LLCs, LLPs and S.C.s: The Rules for Lawyers Have Changed
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By Clay R. Williams
Editor's Note: All Wisconsin statute
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On March 18, 1997, the Wisconsin Supreme Court amended the Supreme
Court Rules of Professional Conduct for Attorneys (the "Rules") to allow
lawyers to avoid vicarious liability by practicing law in the form of
limited liability companies (LLCs), limited liability partnerships
(LLPs) and Service Corporations (S.C.s). In doing so, the court has made
clear that effective July 1, 1997, there will be no ethical impediment
to lawyers organizing and practicing law within a limited liability
entity. (The court's order 96-02 creating the new Rule accompanies
this article.)
Attorneys practicing in groups now can insulate themselves from the
acts or omissions of other attorneys within the practice group.
Wisconsin now has joined the vast majority of states permitting lawyers
to use limited liability entities to avoid vicarious liabilities.
The new Rules, SCR 20:5.4(d) and 20:5.7,
in consonance with the legislation concerning LLCs, LLPs and S.C.s, do
not address the liability either of the entity or of the lawyers
actively engaged in representing a client within those organizations.
They do allow, however, lawyers to avoid the vicarious liability
previously risked by members or shareholders of such organizations for
the acts or omissions of others. In approving the use of such
organizations the court required:
1) Annual
registration with and fee payment to the State Bar of Wisconsin;
2) Professional liability insurance for firms as follows:
- a) 1-3 lawyers, $100,000 per claim/$300,000 aggregate;
- b) 4-6 lawyers, $250,000/$750,000;
- c) 7-14 lawyers, $500,000/$1 million;
- d) 15-30 lawyers, $1 million/$2 million;
- e) 31-50 lawyers, $4 million/$4 million;
- f) 51 or more lawyers, $10 million/$10 million;
3) Inclusion of a written designation of the firm's limited liability
structure as part of its name; and
4) The provision to clients and potential clients in writing of a
plain-English summary of the limited liability features.
Wisconsin's
Limited Liability Company Act, Chapter 183 of the Wisconsin
Statutes, enacted in 1993, authorized the creation in Wisconsin of the
then new form of business organization, the LLC. In 1995 Wisconsin
continued to reflect the nationwide trend toward flexible business
organizations by adopting 1995 Act 97, which provided for the creation
of LLPs. Furthermore, as of July 1, 1996, S.C.s organized under Chapter
180 were allowed to limit the liability of shareholders in the same
manner as members of LLCs and LLPs. 1 All of
these general business statutes - Chapter 183, Act 97 and section
180.1915 of the Wisconsin Statutes - are silent as to whether these
vehicles can be used in practicing law. Under all three statutes, the
organization's members are not personally liable, under ordinary
circumstances, for the errors, omissions or contract claims of their
comembers or coshareholders, beyond their investment in the
organization. With the passage of this recent amendment to the Rules,
attorneys practicing in Wisconsin know they can form limited liability
vehicles without violating any ethical standards.
Background
In the past, Wisconsin allowed the practice of law individually, in a
general partnership or in a corporation. A general partnership organized
under Chapter
178 remains available for use by Wisconsin lawyers, unaffected by
the LLC and LLP statutes. A corporation organized under subchapter 19 of
Chapter 180, the Wisconsin Business Corporation Law, generally has been
accorded tax treatment as a corporation, but the statute previously
provided that service corporation shareholders had the same vicarious
liability for the acts of other shareholders as did partners in a
general partnership. No other state's corporation statute contained such
a provision.
Effective July 1, 1996, the Legislature extended to service
corporations the same limitation of vicarious liability contained in the
LLP and LLC legislation. 2 Following this
legislative extension of protection, attorneys who operated as a service
corporation found themselves in the same catch-22 as lawyers desiring to
organize their firms as LLCs or LLPs. Although technically attorneys had
the statutory authority to organize as a limited liability entity, there
was no conclusive answer as to whether lawyers could do so ethically
since the Rules did not address the question clearly.
National Trend
Wisconsin continued to be an anomaly as most of the states allowed
some limitation of vicarious liability for lawyers. When the State Bar
petitioned the Wisconsin Supreme Court in early 1996, there were only a
few states remaining in which it was either forbidden or unclear whether
attorneys could form a limited liability entity for the practice of law.
