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Illinois Bar Journal

The Magazine of Illinois Lawyers

January 2011Volume 99Number 1Page 20

January 2011 Illinois Bar Journal Cover Image

Law Practice Management

Selling Out

By
Helen W. Gunnarsson

Illinois' ethics rules have accommodated sale of a law practice for a few years now, and the 2010 RPC make it even easier. But there are practical issues beyond the ethical ones, like valuation and transition planning. What to do? Two veteran lawyers share their wisdom.

Ever considered becoming a sellout?

No, not that kind of a sellout. The IBJ would never suggest that you abandon your principles.

But what about selling your law practice?

At ISBA's 2010 Solo and Small Firm Conference, held in October in Springfield, Champaign lawyer John Phipps defined a law practice as follows: "It is a combination of your physical assets, your location, your name, your goodwill, your files, your expected repeat business, the work in process that you have that someone can finish." To those components you may be able to add the expertise of staff members who would remain employed after your departure.

Though owners of businesses routinely sell them when they're ready to retire, a law practice differs from other businesses in that it's also a profession. Unlike a business of, say, widget servicing or manufacturing, the business of law is based on the lawyer-client relationship, which is typically highly personal, and governed by the lawyer's ethical duties toward clients, who, of course, are not commodities and cannot be bought or sold.

And, unlike a medical or accounting practice, "The client is buying you," one audience member said. "The lawyer is the connection to the client."

Improved Rule 1.17

Until 2005, Illinois's Rules of Professional Conduct didn't address whether lawyers might realize some value from their law practice upon retirement or death. Some lawyers did buy and sell practices, of course, but often did so with a degree of uncertainty about whether they were fully satisfying their ethical obligations toward their clients, whether it was ethically permissible to pay or accept money for the goodwill of a law practice, and whether a lawyer's estate might sell the law practice.

In 2005, the Illinois Supreme Court eliminated that uncertainty by adopting RPC 1.17, which permits the sale of a law practice by either a lawyer or a lawyer's estate under certain conditions. As part of its adoption of the Rules of Professional Conduct of 2010, the court modified the rule. It now provides as follows:

RULE 1.17: SALE OF LAW PRACTICE

A lawyer or a law firm may sell or purchase, and the estate of a deceased lawyer or the guardian or authorized representative of a disabled lawyer may sell, a law practice, including good will, if the following conditions are satisfied:

(a) The seller ceases to engage in the private practice of law in the geographic area in which the practice has been conducted;

(b) The entire practice is sold to one or more lawyers or law firms;

(c) The seller gives written notice to each of the seller's clients regarding:

(1) the proposed sale;

(2) the client's right to retain other counsel or to take possession of the file; and

(3) the fact that the client's consent to the transfer of the client's files will be presumed if the client does not take any action or does not otherwise object within ninety (90) days of receipt of the notice.

If a client cannot be given notice, the representation of that client may be transferred to the purchaser only upon entry of an order so authorizing by a court having jurisdiction. The seller may disclose to the court in camera information relating to the representation only to the extent necessary to obtain an order authorizing the transfer of a file.

(d) The fees charged clients shall not be increased by reason of the sale.

The current incarnation of RPC 1.17 has simplified and clarified the 2005 version. No longer does the rule enumerate permissible reasons for ceasing to engage in the private practice of law. The current version of the rule also clarifies that lawyers may continue to practice law in a different geographic area, even within the state of Illinois, after selling their law practices.

And, though lawyers must still give their clients written notice of the proposed sale, the rule no longer requires the notice to be sent by certified mail, nor does it require at least 90 days' notice to the clients. The 2010 rule also includes an official comment in 15 numbered paragraphs.

"You could become a solo overnight"

Phipps and Belvidere lawyer John Maville, who presented "Winding Down Your Law Practice/Sale of Practice," provided helpful advice and commentary at and after the conference, including useful checklists and forms in their materials, for lawyers interested in availing themselves of RPC 1.17's provisions. (Missed the conference? No worries: you can still view that and other presentations and download the materials by visiting isba.fastcle.com.)

In addition to complying with the rule's requirements, planning and organization are essential, Phipps and Maville said, for lawyers to be able to realize value from a law practice by selling it when they decide to retire. "In my opinion," said Maville, "the value of your practice is tied almost exclusively to how well organized it is. If you expect to sell your practice and get some value, you had better be organized."

Leading into their discussion, Phipps and Maville asked lawyers in the audience to consider what would happen to their practices tomorrow if something happened to them tonight.

"Chaos," called out one lawyer.

The question might not concern young, healthy partners in two- or three-person law firms as much as it does solo practitioners. Phipps suggested that those lawyers should think again: "You could become a solo practitioner overnight."

To illustrate Phipps's point, Maville recounted his experience on June 10, 2009. On that day, he said, he got up in the morning and felt the same as usual. He attended meetings and a scheduled court appearance before going to what he assumed would be a routine CAT scan at 2 pm for some discomfort he'd been experiencing in his abdomen. "I had a real estate closing at 4, so I took the file along with me."

