Legal Fees Earned by Departed Partners in Now-Defunct Law Firms Determined Not to Be Property of the Bankrupt Firm
- Two recent court decisions in California and New York call into question the continued viability of the unfinished business theory (the so-called "Jewel" doctrine) with respect to hourly matters earned by departed lawyers in firms that have dissolved.
- With the escalation of the number of dissolved firms in recent years and the complexity of bankruptcies in the modern era of the mega-firm, the unfinished business doctrine has been invoked with greater frequency and with greater scholarly scrutiny. Other states will likely weigh in either favoring, distinguishing or eviscerating the unfinished business doctrine for their own states.
A California District Court recently held that a bankruptcy trustee could not claim a property interest in the hourly fee matters pending at the now-dissolved Heller Ehrman LLP law firm.1 This June California decision was followed by a similar holding less than a month later by the New York Court of Appeals (the highest court in New York), resolving a split among lower New York cases. The New York decision refused to apply the unfinished business doctrine in favor of the bankruptcy trustees for Thelen LLP and Coudert Brothers LLP.2 The two decisions call into question the continued viability of the unfinished business theory (the so-called "Jewel" doctrine) with respect to hourly matters. However, the issue is far from settled as other states will likely consider the issue.
Partner Migration Impacted by the Two Court Opinions
The three cases decided by the two opinions followed similar facts, now familiar in the wake of the demise of several venerable (and large) law firms. Heller and Thelen each dissolved in 2008, with ensuing bankruptcy protection cases. Coudert dissolved in 2005, subsequently seeking chapter 11 bankruptcy protection.
In each case, the bankruptcy trustee initiated adversarial proceedings against the law firms to which the former partners migrated. The suits asserted a property interest in the hourly fee matters pending at the time of dissolution. In Thelen and Coudert, the partners attempted to thwart the doctrine by entering into poorly timed waivers, sometimes referred to as a "Jewel waiver."3 An unfinished business or Jewel waiver is an agreement among the partners to disclaim any interest of the partnership in pending matters. Although an elegant and simple solution to all of the complexities that the unfinished business doctrine presents, timing is everything. The Jewel waivers in Thelen and Heller were thrown out because they were executed too close in time to insolvency and Coudert had no such waiver at all.
In the absence of enforceable Jewel waivers, the courts then turned to the question of whether the legal fees earned on matters opened at the pre-dissolution firm were property of the bankruptcy estate or the subsequent law practice of the departed partners that took the clients with them. In all three matters the answer is now "no." Referring in part to an earlier decision involving contingent fee matters, the courts ruled that a law firm is entitled only to the value of the services already performed – even while acknowledging that some prior case law has referred to contingency cases as an asset of the partnership. In other words, the court makes no distinction between hourly cases and contingency cases in finding that the prior law firm's rights are limited to work actually performed by that prior law firm.
Distinguishing from Jewel v. Boxer
These decisions do not overturn Jewel v. Boxer,4 rather they stand for the proposition that in the context of a law firm bankruptcy, post-dissolution legal fees are not property and are thus not subject to the unfinished business doctrine. In Jewel, the court determined that the partners of a voluntarily dissolved firm owed an accounting to the former partners for the unfinished business of the partnership. The case arose in 1984 under the Uniform Partnership Act, as adopted in California. In that case, a four-person law firm voluntarily dissolved and two new firms emerged, each with two of the former partners. The Jewel court found that the former dissolved firm had a property interest in its "unfinished business," or the matters pending at the time of dissolution. Ever since, the Jewel decision has stood for the proposition of the unfinished business doctrine, or that the pending matters were the unfinished business of a dissolved law firm at the time of dissolution and, as such, is an asset of the dissolved firm.
The opening lines of the Heller decision state unequivocally, "A law firm – and its attorneys – do not own the matters on which they perform their legal services. Their clients do." The Heller court distinguished from Jewel by reason of the involuntary nature of its dissolution, the new fee agreements entered into with the new firms in Jewel, and the adoption of the Revised Uniform Partnership Act following the Jewel decision.
Equitable and Policy Considerations
The courts' holdings in these new decisions turned on equitable and policy considerations thus far rejected or ignored by the courts that have considered these issues. The Heller court emphasized that clients – not their lawyers – own client matters. Goodwill is not an asset that appears on a law firm's financial statements, and any expectation of continued business is personal to each particular lawyer. The court determined that the pending hourly matters could not be considered partnership property. Clients are free to take their business to any lawyer at any time. Therefore, when a client leaves a law firm (absent a dissolution), the only claim that a law firm may have is for work already completed.
The Thelen court was concerned that applying the unfinished business doctrine would create an unjust windfall to the dissolved partnership, allowing it to collect fees based on work conducted by another firm. Further, both courts were concerned that application of the unfinished business doctrine would create perverse incentives, encouraging partners to "jump ship" at the first sign of trouble to avoid a situation of being caught up in a dissolution or bankruptcy (and thereby susceptible to suits on the basis of the unfinished business doctrine), resulting in further destabilizing already floundering firms. Such a rule would also discourage firms from hiring attorneys or accepting client matters from dissolved firms and could cause clients to be concerned that their work was not receiving proper attention since its attorney is not being compensated. Both cases point to strong public policy favoring client choice in law firms, which is linked to lawyer mobility.
Law Firm Bankruptcies Occurring with Greater Frequency and Increased Scrutiny
With the escalation of the number of dissolved firms in recent years and the complexity of bankruptcies in the modern era of the mega-firm, the unfinished business doctrine has been invoked with greater frequency and with greater scholarly scrutiny. The Heller court and the Thelen court, applying laws of different states but with certain parallels in reasoning, have found no property interest in pending hourly matters and further, that the public policy considerations in such states favor the inapplicability of the unfinished business doctrine. Certainly, the law with respect to unfinished business doctrine is far from settled. Other states will likely weigh in either favoring, distinguishing or eviscerating the unfinished business doctrine for their own states.
Going Forward: What Law Firms and Displaced Attorneys Can Expect
For the Law Firm
This may not be the end of Jewel or the unfinished business doctrine. It is a reflection of how complicated the doctrine can be and underscores the importance of the partnership agreement that addresses these issues in the manner the partners wish rather than the state of the law at any one time or one place. A well-crafted partnership agreement is a must. The Jewel waiver can be dispositive in cases of simple dissolution (without the complexities of ensuing bankruptcies). Just like a will, a Jewel waiver is something to be considered in times of health. The waiver language should be considered during prosperous times – well before financial trouble is on the horizon – so that the language is not susceptible to attack as a fraudulent conveyance under the look-back periods afforded such theories.
For Law Firms Hiring Displaced Attorneys
Lateral hiring due diligence should include questions about Jewel waivers and the future of the old firm so that the acquiring firm does not open itself to complicated litigation or possible unfinished business claims. When partners of troubled or dissolving firms do move on to new firms, the new firms should carefully evaluate the risk of application of unfinished business doctrine by reviewing the cases pending (whether hourly or contingent) and determining the state of the firm from which the lawyer has departed – whether it is healthy, troubled, post-dissolution, or even if bankruptcy proceedings have already been filed.