What Is A ‘Shareholder’ In A Law Firm – And Why Is The Concept Changing For Law Firms?

What Is A 'Shareholder' In A Law Firm - And Why Is The Concept Changing For Law Firms? 2

The question is often asked about law firms and shareholders: who can be a shareholder in a law firm? The interest in the issue has intensified in recent years as jurisdictions like the United Kingdom and Australia have introduced rules regarding business owners of law firms, which can include minority owners who are not lawyers.

Mostly law firm shareholders will be attorneys who are actually partners in the firm, although there are some cases where non-attorney professionals can also be shareholders.

The Nature of Law Firm Ownership

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Generally law firms can be organized in a variety of ways, including partnerships that we know about mostly to professional corporations, limited liability partnerships and limited liability companies (LLCs).

The actual structure and shareholder will depend upon the entity that is chosen and also the laws in the state where the law firm is based.

But each law entity will have a different name as to what it is called. A corporate structure will have a shareholder, while a partnership will have a partner and an LLC will have a member.

Keep in mind that a law firm ‘shareholder’ may in fact have no ability to actually vote on how the firm is managed and they will be non-equity or ‘junior partner’ status attorneys who are yet to have genuine management and equity interests in their firm.

There was a time when a ‘partner’ and ‘shareholder’ were one and the same in law firms, but as the way law firm structures have altered, so too have the definitions.

For instance, non-equity partners in law firms do not share in law firm profits as they are not ‘shareholders’ in the sense that they hold an equity interest in the firm.

Similarly, ‘Of Counsel’ attorneys and associates are not shareholders either and do not share in the ‘equity’ of the firm.

In a partnership, shareholders are typically referred to as partners and share in the profits and losses of the firm. In a professional corporation or limited liability company, shareholders are referred to as owners and may have limited liability for the debts and obligations of the firm, which would be the case should major changes be made to the way in which law firms are structured.

US Reluctance To Introduce Changes to Law Firm Shareholding

What Is A 'Shareholder' In A Law Firm - And Why Is The Concept Changing For Law Firms? 3

In the United States the American Bar Association’s Model Rules of Professional Conduct specifies (under Rule 5.4) that nonlawyers cannot hold any ownership interest in a law firm, which was a rule set up to avoid undue influence being made upon law firms by non-lawyers.

But the US has generally been careful to avoid changes to law firm shareholding structure and permitting ‘alternative legal business’ models to alter the structure of the traditional law firm.

Part of the pressure to mix up the ownership of law firms has come from more activist groups and individuals who are concerned about access to justice issues and the like, to ensure that legal opportunities are provided more openly and to more people by freeing up the law firm ownership situation.

One of the issue sin the US has been the bankruptcy of LeClairRyan, a law firm that had entered a tech joint venture with UnitedLex and which was designed to outsource backoffice functions to provide greater efficiencies. A lawsuit agains tUnitedLex for $128 million was also commenced, claiming that the ALSP deal was the reason for the failure of LeClairRyan.

That ‘overhang’ has therefore hindered and lessened the desire for law firms to enter deals with ALSPs.

The failure of that deal has seen reluctance to alter the situation regarding law firm shareholding structures and who the majority owners of law firms should be or how the partnership agreement for a law firm should be structured.

State Law Changes

What Is A 'Shareholder' In A Law Firm - And Why Is The Concept Changing For Law Firms? 4

However Arizona has proceeded to abolish Rule 5.4 and permitted some fee-sharing arrangements and non-lawyer investment in law firms subject to strict conditions.

Similarly, shareholder changes have also occurred in Utah where there is a ‘sandbox’ arrangement permitting firms to test out alternative business structures (ABS) and that change is being observed with interest.

Florida is likely to follow in Utah’s footsteps with their own ‘laboratory’ process that would permit ABSs to be developed also and other states, including California, are looking at making changes to the rules regarding business partners for law firms and who may hold passive or active shareholding interests in law firms.

The arguments generally mounted to make these changes to law firm shareholding structures is to provide law firms with greater access to capital for growth (as well as meeting the legal needs of more people) and to bridge the frequent gap between law firms and those with specialist business skills such as technology, finance, joint venture and other business skills that might enhance the traditional law firm service offering.

Alternative Legal Providers

In the UK and elsewhere, the development of alternative legal service providers (ALSPs) for the business structure of a law firm began in New South Wales, Australia where non-lawyer shareholders could share firm ownership.

This was followed shortly thereafter with legal changes in the UK that permitted ALSPs to be formed and Slater & Gordon, an Australian-based personal injury and class action law firm became an early pioneer in the area.

ALSPs have mostly been concerned with focusing on more commoditized work, but as the law changes it will provide the ability to provide higher end legal services too, which is beginning to occur in the UK in particular.

Big Law Issues

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For the bigger law firms, developing different shareholder strategies using ABSs and the like and the need for compliance and an alteration to their existing structure to create minority shareholders would itself create issues.

They are almost always highly profitable with access to capital and unwilling to create changes to their structure and run the risk of the sort of issues that befell LeClaireRyan, for instance.

So far as the Big Four accounting practices are concerned (Deloitte, EY, PwC, KPMG) they too are similar to the large law firms and in Europe are already providing substantial legal services as part of their professional offering.

In the US, things might differ for the mid-sized law firms that could often benefit from the introduction of new shareholders and the capital they would bring.

It would be simple, as it has been with UK and Australian law firms, to introduce complementary businesses in areas like technology, project managing, financial systems and the like and to help develop new profit centers and business efficiencies.

Law Firm Shareholding Issues

The issues with law firm shareholding and the structures employed continue to exercise the minds of both legal and business entrepreneurs and ethicists seeking to increase the ability of law firms to extend their legal services.

Although the ALBs continue to grow in the UK in particular, it seems apparent that legal changes in the US will see the same occurrence there as ‘shareholders’ in law firms move away from the lawyers alone, to include a raft of different (albeit strictly regulated) non-lawyer shareholders.

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