1) Dev. Specialists, Inc. v. Akin Gump Strauss Hauer & Feld LLP, Case No. 1:11-cv-05995 (S.D.N.Y. May 24, 2012)
The estate administrator of the bankruptcy estate of a dissolved law firm brought suit against 10 law firms for recovery of profits earned by former partners while working for their respective new firms. The estate administrator argued that fees earned from "unfinished business" (fees earned on pending cases by the former partners after the dissolution date of their former firm) constituted estate property. The law firms argued that the "unfinished business" doctrine did not apply to matters billed on an hourly basis. The court disagreed, finding that the doctrine applied regardless of the nature of the legal fees (contingent or hourly), absent a contrary provision in the partnership agreement.
Coudert Brothers LLP was a law firm that operated pursuant to a partnership agreement. Following the dissolution of the partnership, many of Coudert’s partners were hired by other law firms. In numerous instances, the partners brought clients and pending matters that Coudert had been handling with them to their new firms.
Some time after dissolution, the firm filed for bankruptcy, and Development Specialists, Inc., an administrator, was appointed. DSI brought suit against the firms that hired the former Coudert partners who had brought pending business with them. In the lawsuit, DSI alleged that the open matters, and the fees collected therefrom, that the partners took to their new firms constituted "unfinished business," and were partnership assets. DSI sought the return of the fees that the new firms had earned as a result of the Coudert partners’ completion of this unfinished business. The new firms made two arguments: first, the firms argued that Coudert did not have a property interest in the matters following the dissolution date because the clients were billed by the hour; and second, if Coudert has an interest in the matters, it is limited to work performed pre-dissolution, and any benefit generated post-dissolution is the property of the new firm.
The "unfinished business" rule holds that, absent a contrary provision in a partnership agreement, any business that is unfinished as of the dissolution date constitutes an asset of the partnership – not an asset of the partners. Accordingly, each partner owes a duty to account to the partnership for any profits derived from the post-dissolution completion of unfinished business. Prior case law held that law firm contingency matters completed by departed partners following dissolution did constitute "unfinished business," and required that the profits derived from those matters be accounted for and returned to the partnership.
The defendant law firms here argued that a meaningful difference existed between cases billed on an hourly versus contingent fee basis. The district court, looking at other states’ case law, discerned no meaningful difference between legal matters billed on a contingency basis or an hourly basis. The method of calculating fees was irrelevant to the question of whether outstanding matters constituted "unfinished business" and were therefore considered partnership assets, unless the partnership agreement specified otherwise.
The court then analyzed the Coudert partnership agreement to determine if any provisions indicated that unfinished business did not constitute a partnership asset. There were no such indications in the agreement, and in fact, certain provisions expressly incorporated the dissolution provisions of the New York Partnership Law (NYPL).
The district court examined the defendant firms’ argument that the application of the unfinished business doctrine contravened an important public policy – supporting unfettered client choice of counsel. Despite calling this the firms’ strongest argument, the court concluded that the unfinished business rule did not contravene this policy. The court stated two reasons for its conclusion: (i) partnership dissolution is governed by statute, and thus the statute is unlikely to violate public policy; and (ii) neither the Second Circuit nor any New York state court that applied this doctrine to contingency fee matters had expressed a public policy concern. Accordingly, the district court held that applying the unfinished business rule to open, hourly matters did not violate New York’s public policy supporting a client’s choice of counsel.
The defendant firms argued that, if hourly matters were subject to the unfinished business rule, the "efforts, skills and diligence" of the former Coudert partners nullified the value of the fees owed to the partnership. Essentially, the defendant firms argued that they should be allowed to deduct expenses associated with the partners’ "efforts, skills and diligence" before transferring fees to the partnership, and this calculation would equal the amount the partners had generated for the new firms. The Second Circuit has recognized this exception, despite provisions in the NYPL and the Uniform Partnership Act (UPA) that prohibit compensation to a partner for his or her post-dissolution work in completing open matters. The district court ruled that this issue raised factual questions that would require the presentation of evidence, before the court could make a ruling. The court granted DSI’s motion for declaration that the open client matters were partnership assets on the dissolution date, and denied the defendant firms’ motions to dismiss.
The district court’s ruling is germane to current and future law firm dissolutions. Not only does the ruling impact the dissolving law firm, but it also greatly impacts any firm that hires former partners and performs work on matters that originated with the dissolved law firm. This case provides a cautionary tale that firms hiring former partners of a dissolved firm may not reap the rewards of immediate case work and fees that the former partners bring with them. Practically speaking, the dissolved law firm could seek the return of any fees generated by the new firm that are associated with the transferred matter.
Complicating matters, a different judge in the District Court for the Southern District of New York reached the opposite conclusion while reviewing almost identical facts. Both cases have been certified for appeal. The issue must be resolved by the highest New York state court.
2) Geron v. Seyfarth Shaw, LLP, Case No. 1:11-cv-08967 (S.D.N.Y. Sept. 4, 2012)
This is the second of two recent cases involving the application of the "unfinished business" doctrine to fees earned by former partners of the dissolved law firms from matters that had been pending prior to the dissolution. This decision reached the opposite conclusion of the earlier decision, setting up an interesting state of affairs in New York.
