Can a law firm's stock-repurchase agreement reduce a departing lawyer's buyout based on the clients he keeps?

Plain-English summary

A law firm requires shareholders to sign an agreement under which the firm repurchases a departing shareholder's shares. If the departing lawyer takes clients with him, a formula reduces the repurchase price by 125% of the work in process those clients generated in the prior twelve months, for clients the lawyer continues to serve in the following twelve months, but never below zero. On the facts, a lawyer whose stock is worth $20,000 and who continues to represent clients generating more revenue than that ends up with a repurchase obligation of zero. The question is whether the provision violates the Rules of Professional Conduct.

The opinion concludes yes, it violates Rule 5.6(a), which bars a lawyer from offering or making a partnership, shareholder, employment, or similar agreement that restricts the right to practice after the relationship ends, except an agreement about retirement benefits. The opinion explains that Rule 5.6 protects two principles: the client's right to counsel of choice and lawyer mobility. Although this clause is not a typical covenant not to compete (it has no geographic or time limit), it ties the drop in share value to the departing lawyer's continued representation of former firm clients. By doing so it discourages the lawyer from representing clients with whom he has a prior relationship, penalizes him for representing former firm clients, and restricts his right to practice. The opinion adds that the provision does not appear to measure the actual devaluation of the lawyer's shares caused by his departure.

The opinion does not bar every departure-sensitive buyout. Rule 5.6(a) does not prohibit a repurchase provision that takes the financial effect of a lawyer's departure into account, but the provision must use a more refined approach to valuing the loss. A clause that accounts for economic factors affecting share value, such as long-term commitments to staff, space, and equipment leases the firm made in reliance on the departing lawyer's continued contribution, may be acceptable. To the extent a provision fairly assesses the forecasted devaluation in firm ownership caused by the departure and does not penalize the lawyer for taking clients, it might not violate Rule 5.6(a).

In practice

Under the North Carolina rule as it stood at the time of the opinion, the analysis turns on whether the buyout clause penalizes the lawyer for keeping clients or instead fairly measures the financial effect of the departure. The opinion holds that a clause keyed to the revenue from former firm clients the departing lawyer continues to represent violates Rule 5.6(a) because it operates as a disincentive to that representation and restricts practice.

Per the opinion, a repurchase provision that accounts for the firm's forecasted loss of value (for example, long-term staff, space, and equipment commitments made in reliance on the lawyer's continued contribution) and does not penalize the lawyer for taking clients may fall outside Rule 5.6(a).

Common questions

Q: Can a firm's buyout agreement reduce a departing lawyer's payout based on the clients he takes?

A: No. The opinion concludes a clause that cuts the repurchase price in proportion to revenue from former firm clients the lawyer keeps violates Rule 5.6(a), because it penalizes the lawyer for taking clients and restricts the right to practice.

Q: Does it matter that the clause has no geographic or time limit like a typical noncompete?

A: No. The opinion concludes that even without geographic or temporal restrictions, tying the loss of share value to the departing lawyer's representation of former firm clients restricts the right to practice and violates Rule 5.6(a).

Q: Can a firm agreement ever account for the financial effect of a lawyer leaving?

A: Yes. The opinion concludes Rule 5.6(a) does not prohibit a repurchase provision that fairly measures the firm's forecasted devaluation from the departure, such as long-term staff, lease, and equipment commitments, as long as it does not penalize the lawyer for taking clients.

Background and rules framework

The opinion applies North Carolina Rule 5.6(a), which tracks Model Rule 5.6(a), prohibiting a lawyer from offering or making a partnership, shareholder, employment, or similar agreement that restricts the right to practice after termination, except an agreement concerning retirement benefits. The opinion identifies the two principles the rule protects: a client's right to counsel of choice and lawyer mobility. It distinguishes a clause that penalizes a lawyer for keeping clients from one that fairly values the firm's loss on departure.

