High Drama And Hindsight
The LLP Shield, Post-Andersen
By Susan Saab Fortney
First, Enron. Then Arthur Andersen. We all look for lessons in these
Andersen partners and former partners are in a similar position as they
ask questions and agonize over how the firm's collapse will affect them
individually. Current partners know that they will probably never see a
cent from their capital contributions to the firm. Retired partners
anxiously wonder whether their $500 million in retirement accounts will be
protected or used to pay creditors and claimants.
With Andersen already facing more than $1 billion in claims and insurance
coverage estimated to be only $300 million, the most looming concern for
former and current partners of Andersen is whether they may be held
personally liable for Andersen debts and claims.
According to the Wall Street Journal (on April 2, 2002), many
Andersen partners who had "nothing to do with the firm's work for
Enron" are seeking legal advice because they fear personal liability
for the Enron-related claims.
In considering partners' personal liability exposure, some believe that
the good news may be that Andersen reorganized as a limited liability
partnership. At the same time, the bad news is that Andersen is registered
as an Illinois limited liability partnership and that nationwide, the LLP
structure is largely untested. Even if a partnership satisfies the
statutory requirements for LLP status, plaintiffs could attack the LLP
shield or try to plead around the shield. For claims against lawyers,
courts may exercise their inherent power to regulate the legal profession,
refusing to allow lawyers to limit their vicarious liability. Courts must
also answer questions related to interstate practice and conflict of law
Despite the uncertainty surrounding professionals practicing in limited
liability firms, the claims against Andersen and the law firms that
represented Enron have renewed interest in professionals practicing as
LLPs. Firms that have not previously converted to LLPs are now considering
Before rushing to jump on the LLP bandwagon, this article urges firm
managers to consider the various negative consequences of professionals
practicing as an LLP. Using information gleaned from the Andersen-Enron
experience, we'll discuss the possible traps of practicing as an LLP and
identify some developments and challenges to watch for in the cases
against the accounting and law partners who represented Enron.
This discussion should help firm partners realize that conversion to an
LLP is no panacea, but a relatively new organizational structure that may
create new problems and predicaments for practicing professionals and
persons who rely on their work and solvency.
The situation the Andersen partners and former partners (collectively
called Andersen partners) currently face is the very type of catastrophe
that the LLP structure was intended to address — the risk of
personal liability when the firm's assets and insurance are wholly
inadequate to satisfy claims.
To address this risk, Texas lawyers in 1991 proposed the nation's first
LLP legislation, enabling firms to continue to function as general
partnerships while limiting partners' vicarious liability for malpractice.
Following the adoption of LLP legislation in Texas, accountants and
lawyers aggressively pushed other state legislatures to adopt LLP
statutes. Now every state has modified its partnership laws, permitting
general partnerships to register as LLPs.
The actual protection for LLP partners varies from state to state. For
charts and commentary on state variations, see Alan R. Bromberg &
Larry E. Ribstein, Limited Liability Partnerships and the Revised
Uniform Partnership Act (2001 edition), Chapter 3. Most statutes now
limit vicarious liability for all partnership debts and obligations
("full shield" protection.). In some states, including Illinois,
the liability shield only limits a partner's vicarious liability for
claims based on negligence or misconduct of some partnership agent
("partial shield" protection).
Under full and partial shield statutes, partners remain liable for their
own negligence, wrongful acts and misconduct. Most LLP statutes also
provide some degree of personal liability for supervisory partners. As
explained below, the differences in the statutory liability shield can
affect both the dynamics of firm practice and the handling of
Conceptually, the general partnership principle of "all for one, one
for all," encouraged firm partners to actively participate in firm
affairs and management. General partners with unlimited liability should
be willing, indeed eager to devote time and resources to monitoring and
risk management activities that promise to reduce their personal liability
exposure. Conversion to an LLP undercuts this incentive in two ways.
First, it eliminates unlimited liability as an economic incentive to
devote time and resources to monitoring the conduct of firm players.
Second, the LLP statutes that impose supervisory liability actually create
a disincentive, undermining partners' willingness to participate in firm
management and supervisory activities.
As an LLP partner with no vicarious liability exposure, why should such a
partner get involved in firm management and supervision if those
activities will expose the person's assets? Is the desire to protect the
firm's reputation and assets enough to risk personal liability exposure?
When I was a firm partner specializing in legal malpractice work, I took
an active role in firm management and supervision. As a matter of
professional responsibility, risk avoidance and good business, I supported
the investment in monitoring and supervision activities to protect
clients, as well as the firm's assets, reputation and partners. Now,
senior lawyers may be more inclined to shirk supervisory responsibilities
when LLP status eliminates vicarious liability, concentrating liability on
individual tortfeasors and supervisors.
