What Every Lawyer Should Know about Corporate Structure: Professional Business Entities in Washington State.

I was recently asked to speak about the corporate practice of law to the King County Bar Association solo and small firm section.  The aim was to educate section members about the different business entities available to attorneys.  This blog post summarizes that presentation and explains the benefits of focusing on the business side of practicing law.  This post is for you, my fellow small and solo attorneys, and especially for those of you who are just getting started.

Should I Incorporate? YES!

Fundamentally, incorporation is the act of forming a new entity (a legal “person”) under the law.  This creates a separation between you and this new person, and as the owner of the new legal entity, you can use it to shield yourself personally from most liabilities while generating wealth. Accordingly, these fundamental concepts of corporate law provide the benefits of (1) liability mitigation and (2) increased value in your practice.

The first and most important benefit is that many liabilities will fall on your business entity without the ability of third party creditors to satisfy their debts against you personally.  These liabilities include torts where someone is hurt on your premises, employee disputes (staff and associates), and other contract disputes (your lease, legal research provider, paper supplier, etc.).

Many ask me “but aren’t I personally liable for the torts that I commit, like malpractice?”  Yes, you are. But what about a partner’s torts? Unless you and your partners are operating from within a corporate entity, you’re very likely jointly and severally liable, personally, for the torts a partner has committed.  So when you add a partner, the risk mitigation benefit of incorporation increases ten-fold. Yes, the liability protection for solos provided by incorporation is slightly less (and yes malpractice insurance will pay out first); however, even solos often hire an associate, work in tandem with another firm on a matter, or hire an employee. What if one of them is at fault for the tort?  You could be on the hook, personally. That’s how the benefits of incorporation can help a solo in those instances as well. It’s simply wiser for a solo to have a corporate form to maintain the option to hire an employee, associates, or a partner in an efficient and effective manner.

The second benefit of incorporation is the value you can generate separate from simply earning fees from your clients.  Apex Law helps many clients with practice transitions (think selling a dental practice, medical practice, etc.) as a part of our business law focus. We know that attorneys don’t think about selling a law practice in the same way, but they really should (yes, you can ethically and effective sell a law practice! See RPC 1.17).  This demonstrates the value of separating yourself from your business, because when you retire, the legal entity you created can continue on perpetually.[1] Also, having an entity streamlines a merger or acquisition if someone wants you to join their practice (i.e. buy your talent and goodwill) because of what you’ve built.

Finally, ask yourself: why not incorporate? After a cost benefit analysis, you’ll see that it simply makes sense.  To enjoy the benefits of incorporation, you must incur two costs: (1) pay the state filing fees for formation and annual renewal; and (2) follow corporate formalities.  The costs of doing (1) and (2) are negligible. It is roughly $200 to form a corporation in Washington state and $65 to renew your entity with the Secretary of State.  Following corporate formalities is equally as simple: make it clear to the world that you and your business entity are separate individuals. Specifically, this means that you should maintain a separate business bank account in the entity’s name; follow the formalities of your corporate structure (especially the notice process to allow other owners to engage on major business decisions); sign contracts in the legal name of your entity (with your name and title as authorized representative); and use marketing, advertising, and signage depicting the legal name of your entity.[2]

With all the rewards explained above, and for the relatively small costs, it doesn’t make sense NOT to incorporate.

Professional Corporate Entity Options

Okay, so now you’re convinced that you want to incorporate.  Your next question: what are my options?  Your options are: (1) the professional service corporation (P.S. or P.C.); (2) the limited liability partnership (LLP); and (3) the professional limited liability company (PLLC).[3]

Before I explain these options, a general rule bears mention.  Except under very specific instances, only licensed attorneys can be the owners (shareholders, partners, or members) of a professional service corporation whose principals and employees practice law.  Review RPC 5.4(d) (and the statues governing these corporate forms) for more information on that rule.

With that said, here are the basic facts, including some pros and cons, of each entity form.

1.      Professional Service Corporation[4]

A PS  is akin to a standard corporation. In fact, a PS is governed by the Business Corporation Act where that act is not in conflict with the Professional Service Corporation Act.[5]  Accordingly, a PS acts through a board of directors.  Shareholders vote in the corporation’s directors and are also the economic beneficiaries and owners of the PS, but they are not, as shareholders alone, the actors (management) for the company.

