On May 24, 2012, the United States District Court for the Southern District of New York (District Court) issued an opinion with significant ramifications for law firms seeking to hire former partners from bankrupt law firms. At issue was whether, under New York partnership law, the law firms that hired former partners of Coudert Brothers LLP (Coudert), a dissolved and bankrupt law partnership, must account for profits that the former Coudert partners earned while completing work on open client matters they took with them from Coudert.
Coudert filed for bankruptcy protection under chapter 11 of the Bankruptcy Code in September 2006, in the United States Bankruptcy Court for the Southern District of New York (Bankruptcy Court), slightly more than one year following its dissolution. In August 2008, the Bankruptcy Court entered an order confirming the First Amended Plan of Liquidation, under which Development Specialists, Inc. (DSI), was appointed Plan Administrator for the Coudert bankruptcy estate. Thereafter, DSI filed suit against 13 law firms, based upon the premise that the defendant law firms (Firms) were liable to the Coudert estate under the unfinished business doctrine, seeking to recover profits that the former Coudert partners (and their new law firms) earned while completing work on unfinished client matters being billed on an hourly basis. The unfinished business doctrine is the general rule that, absent a contrary provision in a partnership agreement (as in Coudert’s partnership agreement), each partner has a duty to account to the dissolved partnership for profits earned from the “unfinished business” of the dissolved partnership. This principle is also sometimes referred to as the “Jewel Doctrine.” See Jewel v. Boxer, 156 Cal. App. 3d 171, 176 (1984).
Following the denial of the Firms’ motions to dismiss the complaints before the Bankruptcy Court, the Supreme Court issued its decision in the unrelated case of Stern v. Marshall, 131 S. Ct. 2594 (2011), which addressed certain aspects of the jurisdictional authority of the Bankruptcy Court, and provided sufficient grounds for the District Court to withdraw its reference of the cases to the Bankruptcy Court on the basis that the unfinished business claims were derived from state law, involve private rights and the Bankruptcy Court could not adjudicate the issue to finality. Once before the District Court, the parties filed cross-motions for summary judgment on the issue of whether the Jewel Doctrine applies to client matters billed on an hourly basis.
In considering the issue, the District Court focused on distinguishing among finished business, unfinished business and new business. The District Court defined finished business as that business which has been completed prior to dissolution, such as a settled lawsuit or completed merger, and concluded that any resulting receivable at the time of dissolution is unquestionably an asset of the dissolved firm. Likewise, new business is that business flowing from an entirely new matter or engagement post-dissolution, including business derived from a client of the dissolved firm, which fees are decidedly not an asset of the dissolved firm. Finally, the court described unfinished business as contracts to perform legal services that have commenced but are not fully performed on the date of dissolution.
The District Court ultimately concluded that the Jewel Doctrine applies to hourly fee cases. In so holding, the court rejected several arguments of the Firms, which sought to distinguish between business billed on an hourly basis and business paid on contingency. First, the Firms argued that Coudert’s interest in unfinished billable hour matters was limited to the extent of Coudert’s receivables prior to dissolution. The District Court, however, rejected this argument, concluding that it improperly focused on Coudert’s rights to collect from its clients and not the rights of the partners amongst themselves. The District Court noted that the basis for the Jewel Doctrine is to “settle accounts among partners upon dissolution of their business” and that it “does not exist to assure that a law firm is paid for the value of work it has performed prior to dissolution.”
The District Court also rejected the Firms’ argument that the duty to account is contrary to New York’s public policy supporting a law firm client’s unfettered choice of counsel—albeit while concluding that this was “by far the Firms’ most powerful argument.” Specifically, while New York case law supports the proposition that any financial disincentive to an attorney’s continued representation of a client impinges upon a client’s unfettered choice of counsel, the cases cited did not involve dissolution of partnerships, which rules are set by statute and are, therefore, not likely to contravene public policy. Furthermore, and most compelling to the District Court, was the fact that the Second Circuit in a contingency fee case did not express any concern that a dissolved law firm’s participation in a former law partner’s post-dissolution earnings would impinge upon the client’s unfettered choice of counsel.
Accordingly, the District Court held that the open client matters at issue belonged to Coudert on the date of dissolution and that former Coudert partners and their new law firms must account for any profits from those client matters billed on an hourly basis at their new firms.
The ruling may affect claims in the chapter 11 case of Dewey & LeBoeuf LLP, which recently filed for bankruptcy protection in the United States Bankruptcy Court for the Southern District of New York, as well as claims in the cases of other law firm and non-law firm dissolutions. However, litigation of the issue is likely to continue until either the New York Court of Appeals settles the matter (for New York partnerships) or one or more federal appellate courts address the issue of whether the Jewel Doctrine applies to client matters billed on an hourly basis.