To address the liability exposure of supervisors, firms should carry
adequate malpractice coverage. Another approach to providing supervisors
some level of comfort would be for firm partners to agree to indemnify
managers and supervisors for losses they suffer for serving as managers
and supervisors. Without indemnification or insurance protection, risk-
averse partners may avoid supervision and management activities.
The reluctance of risk-averse partners to get involved in supervision and
management is exacerbated by the failure of the LLP statutes to define
clearly the degree and nature of control that will subject a supervisor or
manager to personal liability. Although most statutes hold supervisors
liable for persons under their direct supervision and control, the
statutes provide little guidance on precisely when a partner should be
considered a supervisor.
Is a supervisor strictly liable for acts and omissions of subordinates or
must a plaintiff establish negligence in supervision? Would membership on
an opinion committee or service as a section leader be enough to expose a
partner to personal liability if that partner had no direct involvement in
the alleged malpractice?
Professor Alan R. Bromberg's Comments following the 1991 Texas LLP
amendments explain that questions of supervisory control liability
"involve fact questions as well as interpretation of the statutory
language." Tex. Rev. Civil Stat. Ann. Art. 6132b § 15 cmts.
(1991 expired). Malpractice plaintiffs' lawyers will attempt to raise fact
questions on the responsibility of all firm partners connected with the
An Enron-related class action suggests how far sophisticated plaintiffs'
counsel might seek to extend supervisory liability. In addition to naming
Andersen partners who were an "integral part of the Enron audit and
consulting engagement," the complaint names country and regional
managing partners of Andersen and Andersen-related entities. In re
Enron Securities Litigation, Complaint, U.S. District Court for the
Southern District of Texas, Cv. H-01-3624 (April 8, 2002).
While the complaint identifies four Andersen partners as "control
persons" for purposes of the federal securities acts, their
managerial involvement may expose them to liability if they had
"direct supervision and control" as required by the Illinois LLP
statute. If Andersen supervisors are held personally liable, LLP partners
around the country will be even more reluctant to serve as managers and
Andersen's status as an Illinois LLP also illustrates the problems created
when professional firms eliminate the "all for one, one for all"
relationship in which all partners share unlimited liability for all
partnership debts. The LLP's elimination of unlimited liability for all
debts can create serious conflicts relating to sharing of liability and
payment of debts.
When the firm does not carry sufficient insurance to pay malpractice
claims, those partners with personal exposure will lobby for firm assets
to be devoted to pay the malpractice claim. Contrarily, other partners
will push for firm assets to be used to pay general firm debts such bank
loans and other debts for which partners have personal liability.
This conflict becomes particularly acute when the partnership is
registered under an LLP "partial shield" statute such as the one
in Illinois. Because the Illinois statute only limits liability for
misconduct-type claims, partners in an Illinois LLP can still be
personally liable for contract obligations such as those relating to the
firm's lease and line of credit. As a result, Andersen partners may remain
personally liable for contractual obligations after they leave the
Two former partners of Keck, Mahin & Cate, an Illinois general
partnership, believed that they could escape liability for Keck debts by
switching law firms. Following the bankruptcy of the law firm, former Keck
partners had the option to pay between $5,000 and $10,000 to settle claims
against them under the firm's bankruptcy plan. After Barbara P. Billauer
and Thomas E. Ho'okano declined to participate in the settlement, they
were sued for claims exceeding $5 million. Billauer and Ho'okano denied
liability, asserting that the claims were not in existence when they
withdrew from the partnership.
A bankruptcy judge for the Northern District of Illinois rejected the
former partners' arguments, finding the partners jointly and severally
liable for more than $3.7 million, including $1.6 million in malpractice
claims. As stated by the judge in a March 6, 2002, opinion, a
"partner cannot escape liability simply by leaving the partnership
after the malpractice is committed but before the client wins or settles a
malpractice claim." Keck, Mahin & Cate v. Billauer, 274
B.R. 740 (Bankr. N.D. IL. 2002). The clear message from the
bankruptcy judge was that a partner's change of address does not matter
because a partner remains liable for matters pending at the time of
dissolution. The Keck decision should concern Andersen partners who
believed that they could escape the Enron nightmare by switching
The exodus of Andersen partners and practice groups is another negative
consequence of the LLP structure. Andersen's U.S. payroll has dwindled
from 28,000 to 1,000 and its worldwide staff of approximiately 85,000 has
been similarly decimated. Lee Hackstader, "Andersen Hit with Maximum
Penalty; Judge Fines Firm $500,000, Puts It on Probation," The
Washington Post, Oct. 17, 2002. Rather than jumping ship, Andersen
partners might have been more committed to rebuild the firm had they
believed that they were personally on the hook for Enron claims. Why
remain with a crippled firm and have your future accounts tapped when you
have no personal liability?
