Review Your Business Entity to Minimize Your Malpractice Exposure

www.plaintiffmagazine.com

NOVEMBER 2015

Review your business entity to minimize your malpractice exposure

BY KAREN STROMEYER other lawyers in the firm, and the busi - business of the partnership. This means AND TIMOTHY HALLORAN ness liability of the entity. The primary that each partner assumes personal liabil - business entities available to California ity for the consequences of, and the ac - Two lawyers, one specializing in fam - attorneys such as Clinton & Trump are: tions of, the other partner(s) even when ily law, the other focusing on entertain - General partnership the acts were committed without the ment law, agree to share space together. knowledge or consent of the other part - They identify themselves as “Clinton & A general partnership is an associa - ners. Trump” on their letterhead, on business tion of two or more persons who carry on Most importantly, partners are jointly cards, and on pleadings. They rent office business with the aim of making profit. and severally liable for all legal and fi - space, for which they each pay half. They (Corp. Code, § 16202(a).) Intention is nancial obligations of the partnership keep separate client-trust accounts, and completely irrelevant, and these partner - and for all wrongful acts of any partner business accounts, however, there is a ships are often formed accidentally. Gen - acting in the ordinary course of partner - general office account for overhead costs erally, if you start a law practice with any ship business. This cannot be modified such as rent, utilities, etc. Each lawyer partners and do not incorporate, then though a partnership agreement, as it “eats what they kill,” so do not share prof - your law practice is by default considered would not be binding on third parties. its from any case. Each files his or her a general partnership. Although a part - Partners may dissolve their partner - own separate, individual tax returns. nership agreement is highly recom - ship and wind up the partnership’s busi - They rarely, if ever, assist one another on mended, it is not required. ness at any time by mutual agreement. cases. There is no written or formal A general partnership is an entity (Corp Code, § 16801.) However, as long agreement between them. distinct from the partners. (Gov. Code, as the partnership exists, the partners are One of Trump’s clients sues him for § 16201.) It can sue and be sued in the fiduciaries of one another and have a malpractice, and also sues Clinton and name of the partnership. (Corp. Code, § high duty of fair dealing, and owe to the “Clinton & Trump.” Can Clinton get out 16307). The primary features of a general partnership and the other partners the of the case? The answer – which was partnership are: each partner can bind the duty of loyalty and duty of care. shocking to our client when we handled partnership in its ordinary course of busi - Tax: A general partnership is not a this actual case – is not so easy. Regard- ness (Corp. Code, § 16301; and each part - taxable entity. Instead, partners are taxed less of intention, Clinton’s and Trump’s ner is personally liable for the obligations on a “pass-through” basis on their indi - informal relationship may have created a of the partnership (Corp. Code, § 16306). vidual tax returns (the partners pay indi - general partnership. If so, under partner - In the absence of a written partner - vidual income tax on their respective ship law Clinton is jointly and severally li - ship agreement, the partnership statutes share of the partnership’s profits). There - able for all liabilities of the partnership, will govern relationships among the part - fore, if profits are low, partners will pay including her partner’s malpractice. ners, and between the partners and the little in taxes (and no taxes if they make As many attorneys practice in small partnership. General partnerships are no profit), but if profits are high, then groups, formal or informal, understand - governed by the Uniform Partnership Act you might pay more taxes as a partner - ing the options and “default rules” for of 1994 at Corporations Code sections ship than as a corporation. various business entities is crucial to un - 16100-16962. Pros: This entity is easy to create and derstanding what liability you may be ac - Under these default partnership maintain, and no corporate formalities or cepting. The primary considerations in rules, each partner has an equal right to fees are required. choosing your firm’s business entity are make decisions affecting the business, an Cons: Unlimited liability for all limiting your personal liability and tax equal share in revenue, profits and losses, liabilities of the law practice business, consequences, the latter of which will only and an equal right to manage and operate including for one another’s malpractice. be touched on briefly here. the business. Any partner can unilaterally No business entity shields an attor - bind the partnership and all of its owners Limited liability partnership ney from personal liability for their own to a deal with or without the other part - A limited liability partnership is like malpractice, or from that of the attorneys ner’s knowledge or consent. Absent a writ - a general partnership except that it gives they personally supervise; however, some ten agreement to the contrary, each all partners protection from vicarious entities, if properly administered, can partner is authorized to sign contracts, liability for the malpractice or other shield the lawyer from the negligence of checks, leases, and carry on all the tortious conduct of their partners and

