Forfeiture-for-Competition Agreements

Critics of the majority rule believe that unfettered lawyer mobility destabilizes law firms as institutions and thereby adversely affects lawyers, clients, and the practice of law. See, R. Hillman, Randall-Park Lecture, The Hidden Costs of Lawyer Mobility: Of Law Firms, Law Schools, and the Education of Lawyers (2002). Because clients typically maintain a relationship with one lawyer or a small group of lawyers, rather than the entire firm, clients will often follow their lawyer if he or she leaves the firm for a competitor. Thus, while firms expend significant capital to attract and support lawyers and their practices, the potential departure of lawyers discourages such investments and encourages short-term revenue maximization over long-term investment in lawyer development and other non-economic pursuits. EWALD, supra, at 46-49.

Proponents believe that preserving unrestricted attorney mobility is critical to the profession. They posit that unrestricted mobility is an important counterweight to the economic power of large law firms that might otherwise seek to 'impose draconian restrictive covenants on lawyers who are in an unequal bargaining power vis-'-vis the firm, especially young lawyers.' (Comm. on Prof. Resp., Assoc. of Bar of City of New York, Ethical Issues Arising When a Lawyer Leaves a Firm: Restrictions on Practice, 20 Fordham Urb. L. J. 897, 904 (Summer 1993) (hereinafter 'ABCNY Ethics Opinion')).

This article examines the underlying rationale for the ethical rules restricting limitations on the right to practice and the major cases applying them to forfeiture-for-competition agreements.

Non-Competition Agreements

Business partnerships and corporations generally have responded to the growth of individual market power and greater employee mobility by employing non-competition agreements and other restrictive covenants. These agreements limit the ability of the employee or partner to compete with his former employer for a period of time after departure from the firm. Although courts generally disfavor restrictions on free competition, they will enforce reasonable limitations that protect legitimate business interests, do not impose an undue burden on the employee, and are not injurious to the public. See, e.g., BDO Seidman v. Hirschberg, 93 N.Y.2d 382, 388-89 (1999). What is a reasonable restriction on competition is a fact-intensive inquiry. Id. at 390.

The legal profession has eschewed non-competition agreements as incompatible with the professional obligations of lawyers. In fact, for nearly 40 years, professional conduct rules have expressly prohibited any agreements that restrict an attorney's post-termination right to practice law. The justification for the ethical rule has changed over the years as the legal marketplace has undergone significant transformation, but the substantive rule remains nearly sacrosanct.

The first formal declaration that non-competition agreements for lawyers are unethical came in 1961. The ABA Committee on Professional Ethics issued an opinion, known as ABA Opinion 300, concluding that non-competition agreements among lawyers are inconsistent with the professional values of lawyers. 'The practice of law … is a profession, not a business or commercial enterprise. The relations between attorney and client are personal and individual relationships.' (ABA Comm. On Professional Ethics, Formal Op. 300 (1961) (hereinafter 'ABA Op. 300')). 'Clients are not merchandise. Lawyers are not tradesmen. They have nothing to sell but personal service. An attempt, therefore, to barter in clients would appear to be inconsistent with the best concepts of our professional status.' Id.

The ABA Committee relied on several ethical canons ' including those prohibiting encroachment and solicitation of clients and the obligations to retain confidences of former clients and to not divulge secrets ' to conclude that restrictive covenants are incompatible with the legal profession. EWALD, supra, at 8-9. Characteristic of the time, the Committee concluded that, as an ethical matter, lawyers shouldn't be fighting over clients in the first place. Thus, '[n]o restrictive covenant in an employment contract is needed to enforce these provisions of the Canons of Professional Ethics' (ABA Op. 300).

In 1969, the ABA adopted its Model Code of Professional Responsibility, which contained a formal prohibition on non-competition agreements as Disciplinary Rule 2-108. The commentary on the new rule largely followed the rationale of ABA Opinion 300. Rule 5.6 of the current ABA Model Rules of Professional Responsibility states the rule in nearly identical language to the 1969 Model Code.

A lawyer shall not participate in offering or making: (a) a partnership, shareholders, operating, employment, or other similar type of agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement.

The vast majority of states' ethical rules include similar prohibitions on contractual restrictions to the practice of law. EWALD, supra, at 6.