Consider the response of accountants and lawyers sued by saving and loan
regulators. Law firm partners at Kaye, Scholer, Fierman, Hayes and
Handler, as well as other firms, stuck with their partnerships. To settle
the government's claims, Kaye Scholer partners agreed personally to pay
$16 million. If Kaye Scholer partners had limited liability, they might
have been more inclined to find another firm home rather than paying the
claims out of future revenue.
Lawyers, more than accountants, enjoy a great deal of mobility in theory
because courts typically do not enforce restrictive agreements that
violate lawyer ethics rules. LLP law partners with portable business have
little incentive to stick with a firm facing large claims. On the other
hand, general partners will be more committed to firms when they share
Committed partners who share unlimited liability should be interested in
carrying adequate levels of insurance and devoting commensurate resources
to risk management. Conversion to an LLP firm can affect the firm's
purchase of insurance if partners no longer worry about vicarious
liability exposure and carry lower limits of liability. Andersen's $300
million in malpractice liability coverage appears woefully inadequate
given Andersen's exposure and $4 billion in revenues in 2001.
At insurance renewal time, the LLP structure can also create conflicts
between partners. Those LLP partners who believe that they have a limited
liability shield may prefer to carry policies with lower limits of
liability than they would carry if their firms operated as traditional
partnerships in which partners shared personal liability. On the other
hand, LLP partners with more personal exposure because of the nature of
their practices and firm responsibilities will prefer that the firm carry
higher limits. With the costs of malpractice insurance significantly
increasing, partners who lobby for lower limits may prevail.
The limited liability structure can also affect the adjustment of claims
made under professional liability policies. Unlike the traditional
partnership in which all partners are aligned in sharing unlimited
liability, partners in an LLP sit in different positions. Those partners
involved in the representation share personal liability, while other
partners will try to stand behind the LLP liability shield. Possible
conflicts between sued partners can also result in cross-claims, requiring
separate counsel. Assuming that the policy requires that defense costs be
deducted from the limits of liability, these additional defense costs will
further drain the amount available to pay judgment and
The LLP structure can create conflicts and other problems within firms
that affect both firm stability and relationships. From the perspective
of clients and the public, the most serious consequence of the LLP
structure may be asset insufficiency. Asset insufficiency occurs when the
assets of the firm and the tortfeasors fall short of the amount necessary
to satisfy creditors' claims. This is a real risk with thinly capitalized
firms in which partners minimize their investments in the firm and rely
on debt financing. Following a large judgment, firm partners who are not
personally liable could seek to dissolve the defendant firm and relocate.
To the extent that firm property is collateral for secured creditors'
claims, it will be unavailable to tort victims both in and outside of
bankruptcy. Once the firm is in bankruptcy, the court will give secured
creditors priority over tort victims. This leaves the tort victim holding
a judgment against the bankrupt law firm and the individual
This brings us to the billion-dollar question — would the Andersen
collapse have happened if Andersen were a traditional partnership? While
Andersen's obstruction of justice conviction sounded Andersen's death
knell as a full-service auditing powerhouse, we are left wondering about
the deleterious effects of Andersen functioning as an LLP. Would Andersen
partners have elected to carry higher levels of insurance if they were
exposed to vicarious liability? Would Andersen partners with vicarious
liability have been more inclined to scrutinize risky Enron transactions
rather than take the $52 million in annual revenue from Enron?
As suggested by two scholars, limited liability creates a moral hazard by
allowing participants to reap the benefits of risky activities and not
bear all of the costs. Frank H. Easterbrook & Daniel R. Fishel,
"Limited Liability and the Corporation," 52 Chicago
Law Review 89, 103-04 (1985).
These questions should spur firms to evaluate carefully the advisability
of operating as LLPs. Legislators should revisit statutory minimum
insurance requirements. Rather than using a "one size fits all
approach" requiring that LLP firms carry a specified amount of
insurance, a modest modification would be to require that insurance be
based on the number of firm partners or revenue.
Ten years after adoption of the first LLP statutory provisions, we should
seriously consider if the adoption of LLP legislation was a misguided
reaction to the malpractice claims brought by government regulators. Now
with the failure of Arthur Andersen, we are left re-evaluating whether the
public, and even firm partners, would have been better served had firms
invested in monitoring, insurance and risk management, rather than relying
on the untested LLP shield.
In October, 2002, Joe Berardino, former chief executive officer of
Andersen, participated in a panel discussion at Georgetown University. In
discussing the failure of companies like Enron and WorldCom, he concluded
by saying, "I think that the future is full of promise for those who
heed the lessons and mistakes of the past." Georgetown University
Wire, Oct. 22, 2002.
Identifying lessons from the collapse of Andersen gives professionals an
opportunity to address problems created by practicing in LLPs.
Fortney is a professor at Texas Tech University School of Law, in
Lubbock, Texas. Her e-mail is