3 Yet even while Wisconsin was considering a
change, this list was decreasing. On July 1, 1996, the Georgia Supreme
Court reversed itself and specifically approved legislation allowing
lawyers to practice in limited liability entities. 4 Several states have conditioned the ability to
practice law in limited liability entities upon meeting certain
financial responsibility requirements or upon providing certain amounts
of liability insurance. Wisconsin has now joined this last group.
Numerous bar associations also have drafted and generated ethics
opinions allowing attorneys to practice with limited vicarious
liability. 5 For example, the American Bar
Association issued an ethics opinion as early as 1961 in which it
indicated that where appropriate safeguards are used, attorneys were
entitled to practice as professional corporations. 6 More recently, in ABA Formal Opinion 96-401 of
Aug. 2, 1996, the ABA Standing Committee on Ethics and Professional
Responsibility opined that lawyers are permitted by the ABA Model Rules
to practice in LLPs or similarly limited entities. Indeed, several
states also have applied the principle found in ABA Model Code of
Professional Responsibility EC6-6 to limited liability companies and
limited liability partnerships. 7
Why the Change
Originally, ethics rules and partnership rules evolved separately but
contemporaneously, and it was not the ethics rules that dictated the
vicarious liability of attorneys but rather partnership law that imposed
joint and several liability. 8 Thus,
imposing vicarious liability on attorneys practicing in the form of
general partnerships historically has not been required by ethics rules
but rather by the partnership law that arose from the late 1700s.
Several factors reflect changes in the current practices of law firms
and are the bases for limiting vicarious liability of attorneys. These
factors include the changes in the legal profession that tend to prevent
close lawyer monitoring: that is, the rapid growth in the number of
lawyers in the past 25 years; the rapid growth in the number of
mid-sized and large law firms; the establishment and operation of branch
offices for larger law firms; the increasing specialization and
departmentalization of law firms; and the changing definition of legal
malpractice in which courts have more frequently entertained new legal
malpractice theories for imposing liability upon attorneys. 9 Imposing vicarious liability may result in
inequitable treatment of certain attorneys in a law firm. In response to
this inequitable treatment, attorneys have sought to use limited
liability entities. These practical considerations explain why vicarious
liability no longer works as an effective tool to promote lawyer
monitoring.
In addition, attorneys have become increasingly vulnerable to
multi-million dollar lawsuits - lawsuits founded both on malpractice and
other tort-like claims and contract claims, often including punitive
damages. 10 Thus, not only are law firms
increasing in size but the settlements and judgments for actions against
law firms are increasing in size and frequency. These trends place more
attorneys who achieve their goals of becoming a successful member of a
reputable law firm more at risk for the actions of other partners over
which they have no control. The wholesale bankruptcy of every member of
a law firm adversely affects the legal matters of all clients of the
firm.
Quality Assurance
It has been argued that permitting the use of limited liability
entities by attorneys may result in lower-quality legal service for
clients. But there is little question that it is the desire of all
attorneys in a law firm, to the extent they are able, to protect the
firm's reputation, goodwill and assets.11
Those assets include the firm's accounts receivable, work-in-process and
other assets, all of which remain exposed to claims. Thus, a law firm's
partners and shareholders still have the necessary incentives for
generating quality legal work without the added burden of imposing
vicarious liability among the members.
Mandatory Malpractice Insurance
By conditioning a lawyer's ability to limit vicarious liability on
maintaining a current annual registration and mandatory liability
insurance with prescribed minimum coverages, the Rules recognize that
many law firms are not well capitalized and that eliminating vicarious
liability may, in some cases, limit a client's recourse for malpractice.
The insurance requirement is an alternative to capitalization that is
more easily attainable while providing a recourse for clients that,
unlike conventional capitalization, is not subject to fluctuations
because of liabilities or financial stresses not related to malpractice
claims. This Rule should help decrease the number of uninsured Wisconsin
lawyers.
The Rule's minimum limits are not so high, however, as to place the
Rule's benefits beyond the practical reach of lawyers in smaller
practices. Wisconsin lawyers are not presently required to maintain
malpractice insurance, minimum levels of capitalization or to
demonstrate financial responsibility in any manner as a prerequisite to
licensure and authorized practice. Indeed, some data suggests that many
lawyers have no malpractice insurance at all.12 As a condition to limiting vicarious liability,
the Rule requires minimum insurance coverage on a variable scale
depending upon the number of lawyers in the firm.
