Law Firm Divorces: Who Keeps the Cases?
By Mark B. Wilson, P.C.
Think law firm dissolutions aren’t as messy as marital dissolutions? Think again. Law firms possess many assets. Who owns the building? The paintings on the wall? The furniture? The computers? It’s not as easy to dissolve a law firm as you may think. The biggest problem: What happens to a law firm’s most valuable assets, its cases? For over 30 years, California law has held that the dissolved firm keeps all fees obtained from cases pending at the time of dissolution. However, this rule may change in 2017.
In 1984, the California Court of Appeal, First District, held that “the Uniform Partnership Act requires that attorneys’ fees received on cases in progress upon dissolution of a law partnership are to be shared by the former partners according to their right to fees in the former partnership regardless of which former partner provides legal services in the case after dissolution.” Jewel v. Boxer, 156 Cal. App. 3d 171, 174 (1984). The Court of Appeal based its holding on California’s Uniform Partnership Act (“UPA”) at California Corporations Code (“Corp. Code”) section 15018(f) which prohibited extra compensation for post-dissolution services. The partner who continued to work on cases post dissolution, however, could receive “reimbursement for reasonable overhead expenses (excluding partners’ salaries) attributable to the production of post dissolution partnership income.” Jewel, 156Cal. App. 3d at 180.
Jewel established the law for contingency fee cases. Nearly a decade later, in Rothman v. Dolin, 20 Cal. App. 4th 755 (1993), the California Court of Appeal, Second District, extended Jewel to apply to hourly fee cases. The appellate court reasoned that treating hourly cases differently from contingency cases would result in attorneys “scrambling to get the hourly fee cases rather than the contingency fee cases upon dissolution.” Id. at 758.
While Jewel and Rothman appear to discourage attorneys from working on cases in which the fees would go to the dissolved partnership, there are many reasons attorneys benefit from working on such cases. The attorney who continues the relationship with the client will be more likely to obtain future business. Today, clients increasingly view individual attorneys, and not firms, as their lawyers so maintaining relationships is crucial to success. Also, while Jewel prohibited reimbursement for partner salaries, the partner who continued to work on cases could still receive payment for work performed by associates, paralegals and secretaries.
Partners who feel that Jewel and Rothman do not adequately compensate them for their work post dissolution probably had this same feeling pre-dissolution. Almost every law firm has its share of over-performing and underperforming partners. Such is the nature of a partnership. Therefore, the problem of inequitable results may not lie with Jewel and Rothman, but instead with the partnership model.
As early as 2017, the California Supreme Court will finally weigh in regarding what should happen to a law firm’s cases post dissolution. In 2008, Bank of America declared Heller Ehrman LLP (“Heller”) in default leading Heller’s shareholders to dissolve the firm. In re Heller Ehrman LLP, 830 F.3d 964 (9th Cir. 2016). Heller’s dissolution plan contained a waiver of the Jewel doctrine allowing former Heller attorneys (or their new firms) to retain all legal fees generated from former Heller hourly cases. Id. at 971. In 2010, a plan administrator responsible for recovering assets for Heller’s creditors filed an adversary proceeding against sixteen law firms who received fees from former Heller cases. Id. The plan administrator claimed the Jewel waiver amounted to a fraudulent transfer. Id.
Twelve of the sixteen law firms settled, but the remaining four firms filed motions for summary judgment. Id. at 972. The bankruptcy court ruled in favor of Heller and certified the case for the district court to conduct trials on damages. Id. The district court, however, reviewing the bankruptcy court’s rulings de novo, granted the four law firms’ summary judgment motions. Id. U.S. District Judge Charles Breyer based his ruling on the grounds that the logic of Jewel no longer applied because California replaced the UPA with the Revised Uniform Partnership Act (“RUPA”) in 1996. Id. In particular, Judge Breyer focused on the fact the legislature had replaced Corp. Code section 15018(f), which prohibited extra compensation for winding up partnership business, with Corp. Code section 16401(h), which permits partners to obtain “reasonable compensation” for winding up partnership business. Id.
Heller appealed the district court’s ruling, arguing that if former Heller cases resulted in profits beyond “reasonable compensation” the former Heller attorneys had a fiduciary duty to Heller to account for such profits. Id. The Ninth Circuit reasoned that it needed guidance from the California Supreme Court to determine whether a dissolved law firm still maintains a property interest in fees generated from cases pending at the time of dissolution. Id. at 973.
On August 31, 2016, the California Supreme Court agreed to address whether “[u]nder California law, what interest, if any, does a dissolved law firm have in legal matters that are in progress but not completed at the time the law firm is dissolved, when the dissolved law firm had been retained to handle the matters on an hourly basis?” First, the California Supreme Court must answer whether continuing to work on hourly fee cases amounts to “winding up the business of the partnership.” See Corp. Code section 16401(h). If the California Supreme Court answers this question in the affirmative, this would allow former partners to receive “reasonable compensation” for their work on hourly fee cases. This could mean dissolved partnerships would not receive any funds from ongoing work on its former hourly fee cases. After all, shouldn’t “reasonable compensation” equal an attorney’s hourly rate?
