It will be up to the trial judge to adjust any entitlements if needed
Lawyers who withdrew from the partnership at insurance defence law firm Samis + Company failed to have the firm pay their disputed capital into court amid a breach of contract lawsuit.
Ontario’s Commercial List ruled on the issue in Samis + Company v. Strigberger, 2020 ONSC 585, finding that the capital will not be paid into the court, but that the firm must treat former partners’ capital with the same level of care as the remaining partners’ money, and the firm should provide the withdrawn partners with quarterly reporting of the firm’s financial position. It will be up to the trial judge to adjust any entitlements in light of any “depletion” or accounting issues if needed, said Justice Michael Penny.
“The plaintiffs have, in theory at least, no incentive to undermine the value of partners’ capital, provided there is no differential treatment as between the withdrawn partners’ capital and that of the remaining partners,” wrote Penny. “The potential risk of untoward treatment of the withdrawn partners’ capital can be addressed by appropriate financial management and disclosure orders.”
At the center of the case was a partnership agreement for the parties, who were partners through professional corporations. The defendant lawyers, Daniel Strigberger, Lisa Armstrong, Kathleen O’Hara and Krista Groen, withdrew from the partnership at the beginning of 2018, at which point the remaining partners sued them for breach of contract, breach of fiduciary duty and related claims totalling over $7 million.
The partnership agreement laid out a formula to pay out withdrawn members their entitlements, which yielded capital of $662,687.52. The agreement also says the remaining partners may “deduct and set-off against any payments to be made by the partnership to a partner or withdrawn partner all such losses, costs and damages.”
Because the withdrawn partners were demanding payments — and the remaining partners claimed the right to set off against the payments — the court looked at whether the embattled capital met rule 45.02, which “provides that where the right of a party to a specific fund is in question, the court may order the fund to be paid into court or otherwise secured on terms as are just.”
Core to the court’s analysis was whether the partners’ capital was a “specific fund.” Penny did not make a final call on the issue, but for the purpose of the motion, found that the capital account was a specific fund, not just an “accounting entry” that was comingled with other assets.
“This is not simply a damages claim; it is a claim to a specific amount to which a withdrawn partner is entitled under the agreement,” wrote Penny.
The withdrawn partners argued that they had little proof as to whether their capital was safe within the firm, as the firm paid down a $1.3 million bank loan within the first six months of 2018 “in the face of their obligation to pay the withdrawn partners their capital.” The withdrawn partners claimed they had “significant concerns with the manner in which net income was allocated to the partners in 2017.”
At this point in the case, Penny said that the defendants were not in any economic disadvantage by being deprived of the money ahead of the trial. Plus, wrote Penny, nothing in the partnership agreement requires partners’ capital to be segregated or protected from the firm’s liabilities.
“This is clear from the fact that they do not seek payment to themselves of their capital but payment of that capital into court,” Penny wrote. “[T]he very purpose of partners’ capital is to help with the financing of the firm’s day-to-day operations. It may be true that some of the partners’ capital was used to reduce the bank loan, for example, but the reduction of the bank loan adds concomitantly to the net value of the partnership.”
Lawyer Julian Heller, who represented the firm, says the decision deals with the tension between the right of the departing partners to “ withdrawal payments” based on their respective capital accounts, and the remaining partners’ right of set-off as set out in the partnership agreement.
“The fact that that set-off provision was specifically included in the partnership agreement was important,” says Heller. “The circumstances for ordering any payment into court would have to overcome the law’s extreme reluctance to make substantive monetary orders on an interlocutory motion.”
Both Heller and Lax O'Sullivan Lisus Gottlieb lawyer Nadia Campion (who represented the withdrawn partners), say the case had unique factual circumstances.
“I do not think that the decision will have any material impact on how law firms structure their partnerships. Capital accounts have been used in partnerships for a long time,” says Campion.
“I believe lawyers generally recognize that, although capital accounts are not physically segregated, they do reflect the capital contributed by partners and are therefore accessible for repayment depending on the terms of the partnership agreement.”