Here, the chapter 7 trustee of the bankruptcy estate of a former law firm brought fraudulent transfer claims against two law firms that hired partners from the former law firm. Similar to DSI v. Akin Gump, the trustee sought to recover profits, generated by the partners for their new firms, that were associated with clients and pending matters of the now bankrupt firm. The trustee asserted his claims under the "unfinished business" doctrine and argued that profits derived from hourly fee matters should (like profits associated with contingency fee matters) be deemed property of the estate. Both defendant firms argued that hourly matters were dissimilar to contingency fee matters and did not constitute unfinished business.
In contrast to the DSI v. Akin Gump decision, the district court held that hourly matters are not partnership property under New York law, and not subject to the unfinished business doctrine. The court did, however, find that hourly matters may constitute "unfinished business" under California law, but only to the extent that the former partners received remuneration beyond "reasonable compensation" as set forth in the Revised Uniform Partnership Act.
Thelen LLP, a multi-national law firm, was a registered limited liability partnership governed by California law. In 2008, Thelen’s partners voted to dissolve the firm. A year later, the firm filed a chapter 7 bankruptcy petition in the Bankruptcy Court for the Southern District of New York. In connection with the plan of dissolution, the Thelen partners incorporated a so-called Jewel waiver into their partnership agreement, which, in contravention of the Jewel decision that pending matters are partnership assets, affirmatively removed any unfinished business from partnership assets. The chapter 7 trustee brought fraudulent transfer, accounting and turnover claims against Seyfarth Shaw LLP and Robinson & Cole LLP, arguing that the adoption of the Jewel waiver constituted a fraudulent transfer because the defendant firms received a property interest that rightfully belonged to Thelen. Seyfarth moved for judgment on the pleadings, and Robinson moved to dismiss. The district court granted Seyfarth’s motion and denied Robinson’s motion.
The court applied New York law to the trustee’s claims against Seyfarth because the majority of significant contacts occurred in New York. The trustee argued that under New York judicial interpretation of the "unfinished business doctrine," the partners could not disclaim an interest in unfinished business that would be completed by other law firms. Conversely, Seyfarth argued that New York law did not recognize a law firm’s property interest in pending hourly fee matters. The highest state court in New York has yet to rule on whether pending hourly fee matters constitute partnership property of the dissolved partnership, so the district court had to predict how the state court would rule.
New York courts have applied the unfinished business doctrine to contingency fee cases, but have not extended the doctrine to hourly billed cases. This court refused to extend the unfinished business doctrine to hourly billed cases and cited three reasons for its holding.
First, the court recognized a real distinction between contingent fee and hourly cases. "Unlike in the contingency fee context, applying the unfinished business doctrine to pending hourly fee matters would result in an unjust windfall for the Thelen estate, as ‘compensating a former partner out of that fee would reduce the compensation of the attorneys performing the work.’ Such an expansion of the doctrine would violate New York’s public policy against restrictions on the practice of law." Accordingly, such an extension would violate public policy.
Second, the court found that recognizing a property interest in hourly matters would conflict directly with New York’s Rules of Professional Conduct, which prohibit a lawyer from dividing a fee with another lawyer not associated with the same firm (except under circumstances not relevant here).
Third, the court, citing New York case law, also stated that, unlike a contingency fee case, all post-dissolution fees earned in an hourly case "are due to that lawyer’s post-dissolution efforts, skill and diligence." This holding recognizes that the lawyers and the new firm, and not the former firm, create and add value to a matter after it is transferred.
The court granted Seyfarth’s motion to dismiss pursuant to the court’s interpretation of New York law and subsequent determination that "a dissolved law firm’s pending hourly fee matters are not partnership assets."
Unlike Seyfarth’s claims, which the court determined were governed by New York law, the court applied California law to the trustee’s claims against Robinson. Robinson asserted that California’s enactment of the Revised Uniform Partnership Act nullified the holdings of Jewel and its progeny, arguing that under RUPA, a partner is entitled to "reasonable compensation for services rendered in winding up the business of the partnership." This argument is inapposite to the Jewel holding because under Jewel, absent a contrary agreement, the partnership would be entitled to the profits associated with the completion of any unfinished business. The court agreed with Robinson’s argument, but held the question of what constituted "reasonable compensation" to be fact-intensive and not suitable for dismissal. Robinson’s liability, if any, depended on the quantification of "reasonable compensation" as applied to the former Thelen partners – the court could only make the required determination with a more developed record.
This is the second decision from the Southern District of New York within three months that has dealt with the significant question of whether pending hourly client matters constitute partnership assets under New York law. Recognizing the import of this issue, the Geron court certified the decision for interlocutory appeal. This decision comes on the heels of the DSI v. Akin Gump decision, where a different judge sitting in the Southern District of New York held that unfinished business was a partnership asset (this decision was also certified for appeal). These two cases certainly impact current and future law firm dissolutions, and the likelihood that partners of the dissolved law firm will be forced to return profits earned at their new law firms. We will keep you updated as these appeals progress.