Most partners to a law firm partnership expect that all members share risk equally. In fact, this shared risk and protection of personal assets is, for many, a primary advantage of joining or starting a law firm. However, there can be risk for partners in law firms based on the misconduct of their other partners.

Decisions across the nation can illustrate the risk that so-called “innocent” partners face. For example, in Illinois State Bar Ass'n Mut. Ins. Co. v. Law Office of Tuzzolino & Terpinas, 27 N.E.3d 67 (Ill. 2015), the Illinois Supreme Court rejected a public policy argument seeking to protect innocent partners from a single partner's misconduct and to ensure insurance coverage for the whole firm.

The defendant in that case was a two-attorney partnership. The first attorney submitted a professional liability insurance application on behalf of the firm in which he denied knowledge of “any circumstance, act, error or omission that could result in a claim.” However, he had been accused of malpractice by a client only three months before, and failed to include it in the application or even to share that development with his law partner.

Shortly after the policy came into effect, the second, innocent partner received a lien letter from an attorney representing the aggrieved client. Not realizing that his partner was aware of this development and had failed to inform the insurance company of this potential claim in the application, the innocent partner reported the claim to the firm's insurer. Then, the company filed suit seeking rescission of the policy due to the material misrepresentation on the policy's application.

While the intermediate appellate court agreed with the second partner's public policy argument that it is “unfair . . . to rescind insurance coverage [for] an innocent insured who had no knowledge of [another partner's] misdeeds and the alleged misrepresentation,” the Illinois Supreme Court reversed. It ordered rescission of the policy in its entirety, including as to the innocent partner. Notably, the Court held that the innocent partner could not find refuge in the policy's severability clause. Even though that clause created a separate contract between each attorney and the company, the Court reasoned that both attorneys were equally tied to the representations in the policy's single application, which were material and simply not true.

While that case involved a two-attorney firm, there is a risk that this reasoning could apply to larger law firms, too. Indeed, a dissenting justice noted that he could not agree with his fellow justices' rejection of the public policy ramifications of their decision, because he was “troubled by the scope of the consequences resulting from the majority's holding on other law firms and especially midsize and large firms.”

Such an outcome is not a total outlier. The Sixth and Fourth Circuits have also rejected similar public policy arguments when the law firms did not contract for specific protections for innocent partners. See Am. Guarantee & Liab. Ins. Co. v. Jaques Admiralty Law Firm, 121 F. App'x 573 (6th Cir. 2005) (Michigan law); TIG Ins. Co. v. Robertson, Cecil, King & Pruitt, 116 F. App'x 423 (4th Cir. 2004) (Virginia law).

To protect against these risks, here are some steps that partners can consider in any effort to reduce the risk of facing personal liability arising from another partner's misconduct.

  1. Entity Formation

Formal incorporation might be among the first advice corporate attorneys provide to a client starting a new business. Lawyers can consider the same advice. Attorneys forming a law firm may consider what entity under Texas law best fits their needs and helps them limit their personal liability. For many, a professional association, a professional limited liability company, a limited liability partnership, or another entity available under Texas law may offer protections that general partnerships (or non-incorporated entities) do not.

Typically, once a firm organizes and incorporates in a specialized way, if there is a judgment against the firm, the plaintiff's recovery is limited to the firm's assets and not to the personal or individual assets of any innocent partner.

  1. Consider Insurance That Protects Innocent Partners

Legal malpractice insurance can provide broad, intermediate, or narrow coverage. Identifying and purchasing the best legal malpractice policy for the partnership's needs may help insulate the firm's assets as a whole, and accordingly, innocent partners' interests in those assets.

There are a number of ways to maximize coverage for innocent partners. For some firms, it is most helpful to seek out a policy with an “innocent insured” clause, which can help ensure that the conduct or knowledge of one partner does not negate coverage for other partners. An explicit contractual protection can be an important factor if there is an alleged misrepresentation or omission by a partner who has committed misconduct.

  1. Use the Partnership Agreement

Law firms can also privately contract — through their partnership agreement or other documents — to help innocent colleagues hold their badly-behaving partners accountable. Some firms will use a claw-back provision in the firm's operating agreement that permits innocent partners to claw back payments from at-fault partners as a way to help make sure that liability is fairly allocated after the fact.

Some firms will want to limit relief to claims involving intentional, criminal, dishonest or fraudulent acts or omissions by one of their partners — adhering to similar language as the standard legal malpractice policy exclusion. Other firms will want to permit recovery by the partnership from a partner who has knowingly violated the law or, in some case, has engaged in reckless misconduct.

Finding what works best depends on each partnership, but these three considerations may help limit unfair, personal exposure.

Shari L. Klevens is a partner at Dentons and serves on the firm's US Board of Directors. She represents and advises lawyers and insurers on complex claims and is co-chair of Dentons' global insurance sector team.  Alanna Clair is a partner at Dentons and focuses on professional liability defense.  Shari and Alanna are co-authors of “The Lawyer's Handbook: Ethics Compliance and Claim Avoidance.”