Heller, represented by Christopher Sullivan of Diamond McCarthy LLP, filed its opening appellate brief on November 30, 2016. Heller’s brief argues that Corp. Code section 16404(b)(1) obligates partners “[t]o account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partners in the conduct of winding up of the partnership business.” Heller’s argument thus hinges on the conclusion that partners have a duty to continue to work on hourly fee cases for the benefit of the dissolved partnership. Heller admits that a partner is entitled for “reasonable compensation for services rendered in winding up the business of a partnership.” So for Heller to prevail it must convince the California Supreme Court that continuing to work on hourly fee cases is not merely a service rendered in winding up the business of the partnership, but instead implicates a duty the partner owes the dissolved partnership.
Heller’s opening brief dismisses the notion that the change in the RUPA should impact the holdings of Jewel and Rothman. Heller argues that the duty for partners to account to the partnership for fees earned on pending cases is based on common law, specifically, the “Unfinished Business Rule.” Heller argues that the “Unfinished Business Rule recognizes that cases and matters brought into a law firm are the products of the efforts of the partnership as a whole and is built on long established and basic partnership principles.”
On February 9, 2017, the four law firms (Davis Wright Tremaine LLP, Foley & Lardner LLP, Jones Day, and Orrick Herrington & Sutcliffe LLP) filed their Respondents’ briefs. Respondents argue that Heller cannot rely on pre-RUPA cases such as Jewel and Rothman. Respondents also draw a distinction between hourly cases and contingency fee cases. Respondents argue that in hourly cases the client has chosen to work with the new firm and paid the new firm accordingly. Forcing the new firm to pay the dissolved firm for these hours worked, Respondents claim amounts to “reverse confiscation,” which can impair the attorney client relationship by discouraging attorneys from performing post-dissolution work for former clients of the dissolved firm. Respondents compare firm dissolution to one of client termination or an illness by an attorney which prevents him or her from working on a client file. In these situations, the attorney does not provide any further services so he or she does not get paid. Respondents argue this “no work, no pay principle” should prevent the dissolved firm from receiving any hourly fees since it did not perform the work.
Respondents rely heavily on the New York Court of Appeals’ decision in In re Thelen LLP, 24 N.Y. 3d 16(2014). The New York Court of Appeals rejected the notion that a dissolved law firm had a right to unfinished law firm business under New York’s partnership law. “[T]he 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 28. “As a result, the Partnership Law itself has nothing to say about whether a law firm’s ‘client matters’ are partnership property.” Id. Dismissing partnership law’s impact on the question, the New York Court of Appeals held that “no law firm has a property interest in future hourly legal fees because they are too contingent in nature and speculative to create a present or future property interest, given the client’s unfettered right to hire and fire counsel.” Id. (citation omitted).
Anticipating Respondents’ reliance on In re Thelen LLP, Heller addressed the case in its opening brief. In essence, Heller argued that California should view In re Thelen LLP as an outlier. Heller stated in its opening brief that ” Thelen actually puts New York out of step with virtually every other jurisdiction in the nation by essentially creating a lawyers’ exception to the Unfinished Business Rule.” Heller then attacks the reasoning of In re Thelen LLP, including the conclusion that having to work for the benefit of a dissolved partnership would hurt lawyer mobility and clients. The California Supreme Court will have the benefit of reviewing the analysis of the New York Court of Appeals, and many other state courts, in deciding whether to overturn the law set forth in Jewel and Rothman.
While the certified question only addresses hourly fee cases, hopefully the California Supreme Court will provide guidance on contingency fee cases as well. Jewel itself involved only contingency fee cases. Since some of the work on a contingency fee case likely occurred at the dissolved firm, the dissolved firm should receive a portion of any contingency award. How to apportion the contingency fee is a difficult question. One method could apportion the fee based on the percentage of hours worked predissolution versus post-dissolution. Another approach could permit the dissolved firm to keep the contingency award, but pay the former partner all expenses, including the billable rates for all professional hours worked on the case post dissolution.
No matter what the California Supreme Court holds in In re Heller Ehrman LLP, unanswered questions likely will remain. Just as with a divorce, dissolving law firms can avoid unsettled law and protracted legal battles by agreeing on dissolution terms before any sign of trouble. The first sentence of the Jewel opinion states, “[i]n this case we hold that in the absence of a partnership agreement . . . .” Jewel at 174. Thus, law firms that address in their partnership agreements what happens to pending cases at the time of dissolution can avoid Jewel or any new legal doctrine entirely by contract. Large firms should draft partnership agreements that state upon dissolution pending cases do not remain assets of the partnership. If Heller’s shareholders had set forth its Jewel waiver in a partnership agreement, instead of in its dissolution plan, then Heller’s plan administrator likely would have had no grounds to recover legal fees generated from former Heller cases.
While smaller firms may choose not to make a blanket Jewel waiver, partners at these firms should still include in their partnership agreements terms concerning what happens to pending cases if dissolution occurs. Just as with marriage, no one likes to think about divorce when entering into a partnership. However, firms that have a plan for dissolution in their partnership agreements may save themselves from costly litigation (and a headache) in the end.
This article first appeared in the ABTL Report, Spring 2017.