Give Me Shelter: The Appropriateness of Inter-Partner Contribution Agreements

While LLP statutes were designed to protect partners from statutory vicarious liability, partners are free to contract away this protection. Bromberg & Ribstein, '3.05. For example, New York's statute provides a mechanism by which a majority of the members of a LLP can vote to waive partially or fully the firm's limited liability limitation. N.Y. Partnership Law ch.39 '26(d)(1994) (specified partners of a registered limited liability partnership may be liable in their capacity as partners for all or specified debts, obligations and liabilities of a registered LLP to the extent that majority of the partners have agreed.); Symposium, 'Limited Liability Companies: Possible Futures for Unincorporated Firms', 64 U.Cinn. L. Rev. 322, 343 (1996). If the partners choose to provide that one or more partners will be liable for all or specified debts, obligations or liabilities of the LLP, a statement of such must be included in the registration materials filed by the LLP. N.Y. Pract. Guide – Bus. and Comm. '3.11. It is important to note that in Revenue Ruling 95-55, a New York firm did not agree to 'opt out' (become liable for the firm's debts), suggesting that the firm would not have had corporate characteristics of limited liability if it had opted out. Yet Revenue Ruling 95-10 indicates that a LLC may lack the limited liability characteristic if at least one member with the requisite net worth assumes personal liability for all of the LLC's obligations pursuant to statutory authority. It is not clear whether the same test would apply to an LLP's waiver of the liability limitation. Symposium, 'Limited Liability Companies: Possible Futures for Unincorporated Firms,' 64 U. Cin. L. at Rev. 322, 343.

Traditional partnership laws provided for automatic indemnification for all liabilities incurred in the course of business which is ordinarily imposed on a partnership. See, eg, N.Y. Practice Guide ' Bus. & Comm. '3.11 (2002). Yet the LLP amendments to partnership laws modified this general requirement. Even though LLP statutes generally provide that partners do not have to contribute towards partnership liabilities that are limited by the LLP provisions (see Del. Code Ann. Tit 6 Del. C. '1518(1), '1518(b)), some law firms registered as LLPs have taken it upon themselves to include indemnification and/or contribution clauses in their partnership agreements or to have partners enter into separate indemnification agreements in order to protect their partners, particularly those who may face more exposure to vicarious liability because of their managerial or supervisory positions.

Indemnification refers to a partner's right to recover from the partnership and the partnership's right to recover from the partner, without regards to creditors' rights. It is important to note that partnership agreements can provide that partners who incur partnership liabilities as a result of their negligence, or for acts outside the scope of the agreement or the usual course of business, must, in turn, indemnify the partnership. Bromberg & Ribstein, '2.09(e). LLP statutes pertain only to the liability of partners to creditors. Therefore, indemnification and other assessment liabilities (an assessment is a contractual obligation owed by an individual partner. Bromberg & Ribstein, '3.09(c)) among partners should not create direct liabilities to creditors on account of claims for which liability is otherwise statutorily limited. Bromberg & Ribstein, '3.09(c), '4.04(b). Yet it is up to the courts to officially determine the impact that the LLP statutes will have upon indemnification agreements.

Technically, indemnification rights lie only against the partnership assets with the liability then adjusted among the partners through contribution. Bromberg & Ribstein, '2.09(d). Therefore, indemnification of a partner who is liable for his own negligence, misconduct or the acts of those acting under his authority, pursuant to an express agreement, appears to circumvent the statutory liability shield because the agreement may give the paying partner rights against other partners, despite the fact that their liability is statutorily limited. Bromberg & Ribstein, '2.09(d). Yet without these contractual protections, partners may become more reluctant to engage in certain activities, seek alternative types of compensation to insure against the risks, or ultimately, refuse to become partners in the LLP. Susan Saab Fortney, 'Seeking Shelter in a Minefield of Unintended Consequences; The Traps of Limited Liability Law Firms,' 54 Wash. & Lee L. Rev. 717, 740. Indemnification agreements must be carefully drafted so that they provide the necessary protections for those partners who assume managerial or supervisory positions, but strict enough so that they do not needlessly compensate partners for their own recklessness.

