What will happen to your practice if something happens to you?

Attorneys spend countless hours devoting themselves to their profession by becoming a knowledgeable and tireless advocate for their clients. Every day attorneys invest their blood, sweat, tears and financial resources to build a practice and a list of clients that consider them their trusted advisor, part of their inner circle and provider of exceptional service. In addition, their presence in the office is crucial to the smooth operation of the firm – from overseeing the staff to generating the income that funds day-to-day expenses.
What if you were injured or became sick? Could your practice survive? Would your clients leave?

Life isn’t just about making it. At some point, it’s about keeping it and everything you’ve worked so hard to build. Few attorneys and their partners have a plan in place to protect their business in the event of a prolonged or permanent disability of a partner. In fact, few attorneys or business owners realize that an illness or accident could cause such a disability. If one of the firm’s partners became disabled, the effect on the firm could be devastating. The healthy partners would be faced with the task of running the firm while deciding how long the firm could continue to pay the disabled partner. In addition, in a firm with multiple partners, the working attorneys would not only need to generate enough revenue to compensate the disabled partner but to pay for the disabled attorney’s share of overhead. For example: In a firm with three partners producing equally, if one of the attorneys becomes disabled, the remaining two attorneys would each have to increase their individual production by 50% to replace 100% of their disabled partner’s revenues, as well as increase their overhead ex-pense contributions by 50%. How could this be feasible when they are already maxing out their time by doing as much work as they can and seeing as many clients as possible? Moreover, if the disabled attorney has a particular niche or specialty, his clients will surely leave for another firm. In all likelihood, the disabled partner will want to recover the capital he or she has invested in the firm. In addition, the remaining partners will be challenged to come up with the money to buy the disabled partner’s share while remaining in business.

A Buy/Sell agreement is the first step in protecting a law practice in the event that one of the partners becomes disabled. The Buy/Sell agreement defines how a partner’s interest will be purchased if he or she withdraws from the firm, retires, dies or becomes permanently disabled. It helps to ensure that the professional practice can continue after the total disability of one of the partners forces him or her to stop working. It does this by requiring each disabled partner to sell his or her interest to the remaining owners – or to the business entity itself – under the terms defined in the agreement. It equally obligates the remaining owners or the business entity to purchase the disabled partner’s interest, and stipulates the formula by which the “fair market value” price will be determined. It is negotiated in advance of the disability by a mutual agreement among the partners.

Disability Buy-Out Insurance shifts the burden of funding the buy-out from the partners or the professional practice to the insurance company, and insures that funds are available when needed. It is incredibly economical since the funding is accomplished as a result of paying premiums – not from depleting savings, investment accounts, drawing from future earnings, or affecting credit sources in order to buy out the disabled partner.

From the outset, a buy-out agreement should be drafted to include disability provisions. The three basic forms of buy-out agreements are: 1) an entity purchase disability buy-out; 2) a cross purchase disability buy-out; or 3) a trustee cross purchase plan.

In an entity purchase disability buy-out, the firm itself purchases the disabled partner’s interest in the law firm. The law practice purchases one Dis-ability Buy-out policy on each partner and the firm is the policy owner, loss payee and premium payer on all policies. This is usually the preferred option when a firm has three or more partners.

In a cross purchase disability buy-out, the individual partners purchase disability buy-out policies on the lives of the other partners for an amount equal to each partner’s proportionate share of the business interest. The individual partners are the policy owners, beneficiaries and premium payers on the policies. This arrangement is best when there are only two or three firm partners, otherwise a large number of policies must be purchased.

In a trustee cross purchase plan, the law firm partners pay to a trust or trustee their share of the premium necessary to purchase Disability Buy-Out Insurance policies on each owner. The trust purchases a Disability Buy-Out policy on each owner and acts as premium payor, owner and loss payee. Upon the disability of a partner, the policy proceeds are paid to the trustee. The law firm’s healthy partners purchase the disabled partner’s share when the trust distributes the policy proceeds pursuant to its terms. A trustee cross purchase agreement is generally used when there are more than three partners/owners and they want to retain the tax advantage on a stepped-up basis, should they sell their interest in the future as a result of their disability.

Notwithstanding the inability to provide essential legal services to clients and facing the risks that clients may be forced to leave the firm to find another trusted legal adviser, the law firm’s future may be in jeopardy. A law firm’s revenue will likely suffer due to the attorney’s inability to perform paid-for services, provide the leadership that staff requires and continual or escalating business expenses.

How long will the financial obligations associated with the law practice continue to be met? As day-to-day expenses start to add up, attorneys might be forced to consider drastic measures like terminating staff, taking on debt or even closing the firm’s doors. However, there is another option – one that enables attorneys and professional practices to cover their ongoing overhead expenses and keep the firm running so that there is a viable practice to return to. Overhead Expense Dis-ability Insurance is a cost effective way to ensure that attorneys can meet ongoing expenses during a period of disability. It protects the legal practice from financial loss whether the attorney returns to work or decides to sell his practice. Similar to the way individual disability insurance can help pay living expenses while recovering from a serious injury or illness, Overhead Expense Disability Insurance can help keep a law firm up and running by paying ongoing expenses such as rent, utilities and taxes. In addition, the best policies pay up to 80% of the salary of a temporary replacement, the salary and benefits of employees and payment of interest and installments on loans. Most importantly, it will preserve the continuity of the law firm and retain clients that may otherwise be forced to seek new counsel during the attorney’s absence.

Lawrence M. Cohen, Esq. is co-founder of Strategic Practice Management Group, a Woodbury, New York based firm specializing in risk management, business planning and practice management for attorneys and law firms. Contact him at 516-677-5040 or lawrence@disabilityinsurancestrategies.com.