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New York, California Law Differ on Who Gets Defunct Firm's Fees in Pending Hourly Cases

Tuesday, September 18, 2012

By Joan C. Rogers

Unfinished hourly fee matters of a dissolved law firm do not remain its property under New York law when departing partners finish up that business at other firms, the U.S. District Court for the Southern District of New York held Sept. 4 in the bankruptcy proceeding of the defunct firm Thelen LLP (Geron v. Robinson & Cole LLP, S.D.N.Y., No. 11 Civ. 8967, 9/4/12).

The case applies New York law in one of two consolidated fraudulent transfer cases filed by the bankruptcy trustee against firms that took on former Thelen partners. Judge William H. Pauley III decided that Seyfarth Shaw LLP is not obligated to repay Thelen's bankruptcy estate for fees that it earned on hourly fee matters that were pending when Thelen dissolved.

Extending the “unfinished business” doctrine to pending hourly fee matters in New York would bestow an unjust windfall on the Thelen bankruptcy estate, Pauley concluded. It also would clash with New York's Rules of Professional Conduct and conflict with the state's strong public policy in favor of client autonomy and lawyer mobility, he said.

Applying California law in the companion case, Pauley held that to the extent Robinson & Cole LLP earned profits from former Thelen matters beyond “reasonable compensation,” those profits belong to Thelen and must be repaid. California's policies and partnership law differ from those of New York and dictate a different result, the court decided.

Pauley's view of New York law differs sharply from a recent decision by a different Southern District judge. In Dev. Specialists Inc. v. Akin Gump Strauss Hauer & Feld LLP, 2012 BL 140364, 28 Law. Man. Prof. Conduct 327 (S.D.N.Y. May 24, 2012), Judge Colleen McMahon held that hourly fee matters pending on the date of a law firm's dissolution, like pending contingent fee matters, are assets of the dissolved firm under New York law, so that firms where the business was completed must repay profits earned on those matters.

Flawed Logic or Correct Result?
Two experts on this subject gave BNA very different views on Pauley's interpretation of New York law.

In comments emailed to BNA, Robert W. Hillman characterized Pauley's opinion in the Thelen bankruptcy case as “bold but flawed.” Hillman, a law professor at the University of California, Davis, is co-author of Hillman on Lawyer Mobility (2d ed. 2012) as well as a publication on the Revised Uniform Partnership Act.

“There is no principled basis for distinguishing hourly from contingent fee cases in assessing the unfinished business of a law firm, and the opinion fails to recognize the substantial weight of authority saying there is no distinction,” Hillman said.

Hillman also criticized Pauley's opinion for positing a strong public policy of promoting lawyer mobility, independent of the interests of clients. “Our policy of allowing clients to choose lawyers has fostered lawyer mobility, but the point is to advance the interests of clients, not lawyers,” he said.

But according to another observer, “Judge Pauley got it right.” Ronald Minkoff, of Frankfurt Kurnit Klein & Selz in New York, said in emailed comments to BNA that the court “put the focus exactly where it should be, on the attorney-client relationship, rather than on the inapplicable bankruptcy concept of 'property.'” Minkoff added:

By doing that, he recognized that an attorney-client relationship is terminable at will, and doesn't belong to anyone other than the client. He also recognized that when hourly fees are involved, a dissolved law firm deserves to get paid only through the date of dissolution, and after that it's up to the client to decide whether to continue with the prior lawyer. By ruling that the subsequent fees belong to the new firm, the judge properly incentivized the prior lawyer (and her new firm) to continue on the matter, rather than rewarding the former partners of the failed firm by giving them a windfall of unearned fees.

 
Jewel Doctrine
In the trustee's adversary proceeding against Seyfarth Shaw, the court decided that New York law governs Thelen's interest in its unfinished client matters. New York, where Thelen's bankruptcy case is pending and where most of the former Thelen partners who moved to Seyfarth Shaw are licensed to practice, has a greater interest in the dispute than California, where Thelen was a registered limited liability partnership, Pauley found.

“[T]his concept of law firm 'property' collides with the essence of the attorney-client relationship.”

Judge William H. Pauley III

The trustee based his claim against Seyfarth Shaw on the unfinished business doctrine, which was established by Jewel v. Boxer, 203 Cal. Rptr. 13 (Cal. Ct. App. 1984).

Jewel held that, absent a partnership agreement to the contrary (known as a “Jewel waiver”), profits from work on a dissolved firm's unfinished matters belong to the former partners according to their respective shares in the firm, no matter which former partners wrapped up the matters. In reaching that conclusion, the court emphasized that the Uniform Partnership Act largely prohibits extra compensation for a partner's services after the partnership dissolves.