The justification for proscribing restrictive covenants among lawyers has changed dramatically. No one can reasonably state that restrictive covenants are unnecessary because members of the bar are ethically barred from poaching one another's clients. In fact, the Supreme Court struck down ethical rules restricting solicitation of clients in the 1970s and 1980s as unconstitutional restrictions on free speech. See, Shapero v. Kentucky Bar Ass'n, 486 U.S. 466 (1988); Zauderer v. Office of Disciplinary Counsel of Supreme Court of Ohio, 471 U.S. 626 (1985); In re R.M.J., 455 U.S. 191 (1982); Bates v. State Bar of Arizona, 433 U.S. 350 (1977).

The ethical rule is now premised on the long-standing value of client choice with respect to legal representation. The 'client's power to choose, discharge, or replace a lawyer borders on the absolute.' (Robert Hillman, The Ethics of Lawyer Mobility, '2.3.1). Non-competition agreements are unethical because they limit who an attorney can represent and thereby restrict the client's ability to choose his or her attorney. The rule is 'designed to serve the public interest in maximum access to lawyers and to preclude commercial relationships that interfere with that goal. Jacob v. Norris, 128 N.J. 10, 18 (1992).

Courts have universally refused to enforce non-competition agreements among lawyers because they are clearly forbidden by the ethical rules. See, Jacob v. McMoran & Palmieri, 128 N.J. 10, 22 (1992). The New Jersey Supreme Court, citing ABA Opinion 300 and other ethical opinions, explained that such 'commercial' agreements were incompatible with the professional and 'highly fiduciary' lawyer-client relationship. Dwyer v. Jung, 336 A.D. 2d 498, 500 (N.J. 1975). A lawyer 'may do nothing which restricts the right of the client to repose confidence in any counsel of his choice.' Id. Although courts have been uniform in their repudiation of non-competition agreements, some firms continued to insert such non-competition provisions in their partnership agreements. See, Howard v. Babcock, 6 Cal. 4th 409, 420 (1993).

Forfeiture-for-Competition Agreements

With traditional non-competes virtually unenforceable, many law firms have developed alternate ways to deter lawyers from leaving and grabbing firm clients. One popular mechanism, known as forfeiture-for-competition, conditions payment of certain post-employment compensation on refraining from competition with the firm. As an alternative to winding up the partnership, most partnership agreements entitle a departing partner to receive future payments. These generally include the value of the lawyer's interest in the firm, a share of profits up to the time of departure, and often limited time payment of future firm income ' ranging from fees for work already performed but not yet collected to fees for future work on matters in place at the time of the partners' departure. Under a forfeiture-for-competition arrangement, a partner who withdraws from the firm would forego some of his income if he chooses to compete with his former firm. The definition of competition can vary significantly from firm to firm. Some agreements restrict representation of those who were firm clients over the subsequent 12 months, see, e.g., Jacob v. Norris, 128 N.J. 10, 15 (1992), while others proscribe any private practice of law in a jurisdiction (or neighboring jurisdiction) where the firm has offices, see, e.g., Cohen v. Lord Day & Lord, 75 N.Y.2d 95, 97 (1989).

Majority Rule

Although forfeiture-for-competition provisions do not directly restrict an attorney's ability to represent clients, courts in most U.S. jurisdictions have treated them as equivalent to traditional non-compete clauses for purposes of D.R. 5.6. See, Pettingell v. Morrison, Mahon & Miller, 426 Mass. 253 (1997); Pierce v. Hand, Arendall, Bedsole, Greaves & Johnston, 678 So. 2d 765 (Ala. 1996); Whiteside v. Giffiths & Griffiths, P.C., 902 S.W. 2d 739 (Tx. App. 1995); Jacob v. Norris, 128 N.J. 10; Spiegel v. Thomas, Mann & Smith, 811 S.W.2d 528, 529-31 (Tenn. 1991); Anderson v. Aspelmeier, Fisch, Power, Warner & Engberg, 461 N.W. 2d 598, 601-02 (Iowa 1990); Cohen v. Lord, Day & Lord, 75 N.Y.2d 95; Hagen v. O'Connell, 683 P.2d 563, 564-65 (Or. App. 1984).

The leading case is the New York Court of Appeals' decision in Cohen v. Lord, Day & Lord. The Lord Day partnership agreement entitled a withdrawing partner to receive his capital contribution and a share of fees earned but uncollected as of the time of his departure to be paid out based on a formula over three years. (75 N.Y.2d at 98). The agreement provided, however, that a partner who continued to practice law in any state in which the firm maintained an office, or a contiguous jurisdiction, would forfeit his right to the three years of earned fees. Id.

