Merging two accounting practices can be a complicated endeavor, but the transaction takes on an entirely new order of complexity when one of the practices is simultaneously separating from its current firm.

Separations (also called split-offs) are akin to divorce. Some divorces are amicable, while others are acrimonious, but either way, there is always a level of complication in separating and unwinding a relationship that has existed for a long period of time. While this article will certainly not address all questions, or apply to every situation, I hope that it provides a good framework from which to begin a process that is consistently the cause of much trepidation.

 

CALL FOR A COMMITTEE

Once it is determined that a split-off is likely, a special committee should be formed of the group of partners that will be departing. The committee should be granted certain authority to negotiate with the firm’s executive committee on behalf of the larger group. This arrangement helps to avoid the “too many cooks in the kitchen” scenario that can bog down or even derail any negotiation. In the case of a partner who is both a member of the firm’s executive committee and on the new special committee, that partner will, of course, need to recuse himself from executive committee deliberations on the separation transaction.

This same committee will likely have a continuing role after the transaction closes as representatives of the separated partners. Most important, it will typically have the authority to settle any claims on behalf of all of the separated partners with the old firm. Those sitting on the committee will be indemnified by the partners they are representing, and the committee itself may also have certain rights with respect to the allocation of transaction proceeds (including earn-out proceeds) among the separating partners. In addition, the committee should retain a certain amount of funds after the transaction to finance legal or settlement expenses.

 

EXISTING PARTNERSHIP AGREEMENT

In any separation, it is critical that the existing partnership agreement be reviewed carefully, though it will ultimately be superseded by the agreement containing the terms of separation. The Separation Agreement may call for certain provisions of the partnership agreement to continue post-transaction. For example, the separating partners may retain an interest in certain assets or subsidiaries of the firm. It is also important to note that the separating partners should be released from the restrictive covenants of their existing partnership agreements  at least with respect to clients being purchased.

 

ECONOMICS

The economics of the transaction are the most fundamental and potentially contentious item to navigate, and the difficulty or relative ease of these negotiations largely depends on the degree of civility between the parties involved. If there is distrust between the parties, the negotiations will be more difficult and more expensive, as attorneys on both sides of the table will be instructed to spare no measure to protect their client.

It is important to note that the acquiring firm will be purchasing the goodwill associated with the practice, in the form of client relationships and restrictive covenants, often along with other assets like accounts receivables, work-in-progress, and even furniture and office equipment. The separating partners may receive a portion of the value of their assets as former partners of the selling firm.

 

REPRESENTATIONS TO BUYING FIRM

Before this type of transaction may proceed, representations relating to the separating practice will need to be made to the purchaser.  The question as to who should be responsible for those representations, however, can be a point of material contention.

On one hand, the firm will be receiving the benefit of selling the practice, and so the argument can be made that the liability for the representations should rest with the entity receiving the consideration. On the other hand, the group moving to the new firm may be in a better position to know whether or not the representations and warranties relating to that practice are accurate. To the extent of that exposure, there must be an allocation of liability between the remaining firm and the separated partners that takes into account both who receives the proceeds of the transaction, and who is more likely to be in a position of knowledge relating to the representations and warranties.

 

LITIGATION INSURANCE

Who should have responsibility for potential litigation exposure? This breaks down into several categories. If the selling firm is sued for a matter that predated the separation but did not involve the separating practice, should the separating partners have responsibility for the matter in the same manner as if they had stayed at the firm? If the matter relates to the separating group, should that group have more of the responsibility?

It is my view that regardless of whether the claim relates to separated partners or not, the responsibility for matters related to actions that occurred before the separation should be allocated among those who were partners at that time. In a related vein, the separating partners will want to make sure that the existing firm maintains insurance in a manner similar to that which it maintained in the past, including similar coverage and deductibles. Finally, depending on how these issues are resolved, control of litigation should also be addressed, typically with the party that will bear the preponderance of risk maintaining the right to control the litigation and select counsel that is reasonably suitable to the other party.

 

ADDITIONAL CONSIDERATIONS

  • Releases. Both the separating parties and their former firm will likely require releases from prior actions from the other. Claims that predate the separation are typically released, though there may be certain exceptions, particularly relating to fraud or willful misconduct. The selling firm may also wish to receive indemnities resulting from potential bad acts of the separating partners, such as sexual harassment claims.
  • Transition services. In most cases, the acquiring firm will need to obtain transaction services from the billing firm for a certain period of time. This commonly includes IT services, which must be gradually disentangled and the relevant information migrated over, as well as loaned personnel and office space. In these instances, a point person on each side should be selected to coordinate the transition services.
  • Dealing with clients. The parties must reach an agreement regarding when clients may be notified — generally after the definitive agreement is executed, but in some cases not until the transaction has closed. Additionally, permission to transfer files must be obtained.

There is no doubt that split-offs can be daunting and complex; however, the basic principles of such deals are really no different from any other corporate transaction. The added complexity of adding an additional party to the mix may be mitigated, at least in part, by ensuring that all parties (and their representatives) remain in close communication, and utilize the methodical approach outlined above.
Russell Shapiro is a partner in the Corporate & Securities Group at Chicago-based Levenfeld Pearlstein LLC. He focuses his practice on mergers and acquisitions — particularly those involving accounting firms.

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