Communique November 2017
The 2010 NZIA Practice Series seminar: “Managing Risk in Your Practice”.This article is an update and follow-up to the 2010 seminars that Barry Dacombe presented around the country. They arose from his concern about practice structures in relation to their needs and risks: sole practitioners trading in their own name, informal “partnerships”, and loose arrangements between architects who collaborated on projects. Such arrangements result in all those involved becoming jointly liable for the acts errors and omissions of each other, to the extent of their individual fortunes.The consideration of practice structure includes (at least) succession planning, estate planning, arrangements involving Family Trusts, and risk mitigation.There are concerns about Family Trusts being a potential source of funds where individual practitioners are subject to personal claims against them, and the combined assets of the practice and the practitioner are insufficient to meet the claimed amount. The law in this area has been the subject of much debate in recent times. A properly constructed and operated trust can still afford good protection of assets when there is a claim against a practitioner in their personal capacity. However this area is becoming more complex and it is recommended that you seek the advice of a good solicitor to make sure your trust documents and procedures are adequate for your particular circumstances.What is succession planning about?
These issues may also include staff shareholding schemes, staff shareholding trusts, estate planning, and disaster protection.
This is an important question to ask! It establishes the primary reason or purposes why you should structure your practice to protect it and its principals in the event of a claim.The answers should not be confined to a mechanism solely designed to “protect your back”; they begin with an understanding of what your responsibilities as a professional are, and to whom they are owed:
When setting up your practice (or reviewing its structure) it would be wise to minute these purposes.Practice structures – examplesFor simplicity, three practice structures are used as examples. Each is designed to reduce the likelihood of personal claims against practitioners. Rather, if claims are to be brought, they will be against a limited liability entity.
This structure establishes an ownership entity separate from the trading entity. It uses a limited liability company to keep liabilities in the trading entity as much as possible and not have them flow back into the owner(s). The trading entity is governed by a board of directors (usually comprising solely of the sole practitioner) who in turn manages the practice, employs and pays the staff and through the board, declares dividends to the owners.
This structure also establishes an ownership entity separate from the trading entity. The trading entity is governed by a board of directors which in turn manages the practice, pays the staff (including the directors’ salaries) and pays dividends to the owners. This structure is the same as the single operator model above, just adjusted for multiple practitioners operating together in one company, sharing resources and skills, but also sharing risk. It requires a shareholders’ agreement to regulate the arrangements between the participating shareholders.Complex model Limited Liability large scale practices.
This structure recognises a more complex model again with two entities each with a separate board of directors and a CEO employed by the board. This model includes for the likes of Staff Shareholding Trusts, Brand Ownership, premises leases practice assets and the like separated from the trading entity to protect them in the event of a disastrous claim against the practice and providing a mechanism to continue trading via a separated company if the need arises. The use of a Trust as an Owning EntityNone of these structures should be put in place without professional legal and accounting advice. The basic principle is to use a trust as an owning entity – say, for example, owning a significant proportion of the share capital as compared to the principals.The trust(s) nominate each principal to become a director of the practice to act on their behalf. The trusts may (or may not) advance capital to the practice by way of loans which would bear interest and the trusts would receive dividends in proportion to their shareholding.For their protection, the principals should not own any assets in their individual rights. The principals will be directors of the trading company, and in doing so will have the risk of certain personal liabilities as directors. Having the shares (and possibly other assets) in a family trust may reduce the risk to those assets in the event of the failure of the business and/or a possible claim against directors. Proper conduct of the business and the board as well as taking appropriate professional advice will reduce the potential for claims against the directors personally.Be assured that there is good sense in adopting these types of corporate structure for the practice:
(Generally, an NZACS PI policy protects all principals and staff as well as the practice itself – but you should carefully read your policy and discuss with your broker what is and is not covered.)
NZACS has dealt with claims where the plaintiff’s legal team threatened litigation (potentially resulting in bankruptcy) to leverage the architect into getting his family trust to fund - by way of beneficiary loan or trust payment - the damages sought.If, in such a case, successful litigation followed, the practitioner would be unlikely to continue in practice and the reputational harm for both the individual and the practice would be substantial. If instead the practice was contained in a company, the company may ultimately be liquidated but the chances of the practitioner becoming bankrupt – and reputational damage - are less.Normally, the practice’s PI insurance would cover the cost of such a claim but there are times when it may not! Examples being where the claim exceeds the indemnity sum the insured policy provides or when the policy does not provide cover for the claim. Go back to the old WHRS days for example when water tight cover was virtually unobtainable!While this type of aggressive action is possible, and costly to mount and defend, it is the risk to reputation that is the real concern. But as anyone can sue you for whatever reason it is clearly an option for the plaintiff. Any and all litigation is expensive, whether you win, lose or draw.So, what is the answer here?The realities of such a case and the lessons to be learned from it are to do with the vulnerability of the individual practitioner (operating either alone or in an unlimited liability structure such as a partnership). You may consider that it is prudent to ask of yourself similar questions to those relating to your practice as referred to above under your professional responsibilities.The answers will inevitably lead you to a protective mechanism for yourself enshrined in your practice QA system – DON’T SIGN ANYTHING IN YOUR PERSONAL CAPACITY!Sign as a representative of a limited liability entity - as your accountant does, your builder does, your plumber does and the suppliers of the building materials all do.