The 'Unfinished Business' of Failed Law Firms

One threshold issue addressed by the Coudert court was whether pending client matters were an asset of Coudert at the time of its dissolution. The court, principally relying on New York partnership law, held that such unfinished business was presumed to be a Coudert asset. The Coudert court focused on the former partner's duty to account for use of partnership property after dissolution, noting that “[a] departing partner is not free to walk out of his firm's office carrying a Jackson Pollack painting he ripped off the wall of the reception area, simply because the firm has dissolved.” See Development Specialists, Inc. v. Akin Gump Strauss Hauer & Feld LLP (In re Coudert Brothers LLP), No. 11-cv-5994-CM, 2012 U.S. Dist. LEXIS 110715 (S.D.N.Y. July 18, 2012).

The court also relied heavily on Stem v. Warren, 227 N.Y. 538 (1920), a very old New York case, to support its conclusion that unfinished business is an asset of a dissolved law firm. Careful analysis of the underlying facts in Stem, however, shows that it involved an architectural firm in which a surviving partner breached his fiduciary duty to his former partner by soliciting and obtaining a new contract with the City of New York to design and build Grand Central Station. The Stem court never decided whether unfinished business was an asset of the former firm because the case turned on breach of fiduciary duty. The Coudert court appears to have misinterpreted the case.

The Coudert court also noted that New York courts have uniformly rejected quantum meruit as the analytical basis for a partner's duty to account for profits yielded by unfinished business following law firm dissolution, and that New York partnership law codifies the “no compensation” rule, which provides that
“[n]o partner is entitled to remuneration for acting in the partnership business, except that a surviving partner is entitled to reasonable compensation for his services in winding up the partnership affairs.” That said, the court did acknowledge that three of the four New York Appellate Divisions and the Second Circuit have interpreted the no compensation rule in contingency cases in a way so as to credit a former partner the value of his post-dissolution “efforts, skill, and diligence” against his accounting for profits.

The Coudert court rejected the defendant law firms' attempt to distinguish the treatment of unfinished business matters billed by the hour from matters paid on contingency. The court stated that the “Firms' argument conflates a law firm's rights against its clients ' which may differ according to how the matters is billed ' and the rights of former partners among themselves, including the right to demand an accounting from any partner who derives a benefit from exploiting a partnership asset. As the cases that reject the quantum meruit rationale for the duty to account make clear' these rights are entirely distinct.”

The court concluded by stating that “[i]f the Firms had suggested a principled reason why law firms should be treated differently than architectural firms, I would evaluate it, but they do not; and off the top of my head I can think of none. The Partnership Law certainly does not treat law partnerships any differently than other partnerships.”

In this regard, the Coudert court briefly discussed, but then disregarded, policy and ethical reasons why law firms and their clients should be treated differently from other types of partnerships. This seems to ignore the guidance of the New York Court of Appeals, which stated, “Clients are not merchandise. Lawyers are not tradesman. 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.” See Cohen v. Lord, Day &Lord, 75 N.Y.2d 95, 98 (1989).

Thelen: The Robinson & Cole Decision

Thelen formerly was a limited liability partnership registered in California. In October 2008, under the pressures of the global financial crisis and facing mounting partner defections, Thelen's partners voted to dissolve their partnership and adopted an amended partnership agreement that included a “provision” abandoning, among other things, “any claim or entitlement to clients, cases or matters ongoing at the time of dissolution[.]” This waiver noted expressly the partners' intent to waive any claims to “ unfinished business” of the partnership, as that term is defined in Jewel v. Boxer, 156 Cal. App. 3d 171 (1st Dist. 1984), or as otherwise provided through interpretation of California's Uniform Partnership Act of 1994, as amended (the Jewel Waiver). In September 2009, Thelen filed a voluntary petition for relief under Chapter 7. The trustee of Thelen's bankruptcy estate subsequently instituted adversary proceedings against many of the firms that hired former Thelen partners. The suits, based primarily on fraudulent transfer law, sought to recover profits from hourly fee matters that were pending at Thelen when it dissolved and that the defendant firms thereafter serviced for Thelen's former clients.

