Should Your Partnership Agreement Require Mandatory, Binding Arbitration?

Many partner disputes are resolved informally through discussions with firm management. However, many firms do not have a formal internal grievance procedure for partnership-related matters. What happens when the dispute cannot be amicably resolved? Is litigation the sole solution? Will the parties find a mechanism in the firm's partnership agreement to resolve the dispute?

Few law firm partners refer to their partnership agreement with any frequency, for good reason: There is no billable hour credit for reading it and, more importantly, it does not directly impact on most partners' day-to-day professional and business operations. Fewer partners still are familiar with their partnership agreement's treatment of disputes that may arise among attorneys. Does the agreement call for mediation? Arbitration? Both? Neither?

It is believed that many, if not most, law firm partnership agreements contain some form of arbitration provision. Anecdotal evidence indicates that most require binding arbitration, not merely mediation or non-binding (i.e., appealable) arbitration. Moreover, as is true of many aspects of drafting partnership agreements, there is no universally accepted approach to drafting law firm arbitration provisions.

Benefits of Binding Arbitration

Is binding arbitration the best route for firms and their partners to resolve partner-partnership disputes? Mandatory, binding arbitration has several benefits. First, and foremost, it generally precludes current and former partners from suing their law firms (or vice versa) in court. The mere threat of negative publicity for the firm could otherwise cause it to reach settlement of, or concede entirely, sensitive matters at costs much greater than the merits of the case would otherwise suggest are appropriate. Binding arbitration proceedings can provide a measure of confidentiality not available in court cases; relevant documents submitted in arbitration are not a matter of public record.

Second, there is the generally accepted view that arbitration is less costly to all parties concerned than the cost of litigation. In general the procedural rules in an arbitration matter are not as technical as those applicable in court.

Third, the nature of the arbitration proceeding may be somewhat less adversarial than full-blown litigation, although those who have experienced law firm arbitrations will testify to the intensity of the proceedings, akin to all-out litigation.

In addition, the arbitrator selection process, which is typically described in the partnership agreement, should make it more likely that the trier(s) of fact and decision-maker(s) for the proceeding will have familiarity if not expertise with respect to law firm/partnership matters ' unlike many judges ' which may be beneficial to all concerned parties.

Finally, binding arbitration generally will be recognized by the courts as just that ' binding and non-appealable. It has been held that where the parties have agreed to submit their dispute to binding arbitration, an award that is not clearly in violation of public policy should be given effect. See, e.g., Weiss, et al. v. Carpenter, Brennett & Morrissey, et al., 143 N.J. 420, 444 (1996); Hackett v. Milbank, Tweed, Hadley & McCloy, 86 N.Y. 2d 146 (1995).

The perceived benefits of a mandatory arbitration provision may be somewhat illusory. Leslie Corwin, Executive Editor of LFPBR and co-author of the legal treatise Law Firm Partnership Agreements, earlier this year observed that the idea that mandatory arbitration will shield law firms from the embarrassment of legal actions is “a complete myth”; word of the controversy is “going to get out there.” Moreover, Mr. Corwin reportedly advises against arbitration clauses in partnership agreements, observing that arbitration no longer offers the benefits of a speedier, cheaper resolution, as proceedings have become bogged down in discovery and quasi-motion work that mirrors litigation. See Leigh Jones, “Arbitration and Firms: A Very Delicate Dance,” The National Law Journal, Vol. 30, No. 30, April 7, 2008, page 10.

Drafting Arbitration Provisions

Once the decision has been made to include an effective arbitration provision, a number of questions must be dealt with. Consider the following:

Should Mediation Be the First Step?

Some firms offer or require non-binding mediation as a preliminary dispute resolution mechanism. Mediation is an expedited proceeding to effectuate the voluntary resolution of a dispute between parties. Although it is non-binding, mediation assists the parties in identifying the actual facts (and, if different, as perceived by the parties), issues and possible solutions which may be suggested by a mediator. Mediation may bring a dose of reality to either or both sides, who (being lawyers themselves) may benefit from a third party's evaluation of their respective positions or potential outcomes should they proceed with the dispute.

Some partnership agreements require the parties to mediate as a condition precedent to the commencement of binding arbitration or a lawsuit. It has been observed that the few cases that have addressed the issue have enforced mediation provisions and not permitted actions unless the parties have participated in the contractually required mediation. Corwin and Ciampi, Law Firm Partnership Agreements, Section 3.05[1]. See, e.g., AMF v. Brunswick Corp., 621 F. Supp. 456, 459 (E.D. N.Y. 1985).

What Is the Scope of Mandatory Arbitration?