Although acknowledging that New York has a version of the UPA and that the “no compensation” rule applies in New York, Pauley pointed out that no New York courts have expanded the unfinished business doctrine beyond pending contingent fee matters to reach pending hourly fee matters. On the contrary, he said, the only New York court to consider the issue concluded that a debtor law firm does not possess a property interest in its unfinished hourly fee matters. Sheresky v. Sheresky Aronson Mayefsky & Sloan LLP, 35 Misc.3d 1201, 2011 BL 333719 (N.Y. Sup. Ct. Sept. 13, 2011).

Offends Public Policy
Pauley found Sheresky persuasive and predicted that New York's high court would take the same position. He asserted that recognizing a property interest in pending hourly fee matters would:

  • result in an unjust windfall for the Thelen estate;

  • violate New York's public policy against restrictions on the practice of law;

  • clash with the New York professional conduct rule that sets out conditions for dividing fees between lawyers not in the same firm;

  • contravene New York cases' treatment of post-dissolution contingent fee matters; and

  • lead to bizarre consequences in law firm bankruptcies, such as allowing a debtor firm to auction its pending client matters and turning a client's discharge of the debtor firm into a violation of the automatic stay.


 

Pauley rejected the trustee's reliance on out-of-state cases applying the UPA. Those decisions, he said, “do not represent a consensus view” and do not reliably track New York law to the extent they suggest a result that is contrary to New York policy. The UPA itself does not address whether pending hourly fee matters are partnership property, he pointed out.

“Thus, under New York law, a dissolved law firm's pending hourly fee matters are not partnership assets,” Pauley declared, adding that “this concept of law firm 'property' collides with the essence of the attorney-client relationship.”

Pauley granted judgment on the pleadings for Seyfarth Shaw, saying that the trustee must amend his complaint if he intends to pursue claims against the firm regarding Thelen's pending contingent fee matters.

RUPA's Impact
In the companion case, Robinson & Cole conceded that California law applied for purposes of its motion to dismiss the trustee's claims. But it argued that notwithstanding Jewel and cases following it, California law no longer recognizes a dissolved law firm's property right in its pending hourly fee matters. California's enactment of the Revised Uniform Partnership Act in 1994 abrogated the Jewel doctrine, the firm asserted.

Finding that argument persuasive, Pauley noted that Jewel and its progeny relied on UPA's “no compensation” rule, but that RUPA abolished that rule, providing instead that a partner is entitled to reasonable compensation for services rendered in winding up the partnership's business. “RUPA transformed the law on which Jewel relied and eroded the theoretical underpinnings of the Jewel doctrine,” Pauley said.

Pauley went on to find, however, that although RUPA's reasonable compensation rule undermines the Jewel doctrine, California law may still recognize a dissolving law firm's pending hourly fee matters as assets.

“Specifically, to the extent that Robinson & Cole earned profits from former Thelen matters exceeding 'reasonable compensation,' California law dictates that those profits belong to Thelen,” Pauley wrote. The question of reasonable compensation is fact-intensive and may not be resolved on a motion to dismiss, he said.

Although Robinson & Cole advanced many of the same policy arguments Seyfarth Shaw made, Pauley found them less persuasive in the context of California law. California courts have cited strong policy reasons supporting the Jewel doctrine, and “New York's commitment to attorney mobility appears to be stronger than California's,” Pauley said.

In his comments to BNA, Hillman asserted that RUPA actually supports rather than undermines Jewel.

“RUPA affirms that unfinished business is a firm asset, which is the whole point of Jewel. It then allows reasonable compensation for finishing unfinished business, which softens the impact of Jewel but leaves the underlying structure in place,” he said. Pauley simply got this wrong, in Hillman's view.

Up to Second Circuit
The issue of how the unfinished business doctrine applies to pending hourly fee matters is already pending before the U.S. Court of Appeals for the Second Circuit. On July 18 McMahon certified her ruling inDevelopment Specialists for interlocutory appeal, and the firms affected by her decision have appealed.

Pauley likewise certified his order for interlocutory appeal, characterizing the scope of the unfinished business doctrine as an issue of great importance to both the legal profession and clients. There is good reason to believe, he said, that the highest courts of New York and California would not apply the Jewel doctrine expansively to hourly fee matters.

Howard P. Magaliff of DiConza Traurig Magaliff, New York, represented Thelen's trustee, Yann Geron.

Christopher J. Major of Meister Seelig & Fein, New York, represented Robinson & Cole. Robert W. Dremluk of Seyfarth Shaw, New York, and Thomas Feher of Thompson Hine, Cleveland, represented Seyfarth Shaw.


Full text at /uploadedFiles/Content/News/Legal_and_Business/Bloomberg_Law/Legal_Reports/Geron(1).pdf.

The ABA/BNA Lawyers’ Manual on Professional Conduct is a joint publication of the American Bar Association Center for Professional Responsibility and Bloomberg BNA.

Copyright 2012, the American Bar Association, All Rights Reserved.

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