The procedure took longer than he'd expected, so, around 3:30, Maville gave his file to his wife and told her that one of his associates would need to cover the closing. An hour and a half later, he was in surgery: the scan had revealed a ruptured appendix.

"I'm grateful to have survived," Maville said. "I had no idea that was going to happen that day."

His practice, Maville said, was largely unaffected by his temporary disability as a result of procedures he'd instituted long ago and followed religiously to ensure that anyone could pick up one of his files and see at a glance what needed to be done next. But just as the cobbler's children notoriously went unshod, so, too, many lawyers neglect to plan for their own death, disability, or retirement, or for the more pleasant possibilities of accepting positions as full-time in-house or government counsel or appointments to the bench.

The results of a lawyer's failure to plan for these events include not only the transformation of a difficult experience for the lawyer's clients, associates, and heirs into a horrendous one, but also the probability that neither the lawyer nor the lawyer's estate will be able to realize any value from even a thriving and profitable law practice. (For more on succession planning, see John Cesario's article on page 46)

Client consent

Organization and planning for the eventual sale of a law practice under RPC 1.17 can and should begin as early as, or even before, the engagement agreement for each new client, Phipps and Maville said. Both recommended incorporating client consents to permitting another attorney to work on their files and review confidential information in case of the retained lawyer's unavailability, illness, retirement, death, or disability. Though the rule still requires the lawyer to give clients notice of the actual sale once it's been arranged, the consent in the retainer agreement will enable lawyers to protect their clients' matters during the transition period between the retained lawyer's ceasing to practice and the start of work by the successor lawyer, whether the lawyer who purchases the practice under RPC 1.17 or some other lawyer is chosen by the clients. "You can transfer cases with consent right away and people can start working on them, even though you have other matters to conclude," said Maville.

Phipps said his clients uniformly appreciate these arrangements. "Go through these provisions and talk to your client. Explain that you're gone from time to time and you've made arrangements to have somebody cover the client's matter if you're gone or something happens to you." Clients feel better when they understand that they're signing an agreement with provisions that protect them, Phipps says.

In the course of that conversation, "If you have someone in mind, tell them who it is. If you get some negative feedback, talk about that, and get someone else." Phipps and Maville recommend against designating a particular lawyer in the consent, however. After all, that lawyer's circumstances, or your relationship with that lawyer, might change.

Identifying one or more lawyers who have agreed to cover your cases for you is an advisable step even before that conversation. Choose those lawyers with care, Phipps and Maville said, for they may, when the time comes, not only handle your clients' matters on a temporary, transitional basis but also be potential buyers of your practice. You should also, they said, execute a power of attorney and, if applicable, an appropriate corporate contingency plan designating a lawyer or other individual to sign checks and handle other office and corporate administrative matters.

The body of RPC 1.17 does not speak of any duty of care on the part of selling lawyers in the selection of buyers for a law practice. Paragraph 11 of the rule's official comment, however, provides in part "Lawyers participating in the sale of a law practice are subject to the ethi­cal standards applicable to involving another lawyer in the representation of a client. These include, for example, the seller's obligation to exercise competence in identifying a purchaser qualified to assume the practice…." Prompted by this provision, the lawyers suggested identifying lawyers who should not be considered as potential buyers of the practice as well as those who should.

"[W]hat a willing buyer and a willing seller agree to"

Toward facilitating transitional handling of the law practice's work as well as its sale, Phipps and Maville emphasized the need for a clear organizational system. Phipps said his office uses a case management system and a general ledger and accounting system that integrate and keep track of all client matters, contacts, tasks to do, deadlines, billing, and other information. Were he to consider selling his practice, Phipps said he could easily provide a potential buyer with documentation of receipts, profits, and expected fees from future work to be done on existing matters. Moreover, the case management system would enable any lawyer to immediately identify all pending matters and ascertain their status.

Though Maville doesn't dispute the value of an electronic case management system, he said his office's system is still based on old-fashioned paper. "I have spent a lot of time making sure that if you open up a file in my office, the file itself tells you what the next step is. I put notes in the files saying we're following up for this date and the purpose of the follow-up is to do this. I do memos to the file. I do this on a regular basis. We have a follow-up system. We have forms. We have checklists."

Because of his own paper case management system, Maville says, "I'm fond of saying that if someone were to walk into my office tomorrow morning who had no knowledge of my practice at all and no prior experience in it, I believe that person could pick it up and do what they'd need to do to handle the cases that I have in my office at that time." For lawyers interested in one day realizing some value from their practices, "If you don't have that, I believe you have decreased the value of your practice hugely."

