Incorporated Legal Practice & Directors' Duties

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derived from the LSBs power to conduct an

audit of the compliance of an ILP with theLPA

(s2.7.22).

While there is no stated LSB time limit

for submission of the self-assessment, three

months would be appropriate. Submission

within three months is the requirement of

the Office of the Legal Services Commissioner

(NSW) (OLSC) and the Legal Services

Commission (Queensland) (LSC).6

REQUIREMENT TO HAVE A LEGALPRACTITIONER DIRECTORAn ILP must have at least one legal practi-

tioner director in addition to any directors

who are not legal practitioners (s2.7.10LPA).A legal practitioner director is an Australian

legal practitioner who holds a practising cer-

tificate as a principal of a law practice and is

appointed to the position of a director (s2.7.2).

The CA defines directorasa person who is

appointed to the position of a director, or is

appointed to the position of alternate direc-

tor and is acting in that capacity, regardless

of the name that is given to their position.

Also, unless the contrary intention appears

a person who is not validly appointed as a

director is also regarded as a director if they

act in the position of a director or the direc-

tors of the company are accustomed to act inaccordance with the persons instructions or

is the fundamental obligation placed on an

ILP before it can engage in legal practice.

An ILP wishing to engage in legal practice

in another state must comply with the notifi-

cation requirements under each statesLegal

Professio n Act. Of note, aside from the statu-

tory implications of breaching s2.7.7(1), the

LPA is silent on the recovery of costs during

the period of breach. The equivalent Legal

Profession Acts in NSW, Queensland and WA

explicitly disallow recovery of any amount

for anything the corporation did in contra-

vention of the notification section and allow

the ILPs client to recover as a debt due any

costs paid during the period of breach.2 There

is no prohibition on a corporation providing

non-legal services before notification, but it

must not represent itself as engaging in legalpractice (s2.7.8).

After notification, the LSB requires com-

pletion and submission of the self-assessment

audit (self-assessment).3 The LSB requires

every corporation that engages in legal prac-

tice in Victoria to undertake an internal (or

self-assessment) audit of its compliance with

its obligations under Part 2.7 of the Act.4

Part A elicits information regarding the ILP

and details of all legal practitioner directors,

and all other directors and shareholders. Part

B is an internal self-assessed management

systems audit relating to the implementation

and maintenance of appropriate managementsystems (s2 .7.10(3)).5 The self-assessment is

T

he incorporation of a sole practitioner

or a law firminto an incorporated legalpractice (ILP) is becoming more preva-

lent in Victoria.1 While there is much to

be considered in the decision to incorporate,

the statutory and regulatory obligations are

sometimes not given prominence.

This article outlines the major statutory

and regulatory obligations placed on ILPs

and legal practitioner directors by theLegal

Professio n Act2004 (LPA), theLegal Profession

Regul ation s 2005 (LPR), the Legal Services

Board (LSB), and the Corporations Act2001

(Cth) (CA).

WHAT IS AN ILP?An ILP is a corporation (s57A CA) that

engages in legal practice in the jurisdiction

of Victoria, whether or not it also provides

non-legal services to clients (s2.7.4(1)LPA).

Legal services are defined as work done, or

business transacted, in the ordinary course

of legal practice (s1.2.1LPA).

ILP NOTIFICATION OBLIGATIONSAfter meeting the CA and ASIC obliga-

tions regarding incorporation, the ILP must

notify the LSB in writing on the approved

form before it starts to engage in legal prac-tice in Victoria (s2.7.7(1)LPA). Notification

The legal and professional obligations of law firms that incorporate can be complex andpotential conflicts between them and directors duties need to be watched. By Patrick Oliver

INCORPORATION

PROCEED WITH CAUTION

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LEGAL PRACTICE

ILLUSTRATION SHANE McGOWAN


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Duty to act in good faith in the bestinterests of the company and toexercise powers for a proper purpose

Directors are under fiduciary duties to act ingood faith and in the best interests of the cor-poration and to exercise their powers for aproper purpose, not for the purpose of gain-ing an personal advantage (s181(1) and (2) CA).These duties are of importance to an ILP. Forinstance, if a legal practitioner director wasconsidering leaving the ILP to set up a rivalfirm and was taking clients, would that direc-tor breach the duties to act in good faith and

in the best interests of the ILP?

Duty to avoid undisclosedconflicts of interest

Directors are under fiduciary duties not tomake undisclosed personal profit from theirposition as a director (ss182 and 183 CA). Thestatutory duties extend to employees as well

as directors and officers.

