Management Liability: D&O for Law Firms
by Jonathan H. Kurens
(County Bar Update, December 2003, Vol. 23, No. 11)

Management Liability: D&O for Law Firms

By Jonathan H. Kurens, Esq., EPLI/Management Liability Product Manager for the Professional Services Group at Aon.

As Bob Dylan wrote, “The times they are a-changin’,” and so are the ways in which law firms manage their business. Geographical expansion, mergers and acquisitions, new practice areas, and organic growth, as well as the need to be both proactive and reactive to competitive pressures within the legal industry, have led firms to adopt a more corporate-like governance. Eschewing a traditional, consensus-driven decision-making process in deference to a corporate approach has resulted in small groups (often in the form of management or executive committees, and sometimes individuals) assuming ultimate responsibility for the firm’s business operations.

This management structure exposes partners/shareholders and executive directors to the same liabilities faced by directors and officers of corporate entities. Moreover, when the destiny of the firm is entrusted to a few partners, accountability and liability can be localized and isolated. Firm leadership, very much like a board of directors, needs protection; to this end, management liability insurance exists. Indeed, no one sitting on a board of directors for either a for-profit or a not-for-profit organization would be so cavalier as to not insure against liability exposure with Directors and Officers insurance. Yet most partners/shareholders and executive directors sit on management or executive committees without any such insurance protection. Consider the paradox when attorneys sit on corporate client boards. Firms understand the existing exposure; i.e., firms are potential candidates to be named in shareholder litigation if they have a partner on the board. Therefore, at least one cautious firm asks for a D&O insurance certificate before allowing its partners to join boards. 1

The Exposures

The changing legal market has challenged the industry’s traditional parochial thinking. Today, firms must be both forward-looking and bottom-line-oriented to remain solvent and viable. Globalization, regionalization, or just general expansion present financial opportunities to the partnership, but poor planning and profligate spending present liability exposure for management/executive committees.

For example, a law firm’s executive officers decided to purchase a large building in a nearby city, intending to grow the firm’s practice and reach a new class of clients. A year passed, and others in the firm discovered that the executive officers had not conducted due diligence as to prospective business development and employee growth in that city. As a result, the firm incurred substantial real estate expenses and struggled to establish its practice there. Both factors caused the firm significant financial trouble. The non-officer partners sued the executive officers for mismanagement, and the case settled out of court for $500,000. 2

The most expeditious way to realize national and even global pre-eminence is via the mergers and acquisitions route. M&A is in vogue, but not every partner is keen on a new firm’s style, and mergers and acquisitions often serve to precipitate widespread insecurity. Consider the merger of Whitman Breed with Winston and Strawn, where 13 of the 42 Whitman partners were not laterally welcomed. Further, Whitman’s entire Los Angeles office as well as four other similarly situated branches were left out of the merger. 3    One result was a lawsuit by four former partners of Whitman Breed seeking the return of their capital contributions (approximately $700,000) after they declined to participate in the merger. 4  In addition, two other former Whitman Breed partners reached a settlement for their interests in the firm totaling $781,000. 5

The successful integration of a new mega-firm is contingent upon the harmonious confluence of the respective firms; without synergy in practice areas and economics, we can expect claims from disenfranchised partners. A partner may hold management or executive committees responsible where a merger has occurred upon that group’s recommendation and has compromised the individual partner’s practice and income. Also, claims potentially could arise if the merger causes reduction in overall revenue impacting a partner’s equity interest.

Compensation is always a contentious issue among partners -- Dissonance between production and pay can lead to litigation. It has been said that a firm’s compensation program is the firm’s strategic plan, 6  so a real threat for management liability emerges when changes are made to the firm’s compensation program/strategic plan. For example, the change from a merit-based “eat what you kill” model to a seniority-based “lockstep” model would aggrieve younger, high production partners because invariably they would take a pay cut, while older partners who might produce less would enjoy a windfall. This tension was felt by the managing committee of the merged Rogers & Wells and Clifford Chance, as the new firm adopted a form of the “lockstep” and moved away from the “eat what you kill” compensation model under which the R&W partners had worked. 7

There are also disputes between attorneys and their clients over fees. For example, a client alleging that counsel took a greater percentage of the settlement than appropriate can lead to a lawsuit against the partnership. Such a claim may not fall under professional liability insurance since it does not arise out of any act, error, or omission in rendering or failing to render professional services. 8 To the extent that the management or executive committee approved the fee arrangement, it could be held accountable for subsequent damages. In the same vein, many firms have committees that determine fee arrangements among the partners. Here, too, committee  members find themselves exposed to liability, especially when a partner or counsel leaves the firm.