Robinson & Cole LLP moved to dismiss the adversary complaint filed against it. The firm argued that under California law, no property interest was transferred in connection with hourly fee matters transferred to that firm by Thelen's former clients. The Trustee argued that California law recognizes pending hourly fee matters as assets and that Thelen transferred those assets to Robinson & Cole when its partners executed the Jewel Waiver. He also argued, in the alternative, that Robinson & Cole was liable as a “transfer beneficiary” with respect to such hourly fee matters.

Judge Pauley focused his analysis on whether California law recognizes a dissolved law firm's pending hourly fee matters as partnership assets. See Geron v. Robinson Cole LLP, No. 11-cv-8967-WHP, 2012 U.S. Dist. LEXIS 128678 (S.D.N.Y. Sept. 4, 2012).

Finding authorities such as Jewel and Rothman v. Dolin, 20 Cal. App. 4th 755 (Cal. App. 2 Dist. 1993), to support that proposition, Judge Pauley turned to Robinson & Cole's argument that California's enactment of the Revised Uniform Partnership Act (RUPA) in 1994 abrogated such authority. Judge Pauley concluded that RUPA abolished the “no compensation” rule, providing instead that a partner is entitled to “reasonable compensation” for services rendered in winding up the business of the partnership. In effect, RUPA eroded the theoretical underpinnings of the Jewel doctrine. However, as Judge Pauley noted, “the former Thelen partners' post-RUPA entitlement to 'reasonable compensation' does not necessarily mean that Robinson & Cole did not receive Thelen 'assets'” ' a question better resolved on a developed record.

Notably, while acknowledging that Robinson & Cole advanced many of the same policy arguments proferred by Seyfarth (discussed below), Judge Pauley found these
arguments less persuasive in the context of California law because California courts have rejected them.

Thelen: The Seyfarth Decision

With respect to the adversary proceeding commenced against Seyfarth, Judge Pauley issued a memorandum opinion rejecting a bid by the trustee for Thelen's bankruptcy estate to recover profits from legal services performed by lawyers at Seyfarth on hourly fee matters once serviced by now-defunct Thelen. See Geron v. Seyfarth Shaw LLP, No. 12-cv-1364-WHP, 2012 U.S. Dist. LEXIS 128678 (S.D.N.Y. Sept. 4, 2012).

In his complaint against Seyfarth, the trustee alleged that prior to the Thelen partners' adoption of the Jewel Waiver, each of Thelen's partners had a fiduciary duty under California law to account to Thelen “any property, profit or benefit derived by the partner in the conduct and winding up of Thelen's business” or derived from the use of “partnership property or information.” According to the trustee, execution of the Jewel Waiver effectuated Thelen's waiver of “its rights to recover the value of the Unfinished Business and waived the partners' Duty to Account[.]” This waiver, the trustee contended, constituted a transfer by Thelen of an interest in property. The only alleged “ property” that the trustee sought to reclaim was Thelen's purported ownership interest in unfinished business.

Seyfarth moved for judgment on the pleadings, asserting first that New York, not California, law should govern whether Thelen owned its pending hourly fee matters at the time it dissolved. The trustee argued that California law should control because Thelen's partnership agreement contained a choice-of-law provision stating that California law “shall govern the construction, interpretation, and effect of this Agreement.” Judge Pauley rejected this argument because Seyfarth was not a party to Thelen's partnership agreement and was thus not bound by its terms. Utilizing New York's choice-of-law rules and its “interest analysis,” Judge Pauley then concluded that New York had a greater interest in the litigation than California. He based his decision on the facts that the majority of former Thelen partners whom Seyfarth hired are licensed to practice in New York, Thelen filed for bankruptcy in the Southern District of New York and indicated its domiciliation or residence in New York, and the alleged tort of fraudulent transfer occurred in New York.

Applying New York law, Judge Pauley then considered Seyfarth's argument that New York law does not recognize a dissolved law firm's property interest in pending hourly fee matters. Courts in New York, California, and elsewhere have previously held that a dissolved firm may recover some portion of future revenue generated from contingency fee matters, but Judge Pauley rejected an expansion of the unfinished business doctrine to hourly fees.