CONFLICT BETWEEN LEGALPROFESSIONAL OBLIGATIONS ANDDIRECTORS FIDUCIARY DUTIESThere is an inherent conflict between cer-tain directors fiduciary duties and those ofa legal practitioner under their professional

obligations. Tension arises between a legalpractitioners professional duty to act in thebest interest of their client coupled with theiroverarching duty to the court on one handand their duty as a director to act in the bestinterest of the company (i.e. the shareholders)on the other. Common examples include:t Settling litig ation pre-trial may be in the

best interests of the client and the admin-istration of justice, but not in the bestinterests of an ILP, as a corporation, whichmay stand to generate more fees if the liti-gation process is prolonged.

t Pro bono legal services are certainly inthe best interests of the community andthe administration of justice, but as theydo not generate revenue may not be in thebest interests of the ILP as a corporation.The legal practitioners duties to the court,

the administration of justice and their clientstake precedence over a directors general fidu-ciary duties. Safeguards have been placed intheLPA to ensure that this hierarchy of obli-gations is maintained. In respect of conflictsof interest in general theLPA states that forthe purpose of any law (including the com-mon law) or legal professional rules relatingto conflicts of interest to the conduct of a

legal practitioner who is a legal practitioner

director or an officer or employee then theinterests of the ILP are also taken to be those

t taking all reasonable action available to

deal with any unsatisfactory professional

conduct or professional misconduct of an

employed legal practitioner (s2.7.11(2));

t ensuring that the ILP complies with its dis-

closure obligations (s2.7.15);

t ensuring that a disqualified person (s1.2.1)

is not a director, officer or employee or

shares receipts from the provision legal

services (s2.7.21); and

t not exerting undue influence or causing

or inducing a legal practitioner director or

another legal practitioner who provides

legal services on behalf of the ILP to contra-

vene theLPA, theLPR, the legal profession

rules, or the professional obligations of a

legal practitioner (s2.7.35).

LEGAL PRACTITIONER

DIRECTORS DUTIES AT COMMONLAW AND UNDER THECAThe common law and the CA impose fidu-

ciary duties on the directors and officers of

a corporation. These fiduciary duties apply

to all direc tors of an ILP, so are in addition

to legal practitioner directorsLPA obliga-

tions. The CA fiduciary duties (ss180-183

CA) do not replace the common law fiduciary

duties; rather they replicate, and in some cir-

cumstances extend, those duties.

Duty to exercise reasonable

care, skill and diligence

Directors are under fiduciary duties to exer-

cise their powers and undertake their duties

with a reasonable degree of care and diligence

(s180 CA). Under the tort of negligence, and

the equitable duty of care, directors must

exercise a reasonable degree of care and

diligence in exercising their powers and dis-

charging their duties. The statutory duty

of care and diligence imposes an objective

standard of reasonableness on directors

(s180(1) CA). Section 180(1) is subject to thebusiness judgment rule defence (s180(2) CA).

wishes [shadow dire ctor] (s9 CA). Under the

LPA definition of a legal practitioner director

it would appear that a legal practitioner who

does not hold a principal practising cert ifi-

cate may be appointed a director of the ILP

but will not be a legal practitioner director.

OBLIGATIONS OF A LEGALPRACTITIONER DIRECTORUNDER THE LPAIn addition to directors duties in general and

the professional obligations of a legal practi-

tioner,7 every legal practitioner director has

specific obligations under theLPA,namely:

t responsibility for management of the legal

services provided by the ILP (s2.7.10(2));

t ensuring that appropriate management

systems are implemented and maintained

to enable the provision of legal services in

accordance with professional obligations(s2.7.10(3)(a));

t ensuring that the conduct of non-legal

practitioner directors and other officers

or employees does not affect the conduct

of those who are legal practitioners

(s2.7.10(3)(b));

t if it is reasonably apparent that the provi-

sion of legal services by the ILP will result

in breaches of the professional obligations

by officers and employees who are legal

practitioners, taking all reasonable action

available to ensure that the breaches do not

occur (s2.7.10(4)(a));

t taking appropriate remedial action in

respect of breaches of professional obliga-tions that do occur (s2.7.10(4)(b));

t taking reasonable steps to ensure that theconduct of employed legal practitioners

does not constitute unsatisfactory profes-sional conduct or professional misconduct

(ss2.7.11(1)(a) & 2.7.11(1A)(a));t taking reasonable steps to ensure that the

conduct of non-legal practitioner directors

does not adversely affect the provision of

legal services by the ILP (ss2.7.11(1)(b) and

2.7.11(1A)(b));

t taking reasonable steps to ensure that

non-legal practitioner directors are not

unsuitable to be a directors of the ILP(ss2.7.11(1)(c) and 2.7.11(1A)(c));

44 L I J A U G U S T 2 0 1 1

LEGAL PRACTICE

There is an inherent conflict between certain

directors fiduciary duties and those of a legalpractitioner under their professional obligations.


