Breaking up doesn't have to be hard to do, Part 2

Three steps to reduce the risk and pain of advisor partnership breakups

25 November 2024

Published by Investment Executive  

Part 1 of this two-part series described the more common types of advisor partnerships and the associated risks (see Part 1 here). In this article, I will describe how to reduce your risks to avoid costly and protracted litigation (funny that this is written by a litigation lawyer).

Advisors usually sign a document directing their dealer to a joint code split after a brief discussion. Rarely is much consideration given about what could change between the partners over time and how the split would be adjusted to reflect their changed contributions.   

This article sets out some of the issues to discuss and resolve, preferably before the joint code document is signed, to provide to a corporate lawyer to draft an agreement. The agreement would address the present deal and how to resolve issues in the future.

As a litigator, I would not draft the contract, but I could help you consider and resolve the potential sticky issues. You would then instruct a corporate lawyer to include the terms of how the partners would resolve the “what ifs” in the contract. The goal is to avoid expensive, protracted litigation and instead, when the relationship changes, have a contract to guide you to a quiet and inexpensive resolution.

Most advisors don’t want to think about or spend the time to consider what could go wrong and how each issue would be resolved. Many advisors also say it would be too costly to hire a lawyer to prepare such a contract.

What they do not consider is the potential growth of the business over time and the cost of litigation if there is a bad breakup, which would easily be in excess of $150,000. The stress and distraction of a bad breakup also need to be factored in to the potential cost of not having a contract when things sour or change between partners.

If you are an advisor who is in, or contemplating entering into, a partnership, here are three steps you and your partner can work through to develop terms to incorporate into a contract.   

Step 1. Ask the questions necessary to take stock

Here is a list of questions, but it is not comprehensive because a lot depends on your specific circumstances:

• What are our current assets under administration?
• Who is contributing what? 
• Do we have clients specifically assigned to each partner working separately, or do we operate more like a team servicing each client together?
• What are the present business expenses (advisors in an independent model with their dealer assume more expenses)?
• Do the partners agree on the services they pay for (e.g., know-your-product software and client relationship notes software) and the cost of each?
• What is the present staffing, and does one partner need more staff than the other?
• Does the business operate efficiently or is there improvement to be made?
• Is there duplication of staff or services if you merge the businesses?
• Do you have the right staff — both in quality and quantity?
• How do you review each document or client contact so that the other partner can pick up where you left off, if that is your model? Further, is the documentation kept in a system that is owned by both advisors so that each has the right to the documentation at all times?
• Do you both value and conform to compliance requirements, and what are your present processes for dealing with new rules?    
• Have each of your businesses been audited, either by your dealer or your regulator, and can you share the report(s) received?
• Do either of you have a history of non-compliance? If so, share the details, including any terms and conditions quietly imposed by your dealer or the regulator. Of course, you should both do a search of the regulator’s website and a Google search to identify any skeletons.

Step 2. Consider potential changes, whether planned or unexpected (in five, 10, 15 or even 20 years)

• Is one partner in their prime and the other on a growth trajectory? While your present split of commission may reflect your present respective contributions, what does the future look like? Your contract would need to contemplate these anticipated changes.  
• What if one of the partners chooses or is forced to:
  • slow down for a period of time (e.g., you get sick but will recover, or care is needed for a terminally ill loved one),
  • work less, indefinitely (e.g., values or health result in one partner working less) or
  • stop working altogether (e.g., planned retirement or unexpected serious illness)?

Your contract must contemplate these circumstances; discuss with your corporate lawyer how you could adjust the compensation to the partnership accordingly.  

• Can you think of any other changes to the partnership that would require a change to the way you attribute the split of the code? 

Step 3. Consider circumstances in which the relationship would end

This is very difficult because if you thought you would break up, you probably wouldn’t enter the partnership in the first place. But you need to think through how an end would be managed. Consider the reasons to end the partnership:

• What if one of you suddenly passes away? What are your beneficiaries entitled to? Nothing? Something? How would entitlements be paid — over time or in a lump sum? How would a lump sum be financed?
• If one of you wanted to begin doing your own thing at the current dealer, how would clients be split to avoid disruption?
• What if one of you wants to move to another dealer to join another partnership or work solo?
  • Do you want to have a non-solicitation clause to prohibit the partners from soliciting certain clients or employees? 
  • What about a non-competition clause?

Non-solicitation and non-competition clauses are the subject of numerous judicial decisions. The enforceability of such clauses may differ in circumstances in which the clients are assigned by the dealer to the advisor (MD Physician Services Inc. v. Wisniewski, 2018 ONCA 440) and cases in which there is a clear purchase of a business (Dr. C. Sims Dentistry Professional Corporation v. Cooke, 2024 ONCA 388). To be enforceable, these clauses must be reasonable. Again, ask your corporate lawyer for advice on whether such clauses might be enforceable and how they might pertain to your partnership’s future circumstances.

•  What if one of the partners retires from the industry? This can occur even in a partnership of equal age/rank when one partner is ready before the other.
• What if one partner decides they no longer want to be in the partnership (e.g., the partnership no longer suits them or there is a worry or distrust)? A clause that contemplates this occurrence should be included.

There are other issues to consider including in your contract (again, this is not a comprehensive list):  

• Mediation clause. While I won’t get into details, mediation could be binding or not. Ask your corporate lawyer to explain the difference.
• Arbitration clause. This can result in a quicker, less public resolution than a court case but can be as expensive. This can also be binding or not.
• Legal fees and damages. In the event of a client complaint, who pays the legal fees and damages if the partners do not have errors and omissions insurance?
• Nepotism. Do you want a workplace nepotism clause that prohibits the hiring of family or close friends for jobs in the office?

Conclusion

Most of the time I am hired by one advisor to resolve issues between partners who have had a falling out and no longer trust each other. My recommendation is that, before you enter into a partnership or before matters change or sour between the advisors, consider this three-step process.

While a written contract may not contemplate and resolve every issue, if drafted properly by a corporate lawyer who understands the industry, the contract can guide the parties through most circumstances to resolve issues as the relationship changes, without the cost and stress of protracted litigation. Good luck!

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