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Preparing for Death and Disability of a Law Partner or Shareholder

 By Rachel Blumenfeld

Historically, lawyers carrying on business together have done so through a partnership, often through a limited liability partnership (LLP). Increasingly, due to legislative changes [1], lawyers may now hold their partnership interests through professional corporations. In addition, smaller firms may be structured as professional corporations.

Where lawyers practise law together, either in a partnership or through a corporation, consideration should be given as to what will happen in the event that a lawyer retires, becomes disabled or dies. Both the law firm and each legal practitioner practising in the law firm should prepare for such events.
 
As in any business with multiple owners, problems can arise where a lawyer who is a partner or shareholder in a law firm retires, becomes disabled or dies. In order to minimize the disruption that such events may cause to the business, the partnership or shareholders agreement governing a law firm should specifically contemplate what would happen upon the occurrence of such events.

  1. Considerations for Partnerships and Partnership Agreements

An established law firm will typically have a comprehensive agreement that contemplates the retirement, disability or death of a partner. However, smaller or newly formed firms may not have an agreement in place.
 
A partnership agreement should contain specific provisions to address what happens when a partner becomes disabled or dies. First, a partnership agreement will typically provide that a partner will cease to be a partner upon disability or death, and that the personal representative of the partner be treated as a retired partner for certain purposes. For example, the agreement may include the following:
 

Upon the disability or death of a partner, that partner shall cease to be a partner and the provisions in this Agreement that apply to retired partners shall apply, mutatis mutandis, to the legal personal representative of the deceased partner.

 
Further, upon the death or disability of a partner, a partnership agreement will typically provide that the units held by the partner will be cancelled and the legal representative has no say in the conduct of the affairs of the partnership. A partnership agreement that governs partners that are professional corporations should contain a provision that deems references to the death or disability of a partner to be references to an approved shareholder where the partner is a professional corporation. For example, the agreement may include the following:
 

The references to retirement, death or disability of a partner in this Agreement shall be deemed to be references to the shareholder where the partner is a professional corporation and, for greater certainty, upon the death of a shareholder, the professional corporation of which he or she is a shareholder shall cease to be a partner.
 

The partnership agreement should define what the term “disability” encompasses; for example, a partner might be considered “disabled” if the partner is unable to engage, in any material respect, in the full-time practice of law. Further, the agreement could grant a particular partner or committee of partners (the firm’s executive committee) the power, authority and discretion to determine whether a particular partner is disabled for purposes of the agreement. The agreement could also provide for a particular period of time during which a partner can be away from work because of a disability without being forced to withdraw from the partnership.
 
The partnership agreement should set out the timing of the repayment of the partner’s capital account, as well as any other accounts (e.g., the partner’s interest in unbilled disbursements and WIP), and the partner’s pro rata interest on his or her capital account. Where life insurance proceeds are available to the partnership, the agreement may stipulate that such payments are accelerated (compared to the schedule of payments on the retirement or expulsion of a partner). The agreement could provide that the firm pay such partner, or his or her estate, in a lump sum or in annual or more frequent instalments, over a specified period of time, the partner’s partnership interest multiplied by the value of the firm’s work-in-progress at the end of the month preceding the death of the partner [2].
 
In addition, the agreement could include a clause that either requires each partner to obtain and maintain disability insurance and/or life insurance, or expressly states that obtaining and maintaining such insurance is the sole responsibility of each individual partner. In smaller partnerships, it may be prudent for the partners to hold term life (and/or disability) insurance policies on each other in order to have a source of funds to pay out the capital account of a deceased (or disabled) partner.
 
If life insurance proceeds are available to the partners or the partnership, the agreement may provide that a payment to a partner’s estate as a result of the partner’s death may be made as, when, and to the extent of the amount of, life insurance proceeds received by the partnership as a result of the death of a partner.
 
It would be prudent for the agreement to contain a general limitation on payments that would prevent the partnership from being required to pay an amount that exceeds a certain percentage of the net profit of the partnership for the year, notwithstanding the other provisions of the agreement. This would ensure the continued viability of the firm despite the disability or death of one of its partners.
 
