Why EU law must allow the MSO

The Managed Service Organization is the key to PE investment in Law Firms

The business case for PE participation in law firms is just so strong that current regulatory hurdles will not prevent this from happening. It seems unlikely that PE will want to be actively involved in the day to day legal operational aspects of a law firm, this will like today be left to the lawyers. Regarding legal work and client contact nothing will change, lawyers remain autonomously in control. Private Equity will likely focus on operations and expansion. Their interest is to grow the value. This as such is aligned with the interests of the partners.

With today’s regulatory hurdles still in place in most jurisdictions, the structure of the Managed Service Organization (MSO) is what is making most sense. The MSO separates all non-legal elements from the legal. One should think of all back-office, the office space, the brand, the capital requirements. The legal services arm and the MSO cooperate under a service level agreement, whereby the legal arm receives services in exchange for a fee. Partners and potentially other lawyers and non-lawyers working with the firm will have a stake in the MSO of which the PE is the largest shareholder, but probably not the majority shareholder. One could easily think of other ownership structures for PE depending on creativity and regulatory requirements, but the core elements will remain that PE will not want to interfere with the legal aspects and that partners will have a share in whatever entity that will be created.

Building a case for Private Equity (PE) participation and Management Service Organization (MSO) models in European law firms requires navigating a legal landscape that was significantly reinforced by a major European Court of Justice (ECJ) ruling in late 2024. While the court recently upheld strict bans, the argument for proportionality and necessity remains the primary pathway for future reform, especially when framed through the lens of market evolution and the "inconsistency" of current member state regulations.

In December 2024, the ECJ delivered a landmark judgment in Halmer v. Rechtsanwaltskammer München (Case C-295/23). The court ruled that German laws prohibiting purely financial investors from holding shares in law firms are compatible with EU law, specifically Article 49 TFEU (Freedom of Establishment) and Article 63 TFEU (Free Movement of Capital). The court reasoned that a member state can legitimately assume that a lawyer’s independence and compliance with ethical obligations (like avoiding conflicts of interest) could be compromised if they are beholden to financial investors focused on profit maximization. This ruling currently serves as the "shield" for bar associations across the EU.

To challenge this status quo, the focus must shift to the "suitability" and "necessity" prongs of the proportionality test. One could argue that while protecting independence is a legitimate aim, an absolute ban is no longer the "least restrictive means" available in a modern economy.

•                     The Inconsistency Argument: Under EU law, a measure is only "suitable" if it pursues its objective in a consistent and systematic manner. One could point to the fact that many EU countries allow ‘non-professional’ ownership in other sensitive, public-interest professions like pharmacy (e.g., Commission v Italy, C-531/06) or medicine. If the "public interest" and "professional independence" in these sectors can be protected through regulatory oversight and structural safeguards rather than total bans, the legal profession's absolute prohibition appears discriminatory and inconsistent.

•                     The MSO Model: One could defend the MSO model by emphasizing the separation of clinical (legal) decision-making from administrative and financial management. By drafting "ethical firewalls" where the PE investor manages the business side (HR, IT, marketing) while lawyers retain 100% control over case strategy and client advice, this provides a less restrictive alternative to an outright ban.

•                     Technological Necessity: One could argue that the "necessity" of outside capital has changed. The legal industry now requires massive investment in AI and legal tech to remain competitive and provide "Access to Justice." If law firms cannot access equity markets, they are forced into debt-heavy models that may actually create more financial pressure on lawyer independence than stable equity partners would.

The fact that nearly 12% of law firms in England and Wales operate under Alternative Business Structures (ABS) provides a real-world "control group" for such argument. There has been no documented systemic collapse of legal ethics or independence in those jurisdictions. This empirical data suggests that the "risks" cited by the ECJ in Halmer are speculative rather than inevitable, making a total ban "manifestly inappropriate" in a modern Internal Market.

Article 15 of the Services Directive (2006/123/EC) requires member states to review requirements that limit shareholding in professional companies. While the ECJ in Halmer gave states a wide "margin of appreciation" here, one could argue that as the market for legal services becomes increasingly digital and cross-border, the restrictive German or French models create a "chokepoint" that hinders the development of a unified European legal market, thus violating the spirit of the Directive.

In the MSO model, the law firm remains 100% owned by qualified lawyers, satisfying the "professional control" requirement, while the MSO owns the firm’s non-legal assets, such as real estate, IT infrastructure, and the employment contracts of non-legal staff. The "Ethical Firewall" is established by ensuring that the MSO has no access to the firm’s "privileged" data or client files. Utilizing a "cost-plus" or fixed-fee compensation structure for the MSO removes the direct link between a specific legal outcome and the investor’s return, thereby neutralizing the "profit-at-all-costs" risk that the ECJ cited as a justification for the ban.

This structure mirrors the "Double-Veto" system used in other highly regulated sectors. In this setup, the MSO manages the "business of law" while the lawyers retain a "professional veto" over any business decision that touches upon ethical duties. By codifying this in the firm’s articles of association and making it subject to audit by the national Bar, the MSO model meets the proportionality test: it achieves the goal of capital infusion (modernization) without sacrificing the "public interest" goal of lawyer independence. The absolute ban is an "over-inclusive" measure that ignores these sophisticated governance tools already proven effective in the medical and accounting sectors.

To navigate the requirements that forbid profit-sharing with non-lawyers while satisfying tax authorities, the MSO must transition from a "revenue-sharing" mindset to a "service-delivery" mindset. In the eyes of European Bar associations, any fee that fluctuates purely based on the law firm's profit or gross legal fees is a "red flag" for illegal fee-splitting. Therefore, the case must build a "defensible fee architecture" that relies on objective market metrics rather than the firm’s financial success.

The legal argument for the MSO's fee structure rests on the "Services for Value" principle. One must argue that the law firm is not sharing profits, but rather paying a "commercially reasonable" price for essential infrastructure. To do this, the Management Services Agreement (MSA) should avoid a flat percentage of legal fees. Instead, the fee should be composed of discrete charges for specific services—such as a fixed monthly fee for IT systems, a per-head fee for HR management, and a market-rate lease for office space. Unbundling the fee demonstrates that the MSO is earning a return on its invested capital and operational effort, not on the lawyer’s professional advice.

From a tax perspective, particularly in high-scrutiny jurisdictions like Germany (under the Außensteuergesetz) or France, the MSO and the law firm are "related parties." This triggers the Arm's-Length Principle, requiring that the transfer price for management services mirrors what an independent third-party provider would charge. One should use the Cost Plus Method (CPM) or the Transactional Net Margin Method (TNMM) to build the case. Under the CPM, the MSO identifies its total costs (salaries of non-legal staff, software licenses, etc.) and applies a documented "markup" (typically 5% to 15%, depending on the risk and value added). This markup is legally defensible as a legitimate business profit for the MSO, distinct from the "legal profits" of the law firm.

A significant risk in the MSO structure is the "Constructive Dividend" (Verdeckte Gewinnausschüttung in Germany). If the tax authorities determine that the MSO is overcharging the law firm to siphon off profits into a lower-taxed entity or to benefit PE investors, they may recharacterize those payments as non-deductible profit distributions. This would result in a double-taxation penalty. To mitigate this, the case must include a "Benchmarking Study" that compares the MSO's fees to third-party providers like ADP (for HR) or commercial real estate firms.