Disgorged profits: Partnership terms to manage the impact of Jewel v Boxer

No case in recent history has impacted the portability of rainmakers at US law firms more than Jewel v Boxer.¹ Since then, law firms and their partners have debated exactly how, and more importantly whether, to mitigate its impact.

This issue creates one of the few occasions in which the collective interests of a partnership differ from those of its individual partners. As a result, whether and how to respond to Jewel liabilities depends on each firm’s and partner’s goals and interests.

Jewel v Boxer

In Jewel, the law firm Jewel, Boxer and Elkind was dissolved by the mutual agreement of its four partners. The partners formed two new firms: Jewel and Leary; and Boxer and Elkind. Three associates employed by the old firm were employed by Boxer & Elkind.

At issue in Jewel was the proper allocation of attorneys’ fees received from ongoing cases, some of which were still active at trial. Jewel and Leary filed a complaint for an accounting of these fees, contending that they were assets of the dissolved partnership.

In resolving that dispute, the California Court of Appeals considered whether partners of a dissolved law firm are entitled to the profits earned by their former firm partners who took their portable business to a new firm. The court concluded that, when an attorney leaves a dissolving firm and takes work elsewhere, the departing partner and the new firm may be required to disgorge profits earned in completing the work taken to the new firm.

At the time (1994), it was not clear whether Jewel was an isolated case or if it reflected a significant change in the dynamics of partner departures. Since then, bankruptcy trustees, receivers and successors in interest to law firms have cited Jewel. In addition, courts in California and across the nation have accepted it as a basis for collecting profits for completed work from departing partners and the firms that hire them.

Accordingly, under Jewel, partners must share fees they received from the completion of cases that were started at the now-dissolved firm, unless a written agreement states otherwise. This principle has become known as the ‘Jewel doctrine’. It has been applied not only in California but also in many other jurisdictions throughout the US.

Whether a partner and law firm are required to return their fees to the partner’s former firm depends on the partnership agreement at the former firm. The dissolved firm at issue in Jewel did not have a written partnership agreement. Therefore, the court applied the Uniform Partnership Act and held that, in such situations, former partners of the dissolved firm are entitled to the profits generated from the departing partner’s and his new firm’s completion of unfinished business that began at the old firm. This is true ?even when the old firm has dissolved.

Jewel waiver

Not surprisingly, in response to the ?Jewel doctrine, some law firms developed a solution so that departing partners (and the firms that hire them) could keep the profits earned in completing ‘unfinished business’ ?– now denominated a ‘Jewel waiver’.

A Jewel waiver is a clause in the partnership agreement that allows a partner to complete unfinished business that originated at the dissolved firm without the financial or legal obligation to disgorge fees earned from that business after moving to a new firm. The court in Jewel recognised such a provision as a means “to endure a degree of exactness and certainty unattainable by rules of general application”.²

Of course, the Jewel waiver must meet the strictures of debtor/creditor laws. Consequently, a firm and partner must enter into a Jewel waiver at least two years before the firm’s filing of a bankruptcy petition. That means that firms and partners have to decide whether they want to enter into a Jewel waiver long before any problems arise that might later cause the firm to shut its doors.

For individual partners, especially rainmakers focused on portability, a Jewel waiver is a simple and effective solution. On the other hand, for law firms focused on deterring defecting partners, a Jewel waiver may not be a good option. Indeed, because of its effect, a firm that adopts a Jewel waiver has less ability to predict and control its accounts receivables because anticipated profits are tied to the partner who leaves, not the firm at which the matter originated.

In addition, a Jewel waiver may not be in the best interest of law firms teetering on the edge of insolvency. Finally, for law firms that already have become insolvent, a Jewel waiver is not an option.

 

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Options regarding unfinished business fees

1. Preserve interest with no ?Jewel waiver;

2. Waive interest with Jewel ?waiver no interest; or

3. Define interest with ‘hybrid’ ?or fixed interest.

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To waive or not?

The reality is that Jewel remains controlling law. While the debate continues regarding whether it should be the law, firms and their partners are faced with dealing with the consequences of Jewel on a daily basis. In deciding what to do, each firm should assess the short and long-term benefits and consequences of entering into a Jewel waiver. As evidenced by the facts of the Jewel case itself, no decision is itself a decision; in the absence of a Jewel waiver, Jewel liability will attach.

The choice of whether or not to adopt a Jewel waiver is not easy. Its impact can be significant and should not be taken lightly. Notably, however, there is a third option. The partnership agreement may be amended to require that, after leaving the firm, the partner must pay the prior firm a predetermined percentage of the revenues or profits earned from unfinished business for a prescribed period of time. This provides a level of certainty to all involved in a future move: the partner, the dissolved firm and the new firm.

Regardless of whether a firm chooses to adopt a Jewel waiver or a hybrid arrangement, the relevant contract language should be tailored to meet the specific content and provisions of the firm’s partnership agreement, as well as the applicable Bar rules.

Accordingly, below is some sample wording that firms may consider as guidelines in crafting partnership terms ?to meets their specific and unique ?needs. Of course, this wording is not one-size-fits-all and should be revised to address the unique needs of each firm. However, it is a starting point to help frame the discussion.

Option 1: Jewel waiver

Except as specifically set forth below, neither the Partners nor the Partnership shall have any claim or entitlement to clients, cases or matters ongoing at the time of the dissolution of the Partnership other than the entitlement to collections of amounts due for work performed by the Partners and other Partnership personnel on behalf of the Partnership prior to their departure from the Partnership. The provisions of this Section are intended to expressly waive, opt out of and be in lieu of any right any Partner or the Partnership may have to “unfinished business” of the Partnership, as that term is defined in Jewel v. Boxer.

Option 2: No waiver

Upon dissolution of the Firm, the Partner agrees to account for and pay to the Firm and/or its former partnership any and all legal fees, contingency payments or success fees the Partner generates after the departure date of the Partner from the Firm, minus overheads, that the Partner earns after said date of departure from matters originated by the Partner while ? a partner at the Firm.

Option 3: Hybrid agreement

Upon dissolution of the Firm, the ?Partner agrees to account for and pay to the Firm and/or its former partnership [##] per cent ([##]%) of legal fees, contingency payments or success fees generated after the departure date of ?the Partner, minus overheads, that the Partner earns after said departure date from matters originated by the Partner while a partner at the Firm for a period ?of [##] months/years after said date ?of departure.

Avoiding surprises

There have been several large US law firm failures in recent years, notably Dewey & LeBoeuf and Howrey, and more are expected to collapse over the next two years. Mid-sized and smaller firms are failing too, but without the fanfare and notoriety of larger firms.

One common denominator among many failures, big and small, is the unexpected departure of profitable partners. Needless to say, the consequences of those departures, ?which often happen right when a firm is trying to avoid a catastrophic failure, are often significant.

Even if a firm chooses not adopt a Jewel waiver, the safest course is to address the issue. There is no one right answer that fits all firms or all partners. Yet, to avoid unexpected and unwanted surprises, there is one question that ?every law firm should answer: to Jewel ?or not to Jewel?

J. Randolph ‘Randy’ Evans is chair of the financial institutions practice and Shari L. Klevens is head of the law firm defence and counselling practice at US law firm McKenna Long & Aldridge ?(www.mckennalong.com)

Endnotes

1. 156 Cal. App. 3d 171, 203 Cal. Rptr 13 (Cal. Ct. App. 1994)
2. 156 Cal. App.3d at 179-80