In general, the law firm will want to cover any claim or dispute arising out of or relating to any provision of the partnership agreement, including any rights, benefits or obligations arising in connection with or related to the partnership agreement, and any legal or equitable claim, in tort, in contract, at common law, or under any local, state or federal statute, including but not limited to, discrimination and employment claims, of a past or present partner or the partnership, which claim relates to the partnership or the activities of such past or present partners while engaged in partnership business or arises out of their relationship as current or former partners.

Is the Arbitration Intended to Be Mandatory and Binding?

If so, the provision should provide that such mandatory arbitration is the sole remedy for the resolution of such claim or dispute.

Where Will the Arbitration Be Held?

For a firm with a single office, the answer is that it should be held in the general vicinity of the office (and not 300 miles away). However, for multi-office firms, the question may become a strategic one: if the agreement requires arbitration to be held in the city in which the firm has its headquarters or lead management, there is implicit pressure on an opposing partner not resident in that city to wrap up the arbitration quickly or to settle the matter out before it even gets to that stage. If the arbitration is held in the area where the partner is located (but firm management or its counsel is not), the opposite may be true.

Who Should Be the Arbitrators?

From the law firm's viewpoint, the potential pool of arbitrators ideally may be partners or former partners of law firms based in the geographic area having a somewhat similar size, with each arbitrator having been a member of such a law firm for some minimum number of years prior to commencement of the arbitration.

The firm's objective would be to have an arbitrator who has some experience in law partnership operations (if not firm management) in the local area for several or many years, and thus is likely to have some personal experience and/or exposure to similarly situated firms and partners.

Some arbitration clauses provide that each party to the dispute is to select one arbitrator, and the two appointed arbitrators will mutually select a third arbitrator to chair the panel. See, e.g., Peterson, “Selection of a Panel,” New York Law Journal (May 5, 1994); Law Firm Partnership Agreements, supra, Section 3.05[2], at pages 3-48.

What Should Be the Rules of Engagement?

The partnership agreement may specify rules (such as the National Rules for the Resolution of Employment Disputes established by the American Arbitration Association) then in effect. This does not mean that the organization whose rules are being applied needs to be involved in any way in the arbitration.

What Is the Choice of Law Issues?

From the law firm's perspective, ideally the law of the state that is governing the partnership agreement itself would apply. This is more likely to result in more uniform interpretations of the partnership agreement by the arbitrators and hopefully the firm and its partners with respect to other disputes that may arise with other partners. From the partner's perspective, the law of the state in which his or her office is located may be preferable (or at least more familiar).

Do the Parties Want a Written Ruling?

Do the parties wish to have a written ruling from the arbitrators, stating their findings of fact and conclusions of law on which the ruling is based? If so, the cost of the arbitration will increase, but the clearer resolution as to the outcome may be well worth it.

What Is the Deadline for the Arbitrators to Issue Their Final Ruling?

It has been suggested that the ruling should be required to be issued by the arbitrators within a certain specified period of time after their final hearing and within a specified longer period of time after commencement of arbitration (so that the matter does not linger indefinitely and costs continue to be incurred).

Who Bears the Costs of the Arbitration?

In a law firm context, a partner may be able to afford his or her costs, but as a matter of fairness, rules affecting the awarding of fees or costs, depending upon the outcome of the arbitration ruling, may be appropriate.

Drafting the Proposed Arbitration Provisions

Once these issues have been identified and answers reached, careful and thorough drafting of the proposed arbitration provisions is crucial. As recently observed here, in several recent cases, partners have brought suit against their firms or former firms, and argued that provisions of their partnership agreements should be interpreted one way, while the firms have chosen to implement the provisions in other ways. See generally, Debra L. Raskin and Max Shoengold, “Ambiguity in Law Firm Partnership Agreements,” LFPBR, 914, No. 5 (June, 2008) Page 1.

It may be more difficult for a law firm to switch from a no arbitration to a mandatory arbitration provision than if its initial agreement had provided for arbitration. One long-established, reputable Chicago firm (Kirkland & Ellis) reportedly implemented mandatory arbitration for partners in 2007 (and followed this up with mandatory arbitration requirements for all employees in 2008). Firms that are considering adopting mandatory arbitration provisions may find that its attorneys perceive that the firm is materially changing their position or standing in the firm and attempting to eliminate rights that they might otherwise have (i.e., another “take-away” as the firm grows larger and less democratic, so to speak).

Conclusion

Mandatory, binding arbitration provisions that adequately deal with disputes among partners and partnerships may be beneficial, particularly from the firm's point of view. Many issues (including those described above) should be considered and resolved, before careful drafting can commence.

Sheldon I. Banoff, P.C., a member of this newsletter's Board of Editors, is a partner in the Chicago Office of Katten Muchin Rosenman LLP. His expertise includes general tax and partnership matters, and counseling professional firms. He can be reached at 312-902-5256 or [email protected].

