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Nov. 18 --Guidance from New York's high court is needed to resolve whether the trustee of Thelen LLP's bankruptcy estate may reclaim profits that Seyfarth Shaw LLP earned on hourly fee matters brought to the firm by departing Thelen partners, the U.S. Court of Appeals for the Second Circuit decided Nov. 15 (Geron v. Seyfarth Shaw LLP (In re Thelen LLP), 2013 BL 316640, 2d Cir, No. 12-4138-bk, 11/15/13).
The court decided to delay its ruling on the merits of the trustee's case against Seyfarth Shaw until the New York Court of Appeals answers two certified questions: (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 may be retained by the new law firm.
The court's opinion, written by Judge Gerard E. Lynch, features a review of the legal and policy arguments for and against applying the unfinished business doctrine to hourly fee matters. New York's high court should be asked to resolve this issue in the first instance given its practical importance to law firms and their clients, the court concluded.
When Thelen's partners voted to dissolve the firm after it became insolvent, they adopted a revised partnership agreement containing an “unfinished business waiver” which provided that neither the partners nor the firm itself have any claim to clients, cases or matters ongoing at the time of the firm's dissolution. The clause expressly waived any rights the firm or partners may have to unfinished business under Jewel v. Boxer, 203 Cal. Rptr. 13 (Cal. Ct. App. 1984).
The trustee claims that pending hourly fee matters taken to Seyfarth Shaw by former Thelen partners were Thelen's property, that these assets were fraudulently conveyed by the waiver in the revised partnership agreement and that Seyfarth must account for its earnings on those matters.
The district court decided that 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, so that Seyfarth is not obligated to repay any funds to Thelen's bankruptcy estate.
On appeal, the Second Circuit concluded that it should seek guidance from New York's high court before deciding whether the trustee's claims against Seyfarth are viable.
On a threshold issue, the court ruled that the case is governed by New York law rather than the law of California, even though Thelen was a registered California LLP and its revised partnership agreement provided that it was governed by California law.
New York has a greater interest in application of its law than California because the most significant contacts in this case are with New York, the court found. It pointed out that the majority of the former Thelen partners who moved to Seyfarth are licensed in New York and joined Seyfarth's New York office. Also, New York was Thelen's principal place of business, and New York is where the injury from the alleged fraud was inflicted, the court noted.
Looking into New York law, Lynch found that while New York appellate courts have uniformly held that the unfinished business doctrine applies to contingent fee matters absent a contrary agreement, the state's high court has never applied the unfinished business doctrine to law firms in either contingent fee cases or hourly fee matters.
Certified Questions on Pending Hourly Cases
The Second Circuit certified these questions to the New York Court of Appeals:
“Under New York law, is a client matter that is billed on an hourly basis the property of a law firm, such that, upon dissolution and in related bankruptcy proceedings, the law firm is entitled to the profit earned on such matters as the 'unfinished business' of the firm?
“If so, how does New York law define a 'client matter' for purposes of the unfinished business doctrine and what proportion of the profit derived from an ongoing hourly matter may the new law firm retain?”
Also, the court found “scant New York authority” with respect to whether the unfinished business rule applies to a firm's pending hourly fee matters. No New York appellate court has addressed the issue, and the only New York trial court to confront it has concluded that the unfinished business doctrine does not apply in this context, Lynch said, referring to Sheresky v. Sheresky Aronson Mayefsky & Sloan, LLP, 950 N.Y.S.2d 611, 2011 BL 333719 (N.Y. Sup. Ct. 2011).
“There are strong legal and policy arguments on both sides of the issue,” the court found.
Lynch described three arguments in favor of applying the unfinished business doctrine to hourly fee cases.
First, New York partnership law does not distinguish between types of partnerships, and the New York Court of Appeals has determined that executory contracts to perform professional services are partnership assets unless a contrary intention appears. Thus, the unfinished business rule arguably applies to all partnerships including law firms and to all types of business conducted by law firms.
Second, New York partnership law instructs New York courts to interpret the act in conformity with other states that follow the Uniform Partnership Act. “A substantial majority of cases from such jurisdictions have applied the unfinished business doctrine to hourly rate cases,” Lynch said
Third, creating a different rule for hourly fee matters than contingent fee cases might mean that a law partner's obligations to his firm vary based on the manner in which clients are billed. This result “would undoubtedly encourage the view, now prevailing among many, that an individual partner's book of business is not an asset of the firm, but instead a piece of personal property to be guarded with a Cerberus-like ferociousness,” Lynch wrote.
But substantial arguments may also be made for the opposite view, the court said. Lynch listed these points:
• Recognizing a law firm's property interest in pending client matters might undermine the attorney-client relationship, which New York's high court views as unique and unlike relationships between other partnerships and their customers;
• Rigid application of the unfinished business doctrine may discourage other law firms from accepting lawyers and client engagements from a dissolved law firm, so client services may be disrupted;
• New York ethics rules that prohibit fee splitting and agreements that restrict lawyer mobility could be interpreted to forbid the unfinished business doctrine altogether; and
• Even if the unfinished business doctrine applies to contingent fee cases, hourly fee matters are arguably different because the dissolved firm has been fully compensated for the work it has already done, and the hourly work still to be performed could be viewed as new business rather than unfinished business.
This canvass of arguments convinced the court that it should ask the New York Court of Appeals whether the unfinished business doctrine extends to pending hourly fee matters.
“[T]he resolution of the issue potentially affects not merely the distribution of funds among former members of partnerships, but also the ability of lawyers to continue to practice their profession, and of clients to have their matters adequately serviced by counsel of their choice,” Lynch stated.
Howard P. Magaliff of Rich Michaelson Magaliff Moser, LLP, New York, argued for Thelen's trustee, Yann Geron. Thomas Feher of Thompson Hine LLP, Cleveland, argued for Seyfarth Shaw LLP.
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