June 12 — In a big win for law firms that took over legal work brought to them by former members of the imploding firm Heller Ehrman LLP, a California federal judge June 11 held that hourly fee matters pending when a law firm dissolves are not the property of that firm under California law (Heller Ehrman LLP v. Davis, Wright, Tremaine, LLP, N.D. Cal., No. 3:14-cv-01236-CRB, 6/11/14).
The “unfinished business doctrine” announced in Jewel v. Boxer, 203 Cal. Rptr. 13 (Cal. Ct. App. 1984), does not apply to this situation, the U.S. District Court for the Northern District of California decided. In any event, equities and policy considerations trump Jewel, Judge Charles R. Breyer found.
The ruling is a resounding victory for four firms--Davis Wright Tremaine LLP, Foley & Lardner LLP, Orrick, Herrington & Sutcliffe LLP and Jones Day--that refused to account to Heller's bankruptcy trustee for profits they made on hourly fee matters that were pending when Heller dissolved and that exiting Heller lawyers brought with them.
Beyond the immediate impact in Heller's bankruptcy case, the opinion may buttress the position of law firms that are resisting similar claims in other bankruptcy cases involving disputes over profits from unfinished hourly fee matters, particularly in closely watched litigation pending in New York. (See box.)
Only a week before Breyer handed down his ruling in Heller's bankruptcy case, the New York Court of Appeals heard oral argument on similar issues that came up in the bankruptcy cases of two other formerly major law firms, Thelen LLP and Coudert Brothers LLP. At argument June 4, some of the justices sounded skeptical about the wisdom of applying the unfinished business rule to pending hourly fees matters as opposed to contingent fee cases.
The issue came to the court from the Second Circuit, which asked for guidance on whether the unfinished business doctrine applies to a dissolving law firm's pending hourly fee matters under New York law (25 BBLR 1571, 11/21/13).
In particular, the Second Circuit asked (1) whether hourly fee matters are property of a dissolving law firm under New York law such that it is entitled to the profit earned on those matters as its unfinished business, and (2) if so, how a “client matter” is defined for purposes of the unfinished business doctrine under New York law and what part of the profit from ongoing hourly matters the receiving law firm may retain.
Bankruptcy Judge Dennis Montali, who is presiding over Heller's bankruptcy case, disagreed with the receiving firms' arguments against applying Jewel and also rejected their position that even if they must account for profits on unfinished hourly matters, the amount they owe is zero.
On de novo review, Breyer identified five key differences betweenJewel and the cases here:
• Termination of the firm at issue in Jewel was voluntary, whereas Heller's dissolution was forced when its lender withdrew the firm's line of credit.
• In Jewel the new firms created by the departing members continued to represent their clients by using the old firm's fee agreements with them; here, former Heller clients signed new retainer agreements with the receiving firms.
• The new firms in Jewel consisted entirely of partners from the old firm, while the firms that took over Heller's cases were already in business and never had any fiduciary duty to Heller.
• Jewel treated hourly fee matters and contingent fee matters as indistinguishable, but there are no contingent fee cases at issue here.
• Jewel applied the Uniform Partnership Act, which has been superseded in California by the Revised Uniform Partnership Act (RUPA).
Breyer said that RUPA allows partners to compete immediately upon dissolution of the partnership, so that it would not violate a partner's fiduciary duty to sign a new retainer agreement with a former client of the dissolved firm. “Consequently there is no provision of the RUPA that gives the dissolved firm the right to demand an accounting for profits earned by its former partner under a new retainer agreement with a client,” he said.
Moreover, the new retainer agreements here were not between former Heller clients and former Heller shareholders but rather between the clients and different third-party firms, the court pointed out.
The court also said that while Jewel has been cited in dozens of cases, judges have done so without much analysis or consideration of intervening changes in law firm practice or law.
Moreover, the California Supreme Court has never ruled on the issue presented here, nor do any published California cases applying RUPA cite Jewel for its unfinished business rule, Breyer said. Thus, he said, California law is unsettled on the question whether a law firm may assert a property interest in hourly fee matters pending at the time of its dissolution.
“Balancing the equities, it is simple enough to conclude that the firms that did the work should keep the fees,” Breyer said.
“A law firm never owns its client matters” and a firm has at most an expectation of future business, Breyer stated. For Heller, he said, that expectation was eviscerated when it went bankrupt and its clients were forced to seek representation elsewhere.
The law firms here came to the rescue of these clients and provided them with legal services that required significant resources under entirely new retainer agreements, Breyer said.
The court also found that public policy weighs strongly against making the receiving firms turn over profits from services they provided to former Heller clients in hourly fee matters.
Breyer found that the two policy reasons underlying Jewel--to prevent partners from competing for the most lucrative cases in anticipation of their firm's possible dissolution, and to discourage former partners from grabbing files and soliciting their firm's clients during dissolution--were simply not at play here.
On the contrary, Breyer said, applying Jewel “would incentivize partners of a struggling firm to jump ship at the first sign of trouble to avoid the kind of suit Defendants now find themselves in, even if that would destabilize an otherwise viable firm.”
Moreover, it would offend public policy to discourage law firms from hiring former partners of dissolved firms and accepting new clients formerly represented by defunct firms, the court said.
“It is not in the public interest to make it more difficult for partners leaving a struggling firm to find new employment, or to limit the representation choices a client has available, by establishing a rule that prevents third-party firms from earning a profit off of labor and capital investment they make in a matter previously handled by a dissolved firm,” Breyer wrote.
Christopher D. Sullivan of Diamond McCarthy LLP, San Francisco, represented the Heller firm's bankruptcy estate.
Snyder Miller Orton LLP and Keker & Van Nest LLP represented Davis Wright Tremaine. Snyder Miller & Orton represented Foley & Lardner. Arnold & Porter LLP represented Orrick, Herrington & Sutcliffe. Jones Day represented itself.
To contact the reporter on this story: Joan C. Rogers in Washington at email@example.com
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Oral argument in the unfinished-business rule cases before the New York Court of Appeals is posted at http://www.nycourts.gov/ctapps/arguments/2014/Jun14/060414-136-137-Oral-Argument-Webcast.asx.
Copyright 2014, The Bureau of National Affairs, Inc.
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