Seeking Shelter in the Minefield of Unintended Consequences--The Traps of Limited Liability Law Firms

I Introduction "Where were the professionals?"' This infamous question posed by U.S. District Court Judge Stanley Sporkin ignited a national debate on the role of accountants and attorneys in the savings and loan debacle.2 Banking regulators embraced this quotation as their rallying cry in malpractice actions against attorneys and accountants.3 Government regulators pursued claims against hundreds of attorneys and accountants, including those affiliated with prestigious law firms and accounting firms.4 These actions, which sought millions in damages and restitution, threatened firm members who practiced in general partnerships because the individual members could be held personally liable if firm assets did not satisfy a malpractice judgment.5 Claiming that the potential exposure to these suits was so high and the defense costs so expensive, the professionals and their insurers paid millions of dollars to settle the lawsuits.6 Ironically, the malpractice suits against attorneys and accountants successfully galvanized these professionals to obtain protection from future professional liability claims.' Thereafter, a question on the whereabouts of professionals could easily be answered the professionals were actively lobbying state legislatures to limit the vicarious liability of firm partners for the acts and omissions of other firm partners. These professionals sought legislation that would enable them to limit their vicarious liability without having to organize as professional corporations and risk double taxation. The coalition of professionals and business lobbyists successfully convinced state legislators to adopt legislation providing for limited liability companies and limited liability partnerships (collectively called "limited liability firms"). Because limited liability firms provide liability protection without subjecting firms to double taxation, these new limited liability structures rapidly gained popularity. As described by a partner in a large Boston law firm, big firm partners look at limited liability firms with "an enthusiasm perhaps more appropriately reserved for the Holy Grail. "8 The flurry of firms to reorganize as limited liability firms reflects the enthusiasm for the new business structures. Within a few years, the limited liability firm movement swept the country.9 Those firms that have not yet organized as limited liability firms probably will consider doing so in the future." When they do, there may be little opposition to converting to a limited liability firm because attorneys have wholeheartedly embraced the limited liability firm structure.l' Commentators also herald the coming of the limited liability firm. Even the titles of law review articles reflect how authors have warmly received limited liability firms.'2 Although a plethora of these articles discuss the features and advantages of these limited liability firms, a relatively small number of the articles question the advisability of law firms rushing to reorganize as limited liability firms.'3 The paucity of articles scrutinizing the limited liability form suggests that commentators have devoted little attention to analyzing the negative implications of attorneys' practicing in limited liability partnerships or limited liability companies.'4 Similarly, in converting their practices to limited liability firms, attorneys may overlook the consequences of abandoning the traditional partnership structure. They may not realize how conversion to a limited liability partnership (LLP) or a limited liability company (LLC) completely transforms the dynamics and culture of law firm practice, creating financial and administrative problems.15This Article considers some of the unintended consequences of attorneys' limiting their vicarious liability in limited liability firms. After Part II reviews the forces behind the limited liability movement and the emergence of limited liability law firms, Part III surveys the statutory approaches to limiting vicarious liability in LLCs and LLPs. …