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Washington Lawyer

Legal Spectator: Atticus Finch, LLP—Formerly PC, Formerly LLC

From Washington Lawyer, May 2002

By Jacob A. Stein

spectatorGregory Peck as Atticus Finch in the movie To Kill a Mockingbird inspired many people to go to law school. Atticus Finch, the lawyer who stood against bigotry. Atticus Finch, with quiet dignity, ignoring the dangers as he placed himself between the mob and the wrongfully accused. Atticus Finch, the personification of what every lawyer would like to be, at least once in his or her legal career. One shining moment to be standing up in court speaking eloquently for a just cause rather than sitting in a backroom Bates-stamping documents. If there ever was a real-life chance to be the lawyer Atticus was, that chance was substantially reduced by the turn the profession chose to take in 1960.

In the year 1960 the law practice took a giant step away from Atticus. It went corporate. Until the 1960s every law firm practiced as a general partnership. The good thing about a general partnership is that it requires no special meetings of the partners. There is no need for a written partnership agreement. There are no bylaws. There are no employment agreements between the partners. There are no stock certificates to be issued. There is no stock book. There are no filings of the partnership agreement with any governmental agency.

What would Atticus Finch have said if someone told him that the practice of law had turned itself into a corporate enterprise? He might have used the words of Hugo Grotius:

Lord Coke gravely informs us that corporations cannot be excommunicated, because they have no souls, and they appear to be as destitute of every feeling as if they had also no bowels. There is in truth but one point through which they are vulnerable, and that is the keyhole of the cash box.

     Why in 1960 did the law practice go corporate? First, there was a change in the tax laws that gave retirement benefits to a corporation but not to a general partnership. Second, the state legislatures created the professional corporation. It was now legal for professionals such as doctors and lawyers to incorporate. The professionals, instead of being partners, became stockholders and employees of their corporation. As such they were given the retirement tax benefit and certain corporate shield benefits against personal liability. If there was a malpractice case filed against the professional corporation, only the assets of the professional corporation and the individual assets of the negligent lawyer alone would be available to the plaintiff. All the others get away free. In exchange for these benefits the law firm must indicate its corporateness by the letters PC.

Many lawyers chose to forgo the corporate advantages rather than tack on the clunky PC designation. They also objected to all the other things corporations must do: file articles of incorporation, file yearly reports, hold sterile make-believe corporate meetings, draft fictitious corporate minutes, draft employment agreements, and talk corporate.

In time the corporate advantages overwhelmed the sentimental resistance to going PC. One general partnership after another converted. Then the complications. Some courts refused to honor the statutory corporate shield. A law firm, so it was said, is subject to a higher law and that higher law requires the law firm, despite its PC-ness, to put the individual shareholders’ personal wealth on the line exactly as general partners do. Clients are entitled to deal with the PC just as they would if there was no PC. Then there was the problem of the lawyer who does little real work and gets paid a large salary by the corporation who discovers that the Internal Revenue Service treats that large salary as a corporate dividend that is taxable first to the corporation and then taxed again to the lawyer employee.

It was also discovered that a PC that breaks up gets little guidance from the existing law. Must the PC redeem stockholder shares? There are odd cases where a stockholder holds stock simultaneously in two professional corporations. The first is the one that he has walked away from and is litigating with, and the second is the one he fled to with all his clients. Courts trying to untangle these issues sometimes ignore the corporate law and apply general partnership law.

With all of this going on, resourceful lawyers decided that there must be an entity that would combine the best of the PC and the general partnership. A new species appeared called the limited liability company. A member of a limited liability company need not worry about shares of stock and corporate charters and shareholders’ meetings. In addition, he gets the same protection against malpractice claims as the PC has.

Shortly after the LLC was put on the books, along came the LLP, the limited liability partnership. This has everything the LLC has and picks up the general partnership law to be used to settle disputes. This adds a measure of certainty to the LLP that the LLC does not have. That is good news. The bad news is that the limited liability feature may, as time goes by, destroy the LLP. Here is how it happens:

A key partnership asset in most law firms is the monies received from clients for services rendered. Since law firms are not capital intensive and thus do not need to retain their profits for reinvestment, profits are generally drawn by the partners on a regular basis. In the face of an on-going negligence lawsuit, negligent partners will have an incentive to retain as much of the profits in the firm while non-negligent or innocent partners will have an incentive to draw as much as possible from the firm. Unlike in the general partnership context where liability rules encourage partners to "sink or swim together," partners in law firms organized as LLPs have divergent incentives based on their differing liability status. [15 Geo. J. Legal Ethics 1 (2001)]

     Atticus would find this turn of events very disturbing.

Jacob A. Stein is a senior partner with Stein, Mitchell & Mezines LLP. He may be reached by e-mail at jstein@steinmitchell.com.