Lawyers from dissolved firms may now keep clients, courts say
"The economic turmoil that we saw in 2008 and 2009 was the greatest since the Great Depression. We are still seeing the repercussions of that. We have seen the demise of law firms that were venerable household names, and we will probably see the demise of more," says Leslie D. Corwin, a partner in the New York City office of Blank Rome and a leading partnership and bankruptcy law attorney.
The collapse of large law firms has left partners and their staffs scurrying for new places to work. But while clients lose their lawyers, they retain the same legal needs. And so the question of clawback profits—how much business partners can take with them when fleeing to another firm—has become a key issue.
Until this summer, trustees of bankrupt firms have been able to rely on retaining profits for unfinished work taken from the rubble of a defunct law firm to another legal home and handled there. Under this "unfinished-business doctrine," partners have a duty to account for partnership property when a firm closes.
But in June, U.S. District Judge Charles R. Breyer of San Francisco ruled in a summary judgment that the trustee of defunct law firm Heller Ehrman isn't entitled to profits from unfinished work taken by ex-partners to new law firms.
"Heller ceased to be able to represent its clients, leaving them with no choice but to seek representation elsewhere," Breyer wrote. "A law firm never owns its client matter."
Then, in July, New York state's highest court made a similar call in a decision affecting dissolved firms Coudert Brothers and Thelen.
The rulings appear to thwart the ability of law firm bankruptcy trustees to recoup profits from unfinished hourly work taken by former lawyers to their new firms.
"These are cases that have been watched for a long time," Corwin says. "These cases send a powerful message supporting clients' freedom to choose their counsel. These rulings are huge for any BigLaw firm or any BigLaw firm lawyer because they are a roadmap for lawyer mobility."
While the New York ruling is definitive under state law, the California case is being appealed to the 9th U.S. Circuit Court of Appeals at San Francisco. Nevertheless, legal experts say the rulings indicate that at least two states could be abandoning the unfinished-business doctrine.
"If California and New York end up in the same place, it would be very strange for courts in other jurisdictions to reach a different conclusion," says Anthony E. Davis, a partner at Hinshaw & Culbertson's New York City office whose practice concentrates on the laws governing lawyers.
The seminal case on the unfinished-business doctrine comes from a 1984 California appellate court ruling, Jewel v. Boxer. The doctrine has long been criticized for impinging upon the ability of clients to choose their counsel and ensure the continuity of their representation. In addition, law firm dissolution plans often include "Jewel waivers" through which a firm can try to opt out of the unfinished-business rule.
Abandoning the doctrine, some legal experts say, would make it easier for partners to escape from failing firms without worrying they would have to give back the profit they made if they took their clients with them to new firms.
"The rulings should please every law firm that regularly engages in lateral hiring, and they should also give great comfort to those law firms that unfortunately go out of business," Corwin says. "The rulings send a message that [dying law firms] can allow their attorneys to go to other law firms and take business with them, take associates and office staff with them, and ensure that those individuals continue to have jobs."
But supporters of the unfinished-business doctrine say the rule ensures that partners are held accountable for work belonging to the partnership. Under the Uniform Partnership Act, partners have a duty to account for partnership property when a firm closes.
The June ruling involved suits filed by Heller Ehrman's bankruptcy trustee against Jones Day; Orrick, Herrington & Sutcliffe; Foley & Lardner; and Davis Wright Tremaine. Heller, a global law firm with about 700 lawyers, dissolved in 2008.
The trustee had argued that Heller had a property interest in pending hourly matters, but Judge Breyer disagreed. "Defendants came to the rescue of these clients and provided them with legal services on ongoing matters," Breyer said.
Breyer concluded that clients own the business, and that a law firm, at best, has an expectation of future business.
Breyer also said the trustee's argument failed for policy reasons. "No firm can be expected to contribute those resources if they are not entitled to retain the corresponding profits," Breyer wrote. "Here the trustees ask this court to deprive defendants of profits earned off of defendants' labor and capital investment. Public policy weighs strongly against such an outcome."
However, there's a conflicting ruling in California. U.S. Bankruptcy Judge Dennis Montali ruled this year that partners who depart a firm before it dissolves must return any profits from unfinished legal work. That case involved lawyers who left the now-defunct Washington, D.C., law firm Howrey and brought clients with them to their new firms. The Heller case is being appealed to the 9th Circuit.
Meanwhile, the New York Court of Appeals ruling has its origins in the collapse of legal giants Thelen and Coudert Brothers. Two New York federal district judges reached conflicting conclusions about the applicability of the unfinished-business doctrine in hourly fee cases taken from the fallen firms to new homes. The 2nd U.S. Circuit Court of Appeals at New York City asked the New York Court of Appeals, the highest court in the state, to declare the state of the law on the unfinished-business doctrine.
SHIFT IN NEW YORK LAW
In a unanimous decision released July 1, the New York Court of Appeals sided with law firms that hired lawyers from Coudert and Thelen. The unanimous court said that, under state law, a law firm "does not own a client or an engagement and is only entitled to be paid for services actually rendered."
Judge Susan Phillips Read, writing for the court, also found that the idea "that law firms will hire departing partners or accept client engagements without the promise of compensation ignores commonsense and marketplace realities."
Read concluded that "ultimately, what the trustees ask us to endorse [are] conflicts with New York's strong public policy encouraging client choice and, concomitantly, attorney mobility."
The change in New York law is expected to affect other law firm crashes. The bankruptcy trustee for Dewey had indicated that he intended to pursue clawback money from firms who had taken on unfinished work from Dewey's clients.
"The New York case is both definitive and critically important in settling New York law," Davis says.
"It means the hiring process, the movement of lawyers and the freedom of clients to choose their lawyers can go forward in a straightforward and businesslike way. There's still some uncertainty in California, but hopefully the courts there will reach the same outcome as in New York."