Cohen concluded that the forfeiture provision had the same adverse impact on lawyer competition, and therefore client choice, as a direct bar on competition (Some have challenged the New York court's reliance on client choice. The Association of the Bar of the City of New York's 1993 ethics opinion endorses the court's ultimate conclusion but offers an alternate justification ' attorney mobility. It notes that forfeiture provisions are unlikely to impede clients from being able to hire attorneys of their choice, but that they may unfairly restrict attorneys' autonomy to practice where they wish and should be prohibited on that ground. ABCNY Ethics Opinion, supra.) 'The forfeiture-for-competition provision would functionally and realistically discourage and foreclose a withdrawing partner from serving clients who might wish to continue to be represented by the withdrawing lawyer and would thus interfere with the client's choice of counsel.' (75 N.Y.2d at 98).

The Court of Appeals noted that its decision did not prohibit all forfeiture-for-competition provisions, but only those requiring forfeiture of earned fees, as opposed to unearned (75 N.Y. 2d at 101-102). In so doing, the court attempted to strike a
balance between the competing interests of lawyers and clients in preventing restrictions on mobility and the firms' legitimate financial interests.

While a law firm has a legitimate interest in its own survival and economic well-being and in maintaining its clients, it cannot protect those interests by contracting for the forfeiture of earned revenues during the withdrawing partner's active tenure and participation and by, in effect, restricting the choices of the clients to retain and continue the withdrawing member as counsel (75 N.Y.2d at 101 (citing Post v. Merrill Lynch, Pierce, Fenner & Smith, 48 N.Y.2d 84, 89 (1979)).

Other courts have criticized the distinction between earned and unearned fees, noting that it is the deterrent impact of any forfeiture of income tied to competition that is problematic, not whether 'the departing partner has a 'right' to receive' that income. Jacob v. Norris, 128 N.J. at 24-25.

Other courts adopting the majority rule have also recognized the existence of valid competing interests to be balanced. The New Jersey Supreme Court suggested that a law firm could address the real adverse financial impact caused by a departing partner, as long as it did so for all departing attorneys regardless of whether they compete with the firm. (128 N.J. at 28-29). For example, the firm could adjust downward the value of the firm and its goodwill to reflect anticipated lost revenue caused by a partner's departure when calculating the value of his or her capital contribution. Id. An Oregon court also rejected an economic penalty premised on competition, but recognized the firm's ability to account for its reduced future revenue in valuing the departing partner's capital account. Hagen v. O'Connell, 683 P.2d 563, 565 (Or. App. 1993).

Minority Rule

A distinct minority of courts have rejected the majority's rule that professional ethics restrict firms from reducing post-departure compensation to those who compete. They recognize a distinction between an outright ban on competition, which is the proper subject of the ethical rule, and imposing the financial costs of competition on the departing partner. The latter may be enforceable so long as it is a reasonable effort to compensate the firm for anticipated loss of profit caused by the departure and competition of a former partner.

The California Supreme Court's decision in Howard v. Babcock, 6 Cal. 4th 409 (1993), best illustrates the minority rule. The partnership agreement at issue provided that a departing partner would receive the value of his or her capital account plus a share of the firm's net profits over the next 12 months, but that he would forfeit such withdrawal benefits (other than his capital contribution) if he were to engage in competition with the firm (defined as doing insurance defense work within two counties during 12 months after his departure). (6 Cal. 4th at 412).

The California court sought to reconcile California partnership law, which allows partnerships to impose on a withdrawing partner certain reasonable restrictions on competition, and the California legal ethics rule modeled on D.R. 5-106 of the ABA Model Code. The court, resolving a split among the California appellate courts, interpreted the ethics rule narrowly. While the rule would prohibit 'an absolute ban on competition with the partnership,' (6 Cal. 4th at 425), an 'agreement that assesses a reasonable cost against a partner who chooses to compete with his or her former partners does not restrict the practice of law. Rather, it attaches an economic consequence to a departing partner's unrestricted choice to pursue a particular kind of practice.' (6 Cal. 4th at 419). The court held that imposing such economic consequences is fundamentally different than an outright ban on competition and that lawyers are no different than doctors, accountants, and other professionals for whom reasonable restrictive covenants in partnership agreements are perfectly enforceable. (6 Cal. 4th at 424).

The California Supreme Court voiced many of the practical criticisms of a rule protecting unfettered attorney mobility. 'Contemporary changes in the legal profession' ' such as lateral hiring of associates and partners and frequent departure of clients that accompany such lawyer movement ' undermine the stability of law firms and harm the practice of law for lawyers and clients. (6 Cal. 4th at 420-21). Excessive mobility, made possible in part by the absence of any reasonable limitations on competition by former partners, deters investment in the firm because a departing partner can claim part of the firm's future profits while avoiding liability for firm debts. (6 Cal. 4th at 421). The court predicted that allowing reasonable taxes on competition would have a net positive effect on lawyers and clients by allaying some of the concerns about departing partners grabbing clients, which deters investments in the firm's infrastructure and sharing client relationships among lawyers in the firm. (6 Cal. 4th at 424).

