Is the Unfinished-Business Rule Finished? Recent Decisions Could Close the Book on Hourly Matters

Editor's Note: Reprinted with permission from the ABI Journal, Vol. XXXIII, No. 9, September 2014.

Partnership law and bankruptcy law are not strangers. Perhaps no greater proof can be found than in the recent battle over the unfinished-business claims of dissolved law firms, which pit a law firm’s bankruptcy estate against the lawyers that often served as the firm’s lifeblood prior to their bankruptcy filing.

Recent decisions in the cases of defunct law firms Coudert Brothers, Thelen and Heller Ehrman may serve as the fatal blow for the so-called “unfinished-business rule,” generally asserted by trustees for the firms, who argue that pending hourly matters and the profits generated by those matters are partnership property that belongs to the estate. At the very least, these decisions suggest that courts are beginning to focus more on the equities surrounding a lawyer’s ability to provide services following a law firm’s dissolution and the public policy behind unfinished-business claims.

How Did We Get Here?
The unfinished-business rule is rooted in the basic concepts of partnership law. Under the Uniform Partnership Act of 1997 (UPA) and similar state statutes, a partnership is “an association of two or more persons to carry on as co-owners [of] a business for profit.”[1] Joint ownership of the business and the sharing of profits and losses are key indicia of a partnership. Partners owe one another, and the partnership, fiduciary duties, including the duty to account for any benefit that a partner derives from the use of partnership property. Upon the dissolution of a law firm, the partnership continues in existence until the “winding up” of its affairs has been completed, and partners owe continuing fiduciary duties to each other, whether they stay at the firm or, alternatively, leave and finish the business elsewhere.[2]

Accordingly, while a former partner of a law firm is free to practice elsewhere and has the right to represent former clients of his/her former firm, that right is subject to the former partner’s duty to account for the use of “partnership property” after dissolution. “Partnership property” arguably includes those client matters that he/she takes to the new firm, a concept that has come to be known as the “unfinished-business rule” and that has been extended in the case law to a variety of other types of legal entities, including professional corporations and limited liability companies.

The genesis of unfinished-business claims in the context of a dissolved law firm is Jewel v. Boxer,[3] a 1984 opinion from the California Court of Appeals. In Jewel, a four-partner litigation boutique dissolved and two of the former partners went on to finish the work and receive the fees from several contingency matters that were previously handled by the firm. The two remaining partners brought an action for an accounting against the former partners who collected the fees. Since there was no written partnership agreement providing to the contrary, the court applied the default rules of the UPA and required that the contingency fees be shared among the former partners. In support of its conclusion, the Jewel court considered not only partnership law, but also policy considerations. The court stressed that the rule “prevents partners from competing for the most remunerative cases” and “discourages former partners from scrambling to take physical possession of files and seeking personal gain by soliciting a firm’s existing clients upon dissolution.”[4]

In recent high-profile law firm bankruptcies, bankruptcy trustees have sought to extend Jewel to pending hourly-fee matters that attorneys bring with them to their new firms post-dissolution. Such recovery efforts often come in the form of lawsuits against both the former lawyer and his/her new firm under a variety of theories, including accounting, turnover, preference and fraudulent transfer.

Lower courts have been split on the application of the unfinished-business rule in these cases. First, in In re Coudert Bros.,[5] the U.S. District Court for the Southern District of New York held that unfinished hourly business that followed the firm’s former partners to their new firms constituted an asset of the bankruptcy estate that needed to be accounted for. In reaching this conclusion, the court likened pending hourly matters to any other partnership property, noting that a “departing partner is not free to walk out of his firm’s office carrying a Jackson Pollack painting [that] he ripped off the wall of the reception area, simply because the firm has dissolved.”