In so ruling, Judge Pauley described his role as predicting how the New York Court of Appeals would rule on the property interest question, a state law matter, and ascertaining what the state law is, not what it ought to be. Accordingly, he considered the only New York state court authority on point, a reasoned decision from Justice Eileen Bransten of the New York Supreme Court (the trial court level in New York) in Sheresky v. Shreseky Aronson Mayefsky & Sloan, LLP. (Judge McMahon did not address Sheresky in her Coudert decision.)

Judge Pauley, like Justice Bransten, noted important distinctions between contingency fee and hourly fee matters, such as the fact that all post-dissolution hourly fees are attributable to the “efforts, skill and diligence” of lawyers at the new firm and that Thelen's estate would receive an unjust windfall if awarded fees that should be paid to the attorneys performing the work.

Judge Pauley also examined New York's strong public policies against restrictions on the practice of law and clients' absolute right to choose counsel and its Rules of Professional Conduct barring a division of legal fees that is not in proportion to the services performed by each lawyer. He took heed of the bizarre consequences that would flow from defining hourly fee matters as property, particularly in the bankruptcy context. Judge Pauley expressed his concern with an outcome that would permit a debtor law firm to sell its pending hourly fee matters to the highest bidder pursuant to Bankruptcy Code section 363 or that would sanction a client who discharges a debtor law firm and transfers his case to a new firm for violating the automatic stay in Bankruptcy Code section 362. His concerns, of course, comport with the unique and special relationship between attorney and client and are consistent with Judge Pauley's refusal to find a property interest in hourly fee matters through analogy to executory contracts in other professions, such as architecture partnerships.

Conclusion

The Second Circuit, likely by certification to the New York Court of Appeals, will decide whether Judge Pauley or Judge McMahon has it right under New York law. Likewise, the Second Circuit may certify Judge Pauley's decision with respect to California law to the California Supreme Court. Lawyers in those two jurisdictions may soon have an answer to the significant and complicated question, “Do law partnerships own their client matters?” For partners and law firms in every other jurisdiction, this debate is likely to persist for years to come, particularly for the numerous firms across the country that hire or have hired departing partners from collapsed law firms, such as Thelen, Coudert, Howrey Simon, Heller Ehrman, Brobeck Phleger & Harrison, and, most recently, Dewey & LeBoeuf.

First things first, partnerships ought to consider now ' in advance of any perceived financial distress ' whether to adopt a so-called Jewel Waiver. This important step may, among other things, trigger applicable fraudulent transfer statutes of limitation and save departing partners and their future law firms significant expense and confusion down the road. As for prosecuting or defending fraudulent transfer claims, the starting place is a comprehensive understanding of a particular state's definition of property, ethical rules and guidelines for lawyers, treatment of client autonomy and lawyer mobility, and all the nuances likely interwoven among these concepts. These disputes, as in the Seyfarth case, may also involve a choice-of-law analysis driven by public policy, the law firms' office locations, and the relevant lawyers' states of admission. If the unfinished business claims are viable in a certain state, then partners and law firms can expect to grapple with tremendously difficult questions, like how to value pending client matters in terms of future profits as of the prior firm's dissolution date and precisely what compensation is “reasonable” for lawyers actually servicing such client matters post-dissolution.

Robert W. Dremluk is a partner in the New York office of Seyfarth Shaw LLP. Ryan Pinkston is an associate, resident in Chicago. Seyfarth Shaw was a defendant in one of the Thelen cases discussed in this article.

Recently, two New York federal district courts reached conflicting decisions in the Coudert Brothers LLP (Coudert) and Thelen LLP (Thelen) bankruptcy cases with respect to a law firm's purported ownership interest in future profits from its former clients' matters pending on the date of the law firm's dissolution, or “unfinished business.” In Coudert, United States District Court Judge Colleen McMahon held that in her view, New York courts would recognize unfinished business claims for hourly matters. In Thelen, United States District Judge William H. Pauley III held that New York courts have not and, in his opinion, would not recognize claims for unfinished business for hourly matters based on New York's strong policies regarding client choice and lawyer mobility. However, in a companion case interpreting California law, Judge Pauley held that to the extent that a law firm earned profits from the former firm's client matters exceeding “reasonable compensation,” California law dictates that those profits belong to the former firm. Both judges have certified interlocutory appeals to the Second Circuit Court of Appeals.