The minority rule effectively places forfeiture-for-competition provisions on the same plane as restrictive covenants among other partnerships. The forfeiture must bear a reasonable relationship to the lost income incurred by the firm; it cannot be a penalty.

Such a construction represents a balance between competing interests. On the one hand, it enables a departing attorney to withdraw from a partnership and continue to practice law anywhere within the state, and to be able to accept employment should he choose to do so from any client who desires to retain him. On the other hand, the remaining partners remain able to preserve the stability of the law firm by making available the withdrawing partner's share of capital and accounts receivable to replace the loss of the stream of income from the clients taken by the withdrawing partner to support the partnership's debts. (6 Cal. 4th at 419-420).

In rejecting the majority rule, Howard also sought to debunk the rhetoric of unfettered client choice and lawyer autonomy. The court noted the existence of substantial limits on client choice, including the fact that a lawyer may be unable to represent a client due to a conflict of interest or may choose not to accept representation of an interested client. (6 Cal. 4th at 423). Moreover, the court posited that forfeiture provisions would not impact client choice as a practical matter because lawyers would still likely be available to the client, whether at their former firm or, despite forfeiting compensation, at a subsequent firm. (6 Cal. 4th at 424).

Only a few courts have followed California's lead in Howard. In 2006, the Arizona Supreme Court, while noting the overwhelming majority rule, chose to allow reasonable forfeiture-for-competition agreements. Fearnow v. Ridenour, Swenson, Cleere & Evans, P.C., 213 Ariz. 24 (2006). The court rejected the underlying client-choice rationale as a product of legal arrogance.

We are unable to conclude that the interests of a lawyer's clients are so superior to those of a doctor's patients (whose choice of a physician may literally be a life-or-death decision) as to require a unique rule applicable only to attorneys. The language of ER 5.6 does not support such a sweeping special treatment of lawyers, nor does protection of clients mandate such a result. (213 Ariz. at 30).

A Pennsylvania appellate court also adopted the California rule. Capozzi v. Latsha & Capozzi, P.C., 797 A.2d 314 (PA Super. Ct. 2002). The court ultimately refused to enforce the partnership agreement, however, because it would have paid the founding partner only his original capital contribution of $5,000, if he competed with the firm, despite the fact that the firm's value had appreciated to $2.6 million. Applying traditional restrictive covenant rules, the court determined that the rule was 'not reasonably necessary to protect the firm' and therefore constituted an 'unreasonable restraint on competition.' (797 A.2d at 321).

Conclusion

The departure of a lawyer or a group of lawyers for a competing firm can impose real costs on a law firm. While courts recognize the legitimate interests of law firms that wish to retain their lawyers and prevent them from taking clients with them, in the majority of jurisdictions, the attorneys' interest in unfettered mobility and the clients' right to choose his or her attorney trump the firms' financial interests. Nevertheless, even in jurisdictions adopting the majority rule's broader interpretation of the prohibition on practice restrictions, law firms can account for the costs of a departing lawyer so long as they do so in a way that is neutral with respect to competition.

Wayne N. Outten is the managing partner of Outten & Golden LLP, an employment law firm representing employees, executives, and partners, with offices in New York City and Stamford, CT. He co-chairs the firm's Executives and Professionals Practice Group and lectures and writes extensively on employment law, especially on negotiation, mediation, and arbitration of employment disputes and on employment, severance, and partnership agreements. Mark R. Humowiecki is an associate at Outten & Golden, in New York. He represents employees individually and in class actions, in all areas of employment law.

Lawyer mobility is at an all-time high. Every week, the New York Law Journal contains announcements of partners and entire practice groups leaving one firm to join another. More and more first-time partners joined their firms as lateral associate hires rather than right out of law school. This phenomenon, which parallels the higher rates of mobility among employees in other sectors of the economy, is relatively recent. Through the 1960s, it was rare for a partner to leave his law firm for another firm in the same geographic area. See Linda Ewald, Agreements Restricting the Practice of Law: A New Look at an Old Paradox, 26 J. of the Legal Prof. 1, 1 at n. 6 (hereinafter 'EWALD').

