If you work in a large firm, one question you never have to ask yourself is what business entity makes the most sense for your law practice. Strike out in any entrepreneurial venture, however, and this becomes a key threshold question as you set about your work.
What You Need to Consider
Your choice of business entity has many ramifications, many of which have nothing to do with ethics rules or considerations specific to lawyers. Here is what you need to begin considering when making a decision:
- Type of business. What type of law firm do you plan on operating? A non-profit may have different needs than a for-profit firm.
- Number of lawyers and their roles. Is this a solo practice? A partnership? A single principal with associates?
- Financing. Will you be seeking business loans for the firm? If so, you may want to insulate yourself from personal liability on those loans if the lender will lend to you as an entity.
- Ongoing recordkeeping and reporting requirements. Some entities have more reporting obligations than others. If you are going to be a true solo operation, you probably don’t want more reporting requirements than necessary. If the entity will have more hands on deck, you can afford to have more requirements.
- Management. The person making the decisions on how the firm is run can impact your choice of business entity. A general partnership with two or three equal decision makers may make sense for some; solos may not need to have a lot of structure in management.
- Taxes. One of the biggest concerns for every business entity is how it will be taxed.
- Non-tax costs. Some non-tax costs are directly related to the type of entity you create. An LLC carries a hefty annual cost in some states but only a minimal fee in others.
Leaving the general considerations applicable to all businesses aside for the moment, there are some issues particular to lawyers that you need to consider when choosing an entity. Here are two critical questions that need answers:
- To what extent can you insulate yourself from liability?
- What specific entities are permitted for law firms in your state?
For any business, one of the primary benefits of using an entity is to limit your potential liability for debts of the business. For this reason, any analysis for a business begins with the question of liability insulation.
For lawyers, we are of course concerned about debts a firm may incur, and typical entity liability rules will apply to regular bills such as those owed to vendors. So if your law firm is an LLC and the LLC owes a document reproduction company, the company can only recover from the LLC.
What you should be concerned about, though, is malpractice claims. No business entity can protect you from personal liability on your own malpractice claim, because the tort of malpractice is recoverable against the individual who committed it. For this reason, no business entity takes the place of malpractice insurance.
However, a business entity can help shield you from vicarious liability for malpractice committed by others in your entity. This is a tremendous benefit and a vast improvement from old-school general partnerships where each partner was liable for the acts of others. To take advantage of this benefit, you must strictly comply with your state’s rules for lawyers operating as entities. You may be required to register the entity with the state bar or ethics board, for instance, in order for the protections to be triggered.
Options for Business Formation
Each state regulates for itself the form in which law firms may operate. For specifics on your state, check with your state bar and statutes governing business forms. Generally speaking, law firms are permitted to operate in the following forms:
Limited Liability Partnership
LLPs are a very common way for partnerships of all sizes to operate in a more protected manner than a general partnership. Most of the biggest firms are LLPs, as are countless small firms. In an LLP, the partners are not responsible for the debts of other partners. States that allow law practices to operate as LLPs may also require that they be registered with the state bar.
In California, for instance, an LLP operating as a law firm has certain strict requirements, including that every member of the LLP be a lawyer and that the LLP be registered with the state bar. Failure to register automatically precludes the LLP from invoking the limits of liability set forth by statute.
States have various forms of corporations which can be used for law practice. In New York, the corporate form for lawyers is the Professional Service Corporation; in California, a corporation registered with the state bar to operate as a law firm becomes known as a law corporation; and Texas allows a professional corporation to operate as a firm.
Limited Liability Company
Most states allow law firms to operate as LLCs or as professional limited liability companies. For example, New York and Florida allow PLLCs, and Texas allows law firms to be LLCs. California explicitly does not allow lawyers to be LLCs, as no business for which a professional license is required can operate as an LLC.
Some states also offer law firms to operate as “professional associations” which can have different meanings depending on the state. In Florida, a PA is a corporation registered to provide professional services; in Texas, a PA is a different entity than a professional corporation.
The business entity options allowed for lawyers vary from state to state, as do the specific requirements ensuring that the limitations on liability rules apply to the entity. It is imperative that any entity being formed be fully researched and the state requirements complied with strictly.
And remember, when choosing and implementing a business entity for your firm, no amount of corporate structure can prevent malpractice exposure for your own actions.
Originally published 2015-02-23. Republished 2020-01-17.
Last updated January 17th, 2020