By Samson Habte
Jan. 29 — A clause in a law firm's operating agreement that requires departing shareholders to forfeit half their equity interest if they take clients with them is unethical and thus unenforceable under D.C. law, the U.S. District Court for the Eastern District of Virginia held Jan. 28.
Judge Liam O'Grady said the forfeiture clause is “an impermissible restriction on the right to practice” in violation of District of Columbia Rule of Professional Conduct 5.6(a), and that as such D.C. law prohibits its enforcement.
The ruling grants partial summary judgment to attorney Simor L. Moskowitz, who sued his former firm Jacobson Holman PLLC when it invoked the forfeiture clause to deny Moskowitz half of his equity interest after he departed for another firm.
Moskowitz argued the provision was unenforceable under D.C. law, which applied to his diversity lawsuit.
The court agreed. Although acknowledging that D.C. courts have not addressed whether contracts that violate Rule 5.6 are nonetheless enforceable, O'Grady predicted the district's highest court will agree with “the majority view” that such contracts are unenforceable.
In an earlier opinion O'Grady reserved the issue of whether the firm's anti-competition provision actually violated Rule 5.6. See 31 Law. Man. Prof. Conduct 662.
D.C. Rule 5.6(a), like similar rules adopted in every other jurisdiction, prohibits firms from offering or making operating or employment agreements that restrict a lawyer's right to practice after leaving a firm.
O'Grady first had to decide whether Rule 5.6 applied to the forfeiture clause in Jacobson's operating agreement—which, he noted, does not “impose a direct restriction on a withdrawing partner's right to practice” but rather “attaches a financial cost to a withdrawing member's decision to continue to represent any of his or her clients.”
“For that to amount to an impermissible restriction, the penalty must be ‘substantial' and the penalty must be imposed upon ‘lawyer[s] who compete after leaving the firm,'” O'Grady said, quoting Comment  to Rule 5.6.
Jacobson argued Rule 5.6 didn't apply to the forfeiture clause because the penalty it imposed on withdrawing members wasn't “substantial.”
O'Grady disagreed. He acknowledged that “Rule 5.6 does not provide a bright-line standard with which to determine when a penalty crosses from insubstantial to substantial.” But applying a definition of “substantial” in Rule 1.0, he wrote: “a fifty-percent forfeiture of a withdrawing member's equity interest in the Firm is a financial penalty ‘of clear and weighty importance.'”
According to the opinion, Jacobson also argued “that the penalty cannot be substantial because it is a fraction of Moskowitz's current salary at his new firm.”
But O'Grady said Moskowitz's salary was irrelevant. “Notably, [Jacobson] does not cite any authority supporting the use of a lawyer's current salary as a benchmark in determining whether a penalty is substantial,” he said. “Nor has the Court uncovered any.”
Jacobson also cited the testimony of an expert who said “law firms—and particularly small firms—are very fragile,” and that equity forfeiture was a “perfectly reasonable” way to protect firms from the “death spiral” they can face when equity members unexpectedly leave with firm clients.
Citing cases from other jurisdictions that have declined to adopt per se rules against forfeiture provisions, Jacobson argued the penalty it sought to impose was valid because it was “much less than the financial burden imposed by Moskowitz's departure.”
The court wasn't convinced. “Even assuming for a moment that D.C. adopts a similar exception, there is no evidence in the summary judgment record that suggests Moskowitz's withdrawal would fit within such an exception,” O'Grady wrote.
“Moreover, the practical effect of the Firm's forfeiture clause is to penalize withdrawing members who wish to continue to represent even one of the Firm's clients by depriving them of a previously accrued equity interest to which they would otherwise be entitled,” O'Grady said. “It is that disincentive that risks limiting client choice of counsel and renders [the clause] an impermissible restriction on the right to practice.”
“The Court does not doubt the Firm when it says the intent behind [the clause] was not anticompetitive but was instead due to an honest concern over future rent obligations,” O'Grady added. “But whatever the intent, the practical effect of the provision remains the same.”
Brennan Law LLC represented Jacobson Holman.
Moskowitz was represented by Harvey & Binnall PLLC and the Law Offices of Philip J. Harvey PLLC.
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Copyright 2016, the American Bar Association and The Bureau of National Affairs, Inc. All Rights Reserved.
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