  • Pros: Solos can use this structure as the sole director, officer, and shareholder of the company.  While the formalities of a corporation can be an administrative burden, I’ve found that the heightened formality (shareholder voting, board resolutions, etc.) persuades the company’s owners to appropriately treat their PS as separate from themselves.  In other words, if you think that the less formal PLLC or LLP will not provide enough incentive for you and your partners to treat the company as separate from yourselves, then the PS’s formality is a pro.
  • Cons:  Corporate formalities.  A PS requires more administration than the other corporate forms because there are necessary annual shareholder meetings, board meetings, and a host of statutory and internal (bylaws) rules and procedures to follow.
  • Formation Documents:  The public, state filing is called the Articles of Incorporation.
  • Internal Governance Documents: (1) Bylaws, establish the procedures for electing management (officers and directors) and the processes for how management will operate the company; and (2) a Shareholders’ Agreements, which governing shareholders vis-à-vis one another, is typical to cover items such as share transfer and buy-sell provisions.

2.     Limited Liability Partnership[6]

The LLP is a much less formal structure than the PS.  Partnerships are expressly permitted to vary most of the statutory relationships of the partners to one another and to the LLP itself under a partnership agreement.  Thus, the LLP is governed more by contract law between the partners than by statutory formalities, and so LLPs are more flexible than corporations.

  • Pros: Flexible structure with the benefit of limited liability.  Partners can negotiate a wide-range of governance procedures and processes, as well as profit sharing and buy-sell provisions, within the partnership agreement.
  • Cons:  Solos cannot use an LLP structure because a partnership is defined as having two or more owners.  Solos will have to look to the PS or the PLLC (and the PLLC can achieve the same ends). There is no separation between ownership and management in an LLP—except under very narrow circumstances economic owners and managerial decision makers are the same people.
  • Formation Documents:  The public, state filing is called the Limited Liability Partnership Registration.
  • Internal Governance Documents: The partnership agreement.

3.     Professional Limited Liability Company[7]

The PLLC, akin to the LLC, is a hybrid between a corporation and a partnership. A PLLC is flexible in that they, like partnerships, are typically governed by contract (the limited liability company agreement or “operating agreement”) and not statutory law.   Furthermore, PLLCs are more flexible than LLPs because the members can choose to separate management from ownership (subject to professional ethical restraints) to have the PLLC look and act more like a share-issuing PS.   Called a “manager-managed” PLLC, some members can be afforded only economic interests while others might only be afforded managerial rights. The PLLC is unabashedly the structure I most often recommend.

  • Pros: Flexible structure with the benefit of limited liability.  Owners (called members) can negotiate a wide-range of governance procedures and processes, as well as profit sharing and buy-sell provisions, within the operating agreement.
  • Cons:  Establishing the PLLC to look and operate the way that the members would like it to may take time and effort to spell out in the operating agreement.
  • Formation Documents:  The public, state filing is called the certificate of formation.
  • Internal Governance Documents: The limited liability company agreement (often called the operating agreement).

 

Conclusion

Practicing law is running a business.  Yes, practicing law is a primarily a profession—and a service profession where we must put our client’s interests first—but those attorneys who also understand that their practice is a business will fare better than those who ignore the business aspect.  And the first step to running a law firm business is incorporating a professional business entity.

The article provided above is for general information purposes only and should not be relied on as specific legal advice. This article does not form an attorney-client relationship. If you have any questions about this article, please feel free to contact Peter J. Smith at peter@apexlg.com



[1] Tip:  Name your law practice something like “The Apex Law Group” or “Sophos Law” or “Beacon Law” instead of “the law offices of Peter J. Smith.”  A name apart from your own makes it easier to separate yourself from the “goodwill” value of your business.  When it’s time to sell your practice, the purchase can continue with the same name and reputation of your old firm name.  Therefore you can command a higher price for your practice.

[2] Yes, these are the sorts of things that a court looks for

[3] There is a long, sorted, and fascinating legal history regarding the corporate practice of a profession and why there are these specific professional corporate forms.  A blog post is simply not the best forum for me to geek out over the legal history of the corporate practice of a profession.

[4] See Chapter 18.100 RCW, the professional service corporation act.

[5] RCW 18.100.130.

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