In another example of the exposure attendant to compensation decisions, one firm’s new management committee decided to implement a plan to significantly reduce the compensation of a certain group of partners to induce them to leave the firm and enable the remaining partners to increase their own compensation. The “marginalized” partners noted that the firm’s partnership agreement had no provision for partner termination and, in turn, filed a suit. The claim brought against the firm’s management committee alleged that the committee had acted outside of its authority to constructively terminate the partners’ employment. The case settled for approximately $2 million.9

“De-equitization” is a process whereby equity partners are demoted to salary status. While this business strategy adheres to the bottom-line focus of a corporate world vision, it is an anathema to traditional partnerships and muddies the compensation quagmire, thereby exposing management to liability. In one case, the Equal Employment Opportunity Commission alleged that the executive committee of one law firm executed actions without a vote of the full partnership in violation of Title VII. The 35-member executive committee was purported to have requested that a certain group of partners either assume positions of “Counsel” or “Senior Counsel” or in the alternative leave the firm. The executive committee also lowered the mandatory retirement age, thereby expediting the departure of under-producing, older partners. 10 These types of business decisions predicate increased liability exposure inasmuch as a  partner could argue that “de-equitization,” demotion or expedited retirement is constructive dismissal since the partner has been removed effectively from the partnership. Such decisions may have exposure under Employment Practices Liability Insurance. However, to the extent such decision alleges breach of the partnership agreement solely relating to compensation, coverage may be denied under an EPL policy.

A management committee also could face liability relating to claims of inappropriate hiring. That is, claims can arise where management assumes more direct control over the hiring of associates/paralegals. A partner could argue that a questionable hiring decision compromised the partner’s ability to service a client and thus hindered the development of the partner’s individual practice or advancement within the firm.

Further additional hiring concerns revolve around recruiting lawyers from rival firms -- the practice of “predatory hiring.” Firms losing attorneys could hold the management of the hiring firm responsible for wrongful acts in its hiring processes. The case of Holleb Coff v. Duane Morris & Hecksher illustrates this. Duane Morris was accused of improperly hiring 11 partners as part of a plan to “destabilize and destroy” Holleb. The plaintiff firm also alleged that the 11 partners conspired to defect and damage their former firm, thereby committing a breach of fiduciary duty. The claim was settled for an undisclosed amount. 11  In addition, there was the war of words over a former Pillsbury Winthrop senior partner who planned to join Latham & Watkins. Pillsbury’s managing partner issued a press release announcing that the firm had conducted an investigation into sexual harassment complaints against the partner and concluded, “there was a reasonable likelihood that the harassment occurred.” The statement also concluded that the partner had experienced a “significant decline in productivity.” 12 The partner then dropped his plans to join Latham & Watkins and filed a $45 million lawsuit against Pillsbury, the firm’s chair, managing partner,  vice-chair, and legal recruiting firm for defamation, interference with contract, interference with a business relationship, and injurious falsehoods, among other claims. 13

Other “third-party” issues involve claims alleging unfair trading practices, claims arising out of the misuse of confidential information received during merger/acquisition discussions that result in the loss of clients to the potential firm, and claims by vendors holding partners or shareholders responsible for contracts executed (or implied contracts) by the management if there is no recourse against the firm as a whole. Among other things, this potentially could include claims from landlords, vendors of computer or security systems, or headhunters.

It is arguable whether partners are classified as employees and accordingly whether they are entitled to the rights and protections afforded by employment laws. Generally, this would depend upon the firm’s partnership agreement and the decision rights held by each individual partner. One, Rhoads v. Jones Financial Cos., 957 F. Supp. 1102 (E.D. Mo. 1997), concluded that the partner should not be classified as an employee. However, in Simpson v. Ernst & Young, 100 F.3d 436 (6 th Cir. 1996), the court found that the partner in question should be treated as an employee. This issue is very much in play, and a termination or demotion of a partner could result in claims for mismanagement.

The Policy

In response to the growing exposure identified above, the market has developed Management Liability insurance coverage to protect professional firms and their managers. While the coverage available depends upon a specific firm’s profile, primary markets providing these policies will consider offering the following Management Liability coverage: claims alleging an act, error, omission, misstatement, defamation, neglect, or breach of duty by any of the employees, partners, or associates in a management capacity for the firm. Insureds can include the firm and its subsidiaries, as well as its directors, officers, advisory board members, operating executives, managers, administrators, executive directors, members of management or administrative committees, and any other person serving in any management or administrative position within an insured entity.

Management Liability, like D&O insurance, is customarily written as a claims-made policy form, which means that coverage is triggered by the assertion of a claim during a policy period. A claim is generally defined as a written demand for monetary damages, civil proceeding commenced by a lawsuit, criminal proceeding, administrative or regulatory proceeding/investigation, or arbitration against the firm or partners for a wrongful act (as defined above). The policies usually define loss to include the amount the firm is legally obligated to pay on account of any covered claim including settlements, judgments, pre- and post-judgment interest, defense costs, and punitive or exemplary damages where insurable by law.