The Coudert Decision

DSI, the plan administrator for Coudert, brought 13 separate adversary proceedings against certain law firms that hired former Coudert partners, premised on the “unfinished business” doctrine. DSI argued that the firms were liable to Coudert for any profits derived from completing certain matters that its former clients transferred to the firms. The parties filed cross-motions for summary judgment on the discrete issue of whether the unfinished business doctrine applies.

One threshold issue addressed by the Coudert court was whether pending client matters were an asset of Coudert at the time of its dissolution. The court, principally relying on New York partnership law, held that such unfinished business was presumed to be a Coudert asset. The Coudert court focused on the former partner's duty to account for use of partnership property after dissolution, noting that “[a] departing partner is not free to walk out of his firm's office carrying a Jackson Pollack painting he ripped off the wall of the reception area, simply because the firm has dissolved.” See Development Specialists, Inc. v. Akin Gump Strauss Hauer & Feld LLP (In re Coudert Brothers LLP), No. 11-cv-5994-CM, 2012 U.S. Dist. LEXIS 110715 (S.D.N.Y. July 18, 2012).

The court also relied heavily on Stem v. Warren , 227 N.Y. 538 (1920), a very old New York case, to support its conclusion that unfinished business is an asset of a dissolved law firm. Careful analysis of the underlying facts in Stem, however, shows that it involved an architectural firm in which a surviving partner breached his fiduciary duty to his former partner by soliciting and obtaining a new contract with the City of New York to design and build Grand Central Station. The Stem court never decided whether unfinished business was an asset of the former firm because the case turned on breach of fiduciary duty. The Coudert court appears to have misinterpreted the case.

The Coudert court also noted that New York courts have uniformly rejected quantum meruit as the analytical basis for a partner's duty to account for profits yielded by unfinished business following law firm dissolution, and that New York partnership law codifies the “no compensation” rule, which provides that
“[n]o partner is entitled to remuneration for acting in the partnership business, except that a surviving partner is entitled to reasonable compensation for his services in winding up the partnership affairs.” That said, the court did acknowledge that three of the four New York Appellate Divisions and the Second Circuit have interpreted the no compensation rule in contingency cases in a way so as to credit a former partner the value of his post-dissolution “efforts, skill, and diligence” against his accounting for profits.

The Coudert court rejected the defendant law firms' attempt to distinguish the treatment of unfinished business matters billed by the hour from matters paid on contingency. The court stated that the “Firms' argument conflates a law firm's rights against its clients ' which may differ according to how the matters is billed ' and the rights of former partners among themselves, including the right to demand an accounting from any partner who derives a benefit from exploiting a partnership asset. As the cases that reject the quantum meruit rationale for the duty to account make clear' these rights are entirely distinct.”

The court concluded by stating that “[i]f the Firms had suggested a principled reason why law firms should be treated differently than architectural firms, I would evaluate it, but they do not; and off the top of my head I can think of none. The Partnership Law certainly does not treat law partnerships any differently than other partnerships.”

In this regard, the Coudert court briefly discussed, but then disregarded, policy and ethical reasons why law firms and their clients should be treated differently from other types of partnerships. This seems to ignore the guidance of the New York Court of Appeals, which stated, “Clients are not merchandise. Lawyers are not tradesman. 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.” See Cohen v. Lord, Day &Lord , 75 N.Y.2d 95, 98 (1989).