The collateral benefits of mandatory insurance should not be
overlooked. Careful scrutiny by underwriters may well improve the
internal controls and systems of lawyers and law firms that previously
have not had to participate in that process.13 Those lawyers and law firms unable to secure
minimum levels of coverage because of their claims experience or the
want of suitable internal controls arguably should not qualify for
limited liability in any event. The insurance requirement increases both
a client's protection after malpractice and the client's chances that
such malpractice will not even occur.
Liability and Obligations
The change in the Supreme Court Rule of Professional Conduct is for
the most part purely a statement of ethics by the Wisconsin Supreme
Court. Section
20:5.7(a)(2) of the Rules limits the operation of the Rule to
situations of vicarious liability. A lawyer's personal liability arising
out of his or her own acts, errors and omissions remains unaffected.
This is a feature of the law in virtually every other state that has
allowed limitation of vicarious liability of lawyers.
In large measure a lawyer's ethical responsibilities under the Rules
operate independently of the lawyer's civil liability for professional
negligence. Subsection (c) continues that separateness. Even a lawyer
satisfying all of the Rule's requirements for limiting vicarious
liability still is subject to discipline for failing to maintain client
confidences (SCR 20:1.6); failing to enforce compliance with the Rules
generally (SCR 20:5.1); and failing to supervise subordinate attorneys
and nonattorneys (SCR 20:5.2 and 20:5.3). 14 To allay any concerns that lawyers with limited
vicarious liability may become less attentive to these ethical
responsibilities, the Rule reminds lawyers that these duties remain
undiminished.
Public Notice and Registration
The Rule makes specific provision for public notice and notice to
clients. Most states do not require such extensive notice, although a
few have imposed various disclosure requirements as a precondition to
eligibility for limited liability.15
The Wisconsin Supreme Court has required three basis forms of notices
as part of the Rules: 1) registration with the State Bar; 2) inclusion
of a written designation of the limited liability structure as part of
the name; and 3) provision of a plain-English written summary of both
the features of the operative organizational statute and SCR Chapter
20.
Registration with the State Bar must be annual, on a form to be
provided by the Bar, accompanied by a fee yet to be announced. The
registration must include the information called for by SCR
20:5.7(b), including a certificate of insurance reflecting the
required limits. (Note: The State Bar will mail this form to
all Wisconsin law firms in May or download
the form here.)
The second form of notice, inclusion of a written designation of the
limited liability structure as part of the firm name, is more
problematic. The organizational statutes for LLCs, LLPs and S.C.s all
specifically provide for some abbreviation to reflect the nature of the
organization. 16 Not only does SCR
20:5.7(e)(1) not provide for an abbreviation as a form of notice,
such language was specifically requested by the State Bar and not
included.17
The third type of notice, set forth in SCR
20:5.7(e)(2), requires that clients and potential clients be advised
in writing in a plain-English summary of both the features of the
limited liability law used by the firm and of the applicable provision
of SCR 20.
The Rule at subsection 20:5.7(d)
also provides that law firms organized under other states' limited
liability laws must register with the Wisconsin Supreme Court if it has
at least one lawyer licensed to practice law in Wisconsin. This Rule
clarifies the status of those lawyers practicing in Wisconsin but whose
law firms are organized in other states. As long as the law firm is
organized as a limited liability entity under another state's laws and
registers as provided in the Rule (which includes providing a
certificate of insurance in compliance with 20:5.7(bm)),
its lawyers will have complied with the Rules for their actions in
Wisconsin. The public disclosure aspect of the registration requirement
may be even more valuable in the case of a non-Wisconsin law firm,
because the information required by the registration may be more
difficult to obtain by the Wisconsin public from other sources.
Liability for Noncompliance
The draft of the proposed Rules submitted to the supreme court by the
State Bar as part of its revised petition specifically provided, in then
section 20:5.7(e),
that the provision of the organizing statutes protecting against
vicarious liability would be of no effect during any period the firm was
not in compliance with the new Rules.18
That provision was not enacted by the supreme court. While no reason was
given for the deletion, one assumes it reflected the court's desire to
avoid being seen as usurping the legislative prerogative.
