Law Firm Articles

Are De-Merger Clauses Useful?

Merger discussions generally center around the rationale for and methods of putting two law firms together. The focus is on the opportunities to access new clients and markets, to qualify for more interesting engagements, and to bring on additional expertise. There is a long list of issues to consider — strategy, culture, conflicts, financial results and the like. Then there are structural concerns, redundancies, tax considerations, and more to negotiate prior to bringing the transaction to a successful conclusion. Yet even with careful planning and due diligence, every once in a while, the pre-merger thinking misses the mark and the post-merger firm is not destined to make it.

Like pre-nuptial agreements, de-merger clauses are often considered antithetical to the apotheosis of the deal. Who wants to plan the breakup of the relationship before it has gotten underway? And having an “out” option in one’s back pocket (a sort of “get out of jail free” card) will complicate integration efforts — such as sharing clients, combining service teams and administrative functions.

A de-merger clause may not be appropriate in all situations, but it can be helpful. Undoing a failed merger is tricky under the best situations; it becomes much more challenging when one firm has given up its identity as part of the deal. Having a roadmap or at least a framework within which to conduct oneself can ease the difficult and sometimes contentious task of undoing the deal.

Here are some factors where a de-merger clause might be helpful:

Protecting client relationships — This can be complicated in two ways:

  • How client relationship responsibility is assigned in the combined firm (expertise, location, succession plan and the like), and;
  • Who clients want to continue with as their advisors (the client’s wishes should prevail).

A de-merger clause should put the client’s interests first, then determine how to fairly treat the firm that brought the client to the dance within the applicable canon of ethics. The firm that retains the relationship will obviously be well compensated. Here is a tip: strive for something simple to grasp and implement – such as a split of the profit on the work 50/50 or some weighted apportionment that initially favors the originator of the business and slides over to the successor over time.

Clients generated post-merger, as part of the enhanced competitive position and overall marketing efforts represent a particularly different challenge. Here, the reason for the client acquisition may disappear with the dissolution of the firm. Again, the client’s interests should come first. The demerger framework should consider how to navigate the frank internal conversations required and how to ensure a respectful and productive conversation with the client. It may be that only one of the legacy firms or neither of the legacy firms can represent the client. However, there may be a co-counsel opportunity (again if appropriate within ethics rules). It may also mean that you assist the client to find and transfer their representation to new counsel.

People — A law firm’s most precious resources are its people. Generally, one would expect to have people return to their pre-merger firm. Many times, it is not quite so simple. There may be some unofficial recruiting going on behind the scenes. Some individuals may prefer to “cross-over” to the other firm.

Then there are the redundancies created through rationalization of resources. Neither firm may have the independent complement to be restored to its pre-merger condition. Some of these redundancies occur through partial acquisitions where not all partners become equity partners in the new firm or not all partners are invited to come along. In these instances, the de-equitized or released partners are often bought out of their equity positions as part of the transaction. Some portion of the first group will move to the second as they seek equity opportunities elsewhere. The issues here are how to handle the buy-out costs in the demerger and how to handle the pre-merger firms’ loss of talent and possible alienation of talent through de-equitization.

Finally, there are the reluctant participants — partners who went along with the deal with reservations and now desperately want to take their practices and leave.

Each of these scenarios can be anticipated and protocols agreed to as part of a de-merger clause.

Infrastructure — This becomes more of an issue when the firms have physically combined. Someone will need to move or there will be costs to segregate and reconfigure space to accommodate two separate firms with the necessary and appropriate security regarding client confidentiality. The same holds for technology, record management and other shared administrative services.

When are de-merger clauses possibly not helpful?

Succession deals — The purpose of a succession deal is to provide an exit strategy for “sellers” (and hopefully also to provide representation continuity for their clients) while transferring relationships and market presence to the “buyers.” The acquirer will invest heavily in making the transfer successful and it would not be helpful for the seller to have an out to pursue a more attractive offer that could come along – again the “get out of jail free” card.

Integration efforts — Forging a single firm out of the two predecessor firms is challenging, time-consuming and lengthy – requiring three to five years under good conditions. This effort touches everything from administrative functions to client service delivery. It encompasses every activity in the firm.  For example, consider these three supposedly simple everyday activities – how files are organized, time is entered and expenses are reported (think of all of the stakeholders, processes, policies and technology involved in just those three activities). I have been told by some that anything that gives a lifeline to the legacy methods just complicates the path forward. It is just common sense that each party will tend to protect their positions while the option exists. This creates a point of discord in the efforts required to go forward as a single firm.