Thelen: The Robinson & Cole Decision

Thelen formerly was a limited liability partnership registered in California. In October 2008, under the pressures of the global financial crisis and facing mounting partner defections, Thelen's partners voted to dissolve their partnership and adopted an amended partnership agreement that included a “provision” abandoning, among other things, “any claim or entitlement to clients, cases or matters ongoing at the time of dissolution[.]” This waiver noted expressly the partners' intent to waive any claims to “ unfinished business” of the partnership, as that term is defined in Jewel v. Boxer , 156 Cal. App. 3d 171 (1st Dist. 1984), or as otherwise provided through interpretation of California's Uniform Partnership Act of 1994, as amended (the Jewel Waiver). In September 2009, Thelen filed a voluntary petition for relief under Chapter 7. The trustee of Thelen's bankruptcy estate subsequently instituted adversary proceedings against many of the firms that hired former Thelen partners. The suits, based primarily on fraudulent transfer law, sought to recover profits from hourly fee matters that were pending at Thelen when it dissolved and that the defendant firms thereafter serviced for Thelen's former clients.

Robinson & Cole LLP moved to dismiss the adversary complaint filed against it. The firm argued that under California law, no property interest was transferred in connection with hourly fee matters transferred to that firm by Thelen's former clients. The Trustee argued that California law recognizes pending hourly fee matters as assets and that Thelen transferred those assets to Robinson & Cole when its partners executed the Jewel Waiver. He also argued, in the alternative, that Robinson & Cole was liable as a “transfer beneficiary” with respect to such hourly fee matters.

Judge Pauley focused his analysis on whether California law recognizes a dissolved law firm's pending hourly fee matters as partnership assets. See Geron v. Robinson Cole LLP, No. 11-cv-8967-WHP, 2012 U.S. Dist. LEXIS 128678 (S.D.N.Y. Sept. 4, 2012).

Finding authorities such as Jewel and Rothman v. Dolin , 20 Cal. App. 4th 755 (Cal. App. 2 Dist. 1993), to support that proposition, Judge Pauley turned to Robinson & Cole's argument that California's enactment of the Revised Uniform Partnership Act (RUPA) in 1994 abrogated such authority. Judge Pauley concluded that RUPA abolished the “no compensation” rule, providing instead that a partner is entitled to “reasonable compensation” for services rendered in winding up the business of the partnership. In effect, RUPA eroded the theoretical underpinnings of the Jewel doctrine. However, as Judge Pauley noted, “the former Thelen partners' post-RUPA entitlement to 'reasonable compensation' does not necessarily mean that Robinson & Cole did not receive Thelen 'assets'” ' a question better resolved on a developed record.

Notably, while acknowledging that Robinson & Cole advanced many of the same policy arguments proferred by Seyfarth (discussed below), Judge Pauley found these
arguments less persuasive in the context of California law because California courts have rejected them.

Thelen: The Seyfarth Decision

With respect to the adversary proceeding commenced against Seyfarth, Judge Pauley issued a memorandum opinion rejecting a bid by the trustee for Thelen's bankruptcy estate to recover profits from legal services performed by lawyers at Seyfarth on hourly fee matters once serviced by now-defunct Thelen. See Geron v. Seyfarth Shaw LLP, No. 12-cv-1364-WHP, 2012 U.S. Dist. LEXIS 128678 (S.D.N.Y. Sept. 4, 2012).

In his complaint against Seyfarth, the trustee alleged that prior to the Thelen partners' adoption of the Jewel Waiver, each of Thelen's partners had a fiduciary duty under California law to account to Thelen “any property, profit or benefit derived by the partner in the conduct and winding up of Thelen's business” or derived from the use of “partnership property or information.” According to the trustee, execution of the Jewel Waiver effectuated Thelen's waiver of “its rights to recover the value of the Unfinished Business and waived the partners' Duty to Account[.]” This waiver, the trustee contended, constituted a transfer by Thelen of an interest in property. The only alleged “ property” that the trustee sought to reclaim was Thelen's purported ownership interest in unfinished business.

Seyfarth moved for judgment on the pleadings, asserting first that New York, not California, law should govern whether Thelen owned its pending hourly fee matters at the time it dissolved. The trustee argued that California law should control because Thelen's partnership agreement contained a choice-of-law provision stating that California law “shall govern the construction, interpretation, and effect of this Agreement.” Judge Pauley rejected this argument because Seyfarth was not a party to Thelen's partnership agreement and was thus not bound by its terms. Utilizing New York's choice-of-law rules and its “interest analysis,” Judge Pauley then concluded that New York had a greater interest in the litigation than California. He based his decision on the facts that the majority of former Thelen partners whom Seyfarth hired are licensed to practice in New York, Thelen filed for bankruptcy in the Southern District of New York and indicated its domiciliation or residence in New York, and the alleged tort of fraudulent transfer occurred in New York.