A unique feature of Management Liability is the ability of the firm to specify who is included in the definition of “insured,” which usually includes each person who is, was, or becomes a member of a “Management/Executive” Committee; each person who is, was, or becomes an “Executive Officer;” or the firm or any subsidiary. Therefore, unlike D&O insurance, the firm can be inclusive or exclusive of lawyers or non-lawyers, including executive directors or human resource directors. This feature is important as it relates to the “insured versus insured” exclusion because claims against the firm by partners/members/shareholders who are not identified as insureds under the policy are not subject to the exclusion.

As for defense of any claims, Management Liability, like D&O insurance, allows the firms to choose their own counsel but requires prior consent to settle a claim. Coverage is intended to address, among other things, the following exposures: disputes regarding rights under partnership agreement (does not cover non-monetary relief or compensation); coverage for claims brought by partners/shareholders not involved in the firm’s management, including claims for imprudent business decisions (i.e., excessive borrowings or expenditures, unreasonable contractor lease terms, questionable lateral hiring); disputes arising out of the closure of unsuccessful branch offices; equity in lieu of fees (management of professional liability, bad investment decisions, disputes as to sharing and distributing investment gains); and mergers and acquisitions (increased capital expenditures, poor results, increased conflicts, decreased profitability). The coverage also includes misrepresentations to current or prospective partners/shareholders, business tort coverage (such as for claims of interference with contractual relations), and punitive damages where insurable by law.

The coverage usually excludes claims for bodily injury and employment discrimination, and claims arising out of the violation of responsibilities under benefit plans such as ERISA and COBRA. (These coverages are provided by other insurance policies.) However, the following are expressly excluded: claims brought by an insured acting in collusion with another insured (this exclusion applies if a committee member sues another committee member), claims arising out of fraudulent or criminal acts (exclusion only applies in the case of a final adjudication of fraud and defense costs are covered), claims arising out of illegal profit made by an insured (defense costs would be covered), claims arising out of an insured’s service to an entity other than the insured, claims arising out of a wrongful act in rendering or failing to perform professional services, claims arising out of an employment related wrongful act by an insured, or losses arising from claims out of a breach of an express written contract or agreement with an insured entity (defense costs could be insured).

While a dozen or so markets sell Private Company Management Liability Insurance, to date, only a handful of markets provide Management Liability for professional firms. The premiums and retentions depend on the firm’s size, loss history, partnership agreement, financials, number of attorneys, and limits. In addition, some markets combined Management Liability with EPLI under one aggregate limit.

Sound firm stewardship is flexible, altering the partnership’s course within the legal industry in response to competitive pressures and the economic realities. But while change may translate into greater opportunities for some, change may also foreclose opportunities for others. When the latter occurs, management is often held liable.

1   Laura Pearlman, "Risky Business: Lawyers on Corporate Client Boards," The American Lawyer, June 3, 2002.

From Chubb Executive Risk Promotional Material

Amy Fantini, "The Countdown," The American Lawyer, March 1, 2001.

See Evans v. Winston & Strawn, N.Y. Supreme, Index No. 104193/2001 (summary judgment granted for Winston & Strawn except for plaintiffs’ claim for their unpaid compensation from 2000, notice of appeal filed, modification denied, reargument denied, June 26, 2003).

5  "Former Partners Settle With Now-Defunct Firm," New York Law Journal, August 12, 2002.

6   Krysten Crawford, "Littler’s Labors," The Recorder, November 19, 2001.

Krysten Crawford, "A Marriage of Convenience," The American Lawyer, November 1, 2001.

David Grossbaum and Mark Wade, "Not Everything a Professional Does is Covered as Professional Services," PLUS Journal, November 1998.

From Chubb Executive Risk Promotional Material

10  T. Shawn Taylor, "Partners Put Law Firms in Labor Bind," Chicago Tribune, April 7, 2002.

11  Jeff Blumenthal, report on Rosenthal v. Chadbourne & Park, 277 A.D. 2d 1061; 249 A.D. 178; 672 N.Y.S. 2d 599; The Legal Intelligencer, January 4, 2000, extracted from Law.Com

12  Otis Bilodeau and Jennifer Meyes, "Pillsbury Winthrop’s War of Words," Legal Times, September 9, 2002; and Anthony Lin, "Jensen Drops Plan to Move to Latham," New York Law Journal, September 17, 2002.

13  Anthony Lin, "Ex-Pillsbury Winthrop Partner Sues Firm for $45M," New York Law Journal, October 9, 2002.

This article was originally published in the February 2003 PLUS Journal and is reprinted here with the permission of the Professional Liability Underwriting Society (PLUS). This article is intended to inform the reader of potential liability exposures for attorneys. This article reflects general principles only and does not render legal advice. Readers should consult legal, financial, insurance and other advisors if they have specific concerns. Neither the Los Angeles County Bar Association, Aon and its affiliates, the author, nor PLUS assumes any responsibility for how the information in this article is applied in practice or for the accuracy and completeness of the information. Reproduction without written permission is prohibited. This article is made available by Aon Direct Insurance Administrators, administrators of the LACBA Sponsored Aon Insurance Solutions Program, to LACBA members with the permission of PLUS.   www.aonsolutions.com

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