The partnership agreement would also typically deal with the continued use of the name of a deceased partner and may include an indemnity for the estate of the deceased partner for liability resulting from the continued use of the partner’s name.
  1. Considerations for Professional Corporations

As noted above, lawyers in Ontario are now permitted to practise law through a professional corporation. Where a law firm is organized as a professional corporation under the OBCA and Law Society Act, the shareholders should enter into a shareholders agreement to govern their relationship. The shareholders agreement should contain provisions that are substantially similar to those described above, adjusting for the inherent differences between a partnership and a corporation.

If the deceased or disabled lawyer had a shareholder loan account, the agreement should set out the terms of payment of the loan; as with a partnership, for a smaller corporation, life insurance policies held by the corporation may be a practical solution to ensuring funds are available to pay out the loan.
 
Where a law firm carries on business as a professional corporation with more than one shareholder, the shareholders agreement should also address what should happen to the shares of an individual who retires, becomes disabled or dies. In particular, the agreement should address whether the individual’s shares should be redeemed or purchased for cancellation and, if so, how those shares should be valued.
 
If the shares were acquired by the individual for nominal consideration, a redemption of the individual’s shares may occur for nominal consideration, whereas if the shares were acquired by the individual for value, the agreement may provide that the individual’s shares be redeemed for value.
 
In addition, a professional corporation must comply with the provisions of applicable legislation i.e., the Law Society Act, and applicable Bylaws [3], and the OBCA. The OBCA provides that a corporation does not cease to be a professional corporation despite the death of a shareholder [4].

  1. Considerations for the Practitioner Practising through a Professional Corporation

It is becoming more common for lawyers to incorporate a professional corporation that becomes the partner in the law firm. The individual lawyer practising through a professional corporation or as a shareholder in a firm (i.e., not as an employee) must also prepare for death and disability.

The OBCA requires that all of the issued and outstanding shares of a professional corporation formed under the Law Society Act be legally and beneficially held, directly or indirectly, by one or more members of the same profession, and that all of the officers and directors of the corporation be shareholders of the corporation [5]. The OBCA further provides that the name of a professional corporation must include the words “Professional Corporation” or the French equivalent, and must carry on a business related to the particular profession (in the case of a lawyer, the practice of law).
 
Bylaw 7 of the Law Society of Ontario provides that a professional corporation must apply for permission to surrender its certificate of authorization when, inter alia, the corporation does not wish to renew the certificate or will no longer practise law in Ontario [6]. The corporation is also generally required to publish a notice of its intention to surrender its certificate of authorization and to retain proof of such publication.
 
Accordingly, an individual who practises law through a professional corporation should include a provision in his or her Will that provides that the shares of his or her professional corporation will be held and dealt with by a special trustee who is a lawyer in Ontario. This can be accomplished by having a separate Will that deals only with the shares of the testator’s law corporation (and any debt owing to him or her by the corporation).

Further, provisions of the practitioner’s Will with respect to the law practice should expressly direct the estate trustees to abide by any laws, rules, regulations and restrictions imposed by the Law Society of Ontario. For example, the Will may include the following:

In the event that my Trustees are dealing with my law practice and my shares of ABC LAW PROFESSIONAL CORPORATION, I direct my Trustees to abide by any laws, rules, regulations and restrictions imposed by the Business Corporations Act (Ontario), the Law Society Act (Ontario) and the Bylaws of the Law Society of Ontario.
 

Where the deceased practitioner is not the sole shareholder of the corporation, a shareholders agreement should be in place that dictates the manner in which the deceased shareholder’s interest in the firm can be extracted, as described above with respect to a partnership interest.