If that assumption is accurate, it may predict the answer to
questions sure to arise: Will a lawyer avoid vicarious liability for her
colleague's malpractice during the period after passage of the enabling
legislation for LLCs, LLPs and S.C.s, but before the new Rule's
effective date (7/1/97), or during a period following July 1, 1997, when
a limited liability organization fails to comply with SCR
20:5.7? The deletion of the submitted subparagraph (e) by the
supreme court suggests that it may well conclude, as have others,
19 that it is the Legislature's province to
legislate liability and the supreme court's province to prescribe the
ethical standards of lawyers.
Clay R.
Williams, Michigan 1960, is a shareholder in von Briesen,
Purtell & Roper S.C., Milwaukee.
Conclusion
At a time when malpractice judgments against lawyers are increasingly
being borne by innocent partners and shareholders, with tragic and
potentially catastrophic results both to lawyers and other clients,
Wisconsin now has joined the vast majority of states permitting lawyers
to use limited liability entities to avoid vicarious liabilities. These
changes are designed to assist lawyers in preserving their practices. In
addition to the obvious insurance requirements, the rigors of complying
with modern day insurance underwriting and administrative practices will
improve many of the firms that subscribe. Stronger and better new law
firms will improve the quality of service and the viability of firms for
all clients, not just that rare client who seeks to hold his or her
lawyer financially responsible.
Endnotes
1 See Wis. Stat. 180.1915
(Professional Relationships and Liability).
2 Id.
3 Jennifer L. Johnson, Limited
Liability for Lawyers: General Partners Need Not Apply, 51 Bus.
Law. (Nov. 1995), at 85-145.
4 Henderson v. HSI Fin. Serv.
Inc., Case No. 595G 1746 (1996 WL 36154 (Ga.)). In addition, both
Florida and Georgia adopted new ethical standards.
5 Johnson, supra.
6 ABA Formal Ethics Op. 303
(11/27/61).
7 LLCs permitted: Alabama,
Connecticut, Kansas, Maryland, Michigan, Mississippi, New York, Texas;
LLPs permitted: Washington, D.C., Kansas, Ohio.
8 Michael J. Lawrence, The
Fortified Law Firm: Limited Liability Business and the Propriety of
Lawyer Incorporation, 9 Geo. J. Legal Ethics 207, 207-09
(1995).
9 Id. at 211.
10 See Some Law Firms Were
Hit by Massive Suits, Nat'l L.J., Dec. 26, 1994, at C11. See
also Lisa Isom-Rodriguez, Limiting the Perils of
Partnership, Am. Law, July 1992, at 30.
11 Lawrence, supra at 224.
12 In July 1995, Wisconsin
Lawyers Mutual Insurance Co. estimated that 15 to 30 percent of private
practitioners have no malpractice insurance.
13 The new rules do not specify
any particular levels or amounts of deductible allowed, other than
requiring it be disclosed in the registration process. SCR 20:5.7(bm).
It appears that the supreme court has left that determination to the
insurer's sound underwriting judgment.
14 It is possible that conduct
constituting a lawyer's failure under SCR 20:5.1, 20:5.2 and 20:5.3 may
also subject the lawyer to direct (as opposed to vicarious) civil
liability under several tort theories. See, e.g., Johnson v.
Misericordia Community Hosp., 99 Wis. 2d 708, 734-35, 301 N.W.2d
156 (1981).
15 Johnson, supra at 120-21 and
accompanying footnotes. This may be due to the fact that existing laws
already provide notice of an entity's limited liabilty. Existing
business organization statutes already require the business name to
contain some reference to the type of entity. Moreover, neither existing
law nor the rules require notice to clients of other aspects of a
lawyer's or law firm's financial condition - that it is insolvent,
poorly capitalized, in default on important obligations or subject to
malpractice judgments - or the existence (or lack) of insurance coverage
or applicable coverage limits.
16 See Wis. Stat.
180.1977 (S.C.); 183.0103 (LLC); 178.42 (LLP).
17 Letter of Feb. 27, 1997, to
the supreme court clerk, requesting inclusion in section 20:5.7(e)(1) of
the language "or an appropriate abbreviation thereof." In some states it
has become the practice to incorporate both an abbreviation and a
descriptive phrase in the name, for example, Huey, Dewey & Louie,
L.L.P., a Limited Liability Partnership.
18 See, revised Petition
filed March 27, 1996 SCR 20:5.7(e).
19 Lawrence, supra; Henderson v.
HSI Fin. Serv. Inc., supra.
Wisconsin
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