Payout to a Retiring Partner
by Leland J. Reicher
(County Bar Update, September 2003, Vol. 23, No. 8)

 

Payout to a Retiring Partner

 

By Leland J. Reicher, Esq,. CPA, at the request of the Law Practice Management Section Executive Committee. Reicher is a named partner with the law firm of Reish Luftman McDaniel & Reicher. He focuses on business law for closely held businesses, professional service firms, and their owners. He can be reached through the firm’s Web site at www.reish.com. The opinions expressed are his own.

 

All law firms eventually deal with the retirement of a partner. Whether the retirement is caused by the partner’s death, disability, or voluntary or involuntary termination, in each instance the value of the retiring partner’s interest in the firm must be determined and paid. All firms should have a written agreement specifying the terms of a buy out.

 

Sometimes retirement is precipitated when partners wind down their practices or demonstrate bad business practices. Most buy out provisions do not distinguish between these situations and pay the same amounts whether a partner died with an existing strong practice or was terminated after exhibiting poor management of billings and receivables. These situations can be dealt with in a manner that does not affect the valuation of the buy out price but affects the mode of paying the buy out price.

 

The three most common problems with retiring partners are slow collections, high write-offs, and high unbilled time.

 

Slow collections -- For the partner with unreasonably slow accounts receivable collections, one way to deal with this is assigning those receivables to the partner in payment of a portion of the buy out compensation. The amount of receivables assigned should be determined as those receivables delinquent over the period of time the firm decides is reasonable.

 

For example, the firm should pick a time period (such as 180 days). Any accounts receivable managed by the retiring partner that are more than 180 days old should be assigned to the retiring partner on a dollar-for-dollar basis as payment on the amount owing on the buy out. It is up to the retiring partner to collect those old accounts.

 

Obviously, if they are uncollectible, the retiring partner suffers the penalty of uncollectability. This is only right since the uncollectible account was one that the retiring partner should have managed better to insure that fees billed to that client were collectable.

 

High write-offs -- For accounts that the retiring partner managed that had already been written off prior to retirement, the firm should determine a cut-off date (for example, six months prior to the retirement) and a reasonable dollar amount in write-offs for a partner during a specific time period.

 

If it is reasonable for a partner to write off $3,000 as uncollectible in a six-month period, for example, then to the extent the retiring partner wrote off more than $3,000 of time in the six months prior to retirement, that excess would be credited dollar-for-dollar against the buy out payment. This prevents the partner from writing off large amounts of uncollectible receivables in anticipation of leaving the firm.

 

High unbilled time -- The firm wants to protect against the partner who ran up a large amount of unbilled time, which is likely to be uncollectible.

 

One solution is to specify that any unbilled time for the clients that the partner was supervising prior to retiring will be credited to the buy out price on a dollar-for-dollar basis. Subsequent collections made on that time will be paid to the retiring partner. If the unbilled time gets billed and collected, the retiring partner will receive the benefit of that time. If it turns out that that time cannot be collected, the retiring partner, and not the firm, will suffer the consequences.

 

A buy out agreement can take into account a partner’s performance and client management for the period prior to the partner’s retirement. Most firms have not considered this in the past and then have suffered when terminating an under-performing partner, having to pay a full share buy out notwithstanding the partner’s substandard performance. The partnership agreement should be customized to produce a buy out that fairly reflects the retiring partner’s contribution to the partnership.

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