Individual lawyers command greater market power than at any time before. As law practice has become more specialized and corporate legal departments have taken over some of the basic legal work that used to support law firms, firms are competing for valuable business. Milton Regan, Law Firms, Competition Penalties & The Values of Professionalism, 13 Geo. J. Legal Ethics, 1, 7-9 (Fall 1999). Lawyers (or groups of lawyers) who have a portable book of business can command a larger share of the revenue from their business by going to the highest bidder. Firms also aggressively recruit highly profitable lawyers with promises of enhanced support for the lawyers' practice, including technology, staffing, and marketing. This is on top of the investments that firms make in developing and maintaining strong, long-term client relationships.

Law firms are constrained by professional ethics in how they address the issues of lawyer mobility. Rule 5.6 of the ABA Model Code of Professional Responsibility expressly prohibits lawyers from entering into agreements that restrict their right to practice, including covenants not to compete. The overwhelming majority of jurisdictions interpret the rule to preclude less direct restrictions on competition, including financial penalties known as 'forfeiture-for-competition' agreements.

Critics of the majority rule believe that unfettered lawyer mobility destabilizes law firms as institutions and thereby adversely affects lawyers, clients, and the practice of law. See, R. Hillman, Randall-Park Lecture, The Hidden Costs of Lawyer Mobility: Of Law Firms, Law Schools, and the Education of Lawyers (2002). Because clients typically maintain a relationship with one lawyer or a small group of lawyers, rather than the entire firm, clients will often follow their lawyer if he or she leaves the firm for a competitor. Thus, while firms expend significant capital to attract and support lawyers and their practices, the potential departure of lawyers discourages such investments and encourages short-term revenue maximization over long-term investment in lawyer development and other non-economic pursuits. EWALD, supra, at 46-49.

Proponents believe that preserving unrestricted attorney mobility is critical to the profession. They posit that unrestricted mobility is an important counterweight to the economic power of large law firms that might otherwise seek to 'impose draconian restrictive covenants on lawyers who are in an unequal bargaining power vis-'-vis the firm, especially young lawyers.' (Comm. on Prof. Resp., Assoc. of Bar of City of New York, Ethical Issues Arising When a Lawyer Leaves a Firm: Restrictions on Practice, 20 Fordham Urb. L. J. 897, 904 (Summer 1993) (hereinafter 'ABCNY Ethics Opinion')).

This article examines the underlying rationale for the ethical rules restricting limitations on the right to practice and the major cases applying them to forfeiture-for-competition agreements.

Non-Competition Agreements

Business partnerships and corporations generally have responded to the growth of individual market power and greater employee mobility by employing non-competition agreements and other restrictive covenants. These agreements limit the ability of the employee or partner to compete with his former employer for a period of time after departure from the firm. Although courts generally disfavor restrictions on free competition, they will enforce reasonable limitations that protect legitimate business interests, do not impose an undue burden on the employee, and are not injurious to the public. See, e.g., BDO Seidman v. Hirschberg , 93 N.Y.2d 382, 388-89 (1999). What is a reasonable restriction on competition is a fact-intensive inquiry. Id. at 390.

The legal profession has eschewed non-competition agreements as incompatible with the professional obligations of lawyers. In fact, for nearly 40 years, professional conduct rules have expressly prohibited any agreements that restrict an attorney's post-termination right to practice law. The justification for the ethical rule has changed over the years as the legal marketplace has undergone significant transformation, but the substantive rule remains nearly sacrosanct.

The first formal declaration that non-competition agreements for lawyers are unethical came in 1961. The ABA Committee on Professional Ethics issued an opinion, known as ABA Opinion 300, concluding that non-competition agreements among lawyers are inconsistent with the professional values of lawyers. 'The practice of law … is a profession, not a business or commercial enterprise. The relations between attorney and client are personal and individual relationships.' (ABA Comm. On Professional Ethics, Formal Op. 300 (1961) (hereinafter 'ABA Op. 300')). 'Clients are not merchandise. Lawyers are not tradesmen. They have nothing to sell but personal service. An attempt, therefore, to barter in clients would appear to be inconsistent with the best concepts of our professional status.' Id.

The ABA Committee relied on several ethical canons ' including those prohibiting encroachment and solicitation of clients and the obligations to retain confidences of former clients and to not divulge secrets ' to conclude that restrictive covenants are incompatible with the legal profession. EWALD, supra, at 8-9. Characteristic of the time, the Committee concluded that, as an ethical matter, lawyers shouldn't be fighting over clients in the first place. Thus, '[n]o restrictive covenant in an employment contract is needed to enforce these provisions of the Canons of Professional Ethics' (ABA Op. 300).

