Contributed by Sunny Singh
In a unanimous decision, the New York Court of Appeals stuck a dagger through the heart of bankruptcy estates of failed law firms as it declared that profits earned on matters that former partners of the failed firm take with them to their new employers are not property of the former firm. Those profits belong to the new firm that provides the legal services.
The recent failures and bankruptcies of some of the largest law firms in the country have given rise to substantial litigation. One type of litigation arising out of law firm failures has been the pursuit of profits earned on “unfinished business” that originated with the failed law firm. The theory is premised on a 1984 California appellate court decision – Jewel v. Boxer – that held, absent an agreement to the contrary, profits derived from work begun by former partners of dissolved law firms are partnership assets that must be finished for the benefit of the dissolved partnership. Based on Jewel, trustees and other representatives of failed law firms have argued that, upon a bankruptcy filing, work pending at the time of dissolution of the failed law firm and the profits thereon constitute property of the failed law firm’s bankruptcy estate under section 541 of the Bankruptcy Code. As a result, many law firms that hired former partners from failed firms have been sued for turnover of profits realized on “unfinished business” for the benefit of the failed law firm’s creditors.
The issue was presented to the New York Court of Appeals in connection with the bankruptcy cases of Thelen LLP and Coudert Brothers LLP. In October 2008, the partners of Thelen voted to dissolve the firm. In connection with the dissolution, the Thelen partners executed an “Unfinished Business Waiver” (also known as a “Jewel Waiver”) pursuant to which the Thelen partners, on behalf of themselves and the partnership, waived any right to profits from work that Thelen partners took with them to new law firms. Following Thelen’s bankruptcy filing, Thelen’s chapter 7 trustee commenced an adversary proceeding against Seyfarth Shaw LLP, which hired 11 former Thelen partners. The Thelen trustee argued that because there was no consideration paid to Thelen’s estate for the Jewel Waiver, the waiver was an unenforceable fraudulent conveyance and the pending hourly matters and profits thereon were still property of Thelen’s bankruptcy estate. The District Court for the Southern District of New York held that the unfinished business doctrine does not apply under New York law to a dissolving law firm’s pending hourly fee matters.
The decision was in conflict with another decision by the District Court for the Southern District of New York issued just four months earlier in the Coudert Brothers bankruptcy. Coudert Brothers dissolved in August 2005. After Coudert’s failure, many Coudert partners were hired by several other firms and took with them work that had originated while they were with the Coudert firm. In September 2013, Coudert’s bankruptcy administrator commenced 13 adversary proceedings against some of the firms that hired former Coudert partners asserting Jewel or unfinished business claims. In one of those lawsuits, the district court granted summary judgment for Coudert holding that hourly fee matters were presumed to be property of the partnership on its dissolution date.
The conflicting decisions were appealed to the Second Circuit, which certified the question of whether the “unfinished business doctrine” was valid under New York law to the New York Court of Appeals. The New York Court of Appeals rejected the Jewel claims. The court held that a law firm does not own a client or an engagement and, as a result, a former law firm is not entitled to be paid for services that are rendered by another law firm. In its analysis, the court considered the role of Partnership Law, in particular, the Revised Uniform Partnership Act which has been enacted in every state except Louisiana. The court found that “Partnership Law does not define property; rather, it supplies default rules for how a partnership upon dissolution divides property as elsewhere defined in state law.” Id. at *9. The court then concluded, in New York, given the unqualified right of clients to terminate the attorney-client relationship at any time, “no law firm has a property interest in future hourly legal services . . . .” Id. at *10. The former law firm only has the right to be paid compensation for legal services already provided.
The court’s decision was also guided by public policy considerations and principles governing the attorney-client relationship and the Rules of Professional Conduct. In the court’s view, allowing a former law firm and its partners to profit from work it did not perform would create an unjust windfall. In addition, the Coudert and Thelen trustees conceded that there was no basis for the failed law firms to recover amounts on account of a former partner who left the firm before its dissolution. This distinction would encourage partners to jump ship from a struggling law firm sooner rather than later, thereby making it more difficult for a struggling firm to try to restore its financial condition. In contrast, attorneys who stick around too long may no longer be able to represent their clients when they move to a new employer, “a major inconvenience for the clients and a practical restriction on a client’s right to choose counsel.” Id. at *16. Attorneys may also find it more difficult to secure a position at a new law firm. In sum, the court concluded that the trustees’ position “conflicts with New York’s strong public policy encouraging client choice, and concomitantly, attorney mobility.” Id. at *16-17.
Many commentators have stated that the court’s decision is likely to put an end to Jewel litigation in New York (and perhaps elsewhere). In the spirit of the World Cup, score new law firms, one, failed law firms, nil.