In the next issue: The potential consequences of indemnification and the future of LLPs.

Leslie D. Corwin is a principal shareholder in Greenberg Traurig, LLP;
a member of the Board of Editors of this publication; and the author of 'Law Firm Partnership Agreements' (Law Journal Seminars Press, 1998). Elizabeth Bernard, an associate in Greenberg Traurig, LLP, assisted in the preparation of this article.

In the wake of the recent corporate scandals, such as Enron and WorldCom it is only a matter of time before the sanctity of Limited Liability Partnerships (LLPs) is challenged. Jonathan D. Glater, 'Enron's Many Strands: Accounting; Suits Against Anderson May Test Partners' Risks,' N.Y. Times, February 12, 2002, at C6. Providing lawyers in law firms registered as LLPs with additional liability shields from third parties will undoubtedly become a critical issue and, ultimately, it will be up to the courts to determine the scope and power of LLPs. Nevertheless, as a prophylactic device, it makes sense for law firms registered today as LLPs to consider whether it is appropriate for the partners to agree in the firm's partnership agreement to inter-partner contribution with respect to partner malpractice or other partner-generated liabilities.

To date, all U.S. jurisdictions have adopted some version of an LLP statute. Bromberg AR, Ribstein LE: Bromberg and Ribstein on Limited Liability Partnerships, The Revised Uniform Partnership Act, and The Uniform Limited Partnership Act (2001), NY, Little, Brown: '1.01(e); 2002. Many have adopted statutes similar to the Revised Uniform Partnership Act's model LLP statute, which provides limited liability for all partnership debts and obligations. Bromberg & Ribstein, '3.03. For example, California (Cal. Corp. Code ”16100 Corp. to 16962 Corp.), Connecticut (C.G.S.A. ”34-300 to 34-434), Delaware (Del. Code Ann., tit. 6 Del. C. '15-101 to 6 Del. C. '15-1210), New Jersey (N.J. Rev. Stat. NY, Little, Brown: '42:1A – 1-42:1A-56) and Texas (Vernon's Ann. Civ. St. art. 6132b-1.01 REV. CIV. STAT. To 6132b-11.04 Rev. Civ. STAT.) are among the states that have adopted versions of R.U.P.A. (For a complete listing of all the states that have adopted the R.U.P.A., see Bromberg & Ribstein, Ch.8.)

Such a statute would read that:

An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligations of the partnership. A partner is not personally liable, directly or indirectly, including by way of contribution or otherwise, for such a partnership obligation solely by reason of being or so acting as a partner. R.U.P.A. '306(c).

While these statutes offer additional protection for individuals, the protection is not absolute. Some statutes do not protect LLP partners from certain type of claims, such as contract-based claims, and most maintain partner liability for participation in or supervision of negligent or wrongful conduct. (See, for example, Louisiana's partial-shield LLP statute at La. Rev. Stat. Ann. '9:3431. See also Delaware's statute, which reads in relevant part, that limited liability 'shall not affect the liability of a partner in a limited liability partnership for such partner's own negligence, wrongful acts, or misconduct, or that of any person under his direct supervision and control.' De. Code Ann. tit. 6 Del. C. '1515(c). See also the application of New York's LLP statute in Schuman v. Gallet, Dreyer & Berkey, L.L.P. , 719 N.Y.S.2d 864 (1st Dep't 2001); N.Y.Jur.2d Bus. Rel. '2276; 67 Apr. N.Y.S.B.J. 38 (1995). This is in addition to the lawyer's ethical duty to monitor others in their firm.) Partners remain responsible for liabilities incurred and contracts entered into before the law firm registered as an LLP. Bromberg & Ribstein, '3.11(b). Therefore, despite the apparent barrier created by LLP statutes, creditors will probably always try to pursue LLP partners individually, either by characterizing their liability as direct rather than supervisory or by suing the partnership with contribution by individual partners. Bromberg & Ribstein, '3.08(b).

