredient to a more classic malpractice case, similar to a negligent supervision claim,” she said.

The addition of a management liability claim also expands the scope of discovery, Lamberth said, and may allow plaintiffs to get internal law firm documentation relating to employee reviews, compensation information and other management activity.

She cited the ongoing age discrimination lawsuit against Sidley Austin as an example of the potential breadth of a plaintiff’s discovery requests, where the EEOC is seeking access to client complaints about Sidley’s partners. (See sidebar below for more details about the case.)

Insurance and awareness

Kurens, head of his insurance company’s management liability division, said his company was the first to offer management liability coverage, beginning in 1999, although the insurance has really taken off over the last four years.

“We’ve sold this insurance to small firms as well as very large firms, with policies geared toward their different rationales,” he said.

For small firms, the cost of defending a claim can affect the bottom line much faster than a larger firm, he said. “Accumulating half a million to a million dollars in defense expenses happens very, very quickly,” Kurens said.

In addition, small firms may want to protect themselves against larger firms who want to cherry pick their partners, he added.

On the other end of the spectrum, larger firms with an international presence may face conflict of law issues, and are more likely to need coverage for intra-office disputes, Kurens explained.

“The other big issue that comes up is non-attorney indemnification, when the firm hires a CFO or a COO as an employee,” Kurens noted. “Partnership agreements may or may not indemnify the employees of an organization, which means the firm may want coverage for the business decisions that these employees are making.”

And law firms with an eye towards expansion may also want the protection the insurance provides their ability to grow, he said, with the potential issues that arise from lateral hiring and mergers.

In addition to insurance protection, Lamberth emphasized the importance of awareness.

“There isn’t any silver bullet to prevent claims from being made,” she said. “But law firms need to be aware of the dangers they face and perform a thorough risk analysis.”

Firms should recognize the existence of management liability claims and determine whether the risk for their firm should translate into a difference in the way they document compensation or other decisions that might end up being the subject of discovery years later, Lamberth suggested. “Obviously, we can’t live in fear, but firms should think through how they document performance reviews and compensation with an eye toward future discovery.”

Questions or comments can be directed to the writer at: correy.stephenson@lawyersusaonline.com

Fate of two firms holds lessons for lawyers

A cautionary tale

From a potential management liability perspective, the collapse of a firm is the “worst case scenario,” according to Robert Hillman, a professor at the UC Davis School of Law.

And for a cautionary tale, lawyers can look to the downfall of San Francisco-based Brobeck Phleger & Harrison.

Brobeck, founded in 1926, rode the tidal wave of technology in the 1990s, focusing on tech stock IPOs as it became one of the most profitable firms in California.

But when the tech market declined, the firm was hit hard, and it shut down in January 2003.

The end of the firm was only the beginning of the story, however.

Faced with $258 million in debt, Brobeck filed for Chapter 7 bankruptcy in September 2003, and Ronald Greenspan, the bankruptcy trustee, looked to former partners and their new law firms to help fund the estate.

More than 20 lawyers, led by Brobeck’s former chairman, had joined Clifford Chance. Greenspan filed suit against the firm, alleging unfair competition and claiming that the departure of the partners helped precipitate Brobeck’s collapse. The parties settled for $5.5 million in 2004.

Prior to its collapse, Brobeck had negotiated with Philadelphia-based Morgan Lewis to merge the two firms, but talks failed in 2002. After Brobeck shut down, however, Morgan Lewis hired about 100 of its lawyers, and Greenspan sued the firm for the profits it received on a case once handled by Brobeck, leading to an eventual $10.2 million settlement.

As for the individual partners themselves, the trustee filed a claim against them, seeking to recover distributions and bonuses they received in 2001 and 2002, when the firm was virtually insolvent.

In early 2005, 207 of the partners reached individual settlements, totaling more than $23 million. The settlements ranged from $4,732 to more than $500,000, averaging $118,570 per partner.

Keeping an eye on Sidley

In another case with potential impact for law firms, the ongoing lawsuit brought by the EEOC against Sidley Austin Brown & Wood has been closely watched by attorneys.

The EEOC charged the firm with age discrimination with respect to two groups of partners: 31 former partners who were involuntarily downgraded and/or expelled from the partnership in 1999 because of their age; and a second group of partners, going back to 1978, who were involuntarily retired based on the firm’s mandatory retirement policy.

In a decision last year, the 7th Circuit said the EEOC could obtain monetary relief on behalf of attorneys who were barred from filing their own lawsuits after having failed to file administrative charges in time. (EEOC v. Sidley Austin LLP, 437 F.3d 695 (7th Cir. 2006).)

Currently, the parties are still fighting over the scope of the EEOC’s discovery request. The EEOC wants internal documents from 1995-1999 relating to all complaints made by Sidley Austin clients about all partners. The firm has argued that some of the former partners were demoted because of client complaints, and the EEOC wants to compare the treatment of lawyers who were complained about. To show that this reason is “pretextual,” the EEOC argued in the motion, it should be allowed to investigate whether Sidley failed to discipline any other partners criticized by clients.

Sidley Austin objected, arguing that the request was overbroad.

Going forward, the EEOC will argue that the Sidley partners were “employees” covered by the ADEA because of the structure of the firm’s management system (where most decisions were made by an unelected executive committee and most partners did not vote). Partners are generally considered to be exempt from federal discrimination statutes because they are owners, rather than employees.

“For many years, law firms have felt immune for their actions affecting partners, as they aren’t considered employees” protected by the ADEA, Hillman said.

But the changes to many firms – larger, operated more like corporations – means that it now “makes perfect sense to apply the discrimination laws to them, in terms of how they manage their partners,” he said.

And because many firms have mandatory retirement ages in place, the outcome of the case could have a huge impact.

“Everybody is watching this case to see what happens,” Hillman said.

– Correy E. Stephenson