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of courts and regulatory authorities suchas the Legal Services Board etc.;

t Supervision of practice and staff: providing

for compliance with statutory obligationscovering licence and practising certifi-cate conditions, employment of personsand ensuring proper quality assuranceof work outputs and performance of legal,paralegal and non-legal staff involved inthe delivery of legal services; and

t Trust money and trust accounts: avoidingfailure to account and breaches of Chapter3, Part 3.3 of theLPA.The self-assessment helps by outlining

key concepts to consider when address-ing [the relevant] Objective and providesexamples of possible evidence or systemsmost likely to lead to compliance.10 The TenObjectives are principle-based and flexible,not prescriptive. As each ILP is unique it isfor the legal practitioner direc tor(s) to design,implement and maintain managementsystems appropriate to that ILP. The self-assessment states that all examples provided. . . are suggestions only because ILPs varyin terms of size, work practices and natureof operations and thus no one size fits all.11 Failure by the legal practitioner director(s)to implement and maintain appropriate

of the practitioner (s2.7.14). Furthermore, theprovision of pro bono legal services isexpressly allowed (s2.7.13(4)).

Legal practitioner directors should have anawareness of their general directors fiduciaryduties, their obligations as legal practitionerdirectors under theLPA and professional obli-

gations, and how those duties interact. 8

APPROPRIATE MANAGEMENT SYSTEMSEach legal practitioner director has anobligation to ensure that appropriate man-agement systems are implemented andmaintained to enable the ILP to providelegal services in accordance with over-all professional obligations (s2.7.10(3)(a)).Appropriate management systems arenot defined in theLPA but manifest them-selves as the Ten Objectives of AppropriateManagement Systems (Ten Objectives).9The Ten Objectives are based on profes-sional conduct rules and were drawn up bythe OLSC in conjunction with the College ofLaw and LawCover (NSW PI insurer). TheTen Objectives, which have been adopted bythe LSB with minor amendments to reflecttheLPAand the VictorianProfessional Conductand Practice Rules 2005, are:

t Negligence: competent work practices toavoid negligence;

t Communication: effective, timely and

courteous communication;t Delay: timely delivery, review and follow-

up of legal services to avoid delay;t Liens and file transfers: acceptable pro-

cesses for liens and file transfers;t Costs disclosure, billing practices and ter-

mination of engagement: providing fora shared understanding and appropri-ate documentation from commencementthrough to termination of the engagementcovering cost disclosure, billing practicesand termination of retainer;

t Conflicts of interest: timely identificationand resolution of the many different incar-nations of conflict of interest;

t Records management: minimising thelikelihood of loss or destruction of cor-respondence and documents throughappropriate document retention, filing,archiving etc and providing for compliancewith requirements as regards registers offiles, safe custody, financial interests;

t Undertakings: providing for undertakingsto be given, monitoring of compliance andtimely compliance with notices, orders,rulings, directions or other requirements

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LEGAL PRACTICE

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LEGAL SERVICES BOARDS

POWER TO AUDIT ILPSThe LSB may conduct an audit of an ILPs:t compliance with the obligations contained

in Part 2.7 of theLPA, theLPR and the Legal

Profession Rules as they relate to ILPs

(s2.7.22(1)(a)); and

t management of the provision of legal ser-

vices (including the supervision of officers

and employees providing the services)

(s2.7.22(1)(b)).

An audit may be carried out whether or not

a complaint has been made (s2.7.22(2).

The rationale behind the compliance audit

is to ensure that an ILP has systematically

identified its statutory and regulatory obli-gations, complies with them, and monitors

its compliance. To show compliance with

s2.7.22(1)(a) it might be prudent for an ILP to

have an obligations register outlining all the

obligations under Part 2.7 etc.

In relation to s2.7.22(1)(b), as the imple-

mentation and maintenance of appropriate

management systems is mentioned in the

note to s2.7.22(1), an assumption can be made

this will be within the audit scope, as will the

management systems may amount to unsat-

isfactory professional conduct or professional

misconduct (s4.4.4(a)).

The Queensland Legal Services Commis-

sioner believes management systems . . .

count as appropriate only if they support

and encourage and g uide the firms employ-

ees to do the right thing and discourage anddeter them from doing the wrong thing.12

The NSW Legal Services Commissioner

agrees, stating that . . . by requiring incorpo-

rated legal practices to implement an ethical

infrastructure: that is, formal and informal

management policies, procedures controls,

work team cultures and habits of interac-

tion and practice that support, encourages

ethical behaviour through ethical infrastruc-

tures. [This] provides better protection for

consumers of legal services. This is because

the management systems we require ILPs

to maintain act as a quasi-educative mech-

anism teaching practitioners best practice

to achieve compliance with the require-

ments of the legislation and promote cultural

change.13 Parker et al suggest the legisla-

tive provisions that require incorporatedlegal practices to have appropriate manage-

ment systems [are] in effect a requirement

that incorporated legal practices consciously

implement an ethical infrastructure as a

part of their new business structure.14 The

self-assessment itself touches on ethical

infrastructure, stating the intent of these

provisions is to encourage ethical practice

within ILPs and to promote professional

standards, competence and honesty.15

46 L I J A U G U S T 2 0 1 1

LEGAL PRACTICE

Meeting the statutory and regulatory obligations

on the ILP and the legal practitioner directors isanother, albeit important, consideration in the

decision whether to incorporate.

