Wednesday, October 19, 2016

The Continuing Saga of Who is Entitled to the Proceeds of a Law Firm's Unfinished Business

By Steve Stapleton

In a series of cases generating continued interest, the Ninth Circuit Court of Appeals, on July 27, 2016, certified the following question to the California Supreme Court:

Under California law, does a dissolved law firm have a property interest in legal matters that are in progress but not completed at the time the law firm is dissolved, when the dissolved law firm had been retained to handle the matters on an hourly basis?

The matter was certified by the Ninth Circuit in an attempt to resolve a dispute between a plan administrator hired to marshal the assets of the dissolved law firm and the partners who used to work there.1**  The issue is whether the dissolved law firm has a continuing property right in the unfinished business the partners are doing at their new firms on matters they took from the now-dissolved firm.  The partners claim the dissolved law firm has no right to the work they are currently doing because that alleged property right is too attenuated and is predicated on law that has been revised.  The trustee claims that because the work is on matters derived from the dissolved firm, the dissolved firm has a right to the proceeds.

A similar issue was raised in an appeal to the Second Circuit Court of Appeals.  That court certified the question to the New York Court of Appeals which rejected the concept that a law firm has a continuing property right in unfinished law firm business.2**  The Thelen Court stated that the partnership law of New York does not define property; “rather, it supplies default rules for how a partnership upon dissolution divides property as elsewhere defined in state law.”  Additionally, because clients have always enjoyed “the ‘unqualified right to terminate the attorney-client relationship at any time’ without any obligation other than to compensate the attorney for ‘the fair and reasonable value of the completed services,’” the “expectation of any continued or future business is too contingent in nature and speculative to create a present or future property interest.”  Thus, no law firm (based in New York) has a property interest in future hourly legal fees because such hourly fees are too contingent and speculative to create such an interest. Id.

Brobeck, Phleger & Harrison LLP was a very large law firm of national scope based in California.  It experienced financial difficulties and the partners decided to dissolve the firm.  In conjunction with its dissolution the partners entered into an agreement in which the partners disclaimed any interest in unfinished business of the partnership.  The dissolution agreement included a waiver of any rights or claims under the doctrine of Jewel v. Boxer, 156 Cal.App. 3d 171 (1984).  Jewel involved the dissolution of a law firm from which the partners subsequently formed two new firms.  The partners had a dispute over who was entitled to the law firm profits from the unfinished business the partners took with them.  The court in Jewel held that fees generated following dissolution were “to be shared by the former partners according to their right to fees in the former partnership.”  The court held that a client’s right to choose the attorney of their choice was irrelevant to the rights and duties of the former partners with regard to income from unfinished partnership business.”  Id. at 177-78.

Following Jewel, the California legislature revised its partnership law and clarified the fiduciary duties of partners after dissolution providing now that former partners in a dissolved firm are entitled to “reasonable compensation” for winding up the affairs of the defunct partnership.  That suggests, as the Ninth Circuit noted, that former partners may have a claim to some or all of their hourly rate for working on unfinished business – even if that business is being undertaken by a new law firm.  Remarkably, though the fiduciary duty changes were made in 1996, no published opinion detailing its scope has been issued.3**

The Brobeck partners moved to other firms, taking the then-pending legal matters with them.  In 2009, the firm was put into involuntary bankruptcy and the trustee of the now defunct law firm filed lawsuits seeking a declaration from the bankruptcy court that the unfinished business of the law firm was the property of the law firm and that the dissolution agreement could be challenged as a fraudulent transfer.  The bankruptcy court agreed.4**

Heller Ehrman LLP was a global law firm with more than 700 lawyers.  As a partnership organized under California law, it was comprised of professional corporations each of which employed lawyers as shareholders. In 2008, Heller was experiencing financial difficulties with $5 million in cash and $55 million in bank debt.  In September 2008, Bank of America as agent for itself and Citibank declared Heller in default and thereafter the firm’s shareholders voted for a dissolution plan. Its dissolution plan, too, included a Jewel waiver.  The plan administrator in Heller, too, filed lawsuits against sixteen law firms seeking return of the profits generated by the unfinished business of the now defunct law firm.  

Relying on the prior holding in Brobeck, the bankruptcy court ruled in favor of the Heller plan administrator.  While most of the law firms settled with the plan administrator following the decision, several did not and filed an appeal.  The district court, Judge Charles Breyer presiding, in a de novo review, reversed the bankruptcy court.  The district court first noted that the partnership law had been revised and as such undermined the legal foundation upon which the Jewel decision had been based.  The court further held that Heller “lacked the financial ability to continue providing legal services to its clients, leaving clients with ongoing matters no choice but to seek new counsel and Heller shareholders no choice but to seek new employment.”  The court further noted that public policy “favor[s] the primacy of the rights of clients over those of lawyers” and “it is essential to provide a market for legal services that is unencumbered by quarrelsome claims of disgruntled attorneys and their creditors.” Because the court held that Heller did not have a property interest in the law firm’s unfinished business at dissolution, the court did not reach the issue of whether the waiver agreement constituted a fraudulent transfer.

The case is now on appeal with the Ninth Circuit; hence, the certification of the question to the California Supreme Court.  Who will win?  Stay tuned.

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  1. In the Matter of Heller Ehrman LLP, No. 14-16314 (9th Cir., July 27, 2016).
  2. In re Thelen LLP, 24 N.Y.3d 16, 28 (2014).
  3. The Ninth Circuit notes that two unpublished California opinion have applied Jewel after the enactment of the new partnership law. See Marquart v. Smith, 2014 WL 1990286 (Cal.Ct.App., May 16, 2014); Kuist v. Hodge, 2008 WL 510075 (Cal.Ct.App.. Feb. 27, 2008).
  4. In re Brobeck, Phleger & Harrison, LLP, 408 B.R. 318 (N.D.Cal. 2009).
     

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