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Is key-person risk lurking at your firm?

When the CEO of QuadrigaCX, a Canadian cryptocurrency exchange company, died unexpectedly in December, hundreds of millions of dollars of its customers’ money may have perished with him. The CEO, Gerald Cotten, was the only person at the company who had the passwords needed to access its crypto-assets, and its customers’ funds are now left stranded, possibly forever.

Quadriga’s quandary is an unusually tragic example of a hazard that gnaws at many companies, and particularly at a lot of law firms, known as “key person risk.” Well-run firms will no doubt have all of the passwords backed up somewhere, but some of their most precious assets may nevertheless reside exclusively in the brains of a single attorney, creating perilous risks for the firm that may only manifest themselves if the attorney suddenly becomes unavailable.

Key-person risk (sometimes called “key-man risk” by people not keeping up with the times) occurs when a company’s continued success becomes dependent on one or more crucial employees. As it happens, this dynamic can describe a lot of law firms, given that many attorneys are fiercely independent about their work. If something abruptly happened to a firm rainmaker—poaching by another firm, bar discipline, illness, or worse—how would the firm cope?

Oftentimes, not as well as they might think, said Pierce Campbell, an attorney with Turner Padget in Florence, South Carolina, especially if attorneys are territorial about “their” clients.

“The risk can be great. It can mean as much as jeopardizing entire relationships with firm clients,” Campbell said. “If someone has been the face of the firm and the voice of the firm with the client for many years, other people at the firm may not even know who to talk to. It’s a very big risk to law firms, and it’s one of the reasons why both law firms and clients’ law departments need to work on planning for the future and always having a backup plan.”

A plan for all seasons

Discussions about continuity planning can be challenging because people generally tend to dislike and avoid thinking about worst-case scenarios, but firms can benefit substantially from having such plans in place, even if everything keeps running along smoothly.

The most obvious reason for being proactive about continuity planning is to protect the firm and ensure that revenues remain stable even if something happens to a key person, whether they’re an attorney who is the linchpin of a firm’s relationship with an important client, or one who has vital legal knowledge or experience that would be difficult for anyone else at the firm to replicate.

But continuity planning can also double as an effective talent retention strategy. Tom Lenfestey, an attorney and the managing member of The Law Practice Exchange in Cary, which helps with law firm ownership transition planning, said that making sure that important clients interact with a team of attorneys at the firm, rather than just one, can help mitigate key-person risk and at the same help prevent promising talent from leaving for other firms.

“I think that’s where law firm continuity planning becomes such a strategic opportunity to retain or attract that next generation of talent,” Lenfestey said. “For those who are in firms now, if there are good attorneys and they don’t see the future opportunity, they don’t see the path to equity or greater financial opportunity, they’ll leave, or they won’t join the firm. The opportunity is that if you can create a continuity structure, you can really bring in the next generation of talent.”

In many cases this will mean that older attorneys are consciously mentoring younger ones, but key-person risk is by no means limited to older attorneys. Retirement is, in some ways, actually the easier thing to plan for because it tends to be a foreseeable event. Conversely, Cotten, the cryptocurrency CEO, passed away at the age of 30, which may help to explain why his company was so caught out.

What gets measured gets done

Talking about risk is a good first step, but tackling it in earnest may require a serious rethinking about compensation structures. For instance, many firms award origination fees to attorneys who bring in new clients, and in some firms attorneys can continue to collect these fees for however long the client continues to do business with the firm. While this can encourage attorneys to hunt down new clients, it can also incentivize them to hoard those clients once they have them, and discourage teamwork within firms.

Instead, firms ought to look for ways to explicitly compensate attorneys for mentoring other lawyers and making sure that the firm has good continuity plans in place, said Camille Stell, president of Lawyers Mutual Consulting and Services.

“What we reward people for is what they’re going to do. When we reward people based on billable hours and client origination that’s what they’re going to do,” Stell said. “But if you can reach a point where you’re not going to have origination fees, or at least share them, and build a compensation system that rewards attorneys for sharing more, for mentoring lawyers, and building their skills and transitioning clients, then you’re going to have a better plan in place.”

Oftentimes the clients will also find it reassuring to know that such plans are in place. Campbell said that the best plans are crafted with the input of the clients, who may well have some thoughts about who they would like to see matters handed off to.

Firms can also benefit by thinking about how the conversation might go if the shoe were on the other foot: How might a firm advise a client who had a single employee that was in sole possession of some of the company’s most important know-how or institutional knowledge?

“Oftentimes lawyers are guilty of needing to follow their own advice,” Campbell said. “They can tell clients what they should or shouldn’t do, but sometimes they have trouble implementing that into their own practice.”

Follow David Donovan on Twitter @NCLWDonovan

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