Vol. 70, No. 5, May
1997
LLCs, LLPs and S.C.s:
The Rules for Lawyers Have Changed
By Clay R. Williams
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to the WisBar Toolbox On March 18, 1997, the Wisconsin Supreme Court
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. |
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.)
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.*) (* Requires Acrobat Reader. Go to the WisBar Toolbox and download it NOW! Need an Acrobat tutorial? Go
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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. |