NOVEMBER 2015

employees, as well as the debts, obliga - that require a state license in order to Ostensible partnership tions, or liabilities of the partnership. practice. (Corp. Code, § 13401.) Profes - What Clinton and Trump may have (Corp. Code, § 16306(c).) Thus an LLP sional corporations are available to associ - created is an ostensible partnership. partner’s personal assets will generally not ations of attorneys and solo attorneys, Under California law the informal be at risk in the event of a financial disas - however, all owners of the corporation arrangement in which the public sees a ter resulting from business losses, or errors must be licensed attorneys. purported partnership, can create part - and omissions or other tortious conduct of Professional Corporations require the nership liability based on an estoppel the - an employee or a co-LLP partner. greatest administrative burden, but can ory, even where no partnership ever The LLP law eliminates personal ex - provide the greatest tax advantages. Like really existed. “Ostensible agency or acts posure for vicarious tort liability as LLPs, incorporation protects the share - within the scope of the partnership busi - well as liability for partnership debts and holders of a corporation from personal li - ness are presumed where the business obligations such as bank loans and lease ability for liabilities that arise in the done by the supposed agent, so far as obligations. The LLP law does not, how - normal course of business (premises liabil - open to the observation of third parties, ever, change the fact that an LLP partner ity, employee liability, etc.), and the mal - is consistent with the existence of an will still be personally liable for his or her practice of other attorneys in the firm. agency, and where, as to the transaction own errors and omissions; whether aris - To form a professional corporation, in question, the third party was justified ing from his or her own acts or failures to Articles of Incorporation must be filed in believing that an agency existed.” act, or negligent supervision of associates with the California Secretary of State (Blackmon v. Hale (1970) 1 Cal.3d 548, and staff. (See PCO, Inc. v. Christensen, and register with the California State 557; Redman v. Walters (1979) 88 Miller, Fink, Jacobs, Glaser, Weil & Shapiro, Bar. However, in order to keep limited li - Cal.App.3d 448, 453; see also Civ. Code, LLP (2007) 150 Cal.App.4th 384, 391.) ability protection, corporate formalities § 2300: “An agency is ostensible when the Corporate Formalities/Formation: must be observed, such as enacting by - principal intentionally, or by want of ordi - LLPs are required to file a registration with laws; annual reports; conducting regular nary care, causes a third person to believe the California Secretary of State. (Corp. meetings for the individuals managing another to be his agent who is not really Code, § 16953(a).) The partnership must the corporation and annual meetings for employed by him; Corp. Code § 15016 be formed under a partnership agreement the shareholders; preparing minutes of states: When a person, by words spoken governed by Corporations Code sections those meetings; maintaining a separate or written or by conduct, represents him - 16951-16962. A limited liability partner - bank account for the corporation and self, or consents to another representing ship must be registered with the California maintaining detailed financial records him to anyone, as a partner in an existing State Bar to be entitled to this protection, that are separate from the owners, such partnership or with one or more persons and maintain at least a million dollars in as balance sheets and records of transac - not actual partners, he is liable to any malpractice insurance. (Corp. Code, §§ tions. such person to whom such representation 16306(f); 16956(a)(2).) Annual certifica - A professional corporation may be a has been made ...). Thus in such a case as tion must be filed with the California Sec - C-Corporation or an S-Corporation, and “Clinton & Trump,” the use of letterhead, retary of State, as well annual renewal with can be structured to allow for corporation business cards, shared office space and the California State Bar. profits to be distributed to the lawyer as a shared pleadings, all can support the im - Taxes: While an LLP must file an dividend, which is taxed at a lower rate position of liability for the negligent at - informational tax return, its income is than salary. Tax benefits may also in - torney on all other attorneys with whom passed through to its partners and taxed clude greater deductions for health insur - the attorney shares these indicia of part - at the individual partner level, without ance and medical expenses, and have nership. any income tax assessment at the LLP lower payments for Social Security and Formalities in the arrangements with entity level. Medicare taxes. other attorneys can be a pain, but are ab - Pros: Pass-through taxation, and no Pros: Limited liability. Shareholders solutely essential to make sure everyone is vicarious liability. of a corporation do not have personal lia - aware what risks exist. When choosing to Cons: Some corporate formalities re - bility for liabilities that arise in the nor - work with another attorney, you are es - quired and annual reporting required. mal course of business or vicarious sentially in for a penny in for a pound. If liability for liabilities that arise from the you do not intend to share partnership A professional law corporation malpractice of other attorneys in the and malpractice liability, do not. But, if A California Professional Corporation is firm. Possible tax benefits. you show the public that you are a part - organized to provide services in professions Cons: Administrative burden. nership, you will likely be judged as one.

NOVEMBER 2015

Karen Stromeyer is a Pearson, Bradley & Feeney, she spent several jury verdict and is a member of senior associate attorney years as an associate at a prominent plaintiffs’ the American Board of Trial at Murphy, Pearson, firm in San Francisco where she represented Advocates, is a Certified Legal Bradley & Feeney with a catastrophically injured individuals. Malpractice Specialist, and practice emphasizing general currently sits on the State Bar civil litigation including de - Timothy Halloran is a senior partner at Legal Malpractice Law Advi - fending lawyers against Murphy, Pearson, Bradley & Feeney . An sory Committee. Stromeyer claims of professional liabil - experienced trial lawyer and civil litigator, he Halloran ity. Prior to joining Murphy, has tried over 20 legal malpractice cases to