SIX QUESTIONS TO ASK AT THE OUTSET WHEN TWO LAW FIRMS MERGE

Merging law firms is a complex undertaking. The enormous time and money involved, not to mention disruption to the respective practices, should not be undertaken without first addressing some of the basic considerations. It is impossible to provide a hard and fast list of all the issues that must be analyzed at the outset. However, there are some very basic questions to ask, that can provide an excellent first step down the path toward a successful merger. What follows is a non-exclusive list of six such initial questions.

Question One: Are there any obvious impediments relating to the assumption of liability of one firm for the other’s acts or omissions?

DISCUSSION: It may seem rather impolitique to start out questioning whether a law firm with which you intend to merge may have undisclosed and unknown potential lawsuits. However, if such a lawsuit is brought after the merger occurs, it can become everyone’s problem. Therefore, it makes sense to start with two fundamental inquiries. First, each firm should review the other’s professional negligence insurance application that was most recently submitted. That should contain a list of at least some of the potential liabilities. Second, the respective firms should discuss whether they are willing to include a robust and personally guarantied indemnification provision in the merger agreement.

Question Two: Are there ethic issues concerning either firm’s practices and procedures that will come up once the two are merged?

DISCUSSION: There are really two categories of ethics issues that can impact a firm that is merging with another: first, arguably unethical practices that are well-known within one firm that will continue to be a problem after the merger; and second, such practices that exist, though the aquired law firm does not know they are going on. The way to handle that is to conduct an ethics audit as part of the initial due diligence.

There are a host of practices and procedures that need to be reviewed, but obviously, the first should be a forensic review of the trust and operating accounts in each state in which the firm has an office. Some additional ones are potential conflicts of interest that may exist between the merging law firms; professional negligence judgments or litigation sanction awards that may have been entered and have an ethical component; and attorney or paralegal employment discharges that implicated ethical violations (such as misappropriation of funds).

Question Three: Are the firms’ tax and accounting approaches compatible?

DISCUSSION: The respective law firms’ accounting firms should be introduced to one another so that they can go over such items as the definition of the respective law firms’ fiscal years, choice of accrual or cash basis accounting, determinations of employee/independent contractor status w and generally, the extent to which bookkeeping is being maintained in a manner that is consistent between the two entities.

Question Four: Are the digital infrastructures of the respective law firms compatible?

DISCUSSION: While it may seem that the digital infrastructure of the two firms is something that can be integrated by simply “throwing enough money at the problem,” that doesn’t really resolve the internal case management issues. The goal is to preserve the internal litigation docket, drafts of documents, emails and so forth of two distinct practices merging into one. Obviously, that can create complete chaos.

For example, if one firm has a document destruction policy (or, even digital backup destruction policy) that deviates from the other, the ability to research what the firm has done in the past for a particular client could depend upon whether the client originally retained one merging firm vs. the other. That is obviously unacceptable, and is just one example of the many reasons the underlying policies and procedures for the merging firms’ digital systems need to be assessed for compatibility at the outset.

Question Five: Is any of the practice being sold made up of a portable client base that could disappear before or after the sale?

DISCUSSION: One of the hallmarks of the business of law that has always been distinct from other personal services firms is that attorneys are generally not allowed to have in place restrictive covenants a/k/a non-compete clauses. The idea is that a law firm’s clients should be allowed to pick whatever lawyer they wish, even one who is departing the current law firm that is servicing that client. (Of course, there has never been an adequate answer to the question of why a physician’s patients or accountant’s clients should not neessarily enjoy the same right, but that is a different issue.)

The larger point is that when purchasing a practice, an acquiring law firm must engage in a bit of a dance: on the one hand, it cannot enforce or implement a non-compete for the acquired practice, and on the other hand, it needs to do its best to ensure that there are no defections. The basic approach resides more in developing relationships of trust with the new legal team than any sort of  legal restriction. One way of doing so is to create a robust series of financial incentives that relate to cash flow over time, that can provide a good reason for the attorneys in the acquired firm to not depart.

Question Six: How do you define the end goal of the law firm buyout in terms of the legal structure of the transaction?

DISCUSSION: Given all of the above considerations, what end goal should be underlie the legal documentation? There is obviously an endless list, but some of the most important ones are (a) the compensation structure for the newly-organized law firm; (b) the administrative staff and other operational personnel who will be employed by the new firm; (c) the manner in which pending or actual lawsuits against the attorneys or others in the old law firm(s) will be handled (if at all) by the new firm; (d) the manner in which the new law firm will create a positive firm culture that will serve to merge the personnel and practices of the old firms; and (e) the manner in which the new firm will develop unique practice areas/client bases in existing practice areas.