Unfinished business: The risks of hiring 'partners of bankrupt firms

Successor firms are still liable for fees earned on the unfinished business of failed New York practices, say Wiley Rein partners '¨H. Jason Gold and Dylan G. Trache

As a result of a recent decision from the US district court for New York arising out of the Coudert Brothers bankruptcy case and other recent law firm failures, successor firms continue to be held liable for fees earned '¨when completing the ‘unfinished business’ of failed firms. Accordingly, firm management must carefully weigh these potential costs when considering lateral hires of former '¨partners of bankrupt firms.

At issue in the Coudert case was whether, under New York partnership law, the law firms that hired Coudert’s former partners must account for profits that the former Coudert partners earned while completing work on open client matters they took with them from Coudert.

The district court ultimately concluded that the Jewel Doctrine (or unfinished business doctrine) applies to hourly '¨fee cases. Accordingly, it held that the open client matters '¨at issue belonged to Coudert on the date of dissolution and that former Coudert partners and their new law firms must account for any profits from those client matters billed on '¨an hourly basis at their new firms.

The ruling may affect claims in the chapter 11 case of Dewey & LeBoeuf, which recently filed for bankruptcy protection, as well as claims in the cases of other law firm '¨and non-law firm dissolutions.

Litigation is likely to continue until either the New York Court of Appeals settles the matter (for New York partnerships) or one or more federal appellate courts address the issue of whether the Jewel Doctrine applies to client matters billed on an hourly basis.

The Coudert estate

After entering dissolution in 2005, Coudert filed for bankruptcy protection under chapter 11 of the Bankruptcy Code in September 2006 in the US bankruptcy court for the southern district of New York. The case resulted in a confirmed plan of liquidation, under which Development Specialists Inc (DSI) was appointed plan administrator for the Coudert bankruptcy estate.

Thereafter, DSI filed lawsuits in the bankruptcy court against 13 law firms, based upon the premise that these '¨firms were liable to the Coudert estate under the unfinished business doctrine, seeking to recover profits that the former Coudert partners (and their new law firms) earned while completing work on unfinished client matters being billed '¨on an hourly basis.

The unfinished business doctrine is the general rule that, absent a contrary provision in a partnership agreement (Coudert’s partnership agreement did not have such a provision), each partner has a duty to account to the dissolved partnership for profits earned from the unfinished business of the dissolved partnership. This principle is also sometimes referred to as the Jewel Doctrine (see Jewel v Boxer, '¨156 Cal. App. 3d 171, 176 (1984)).

In considering the issue, the district court distinguished finished business, unfinished business and new business. Finished business consists of matters that had been completed before dissolution of the relevant firm, such as a settled lawsuit or completed merger.

It concluded that any resulting receivable at the time of dissolution is unquestionably an asset of the dissolved firm. Likewise, new business is that business flowing from an '¨entirely new matter or engagement post-dissolution, including business derived from a client of the dissolved firm, which fees are decidedly not an asset of the dissolved firm. Finally, the court described unfinished business as contracts to perform legal services that had commenced but were not '¨fully performed on the date of dissolution.

The district court concluded that the Jewel Doctrine '¨is applicable to hourly fee cases under New York law. '¨In so holding, the court rejected several arguments of '¨the firms, which sought to distinguish between business '¨billed on an hourly basis and matters taken on contingency '¨fee arrangements.

First, the firms argued that Coudert’s interest in unfinished billable hour matters was limited to the extent of its receivables before dissolution. The district court, however, rejected this argument, concluding that it improperly focused on Coudert’s rights to collect from its clients and not the rights of the partners among themselves.

The district court noted that the basis for the Jewel Doctrine is to “settle accounts among partners upon dissolution of their business” and that it “does not exist to assure that a law firm is paid for the value of work it has performed before dissolution”.

More compelling to the district court was the firms’ argument that the duty to account is contrary to New York’s public policy supporting a law firm client’s unfettered choice '¨of counsel. While concluding that this was by far the firms’ most powerful argument, the court held that, because partnership rules are established by statute, those rules '¨are not likely to contravene public policy.

In addition, the district court noted that, while New York case law supports the proposition that any financial disincentive to an attorney’s continued representation of a client impinges upon a client’s unfettered choice of counsel, the applicable case law cited did not specifically involve the dissolution of partnerships.

Furthermore, and most compelling to the district court, was the fact that the second circuit had held in Santalucia v Sebright Transp Inc, 232 F.3d 293 (2d Cir. 2000) that profits earned in completing a contingency fee case were the property of a dissolved firm. It did not express any concern that a dissolved law firm’s participation in a former law partner’s post-dissolution earnings would impinge upon the client’s unfettered choice of counsel.

Accordingly, the district court held that the open client matters at issue belonged to Coudert on the date of dissolution and that former Coudert partners and their new law firms must account for any profits from those client matters billed on an hourly basis at their new firms.

Impact on former partners

As noted by the firms in a request to certify immediate appellate review, the ruling may affect claims in the chapter 11 case of Dewey & LeBoeuf, which recently filed for bankruptcy protection in the US bankruptcy court for the southern district of New York, as well as claims in the cases of other law firm and non-law firm dissolutions.

Litigation of the issue is likely to continue until either the New York Court of Appeals settles the matter (for New York partnerships) or one or more federal appellate courts address the issue of whether the Jewel Doctrine applies to client matters billed on an hourly basis.

Firm management should be cognisant of the unfinished business doctrine, both in evaluating lateral hires as well as in connection with current partnership agreements. With respect to the latter point, because the Jewel Doctrine is the default rule, a partnership agreement may specify a different method of winding up its business and may waive rights to unfinished business in hourly fee matters, so long as that waiver occurs while the firm is solvent.

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jgold@wileyrein.com; dtrache@wileyrein.com