While LLP statutes were designed to protect partners from statutory vicarious liability, partners are free to contract away this protection. Bromberg & Ribstein, '3.05. For example, New York's statute provides a mechanism by which a majority of the members of a LLP can vote to waive partially or fully the firm's limited liability limitation. N.Y. Partnership Law ch.39 '26(d)(1994) (specified partners of a registered limited liability partnership may be liable in their capacity as partners for all or specified debts, obligations and liabilities of a registered LLP to the extent that majority of the partners have agreed.); Symposium, 'Limited Liability Companies: Possible Futures for Unincorporated Firms', 64 U.Cinn. L. Rev. 322, 343 (1996). If the partners choose to provide that one or more partners will be liable for all or specified debts, obligations or liabilities of the LLP, a statement of such must be included in the registration materials filed by the LLP. N.Y. Pract. Guide – Bus. and Comm. '3.11. It is important to note that in Revenue Ruling 95-55, a New York firm did not agree to 'opt out' (become liable for the firm's debts), suggesting that the firm would not have had corporate characteristics of limited liability if it had opted out. Yet Revenue Ruling 95-10 indicates that a LLC may lack the limited liability characteristic if at least one member with the requisite net worth assumes personal liability for all of the LLC's obligations pursuant to statutory authority. It is not clear whether the same test would apply to an LLP's waiver of the liability limitation. Symposium, 'Limited Liability Companies: Possible Futures for Unincorporated Firms,' 64 U. Cin. L. at Rev. 322, 343.

Traditional partnership laws provided for automatic indemnification for all liabilities incurred in the course of business which is ordinarily imposed on a partnership. See, eg, N.Y. Practice Guide ' Bus. & Comm. '3.11 (2002). Yet the LLP amendments to partnership laws modified this general requirement. Even though LLP statutes generally provide that partners do not have to contribute towards partnership liabilities that are limited by the LLP provisions (see Del. Code Ann. Tit 6 Del. C. '1518(1), '1518(b)), some law firms registered as LLPs have taken it upon themselves to include indemnification and/or contribution clauses in their partnership agreements or to have partners enter into separate indemnification agreements in order to protect their partners, particularly those who may face more exposure to vicarious liability because of their managerial or supervisory positions.

Indemnification refers to a partner's right to recover from the partnership and the partnership's right to recover from the partner, without regards to creditors' rights. It is important to note that partnership agreements can provide that partners who incur partnership liabilities as a result of their negligence, or for acts outside the scope of the agreement or the usual course of business, must, in turn, indemnify the partnership. Bromberg & Ribstein, '2.09(e). LLP statutes pertain only to the liability of partners to creditors. Therefore, indemnification and other assessment liabilities (an assessment is a contractual obligation owed by an individual partner. Bromberg & Ribstein, '3.09(c)) among partners should not create direct liabilities to creditors on account of claims for which liability is otherwise statutorily limited. Bromberg & Ribstein, '3.09(c), '4.04(b). Yet it is up to the courts to officially determine the impact that the LLP statutes will have upon indemnification agreements.

Technically, indemnification rights lie only against the partnership assets with the liability then adjusted among the partners through contribution. Bromberg & Ribstein, '2.09(d). Therefore, indemnification of a partner who is liable for his own negligence, misconduct or the acts of those acting under his authority, pursuant to an express agreement, appears to circumvent the statutory liability shield because the agreement may give the paying partner rights against other partners, despite the fact that their liability is statutorily limited. Bromberg & Ribstein, '2.09(d). Yet without these contractual protections, partners may become more reluctant to engage in certain activities, seek alternative types of compensation to insure against the risks, or ultimately, refuse to become partners in the LLP. Susan Saab Fortney, 'Seeking Shelter in a Minefield of Unintended Consequences; The Traps of Limited Liability Law Firms,' 54 Wash. & Lee L. Rev. 717, 740. Indemnification agreements must be carefully drafted so that they provide the necessary protections for those partners who assume managerial or supervisory positions, but strict enough so that they do not needlessly compensate partners for their own recklessness.

In the next issue: The potential consequences of indemnification and the future of LLPs.

Leslie D. Corwin is a principal shareholder in Greenberg Traurig, LLP;
a member of the Board of Editors of this publication; and the author of 'Law Firm Partnership Agreements' (Law Journal Seminars Press, 1998). Elizabeth Bernard, an associate in Greenberg Traurig, LLP, assisted in the preparation of this article.