In 1969, the ABA adopted its Model Code of Professional Responsibility, which contained a formal prohibition on non-competition agreements as Disciplinary Rule 2-108. The commentary on the new rule largely followed the rationale of ABA Opinion 300. Rule 5.6 of the current ABA Model Rules of Professional Responsibility states the rule in nearly identical language to the 1969 Model Code.

A lawyer shall not participate in offering or making: (a) a partnership, shareholders, operating, employment, or other similar type of agreement that restricts the right of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement.

The vast majority of states' ethical rules include similar prohibitions on contractual restrictions to the practice of law. EWALD, supra, at 6.

The justification for proscribing restrictive covenants among lawyers has changed dramatically. No one can reasonably state that restrictive covenants are unnecessary because members of the bar are ethically barred from poaching one another's clients. In fact, the Supreme Court struck down ethical rules restricting solicitation of clients in the 1970s and 1980s as unconstitutional restrictions on free speech. See, Shapero v. Kentucky Bar Ass'n , 486 U.S. 466 (1988); Zauderer v. Office of Disciplinary Counsel of Supreme Court of Ohio , 471 U.S. 626 (1985); In re R.M.J., 455 U.S. 191 (1982); Bates v. State Bar of Arizona , 433 U.S. 350 (1977).

The ethical rule is now premised on the long-standing value of client choice with respect to legal representation. The 'client's power to choose, discharge, or replace a lawyer borders on the absolute.' (Robert Hillman, The Ethics of Lawyer Mobility, '2.3.1). Non-competition agreements are unethical because they limit who an attorney can represent and thereby restrict the client's ability to choose his or her attorney. The rule is 'designed to serve the public interest in maximum access to lawyers and to preclude commercial relationships that interfere with that goal. Jacob v. Norris , 128 N.J. 10, 18 (1992).

Courts have universally refused to enforce non-competition agreements among lawyers because they are clearly forbidden by the ethical rules. See, Jacob v. McMoran & Palmieri , 128 N.J. 10, 22 (1992). The New Jersey Supreme Court, citing ABA Opinion 300 and other ethical opinions, explained that such 'commercial' agreements were incompatible with the professional and 'highly fiduciary' lawyer-client relationship. Dwyer v. Jung , 336 A.D. 2d 498, 500 (N.J. 1975). A lawyer 'may do nothing which restricts the right of the client to repose confidence in any counsel of his choice.' Id. Although courts have been uniform in their repudiation of non-competition agreements, some firms continued to insert such non-competition provisions in their partnership agreements. See, Howard v. Babcock , 6 Cal. 4th 409, 420 (1993).

Forfeiture-for-Competition Agreements

With traditional non-competes virtually unenforceable, many law firms have developed alternate ways to deter lawyers from leaving and grabbing firm clients. One popular mechanism, known as forfeiture-for-competition, conditions payment of certain post-employment compensation on refraining from competition with the firm. As an alternative to winding up the partnership, most partnership agreements entitle a departing partner to receive future payments. These generally include the value of the lawyer's interest in the firm, a share of profits up to the time of departure, and often limited time payment of future firm income ' ranging from fees for work already performed but not yet collected to fees for future work on matters in place at the time of the partners' departure. Under a forfeiture-for-competition arrangement, a partner who withdraws from the firm would forego some of his income if he chooses to compete with his former firm. The definition of competition can vary significantly from firm to firm. Some agreements restrict representation of those who were firm clients over the subsequent 12 months, see, e.g., Jacob v. Norris, 128 N.J. 10, 15 (1992), while others proscribe any private practice of law in a jurisdiction (or neighboring jurisdiction) where the firm has offices, see, e.g., Cohen v. Lord Day & Lord, 75 N.Y.2d 95, 97 (1989) .

Majority Rule

Although forfeiture-for-competition provisions do not directly restrict an attorney's ability to represent clients, courts in most U.S. jurisdictions have treated them as equivalent to traditional non-compete clauses for purposes of D.R. 5.6. See, Pettingell v. Morrison, Mahon & Miller, 426 Mass. 253 (1997); Pi erce v. Hand, Arendall, Bedsole, Greaves & Johnston, 678 So. 2d 765 (Ala. 1996); Whiteside v. Giffiths & Griffiths, P.C., 902 S.W. 2d 739 (Tx. App. 1995); Jacob v. Norris , 128 N.J. 10; Spiegel v. Thomas, Mann & Smith , 811 S.W.2d 528, 529-31 (Tenn. 1991); Anderson v. Aspelmeier, Fisch, Power, Warner & Engberg , 461 N.W. 2d 598, 601-02 (Iowa 1990); Cohen v. Lord, Day & Lord , 75 N.Y.2d 95; Hagen v. O'Connell , 683 P.2d 563, 564-65 (Or. App. 1984).