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7. Professional obligations of an Australian legal prac-titioner include: duties to the Supreme Court;obligations in connection with conflicts of interest;

duties to clients, including disclosure; and ethical rulesrequired to be observed by the practitioner (s2.7.2).8. Other Corporations Ac tobligations include: report-ing; record keeping; and accounting.9. Note 3 above, p6.10. Note 3 above, pp8-38.11. Note 3 above, p7.12. J Briton, Rethinking theregulation of lawyer con-duct: the centrality of law firm management andethical infrastructure, speech to Australian LegalPr a c t ic e M a n a ge me n t A s s o c ia t io n N a t io n a lConference, 15 August 2009, p10: www.lsc.qld.gov.au/speeches/ALPMA_National_Conference_Aug_09.pdf.(accessed 17 June 2011).13. S Mark, The future is here, Jo ur na l of th eProfessional Lawyer, American Bar Association, Centre forProfessional Responsibility, May 2009, pp45-63 at p46 .

14. C Parker et al, The Ethical Infrastructure of LegalPractice in Larger Law Firms: Values, policy and b ehav-

iour, (2008) 31(1) University of New South Wales LawJournal 158-188, p174.15. Note 3 above, p2.16. Supervision in this context means the supervisionof the overall ILP (governance) and/or the supervisionof matter files (professional supervision).17. Note 13 above, p15.18. An LSB representative in a conversation with theauthor on 1 September 2010.19. Legal Services Board,Annual Report 2009, p17 andtheAustralian Financial Review, 2 July 2010, p58.

supervision of officers and employees who

provide legal ser vices (s2.7.22(1)(b)).16Most audits are internal (self-assessment);

in fact every ILP should have completed theself-assessment. Records should be kept of

all self-assessments, any gap analysis under-

taken (internal or external), and the results

of any audits. With regard to external audits,

there is no public information on the LSBs

thinking as to their scope or frequency. It

is instructive to note that the LSC conducts

two types of external audit: web-based sur-

veys to test discrete aspects of an ILP s ethical

infrastructure; and comprehensive on-site

reviews.17 It is understood that the LSB is

likely to carry out audits in 2011-12.18

CONCLUSIONStatistics from the LSB suggest that most new

law practice registrations in Victoria (aside

from sole practitioners) are ILPs, as in New

South Wales and Queensland.19 The number

of law practices incorporating may increase

if agreement is reached between the repre-

sentative bodies (the LIV etc.) and the ATO

on certain taxation issues. The incentives to

incorporate may include: limited liability;

asset protection; share ownership; capital

raising; tax structuring; entry and exit of

directors; succession planning; and overall

management. The disincentives may include:taxation; disclosing financial information;

and potential payroll tax liabilities. Meeting

the statutory and regulatory obligations on

the ILP and the legal practitioner directors

is another, albeit important, consideration in

the decision whether to incorporate.

PATRICK (PADDY) OLIVER is a lawyer, management con-sultant and managing director of Lexcel Law PracticeConsultants. He has worked extensively with law firmclients in practice management, management systemsand risk management.

1. 761 ILPs are registered in Victoria: www.lsb.vic.gov.au/PractitionerStatistics.htm (accessed 22 June 2011).

2. See Legal Profession Act2008 (WA), ss102(5) and (6).Sections material in the WA matter ofHammond Legalin which an ILP in breach of s102(1) (failure to notify)was disallowed from recovering costs during the periodof breach: www.perthnow.com.au/business/news/h igh -p rof i l e - l awyer - john -hammond/story -e6frg2qu-1225796121613 (accessed 17 June 2011).3. Legal Services Board, Incorporated Legal Practices: Self-

Asse ssment A udit: www.lsb.vic.gov.au/documents/LSB_ILPSelfAssessmentAudit.pdf(accessed 17 June 2011).4. Note 3 above, p2.5. Note 3 above, p6.6. OLSC and LSC perform regulatory duties with regardto ILPs. LSC allows online self-assessment submission.

47L I J A U G U S T 2 0 1 1

LEGAL PRACTICE

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