Applying New York law, Judge Pauley then considered Seyfarth's argument that New York law does not recognize a dissolved law firm's property interest in pending hourly fee matters. Courts in New York, California, and elsewhere have previously held that a dissolved firm may recover some portion of future revenue generated from contingency fee matters, but Judge Pauley rejected an expansion of the unfinished business doctrine to hourly fees.

In so ruling, Judge Pauley described his role as predicting how the New York Court of Appeals would rule on the property interest question, a state law matter, and ascertaining what the state law is, not what it ought to be. Accordingly, he considered the only New York state court authority on point, a reasoned decision from Justice Eileen Bransten of the New York Supreme Court (the trial court level in New York) in Sheresky v. Shreseky Aronson Mayefsky & Sloan, LLP. (Judge McMahon did not address Sheresky in her Coudert decision.)

Judge Pauley, like Justice Bransten, noted important distinctions between contingency fee and hourly fee matters, such as the fact that all post-dissolution hourly fees are attributable to the “efforts, skill and diligence” of lawyers at the new firm and that Thelen's estate would receive an unjust windfall if awarded fees that should be paid to the attorneys performing the work.

Judge Pauley also examined New York's strong public policies against restrictions on the practice of law and clients' absolute right to choose counsel and its Rules of Professional Conduct barring a division of legal fees that is not in proportion to the services performed by each lawyer. He took heed of the bizarre consequences that would flow from defining hourly fee matters as property, particularly in the bankruptcy context. Judge Pauley expressed his concern with an outcome that would permit a debtor law firm to sell its pending hourly fee matters to the highest bidder pursuant to Bankruptcy Code section 363 or that would sanction a client who discharges a debtor law firm and transfers his case to a new firm for violating the automatic stay in Bankruptcy Code section 362. His concerns, of course, comport with the unique and special relationship between attorney and client and are consistent with Judge Pauley's refusal to find a property interest in hourly fee matters through analogy to executory contracts in other professions, such as architecture partnerships.

Conclusion

The Second Circuit, likely by certification to the New York Court of Appeals, will decide whether Judge Pauley or Judge McMahon has it right under New York law. Likewise, the Second Circuit may certify Judge Pauley's decision with respect to California law to the California Supreme Court. Lawyers in those two jurisdictions may soon have an answer to the significant and complicated question, “Do law partnerships own their client matters?” For partners and law firms in every other jurisdiction, this debate is likely to persist for years to come, particularly for the numerous firms across the country that hire or have hired departing partners from collapsed law firms, such as Thelen, Coudert, Howrey Simon, Heller Ehrman, Brobeck Phleger & Harrison, and, most recently, Dewey & LeBoeuf.

First things first, partnerships ought to consider now ' in advance of any perceived financial distress ' whether to adopt a so-called Jewel Waiver. This important step may, among other things, trigger applicable fraudulent transfer statutes of limitation and save departing partners and their future law firms significant expense and confusion down the road. As for prosecuting or defending fraudulent transfer claims, the starting place is a comprehensive understanding of a particular state's definition of property, ethical rules and guidelines for lawyers, treatment of client autonomy and lawyer mobility, and all the nuances likely interwoven among these concepts. These disputes, as in the Seyfarth case, may also involve a choice-of-law analysis driven by public policy, the law firms' office locations, and the relevant lawyers' states of admission. If the unfinished business claims are viable in a certain state, then partners and law firms can expect to grapple with tremendously difficult questions, like how to value pending client matters in terms of future profits as of the prior firm's dissolution date and precisely what compensation is “reasonable” for lawyers actually servicing such client matters post-dissolution.

Robert W. Dremluk is a partner in the New York office of Seyfarth Shaw LLP. Ryan Pinkston is an associate, resident in Chicago. Seyfarth Shaw was a defendant in one of the Thelen cases discussed in this article.