Citations and references

Rules of Professional Conduct:

• MR 5.6 / NC Rule 5.6(a) (a lawyer shall not make an agreement restricting the right to practice after termination, except as to retirement benefits)

Other opinions cited:

• NC 2001 FEO 10: an employment agreement whose purpose was to discourage competitive activity was unethical.

See also

• NC 2001 FEO 10: Restrictions on Right to Practice
• ABA Formal Op. 06-444: Restrictive Covenants and Retirement Benefits
• ABA Formal Op. 94-381: Restrictions on the Right to Practice

Source

• Landing page: https://www.ncbar.gov/for-lawyers/ethics-and-governing-rules/ethics-opinions/opinions/2007-formal-ethics-opinion-6/

Original opinion text

Reproduced from the official source for research purposes. The linked source is authoritative.

Inquiry:

Law Firm requires all its shareholders to sign an agreement providing for the purchase of shares by incoming shareholders and the repurchase of those shares by the firm upon each shareholder's departure. Attorney A, a shareholder at Law Firm, is leaving to join another firm. A number of clients have elected to have Attorney A continue their representation after he leaves the firm.

Pursuant to the agreement, in the event a departing shareholder takes clients with him, the repurchase obligation of Law Firm is reduced according to the following formula:

The purchase price shall be reduced...by an amount equal to one hundred twenty-five Percent (125%) of the work in process generated by employees of the corporation during the twelve (12) months preceding the event requiring or permitting the stock purchase on behalf of clients of the corporation for whom the shareholder or law firm with whom the shareholder is or becomes associated, performs legal services during the twelve (12) month period following the event requiring or permitting the stock purchase...

In no event does the stock purchase price become reduced below zero.

Assume that the value of Attorney A's stock is $20,000. After leaving Law Firm, Attorney A will continue to represent clients who have traditionally generated more firm revenue than the value of Attorney A's stock. Therefore, Law Firm's repurchase obligation to Attorney A under the circumstances is zero.

Does the above provision violate the Rules of Professional Conduct?

Opinion:

Yes. Rule 5.6(a) of the Rules of Professional Conduct reads as follows:

A lawyer shall not participate in offering or making:

(a) a partnership, shareholders, operating, employment, or other similar type of agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement;

Rule 5.6 protects two important ethical principles: the right of clients to legal counsel of their choice and lawyer mobility. Although this provision is not like a typical covenant not to compete in that it does not have geographical or temporal restrictions, it does tie the decrease in share value to the fact that the departed lawyer represents former clients of the firm. By so doing, the provision provides a disincentive for the departing lawyer to represent clients with whom the lawyer has a prior relationship, penalizes the departing lawyer for representing former clients of the firm, and restricts the lawyer's right to practice. Moreover, the provision does not appear to measure the devaluation of the lawyer's shares in the firm due to the lawyer's departure. If a provision in a firm agreement penalizes a lawyer for taking clients, will dissuade a lawyer from continuing to represent firm clients after his departure, or does not otherwise fairly represent the devaluation of ownership interest in the firm engendered by the lawyer's departure, it violates Rule 5.6(a). See e.g., 2001 FEO 10 (purpose of employment agreement was to discourage competitive activity and was, therefore, unethical).

Nevertheless, Rule 5.6(a) does not prohibit a repurchase provision in a firm agreement that takes into account the financial effect of a lawyer's departure from a firm. However, the provision must include a more refined approach for evaluating the loss of value due to the lawyer's departure. For example, a provision that takes into account various economic factors that affect the value of the firm's shares, such as long-term financial commitments to staff and for space and equipment leases originally made by the firm in reliance upon the departing lawyer's continued contribution to the firm, may be acceptable under the rule. To the extent that a contractual provision represents a fair assessment of the forecasted devaluation in the ownership interest in the firm engendered by a lawyer's departure and does not penalize the lawyer for taking clients with him, the provision might not violate Rule 5.6(a).