On June 4, 2014, the New York Court of Appeals will hear arguments arising from the bankruptcies of two law firms—Thelen and Coudert Brothers—as to whether the former partners of the bankrupt law firms must turn over profits earned on billable-hour client matters they brought to their new firms.

The battle lines have been drawn, with the American Bar Association and twelve prominent New York law firms filing amici curiae briefs arguing that the so-called “unfinished business” profits are not property of the bankrupt law firms.  On the other side, the trustees and plan administrator for the bankrupt law firms of Dewey & LeBoeuf, Howrey and Heller Ehrman, filed an amici curiae brief urging the court to rule that the former partners have a fiduciary duty to account for profits earned from the completion of ongoing client matters for the benefit of the dissolved partnership and its creditors.

After two judges of the United States District Court for the Southern District of New York issued conflicting opinions on whether a client matter that is billed on an hourly basis is property of the bankrupt law firm where the matter originated, the Second Circuit certified two questions to New York’s highest court:

Under New York law, is a client matter that is billed on an hourly basis the property of a law firm, such that, upon dissolution and in related bankruptcy proceedings, the law firm is entitled to the profit earned on such matters as the “unfinished business” of the firm?

If so, how does New York law define a “client matter” for purposes of the unfinished business doctrine and what proportion of the profit derived from an ongoing hourly matter may the new law firm retain?

Claw-Back Actions Against Former Partners of Bankrupt Laws Firms

The unfinished business doctrine traces its origins to Jewel v. Boxer, a decision of the California Court of Appeals holding that, absent a contrary provision in a partnership agreement, a former law firm partner had a duty to account to a dissolved partnership for any profits generated through winding up unfinished partnership business. Jewel v. Boxer, 156 Cal. App. 3d 171, 203 Cal. Rptr. 13, 15-17 (1984).

Trustees and administrators of bankrupt law firms—including those for Thelen, Coudert, Brobeck, Phleger & Harrison, Heller Ehrman and Howrey—have initiated lawsuits against former partners and their new firms to recover unfinished business profits. Some of the bankrupt law firms, such as Thelen, included a “Jewel waiver” in their partnership agreement, wherein the partnership waived any rights to clients, cases or matters ongoing at the time of the partnership’s dissolution other than for work performed prior to a partner’s departure from the firm.  The Jewel waiver, however, may be avoidable as a fraudulent transfer under § 548 of the Bankruptcy Code or applicable state law if adopted in conjunction with dissolution of the firm while it is insolvent. 

Split Within S.D.N.Y. Over the Bankrupt Firm’s Ownership of Client Matters

The Thelen and Coudert appeals before the N.Y. Court of Appeals on June 4 both arise from lawsuits brought by the bankruptcy trustee or plan administrator of the bankrupt firms to recover unfinished business profits from former partners and their new law firms. Months apart, two S.D.N.Y. judges considering the Thelen and Coudert unfinished business lawsuits reached opposite conclusions regarding the bankrupt firm’s ownership rights in hourly client matters, with the judge in the Coudertcase finding that pending hourly matters are law firm assets and the judge in the Thelen case holding that they are not.

Trustees of Bankrupt Law Firms, the American Bar Association and N.Y. Law Firms Weigh In

The trustees and plan administrator for the bankrupt law firms of Dewey & LeBoeuf, Howrey and Heller Ehrman submitted an amici curiae brief arguing that bankrupt law firms have property rights in hourly matters, entitling bankruptcy trustees to recover unfinished business profits for the benefit of the bankrupt firm’s creditors. They noted the significance of the ruling in Thelen:

Until Judge Pauley’s decision in the Thelen LLP bankruptcy, three federal judges had ruled that New York would apply the Unfinished Business Rule to a law firm’s hourly matters and every court in every major urban or financial center – from California to Washington D.C. to Illinois and Pennsylvania – had applied the Unfinished Business Rule to law firms, regardless of whether ongoing client matters were billed on a contingent or hourly basis.  . . . In the fall of 2012, Judge Pauley’s decision brought chaos where there was once order by finding that New York, the epicenter of the U.S. legal market, would not abide by the uniform application of the Unfinished Business Rule.

Also filing an amici curiae brief, a group of twelve prominent firms with offices in New York argued that the application of the unfinished business rule to hourly fee matters infringes on clients’ fundamental right to choose their counsel and “would impose a monetary penalty on firms agreeing to represent clients who, through no fault of their own, happened to be represented at one time by attorneys whose former law firm failed.”

The American Bar Association also weighed in, “in support of neither party, but rather in support of the client’s right to choose its counsel.” The ABA, with nearly 400,000 members including over 36,000 lawyers in New York, asserted “that the contention that an unfinished hourly rate client matter of a dissolved firm is property of the dissolved firm conflicts directly with the long-standing principle that the client has the right to control its relationship with its attorney, and to select and retain or change counsel at any time.”

Conclusion

The N.Y. Court of Appeals ruling in the Coudert and Thelen cases will likely have a significant impact on the ability of  bankruptcy trustees in more recent bankruptcy cases to claw back unfinished business profits from law firms who absorbed partners from the bankrupt firms.