The leading case is the New York Court of Appeals' decision in Cohen v. Lord, Day & Lord. The Lord Day partnership agreement entitled a withdrawing partner to receive his capital contribution and a share of fees earned but uncollected as of the time of his departure to be paid out based on a formula over three years. (75 N.Y.2d at 98). The agreement provided, however, that a partner who continued to practice law in any state in which the firm maintained an office, or a contiguous jurisdiction, would forfeit his right to the three years of earned fees. Id.

Cohen concluded that the forfeiture provision had the same adverse impact on lawyer competition, and therefore client choice, as a direct bar on competition (Some have challenged the New York court's reliance on client choice. The Association of the Bar of the City of New York's 1993 ethics opinion endorses the court's ultimate conclusion but offers an alternate justification ' attorney mobility. It notes that forfeiture provisions are unlikely to impede clients from being able to hire attorneys of their choice, but that they may unfairly restrict attorneys' autonomy to practice where they wish and should be prohibited on that ground. ABCNY Ethics Opinion, supra.) 'The forfeiture-for-competition provision would functionally and realistically discourage and foreclose a withdrawing partner from serving clients who might wish to continue to be represented by the withdrawing lawyer and would thus interfere with the client's choice of counsel.' (75 N.Y.2d at 98).

The Court of Appeals noted that its decision did not prohibit all forfeiture-for-competition provisions, but only those requiring forfeiture of earned fees, as opposed to unearned (75 N.Y. 2d at 101-102). In so doing, the court attempted to strike a
balance between the competing interests of lawyers and clients in preventing restrictions on mobility and the firms' legitimate financial interests.

While a law firm has a legitimate interest in its own survival and economic well-being and in maintaining its clients, it cannot protect those interests by contracting for the forfeiture of earned revenues during the withdrawing partner's active tenure and participation and by, in effect, restricting the choices of the clients to retain and continue the withdrawing member as counsel (75 N.Y.2d at 101 (citing Post v. Merrill Lynch, Pierce, Fenner & Smith , 48 N.Y.2d 84, 89 (1979)).

Other courts have criticized the distinction between earned and unearned fees, noting that it is the deterrent impact of any forfeiture of income tied to competition that is problematic, not whether 'the departing partner has a 'right' to receive' that income. Jacob v. Norris, 128 N.J. at 24-25.

Other courts adopting the majority rule have also recognized the existence of valid competing interests to be balanced. The New Jersey Supreme Court suggested that a law firm could address the real adverse financial impact caused by a departing partner, as long as it did so for all departing attorneys regardless of whether they compete with the firm. (128 N.J. at 28-29). For example, the firm could adjust downward the value of the firm and its goodwill to reflect anticipated lost revenue caused by a partner's departure when calculating the value of his or her capital contribution. Id. An Oregon court also rejected an economic penalty premised on competition, but recognized the firm's ability to account for its reduced future revenue in valuing the departing partner's capital account. Hagen v. O'Connell , 683 P.2d 563, 565 (Or. App. 1993).

Minority Rule

A distinct minority of courts have rejected the majority's rule that professional ethics restrict firms from reducing post-departure compensation to those who compete. They recognize a distinction between an outright ban on competition, which is the proper subject of the ethical rule, and imposing the financial costs of competition on the departing partner. The latter may be enforceable so long as it is a reasonable effort to compensate the firm for anticipated loss of profit caused by the departure and competition of a former partner.

The California Supreme Court's decision in Howard v. Babcock , 6 Cal. 4th 409 (1993), best illustrates the minority rule. The partnership agreement at issue provided that a departing partner would receive the value of his or her capital account plus a share of the firm's net profits over the next 12 months, but that he would forfeit such withdrawal benefits (other than his capital contribution) if he were to engage in competition with the firm (defined as doing insurance defense work within two counties during 12 months after his departure). (6 Cal. 4th at 412).

The California court sought to reconcile California partnership law, which allows partnerships to impose on a withdrawing partner certain reasonable restrictions on competition, and the California legal ethics rule modeled on D.R. 5-106 of the ABA Model Code. The court, resolving a split among the California appellate courts, interpreted the ethics rule narrowly. While the rule would prohibit 'an absolute ban on competition with the partnership,' (6 Cal. 4th at 425), an 'agreement that assesses a reasonable cost against a partner who chooses to compete with his or her former partners does not restrict the practice of law. Rather, it attaches an economic consequence to a departing partner's unrestricted choice to pursue a particular kind of practice.' (6 Cal. 4th at 419). The court held that imposing such economic consequences is fundamentally different than an outright ban on competition and that lawyers are no different than doctors, accountants, and other professionals for whom reasonable restrictive covenants in partnership agreements are perfectly enforceable. (6 Cal. 4th at 424).

