Reforms Have Lawyers Running for Liability Coverage

Staff Reporter

It's more than a name change.

A few months ago, Latham & Watkins began laying the groundwork for the conversion from a general to a limited liability partnership.

Latham is the only major L.A. firm not to have restructured as an LLP. As a general partnership its partners could see their personal assets used to satisfy a substantial judgment against the firm what had been considered unlikely legislation extending professional responsibility began wending its way through Congress.

"We now feel that it may be appropriate to look at becoming an LLP," said John Walker, a senior partner. Walker, former managing partner and chairman of the firm's executive committee, said, "Because of the Enron and Andersen situation, some of the partners are concerned about that."

Latham's restructuring is the most substantial move being made by L.A. firms assessing how to better protect themselves over potential liability issues. Besides restructuring partnerships, law firms are buying more insurance, creating new document retention policies and meeting more regularly on ethical issues.

The fears are real. Several months ago, Chicago-based Kirkland & Ellis and Houston-based Vinson & Elkins LLP were named in an amended shareholder lawsuit against the former directors and officers of Enron Corp.

And on July 30, President Bush signed into law a corporate reform bill specifically tagging lawyers with more responsibility for their clients' wrongdoings.

"All it takes is one lawsuit and you're out of business," said Ward Bower, principal of legal consulting firm Altman Weil Inc. in Philadelphia. "You could very easily find yourself on the other end of a lawsuit, even if it's frivolous, for much more than what traditional liability coverage would be. Insurance that covers millions of dollars doesn't do much good where liability is in the billions, which is what we're seeing in situations today."

Limiting risk

Historically, law firms were structured as general partnerships, where partners would have to come out of pocket if the firm's assets could not cover damages incurred in a malpractice claim, or if the firm could not pay its lease or repay bank loans.

"As a matter of traditional ethical concepts for lawyers, it was not appropriate to have that corporation between you and your clients," said Steven Weise, a partner at Heller Ehrman White & McAuliffe LLP who helped draft the LLP statute in California. "You were supposed to have a personal relationship with your client."

In the 1980s, however, many states began to approve statutes allowing law firms to become professional corporations, exempting partners from any personal liability, unless they committed the malpractice themselves or they signed documents with banks or landlords guaranteeing debt with part or all of their personal assets, Weise said.

But by the late 1980s, partners, taxed both as individuals and through the professional corporation, found themselves paying more income tax. In partnerships, only the partners are taxed individually.

In the event of a malpractice judgment, a limited liability partnership shields partners who did not commit the malpractice from being tapped to help pay the debt personally. Under the LLP structure, payment of a settlement is limited to insurance coverage and a firm's assets.

But LLP status alone does not shield firms from liability concerns, and as a result many are buying more insurance.

Kirk Pasich, insurance recovery partner in the Century City office of Howrey Simon Arnold & White LLP, said a number of mid-sized firms carrying $20 million in liability insurance are looking to double their coverage, despite premium increases of as much as 100 percent by some carriers.

Elliott Rothman, vice president of Professional Practice Insurance Brokers Inc. in Beverly Hills, has a client considering restructuring its insurance coverage to keep down both its rates and liability.

The law firm, an intellectual property practice he declined to name, is considering splitting its coverage between general liability issues and coverage of opinion letters in order to shave costs, he said. The client is also considering passing on the costs of coverage on opinion letters directly to clients, he said.

"That's an example of carving out exposures so you don't have to buy high limits to cover something that happens once every two years," Rothman said.

Added pressure

The corporate reform bill enacted July 30 places greater responsibility on lawyers to report potential fraud to corporate boards, adding further pressure in an environment of increased shareholder activism.

That provision has become a thorny issue since, as Marvin Garrett, general counsel and partner at Allen Matkins Leck Gamble & Mallory LLP, said, "Lawyers don't want to be placed in a position to be snitches."

The law also created new requirements regarding document retention. Allen Matkins is drafting a standard policy it will submit to clients, Garrett said. In the past, the decisions on which legal documents to keep and which to destroy were largely determined by client requests, he said.

Types of California Law Firms

General Partnership: Traditional structure of law firms. Firm's liability shared among partners as individuals.

Professional Corporation: Introduced in the 1980s. Liability limited to individual partner responsible for specific action and to the firm as a business. The firm pays income taxes, as do all the partners individually.

Limited Liability Partnership: Introduced in California in 1995. Liability limited to the partner responsible for specific action and to the firm as a business. The firm does not pay income taxes, but the partners do.

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