By Laura A. Sell
Attorneys are good at identifying their clients’ vulnerabilities and crafting solutions to fortify their clients’ positions. Like the cobbler whose children have no shoes, attorneys — particularly solo and small-firm practitioners — are often too busy tending to the business of law and taking care of their clients to give time and attention to protecting their practices from the consequences of a marital dissolution.
Most practicing lawyers who own and participate in the management of their law practices tend to rely upon that practice to generate nearly all of their income. Small and solo law practices generally have little intrinsic value beyond the tangible assets such as computers and furnishings; therefore the value in a law practice is the ability to generate income.
Clients and referral sources can be fickle and attorneys expend a substantial amount of sweat equity to build a brand and establish their names in the legal community and in the marketplace. The ability to continue to attract and retain clients who pay for the attorney’s work is his or her goodwill, and that goodwill is arguably the most valuable asset of the law practice. For those practices that do not lend themselves to attracting and retaining institutional clients or those who can provide repeat business, the attorney’s ability to attract future business is crucial to the success of the practice.
Who Gets the Practice?
For those who are the only lawyer of the marriage, it is without dispute which party is eligible to receive the law practice in the dissolution. Rule of Professional Conduct (RPC) 5.4(b) forbids lawyers and non-lawyers from forming partnerships in the context of a law practice. RPC 5.4(d)(1)-(3) prohibits lawyers from working in a practice where a non-lawyer: owns an interest in the law practice; is a corporate director or officer; or has the right to direct or control the professional judgment of the lawyer.
Despite the prohibitions against the ownership of law practices by non-lawyers, the non-lawyer spouse has a financial interest in the law practice. This interest is the basis for a valid claim against the value of the law practice as part of the asset and debt division in a divorce case.
Given that it is estimated that roughly half of all marriages end in divorce, odds are that a fair number of solo and small law practices will be subject to a dissolution proceeding. As a practical matter, the value of the non-
lawyer spouse’s interest in the practice will likely be paid to him or her by trading another valuable component of the marital estate for their share of the practice, which will be awarded to the attorney spouse in the dissolution.
The compensation to the non-lawyer spouse can take the form of incremental payments over time, the award of other assets of the marriage, or a combination of both asset division and payments. The payments may be either a property transfer payment that is tax neutral or spousal maintenance payments, which are taxable to the receiving spouse and tax deductible to the paying spouse. By agreement, parties have flexibility to craft a division of their assets and debts that takes into account the illiquidity of certain assets, the need for cash flow, and the desire to maintain the law practice post-divorce.
The uncertainty around how a divorce will impact the attorney’s ability to maintain his or her law practice while honoring the terms of the divorce decree can be difficult to manage. The following are some ideas to better protect the law practice in a divorce.
Prenuptial or Postnuptial Agreement
Relationship agreements can elicit such a negative reaction that the mere mention of one can discourage even the fiercest litigator. The perception is often that one spouse is trying to take advantage of the other or is signaling that he or she does not believe in the marriage. Getting through or around that initial reaction can be as simple as communicating that the agreement is intended to provide certainty for both parties and reduce legal costs in the event of a divorce.
The agreement can define how the practice will be treated, such as the preservation of cash flow to allow the practice to continue and the scope of the valuation of the practice — both of which may be impacted by the lawyer’s individual practice and the lawyer’s client base. The execution of a relationship agreement can offer reassurance to not only the parties, but also to third parties, such as business partners and lenders, that the non-lawyer spouse will not seek to liquidate or hinder the ability of the practice to continue.
Operating agreements between partners in small firms may require partners or members of the firm to execute relationship agreements with their spouses or future spouses in order to provide that sense of security for each other.
Properly Compensate Yourself
Like many small-business owners, attorneys are often scraping by in the early years and will pay themselves what they can when they can. This practice should discontinue after the practice reaches a level where revenue is more consistent.
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