As mergers and acquisitions continue in a consolidating professional services market, and firms continue to look at their own equity structures to make sure they are able to recruit, reward and performance manage by reference to equity awards in the ongoing war for talent, it is worth considering the terms on which any partners can be removed from the equity structure and the potential pitfalls of so doing. De-equitisation for poor performance or on compulsory (eg age related) grounds is an area which is ripe for disputes given the potential emotional response it may attract. That is especially so where a capital event such as a sale or flotation occurs after the de-equitisation takes place. Firms considering any sale may take some comfort from the recent decision of the Court of Appeal in Parr -v- MSR Partners LLP (formerly Moore Stephens LLP) [2022] EWCA Civ 24.

Facts

Mr Parr joined the accountancy firm, Moore Stephens, in 1982, was promoted to salaried partner in 1988 and became an equity partner in 1995. The firm became a limited liability partnership (LLP) in 2005 and Mr Parr retained the status of equity partner under the LLP membership agreement (the Members’ Agreement).

The Members’ Agreement required partners to retire on the accounts date following their 60th birthday. In Mr Parr’s case, his contractual retirement date was 30 April 2018. There was also a provision permitting the firm to extend the retirement date of an individual partner if there was a valid business case to do so.

Mr Parr indicated that he would like to continue working past his retirement date as an equity partner. This was rejected by the firm, however it was agreed that Mr Parr would continue to be employed as a salaried partner for a period of 2 years until 30 April 2020 (‘the De-Equitisation Agreement’). The De-Equitisation Agreement was entered into on 13 October 2017.

In February 2019 the firm sold its wealth management division and a proprietary software product to third party buyers. The remainder of the business merged with a separate firm.

In January 2019 Mr Parr brought employment tribunal proceedings against the firm and its partners (‘the Respondents’). It was alleged that his demotion from equity to salaried partner was a result of direct age discrimination, such conduct extending over a period of time. Had he remained an equity and not a salaried partner, he claimed his share in the proceeds of the sale and merger would have been in the region of £3,000,000.

Employment Tribunal (ET)

The ET was also asked to consider as a preliminary issue whether Mr Parr had issued his claim in time.

Section 123(2)(a) of the Equality Act 2010 (‘the Act’) requires a claimant to issue any claim within 3 months of the date of the act to which the complaint relates. The firm argued that Mr Parr’s claim was time-barred, as he had failed to issue a claim in the 3-month period following the execution of the De-Equitisation Agreement on 13 October 2017.

However, the Act also provides that if the complaint relates to ongoing conduct extending over a period of time, the 3-month period will run from the date of when the ongoing conduct ceased. Mr Parr contended that the conduct complained of was ongoing. The ET agreed that there was a continuing act of discrimination (placing Mr Parr in a lesser role for reason of his age) which existed at the date upon which he issued his claim. Not surprisingly this point was appealed.

Employment Appeal Tribunal (EAT)

On appeal by the firm, the EAT determined that Mr Parr’s demotion was the result of a one-off event. Whilst the effects of the demotion had continuing consequences (eg reduction in salary), crucially, it was not conduct extending over a period of time. As such, Mr Parr’s claim was time-barred pursuant to section 123(2)(a) of the Act. Mr Parr appealed the decision of the EAT to the Court of Appeal.

Court of Appeal

It was held that the exercise of the compulsory retirement clause in the Members’ Agreement could only be applied once to any individual. It constituted one act and was not therefore, conduct extending over a period of time.

The Court of Appeal agreed that Mr Parr’s claim was time-barred pursuant to section 123(2)(a) of the Act and dismissed the appeal. It did however refer the matter back to the ET to decide whether it would be just and equitable to extend the limitation period pursuant to section 123(2)(b).

Had the court found that the exercise of compulsory retirement clause was a continuing act, then Mr Parr would have been entitled to bring a claim under the Act at any point until three months after the termination of his employment. Essentially, the limitation period would be live for as long as there was a contractual relationship between the firm and Mr Parr (notwithstanding that the De-Equitisation Agreement was entered into in October 2017, and that he was no longer an equity partner).

This would be unsatisfactory for any partnership or LLP considering any kind of sale or merger which may trigger a capital event as there would be no certainty on whether former partners still employed by the firm might bring a claim. Bean J recognised this in his judgment, considering that such an approach would encourage ‘greater ruthlessness’ by partnerships and LLPs to sever contractual ties completely with retiring equity partners, instead of allowing them to continue as salaried partners. This position would also be inconsistent with the Act, which encourages claims to be brought expeditiously.

That said, firms will need to continue to exercise any rights to de-equitise partners whether compulsorily or for performance related matters very carefully. The question of whether compulsory retirement was discriminatory was also considered by the Supreme Court in the case of Seldon -v- Clarkson Wight & Jakes and many firms have revisited their own members and partnership agreements in the light of this decision to make sure any decisions on compulsory retirement on performance grounds are justifiable. Many will now make sure that there are clear terms which allow for de-equitisation to manage financial underperformance and make room for junior associates’ progression to allow for succession in the business.

Both a firm considering de-equitisation (or indeed a revision of the equity structure) and any partner who is a potential candidate for de-equitisation will need to be clear on the terms of the partnership or members agreement. In particular they will need to be clear on whether there is a power to de-equitise; what the potential grounds are and whether they are met; and what is the voting threshold and can it be reached. They will also need to ensure that the correct procedure is followed (eg can the power be exercised in writing or does there have to be a partners’ meeting).

Importantly, the same considerations need to be taken into account as if the power were being exercised against an employee in terms of potential discrimination as well as giving consideration to the duty of good faith where that applies. In any case, any reasons or criteria for the exercise of the power must stand up to external scrutiny and the decisions leading to the exercise and the procedure to exercise the power itself must be clearly documented.

A failure to exercise any power in accordance with the terms of the members or partnership agreement, or to take into account any potential discrimination, may lead to lengthy and costly litigation, which could interfere with the smooth running of any sale or planned restructure.