Many partner disputes are resolved informally through discussions with firm management. However, many firms do not have a formal internal grievance procedure for partnership-related matters. What happens when the dispute cannot be amicably resolved? Is litigation the sole solution? Will the parties find a mechanism in the firm's partnership agreement to resolve the dispute?

Few law firm partners refer to their partnership agreement with any frequency, for good reason: There is no billable hour credit for reading it and, more importantly, it does not directly impact on most partners' day-to-day professional and business operations. Fewer partners still are familiar with their partnership agreement's treatment of disputes that may arise among attorneys. Does the agreement call for mediation? Arbitration? Both? Neither?

It is believed that many, if not most, law firm partnership agreements contain some form of arbitration provision. Anecdotal evidence indicates that most require binding arbitration, not merely mediation or non-binding (i.e., appealable) arbitration. Moreover, as is true of many aspects of drafting partnership agreements, there is no universally accepted approach to drafting law firm arbitration provisions.

Benefits of Binding Arbitration

Is binding arbitration the best route for firms and their partners to resolve partner-partnership disputes? Mandatory, binding arbitration has several benefits. First, and foremost, it generally precludes current and former partners from suing their law firms (or vice versa) in court. The mere threat of negative publicity for the firm could otherwise cause it to reach settlement of, or concede entirely, sensitive matters at costs much greater than the merits of the case would otherwise suggest are appropriate. Binding arbitration proceedings can provide a measure of confidentiality not available in court cases; relevant documents submitted in arbitration are not a matter of public record.

Second, there is the generally accepted view that arbitration is less costly to all parties concerned than the cost of litigation. In general the procedural rules in an arbitration matter are not as technical as those applicable in court.

Third, the nature of the arbitration proceeding may be somewhat less adversarial than full-blown litigation, although those who have experienced law firm arbitrations will testify to the intensity of the proceedings, akin to all-out litigation.

In addition, the arbitrator selection process, which is typically described in the partnership agreement, should make it more likely that the trier(s) of fact and decision-maker(s) for the proceeding will have familiarity if not expertise with respect to law firm/partnership matters ' unlike many judges ' which may be beneficial to all concerned parties.

Finally, binding arbitration generally will be recognized by the courts as just that ' binding and non-appealable. It has been held that where the parties have agreed to submit their dispute to binding arbitration, an award that is not clearly in violation of public policy should be given effect. See, e.g., Weiss, et al. v. Carpenter, Brennett & Morrissey, et al., 143 N.J. 420, 444 (1996); Hackett v. Milbank, Tweed, Hadley & McCloy , 86 N.Y. 2d 146 (1995).

The perceived benefits of a mandatory arbitration provision may be somewhat illusory. Leslie Corwin, Executive Editor of LFPBR and co-author of the legal treatise Law Firm Partnership Agreements, earlier this year observed that the idea that mandatory arbitration will shield law firms from the embarrassment of legal actions is “a complete myth”; word of the controversy is “going to get out there.” Moreover, Mr. Corwin reportedly advises against arbitration clauses in partnership agreements, observing that arbitration no longer offers the benefits of a speedier, cheaper resolution, as proceedings have become bogged down in discovery and quasi-motion work that mirrors litigation. See Leigh Jones, “Arbitration and Firms: A Very Delicate Dance,” The National Law Journal, Vol. 30, No. 30, April 7, 2008, page 10.

Drafting Arbitration Provisions

Once the decision has been made to include an effective arbitration provision, a number of questions must be dealt with. Consider the following:

Should Mediation Be the First Step?

Some firms offer or require non-binding mediation as a preliminary dispute resolution mechanism. Mediation is an expedited proceeding to effectuate the voluntary resolution of a dispute between parties. Although it is non-binding, mediation assists the parties in identifying the actual facts (and, if different, as perceived by the parties), issues and possible solutions which may be suggested by a mediator. Mediation may bring a dose of reality to either or both sides, who (being lawyers themselves) may benefit from a third party's evaluation of their respective positions or potential outcomes should they proceed with the dispute.

Some partnership agreements require the parties to mediate as a condition precedent to the commencement of binding arbitration or a lawsuit. It has been observed that the few cases that have addressed the issue have enforced mediation provisions and not permitted actions unless the parties have participated in the contractually required mediation. Corwin and Ciampi, Law Firm Partnership Agreements, Section 3.05[1]. See, e.g., AMF v. Brunswick Corp. , 621 F. Supp. 456, 459 (E.D. N.Y. 1985).

What Is the Scope of Mandatory Arbitration?

