As investors explore opportunities in the legal industry and a growing number of law firms seek new sources of capital, the management services organization (MSO) model has emerged as a leading structure to effectuate these transactions. MSOs are designed to comply with various ethics rules that require lawyer independence, professional judgment, and the preservation of attorney-client privilege, while providing law firms with access to capital and resources for support services. Requirements vary by jurisdiction, and an MSO arrangement does not, by itself, establish compliance with applicable rules.
The Basic Framework
In most[1] U.S. jurisdictions, professional-conduct rules modeled on ABA Model Rule 5.4 restrict or prohibit nonlawyer ownership of law firms, the sharing of legal fees with nonlawyers, and nonlawyer direction of a lawyer’s professional judgment. The MSO model operates within these limits by separating the practice of law from supporting business functions. The law firm remains wholly owned and controlled by licensed lawyers. It employs the lawyers, holds client relationships, maintains trust accounts, and makes professional decisions. The MSO, owned by investors and lawyers who choose to invest, provides nonlegal support services such as those relating to technology, finance and accounting, human resources, and facilities.
The two entities are linked by a set of contractual arrangements. Each arrangement is generally structured to be arm’s length and commercial such that the law firm retains sole authority over the practice of law.
The Services Agreement
The Services Agreement is the central agreement that sets out the terms between the law firm and the MSO. Under the terms of a Services Agreement, a law firm may engage an MSO to provide mutually agreed services, including financial reporting, budgeting, information technology services, human resources administration, non-professional vendor contracting, and facilities coordination. Notably, the law firm retains authority over the hiring, supervision, and compensation of lawyers (and, in some jurisdictions, other professionals such as paralegals), client engagements, privileged work product, and the practice of law. Accordingly, the MSO’s access to client confidential information and trust accounts is restricted.
In exchange for services provided, the MSO receives a fee from the law firm. Such fee should reflect the fair market value of the services and should be structured so that it does not constitute the sharing of legal fees with nonlawyers. Some jurisdictions expressly restrict percentage-based fee models. Potential fee models include flat, cost-plus, per-lawyer, or per-location fees, or combinations of these approaches. Whether a particular fee model is permissible depends on the applicable rules and the facts of the arrangement.
Related Key Issues
In preparing a law firm MSO transaction, parties may consider the following issues:
- Law firm governance and ethics: The law firm’s governing documents keep management and professional decisions exclusively with its lawyers, consistent with applicable ethics rules.
- Lawyer retention mechanisms: The parties may consider arrangements designed to retain key lawyers, consistent with applicable ethics rules.
- Continuity and succession planning: The documents address the effect of a founding or key lawyer’s retirement, departure, or inability to practice on the law firm-MSO relationship.
- Intellectual property matters: The parties address how brands, technology, and other assets are held and used across the relationship.
- Rollover equity in the MSO or its parent company and governance: The parties may negotiate the economic and governance rights associated with lawyers’ equity in the MSO or its parent company.
- Financing arrangements: The parties consider the terms of any financing, including the scope of the collateral package, and how those terms interact with applicable ethics rules and the law firm’s independence.
- Employee benefits and labor matters: The parties determine which entity employs nonlegal staff and how benefit plans, leasing arrangements, and employment obligations are allocated.
- Tax matters: The parties consider the potential tax treatment of the transaction structure, fee model, and any rollover equity issuance for the law firm, its lawyers, and investors.
- Multi-jurisdictional matters: The parties consider how the arrangement operates under the laws and professional-conduct rules of each relevant jurisdiction.
Conclusion
There is no one-size-fits-all structure for law firm MSO transactions. The applicable framework varies by jurisdiction, and some states, including California, Colorado, and Illinois, have imposed new limitations on these arrangements. As a result, structuring a law firm MSO transaction is a fact-specific exercise that turns on the jurisdictions where the law firm practices, the scope of services the MSO provides, the fee model, and the governance rights of each party. Careful drafting is necessary, but it is not sufficient. The structures most likely to endure are those that comply not only on paper but in practice, where the day-to-day operation of the relationship preserves the law firm’s independence, protects client confidences and privilege, and keeps professional judgment in the hands of lawyers.
[1] Certain jurisdictions like Arizona offer alternative paths to non-lawyer investment directly in law firms.