Sunday, April 17, 2011

Modern Law Firms May Not Be What They Seem

There is a recent case from March 2011 that caught my attention: a Louisiana personal injury lawyer, who operated an “attorney incubator”, owned $158,000 in back taxes because he misclassified his associates as independent contractors instead of as employees. The U.S. Tax Court decision can be found here:

I found this case to be of interest for two reasons. First, this case highlights a widespread practice in the legal community where small law firms that are essentially solo operations affiliate with other attorneys who they qualify as independent contractors rather than employees. Second, this case brings into spotlight the operations of smaller law firms and raises ethical questions.

I. Employees or independent contractors?

In Donald Cave’s case, his firm had three associates. Mr. Cave did not require associates to work from the office or have set hours or account for their time. He did not require the associates to sign employment contracts or non-compete agreements. The associates received one-half of the gross fees collected in cases they generated and one-third of the gross fees collected in cases referred to them by Mr. Cave. The remainder of the fees went to pay for firm expenses, including support staff salaries, telephone bills, and computer and software expenses, as well as for distributions to Donald Cave. Associates generally decided their legal strategies and were only required to give oral updates with respect to the cases referred to them by Mr. Cave and for which he provided an advance payment of case expenses. In addition, Mr. Cave provided his associates with professional office space, secretarial services, business cards identifying the associates as his attorneys, computers, printers, telephones, copy machines, faxes, offices supplies, access to his law library, internet service and computer server.

The Tax Court looked at the following factors to determine whether these associates were independent contractors or employees: “(1) the degree of control exercised by the principal over the worker, (2) which party invests in work facilities used by the worker, (3) the worker’s opportunity for profit or loss, (4) whether the principal has the right to discharge the worker, (5) whether the work is part of the principal’s regular business, (6) the permanency of the relationship, and (7) the relationship the parties believed they were creating.” The Tax Court also stated in the opinion that “no single factor is determinative, all facts and circumstances must be taken into account, and doubtful questions should be resolved in favor of employee status.”

Interestingly, in discussing the first factor, the Court noted that for professionals, the level of required control is generally lower and there are many lawyers who are employees but who “carry on their professional work with a minimum of direct supervision or control over their methods.” Also, the Court took into account the fact that the associates were expected to help Mr. Cave on his cases and that he referred to them his overflow work in order to help them build their practices. At the end, the Tax Court deemed that the associates were in fact employees and not independent contractors, as Mr. Cave classified them throughout their association with his firm.

II. Attorney Incubator - good practice?

This case is also about the confusing structure of modern small law firms, where the relationship among the attorneys is not always clear. Are attorneys partners, associates or of counsel? Also, how does the relationship among lawyers affect the legal services that such lawyers provide to their clients, if at all? The “attorney incubator” model that Donald Cave practiced is not that rare, but does it raise any ethical concerns?

So, to all the clients out there, - be careful in choosing a law firm to represent you or your business. You should make sure that the attorneys you choose will work as a team rather than as a loosely affiliated group of essentially solo practitioners. There is a lot of value in being represented by a team of attorneys, who can discuss your case and add to it their own perspectives and legal strengths (of course, as long as it is done effectively and cost efficiently).

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