In general, the law firm will want to cover any claim or dispute arising out of or relating to any provision of the partnership agreement, including any rights, benefits or obligations arising in connection with or related to the partnership agreement, and any legal or equitable claim, in tort, in contract, at common law, or under any local, state or federal statute, including but not limited to, discrimination and employment claims, of a past or present partner or the partnership, which claim relates to the partnership or the activities of such past or present partners while engaged in partnership business or arises out of their relationship as current or former partners.

Is the Arbitration Intended to Be Mandatory and Binding?

If so, the provision should provide that such mandatory arbitration is the sole remedy for the resolution of such claim or dispute.

Where Will the Arbitration Be Held?

For a firm with a single office, the answer is that it should be held in the general vicinity of the office (and not 300 miles away). However, for multi-office firms, the question may become a strategic one: if the agreement requires arbitration to be held in the city in which the firm has its headquarters or lead management, there is implicit pressure on an opposing partner not resident in that city to wrap up the arbitration quickly or to settle the matter out before it even gets to that stage. If the arbitration is held in the area where the partner is located (but firm management or its counsel is not), the opposite may be true.

Who Should Be the Arbitrators?

From the law firm's viewpoint, the potential pool of arbitrators ideally may be partners or former partners of law firms based in the geographic area having a somewhat similar size, with each arbitrator having been a member of such a law firm for some minimum number of years prior to commencement of the arbitration.

The firm's objective would be to have an arbitrator who has some experience in law partnership operations (if not firm management) in the local area for several or many years, and thus is likely to have some personal experience and/or exposure to similarly situated firms and partners.

Some arbitration clauses provide that each party to the dispute is to select one arbitrator, and the two appointed arbitrators will mutually select a third arbitrator to chair the panel. See, e.g., Peterson, “Selection of a Panel,” New York Law Journal (May 5, 1994); Law Firm Partnership Agreements, supra, Section 3.05[2], at pages 3-48.

What Should Be the Rules of Engagement?

The partnership agreement may specify rules (such as the National Rules for the Resolution of Employment Disputes established by the American Arbitration Association) then in effect. This does not mean that the organization whose rules are being applied needs to be involved in any way in the arbitration.

What Is the Choice of Law Issues?

From the law firm's perspective, ideally the law of the state that is governing the partnership agreement itself would apply. This is more likely to result in more uniform interpretations of the partnership agreement by the arbitrators and hopefully the firm and its partners with respect to other disputes that may arise with other partners. From the partner's perspective, the law of the state in which his or her office is located may be preferable (or at least more familiar).

Do the Parties Want a Written Ruling?

Do the parties wish to have a written ruling from the arbitrators, stating their findings of fact and conclusions of law on which the ruling is based? If so, the cost of the arbitration will increase, but the clearer resolution as to the outcome may be well worth it.

What Is the Deadline for the Arbitrators to Issue Their Final Ruling?

It has been suggested that the ruling should be required to be issued by the arbitrators within a certain specified period of time after their final hearing and within a specified longer period of time after commencement of arbitration (so that the matter does not linger indefinitely and costs continue to be incurred).

Who Bears the Costs of the Arbitration?

In a law firm context, a partner may be able to afford his or her costs, but as a matter of fairness, rules affecting the awarding of fees or costs, depending upon the outcome of the arbitration ruling, may be appropriate.

Drafting the Proposed Arbitration Provisions

Once these issues have been identified and answers reached, careful and thorough drafting of the proposed arbitration provisions is crucial. As recently observed here, in several recent cases, partners have brought suit against their firms or former firms, and argued that provisions of their partnership agreements should be interpreted one way, while the firms have chosen to implement the provisions in other ways. See generally, Debra L. Raskin and Max Shoengold, “Ambiguity in Law Firm Partnership Agreements,” LFPBR, 914, No. 5 (June, 2008) Page 1.

It may be more difficult for a law firm to switch from a no arbitration to a mandatory arbitration provision than if its initial agreement had provided for arbitration. One long-established, reputable Chicago firm (Kirkland & Ellis) reportedly implemented mandatory arbitration for partners in 2007 (and followed this up with mandatory arbitration requirements for all employees in 2008). Firms that are considering adopting mandatory arbitration provisions may find that its attorneys perceive that the firm is materially changing their position or standing in the firm and attempting to eliminate rights that they might otherwise have (i.e., another “take-away” as the firm grows larger and less democratic, so to speak).

Conclusion

Mandatory, binding arbitration provisions that adequately deal with disputes among partners and partnerships may be beneficial, particularly from the firm's point of view. Many issues (including those described above) should be considered and resolved, before careful drafting can commence.

Sheldon I. Banoff, P.C., a member of this newsletter's Board of Editors, is a partner in the Chicago Office of Katten Muchin Rosenman LLP. His expertise includes general tax and partnership matters, and counseling professional firms. He can be reached at 312-902-5256 or [email protected].