The California Supreme Court voiced many of the practical criticisms of a rule protecting unfettered attorney mobility. 'Contemporary changes in the legal profession' ' such as lateral hiring of associates and partners and frequent departure of clients that accompany such lawyer movement ' undermine the stability of law firms and harm the practice of law for lawyers and clients. (6 Cal. 4th at 420-21). Excessive mobility, made possible in part by the absence of any reasonable limitations on competition by former partners, deters investment in the firm because a departing partner can claim part of the firm's future profits while avoiding liability for firm debts. (6 Cal. 4th at 421). The court predicted that allowing reasonable taxes on competition would have a net positive effect on lawyers and clients by allaying some of the concerns about departing partners grabbing clients, which deters investments in the firm's infrastructure and sharing client relationships among lawyers in the firm. (6 Cal. 4th at 424).

The minority rule effectively places forfeiture-for-competition provisions on the same plane as restrictive covenants among other partnerships. The forfeiture must bear a reasonable relationship to the lost income incurred by the firm; it cannot be a penalty.

Such a construction represents a balance between competing interests. On the one hand, it enables a departing attorney to withdraw from a partnership and continue to practice law anywhere within the state, and to be able to accept employment should he choose to do so from any client who desires to retain him. On the other hand, the remaining partners remain able to preserve the stability of the law firm by making available the withdrawing partner's share of capital and accounts receivable to replace the loss of the stream of income from the clients taken by the withdrawing partner to support the partnership's debts. (6 Cal. 4th at 419-420).

In rejecting the majority rule, Howard also sought to debunk the rhetoric of unfettered client choice and lawyer autonomy. The court noted the existence of substantial limits on client choice, including the fact that a lawyer may be unable to represent a client due to a conflict of interest or may choose not to accept representation of an interested client. (6 Cal. 4th at 423). Moreover, the court posited that forfeiture provisions would not impact client choice as a practical matter because lawyers would still likely be available to the client, whether at their former firm or, despite forfeiting compensation, at a subsequent firm. (6 Cal. 4th at 424).

Only a few courts have followed California's lead in Howard. In 2006, the Arizona Supreme Court, while noting the overwhelming majority rule, chose to allow reasonable forfeiture-for-competition agreements. Fearnow v. Ridenour, Swenson, Cleere & Evans, P.C., 213 Ariz. 24 (2006). The court rejected the underlying client-choice rationale as a product of legal arrogance.

We are unable to conclude that the interests of a lawyer's clients are so superior to those of a doctor's patients (whose choice of a physician may literally be a life-or-death decision) as to require a unique rule applicable only to attorneys. The language of ER 5.6 does not support such a sweeping special treatment of lawyers, nor does protection of clients mandate such a result. (213 Ariz. at 30).

A Pennsylvania appellate court also adopted the California rule. Capozzi v. Latsha & Capozzi , P.C. , 797 A.2d 314 (PA Super. Ct. 2002). The court ultimately refused to enforce the partnership agreement, however, because it would have paid the founding partner only his original capital contribution of $5,000, if he competed with the firm, despite the fact that the firm's value had appreciated to $2.6 million. Applying traditional restrictive covenant rules, the court determined that the rule was 'not reasonably necessary to protect the firm' and therefore constituted an 'unreasonable restraint on competition.' (797 A.2d at 321).

Conclusion

The departure of a lawyer or a group of lawyers for a competing firm can impose real costs on a law firm. While courts recognize the legitimate interests of law firms that wish to retain their lawyers and prevent them from taking clients with them, in the majority of jurisdictions, the attorneys' interest in unfettered mobility and the clients' right to choose his or her attorney trump the firms' financial interests. Nevertheless, even in jurisdictions adopting the majority rule's broader interpretation of the prohibition on practice restrictions, law firms can account for the costs of a departing lawyer so long as they do so in a way that is neutral with respect to competition.

Wayne N. Outten is the managing partner of Outten & Golden LLP, an employment law firm representing employees, executives, and partners, with offices in New York City and Stamford, CT. He co-chairs the firm's Executives and Professionals Practice Group and lectures and writes extensively on employment law, especially on negotiation, mediation, and arbitration of employment disputes and on employment, severance, and partnership agreements. Mark R. Humowiecki is an associate at Outten & Golden, in New York. He represents employees individually and in class actions, in all areas of employment law.