Where the deceased practitioner is the sole shareholder of the corporation and he or she has a separate Will dealing with the law practice and naming another lawyer as estate trustee, or the Will of the deceased practitioner provides that the shares of his or her corporation be held and dealt with by a special trustee, the estate trustee or special trustee can appoint himself or herself as the director of the corporation. Depending on the circumstances and any specific direction in the deceased practitioner's Will, the estate trustee or special trustee will then have two choices:

  1. The estate trustee or special trustee of the deceased practitioner may have the shares of the professional corporation valued and may arrange for the sale of the shares to a lawyer licensed to practise law in Ontario. The purchasing lawyer would then appoint himself or herself as the director of the corporation, change the corporate name to reflect the purchasing lawyer's name, notify the Law Society of the sale as required by section 11 of By-Law 7, and continue the law practice. The proceeds of sale of the shares would be distributed in accordance with the deceased practitioner's Will.

  2. Alternatively, the estate trustee or special trustee of the deceased practitioner could cause the professional corporation to surrender its certificate of authorization. Pursuant to section 10 of By-Law 7, a professional corporation must apply for permission to surrender its certificate of authorization when, inter alia, the corporation does not wish to renew the certificate or will no longer practise law in Ontario. The corporation is also generally required to publish a notice of its intention to surrender its certificate of authorization and to retain proof of such publication. The Law Society will grant the application if it is satisfied that certain matters related to the protection of clients' interests have been dealt with. Once the certificate of authorization has been surrendered, the estate trustee or special trustee, as director, can file for a change of the corporation’s name to delete references to legal practice and enable the corporation to continue as a holding corporation. Once the corporation ceases to be a professional corporation and, if necessary, its name has been changed, the shares of the corporation can either remain with the special trustee or be transferred to the general trustee(s) of the estate to be dealt with as ordinary shares of a private holding corporation.

Summary

A partnership agreement should contain specific provisions to address what happens when a partner becomes disabled or dies. For example, the agreement may provide that:

  • A partner will cease to be a partner upon disability or death, and the legal representative of the partner will be treated as a retired partner for certain purposes;
  • The units held by a disabled or deceased partner will be cancelled;
  • References to the death or disability of a partner are be deemed to be references to an approved shareholder where the partner is a professional corporation;
  • A partner will be deemed to be disabled in certain circumstances;
  • The partner’s capital account and other accounts will be paid to the personal representative of the partner in a certain manner;
  • The repayment of a partner’s accounts and interest will be accelerated;
  • Each partner will be required to maintain disability insurance and/or life insurance;
  • In smaller partnerships, partners may hold life/disability insurance policies on each other;
  • Payments of amounts exceeding a certain percentage of the net profit of the partnership for the year are prohibited; and
  • The use of the name of a deceased partner is permitted.
 

Where a firm operates as a professional corporation, a shareholders agreement should contain substantially similar provisions to the ones described above.

An individual lawyer practising as a professional corporation or as a shareholder in a firm must also prepare for death and disability. In particular:

  • The practitioner should consider having a separate Will prepared that deals with his or her shares of the law corporation, appointing a lawyer in Ontario as the estate trustee. At the very least, the practitioner’s Will should provide that the shares of the corporation will be held and dealt with by a special trustee who is a lawyer in Ontario; and
  •  The estate trustee or special trustee can appoint himself or herself as the director of the corporation in order to either sell the law practice to a lawyer practising in Ontario who could apply for a certificate authorizing the corporation as a Professional Corporation, or apply to surrender the certificate of authorization of the corporation and, if necessary, file for a change of the corporation’s name to exclude references to legal practice and enable the corporation to continue as a holding corporation. The corporation could then continue as a holding company.

1    Lawyers in Ontario have been permitted to practise through professional corporations since 2006. (See sections 3.1 and 3.2 of the Business Corporations Act (Ontario), R.S.O. 1990, ch. B.16, as amended (“OBCA”), and ss. 61.0.1.- 61.0.9 of the Law Society Act (Ontario), R.S.O. 1990, ch. L.8, as amended (“Law Society Act”).
2    The partners should obtain advice from an accountant or valuator.
3    See Part II of Bylaw 7 
4    Subsection 3.3(1).
5    Subsection 3.2(2).
6    Section 10.

Created on: October 2014
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