Figuring out that value for the purpose of a sale, though, is a difficult task with no clear standards, the lawyers agreed. (See sidebar on page 23 for a more detailed article on valuation.) Phipps said accountants have used several methods for valuing a law practice, including book value, fair market value, the income/cash flow method, and the excess earnings approach. Observing that RPC 1.17 is so recent that not many lawyers have yet used its provisions, he said he's aware of sales ranging from three-quarters of a year's net profits to twice that.

But Phipps warned that law practices are so distinct and often so personal that it may not be possible to identify clear rules for their valuation. The expected annual earnings from a collections practice with clients who are almost certain to transfer their business to the buying lawyer, for example, may be relatively easy to project, he said. The expected annual earnings from a personal injury practice, however, may be far more difficult to predict. Unhelpful as he acknowledged it may seem, in the end, Phipps said, "The basic rule is what a willing buyer and willing seller agree to."

Returning to the theme that organization and planning are essential to maximizing value and facilitating the sale of a law practice, Maville concluded the presentation by sharing an aphorism that an older lawyer shared with him at the outset of his legal career. "Begin, and the rest comes easy." Saying he applies this principle to his ongoing, everyday law practice, Maville urged all lawyers likewise to include preparation for one day concluding their practices as part of their routine office tasks.

 

Find out more

For more on this topic, see Helen Gunnarsson's article Taking Down Your Shingle in the January 2009 IBJ and the many links under "Selling, Winding Up or Leaving Your Practice" at ISBA's online Practice Resource Center (isba.org/practiceresourcecenter).

 

Putting a dollar value on your practice

Valuing a law practice may be the most difficult step in the sale process, according to Phipps and Maville. Here are some tips for determining a dollar amount.

You've decided to sell your law practice or to buy out another lawyer, and you've familiarized yourself with RPC 1.17, which governs those transactions. What price should you expect to pay or receive for it, and how can you and the other lawyer arrive at a reasonable and satisfactory figure?

Run the numbers. The value of a practice, Phipps said in his Solo and Small Firm Conference written materials, involves predicting the future based on present facts. The more facts you can muster about the practice for sale, the better able you'll be able to determine a value the seller will accept and the buyer will pay.

Phipps noted in his presentation that his firm's case management system makes it fast and easy to compile and present many facts about the practice in a variety of ways, including printing out profit and loss statements that show prospective buyers not only what the firm's fee receipts are but also where they're coming from.

Expert schmexpert. Both lawyers are at best lukewarm toward the idea of hiring an expert such as an accountant to value a law practice. "The problem with a lot of value experts is they tend to look in terms of cash generated and not a lot else," Phipps said. "They need to look at the underlying data and not just crunching numbers."

As examples of matters that buyers should delve into, Phipps suggested considering whether the seller has presented information over a sufficient number of years to enable a buyer to project a realistic income figure for future years, whether the data presented includes bad years along with the good, and whether the practice is so enmeshed with the identity of the selling lawyer that it will likely lose significant value on the seller's departure.

The two expressed skepticism about the need for a broker to find a buyer. Maville said, "The most likely buyers are those in your own community: assistant state's attorneys, assistant public defenders, young lawyers just out of school, and associates in larger firms whom you already probably know. Those people probably already know your practice and what you do. In a smaller community, they probably already know a number of your clients and the type of clients you have. They know the value of your practice."

The lawyers' commentary suggested that hiring either a valuation expert or a broker may result in nothing but an additional fee to pay, diminishing the transaction's value for both seller and buyer. Then again, as the profession gains experience and collective knowledge about transactions under RPC 1.17, experts who can provide solid assistance in these transactions may emerge. For those who do decide to hire experts, Phipps suggested that a combination of a lawyer and accountant with expertise in law office management might be best.

Keeping an income stream. Phipps and Maville said that some lawyers have agreed to accept a combination of a down payment from the buyer and a percentage of the fees collected over the next three to five years. Others gradually wind down their practices by finding lawyers who ease into taking over their practices while they remain at the firm, available for consultation and facilitating clients bonding with the lawyer taking over while continuing to receive a percentage of the fees collected.

"It gets them out of the practice and frees them up to do other things, but they keep a stream of income," said Phipps. "That may not be what RPC 1.17 contemplates, but they're transferring their files in accordance with ethical rules." Lawyers deciding to use either method should, of course, take care to comply with all ethical rules and may even wish to consult ethics counsel in case of any uncertainty.

In the case of a disabled or deceased lawyer's practice, Maville emphasized that time is of the essence in completing the sale. "The faster you act, the better the price you're going to get. If you can't sell it within a month, you've got some serious problems, because letting the matter languish has already damaged the value of the practice."

And that, said Maville, illustrates why he feels so strongly about the importance of planning. "The failure of the selling lawyer to plan is what interferes the most with the sale of a practice. Part of your duty to your clients is to plan for your death, disability, or retirement."

Helen W. Gunnarsson, a lawyer in Highland Park, is an Illinois Bar Journal contributing writer.


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