Legal market not yet ready for limited liability partnerships

If one partner or more than one partner of a special general partnership law firm cause(s) the law firm to incur a debt due to a deliberate act or gross negligence by him/her/them in his/her/their practice activities, he/she shall bear unlimited liability therefor or they shall bear unlimited joint and several liability therefor and the other partners shall bear liability therefor to the extent of their shares of the property in the firm; if the firm incurs a debt for a reason other than a deliberate act or gross negligence by a partner or partners in his/her or their practice activities, all of the partners shall bear unlimited joint and several liability in respect thereof.

“These two laws have made significant changes, especially the partnership forms of law firms. The special general partnership is good news to big firms, because not all partners need to bear the costs of negligence,” says Linda Liang, partner at King & Wood.

No limited partnership

However, many lawyers find the rules disappointing as they make no mention of limited liability partnerships (LLP). One of the core differences between LLPs and SGPs is that the former allows all partners to have limited liability in all circumstances, while the latter grants partners who were not involved in the misconduct limited liability, but only under a circumstance in which the misconduct is unintentional. To both practitioners and law firms, LLP provides more protection and is widely recognised by law firms in other jurisdictions, such as the US and Europe.

“I think the government is still cautious about opening the door to limited liability partnership,” says Liu Jinrong, partner at Global Law Office.

Though many law firms prefer to have such a liability system, Liu says that it appears that the government prefers to introduce such a process gradually. It is crucial, he says, for the government to make certain that law firms are capable to meet the threshold requirements of SGP and practise in this form of partnership before fully considering LLP.

Yet the lack of a full LLP falls well short of lawyers' expectations, and the very concept of LLP fails to appear in the MALF as many had hoped. The SGP leaves partners liable to costs which for a large law firm with more than 100 partners, there is great difficulties and problems when it comes to ensuring the entire firm is protected.

However not everyone agrees that LLP is suitable for PRC firms.

Roy Zou, counsel at Hogan & Hartson, says SGP is at the very least a very basic requirement for a law firm.

“I don't understand why they want limited liability partnership, and I don't think they should. Who do they think they are to say that only the lawyer who makes the mistake should bear the liability?” he says.

Once a partnership is formed, Zou says, partners within the firms should have an obligation to share the liabilities and responsibilities.

“Only by having all the partners bear liability can a firm be strengthened and developed,” he says.

Lawyers might have different opinions on the extent of liabilities in their partnerships, but there is no doubt the reforms are a step in the right direction. Yao Yi, senior partner at Concord & Partners, says that while LLP is more preferable in other jurisdictions, the fact that LLP is not mentioned is of concern. However she welcomes the fact the reforms are taking place.

“Now this is progress, but it hasn't come to exactly what we had hoped,” she says.

Thresholds focus

For some firms, the requirements for SGP could well be out of reach, leaving smaller firms outside the thresholds.

According to Article 8 in the MALF:

To establish a special general partnership, the following conditions shall be satisfied, in addition to the conditions specified in Article 6 hereof:

(1) having a written partnership agreement;

(2) having at least 20 partners as founders;

(3) the founders being lawyers with at least three years of practice experience and who practise full time; and

(4) having assets of at least Rmb10 million.

“It is very rare for a start-up law firm to have Rmb10 million assets and 20 partners,” Yao says. “To be honest, these requirements actually focus on the law firms that are strong and established.”

Unlike law firms in the US or Europe, law firms in the PRC tend to expand by increasing in size rather than merging externally with others. Therefore it could take many years before a small sized firm is able to meet the thresholds. And in the PRC, the majority of local law firms are small to medium in size.

The issue of asset versus liability is also one that does not make sense. The compensation could be far above the amount of assets, so requiring firms to have at a minimum Rmb10 million in assets is in fact not realistic.

“The requirements of assets are meaningless, and the government should not use asset value to insure a lawyer's practice,” says Wang Weidong, partner at Grandall Legal Group.

The regulations provide no explanation in respect to asset share, nor do they give details on how equally the assets should be divided between partners.

In a law firms' decision making process, one partner is usually allowed to have one voting right. However, the new regulations are ambiguous in whether a partner who holds more shares has more voting power.

“We don't know whether each partner can have different shares of assets in a law firm and how the voting rights are determined accordingly to the respective shares in a law firm,” Wang says. “This kind of asset standard is not relevant to a law firm. The government shouldn't use the amount of capital or assets to insure a practice. I think how much insurance a law firm buys to cover the firm's practice is far more important.”

But the reality is that the amount of insurance law firms purchase is not substantial. Yao doubts whether the amount of insurance a law firm can buy could cover all its potential losses.

“I hope in the future we can see the limited liability partnership together with the professional insurance,' she says.

Rules may encourage law firms to grow

Although the ceiling of the thresholds is high for start-up firms, the government's goal is to encourage the expansion of law firms in the PRC. As SGP allows more room for partners in terms of bearing liabilities, law firms should therefore be motivated to expand in order to meet the SGP requirements of number of partners and value of assets.

Dong Chungang, partner at Jingtian & Gongcheng, says that the measures are certainly good news for those that have already met the thresholds. Jingtian & Gongcheng, for example, now has 51 partners, and to continue to grow in size, without changing from general partnership to SGP would be a challenge. It's impossible, Dong says, for all partners to share the liabilities of a new partner. “But the regulations get rid of such concerns for us when we want to expand,” he says.

Now that this law gives certain protection to partners, “law firm's growth certainly is the intention of these measures,” Wang says.

Ambiguities remain

But the measures still contain some ambiguities that lawyers find it difficult to interpret. For law firms that are planning to change their form of partnership, the measures provide no guidelines on how to do so.

“I doubt whether it will be easy to convert into special general partnership. I am not sure if any firms have applied for such a convergence. I certainly haven't heard of any,” Liu says.

The measures do not provide any definition for terms such as “intentional” and “unintentional” either. This could be a crucial issue. If misconduct is caused intentionally, partners not involved in the incident have limited liability for the costs. But if the misconduct is caused unintentionally, the entire firm's partners will need to bear unlimited liability. Given that now the measures provide no clarification, it is completely ambiguous for practitioners to understand in what situations they might be considered liable.

Besides, it would be on the rarest of occasions for a partner to intentionally make such a mistake. What may happen is unintentional misconduct due to a lack of judgment or a careless decision could occur. In such instances, partners are required to bear unlimited liability. Without any clear definition, lawyers are thus less protected and are more vulnerable to unlimited liability.

“If the law really wants to provide more protection to partners, it should cancel this definition. All partners should bear limited liability, regardless intentional or unintentional,” Dong says.

Endnotes

1. See Amendments to the Law on Lawyers: Ethical Standards Raised, but Not Yet to International Standards in CLP March 2008

2. See Measures for the Administration of Law Firms in CLP September 2008

3. See Measures for the Administration of Legal Practice by Lawyers in CLP September 2008

4. See China's Partnership Enterprise Law Revised in CLP March 2007