Months later, another court in the Southern District of New York issued an opinion in In re Thelen,[6] holding that unfinished hourly-fee matters do not remain the firm’s property under New York law. The court reasoned that applying the unfinished-business doctrine to pending hourly-fee matters would result in an unjust windfall for the estate, as well as “conflict with New York’s strong public policy in favor of client autonomy and attorney mobility.”[7] Both Coudert Bros. and Thelen were appealed to the Second Circuit Court of Appeals, and the question was certified to the New York Court of Appeals for determination. Finally, in In re Heller Ehrman LLP,[8] the U.S. Bankruptcy Court for the Northern District of California found that hourly, unfinished business was property of the dissolved firm’s estate. That opinion was likewise appealed.

Heller Ehrman
Prior to its dissolution in 2008, Heller Ehrman was a “global law firm with approximately 700 lawyers.” After defaulting on its line of credit, Heller’s partners chose to dissolve the firm. Included in the shareholders’ dissolution plan was a provision waiving unfinished-business claims. (Such waivers are often referred to as Jewel waivers.) In its subsequent bankruptcy proceeding, the trustee sought to avoid the Jewel waiver as a fraudulent transfer and recover the profits that were generated by Heller’s former attorneys from any pending hourly matters.

On appeal, the U.S. District Court for the Northern District of California rejected the trustee’s argument that the bankruptcy estate of a dissolved law firm has a property interest in the profits that were earned by attorneys for hourly matters that the law firm had once handled.[9] In reaching its conclusion, the court focused on the law of Jewel, a balancing of the equities and policy concerns. The court distinguished Heller Ehrman from Jewel for the following reasons:

(1) Heller’s dissolution was forced, not voluntary;

(2) Heller’s former clients signed new retainer agreements while the new firm in Jewel functioned under the fee agreement entered into by the client and the old firm;

(3) the new firms in Jewel consisted entirely of partners of the old firms that continued to owe fiduciary duties to each other and the old firm while the defendant firms in Heller owed no fiduciary duties to the dissolved firm;

(4) unlike Jewel, which made no distinction between hourly- and contingency-fee matters, Heller did not involve contingency-fee matters; and

(5) Jewel was decided under the UPA, while Heller was decided under the “materially different” Revised Uniform Partnership Act (RUPA).[10]

Regarding this last point, the court noted that the application of the RUPA, not the UPA, in Heller was “significant” because the RUPA does not extend a partner’s duty not to compete through the winding up of partnership business, allowing for competition “immediately upon an event of dissolution.”[11] Unlike in Jewel, where a partner under the UPA owed a fiduciary duty “not to take any action with respect to unfinished partnership business for personal gain,” Heller’s former shareholders were free to sign retainer agreements with former Heller clients.[12]

Turning to a balancing of the equities, the Heller court also observed that the equities favored a finding that pending hourly matters were not the property of a dissolved law partnership, holding that “the firms that did the work should keep the fees.”[13] The first sentence of the court’s opinion best sums up its view of the ownership of client matters: “A law firm — and its attorneys — do not own the matters on which they perform their legal services. Their clients do.”[14]

In finding that the equities favored the defendant law firms and not the trustee, the court also found that “Heller ceased to be able to represent its clients, leaving them with no choice but to seek representation elsewhere.”[15] As Heller’s former clients faced uncertainty regarding their legal representation, the firm’s former attorneys “came to the rescue of these clients and provided them with legal services on ongoing matters.”[16] The result, the court found, was a new representation of the former Heller clients, evidenced by a new retainer agreement and services using the resources of an entirely new law firm.

The opinion suggests that the policy considerations of unfinished-business claims, as well as their implications on legal representation and employment, are as important — if not more so — than the legal considerations. Public policy, the court reasoned, does not support an outcome where “Heller’s estate is entitled to a share of all profits earned, even on litigation lasting long after Heller ceased to function, into the indefinite future perpetuating the inequity over time.”[17] The court also rejected the policy concerns set forth in Jewel, finding that such concerns are not supported by the public interest because they would result in limitations on client engagements and legal employment, neither of which are in the public interest.[18]

Thelen and Coudert
Coudert Brothers employed almost 650 lawyers prior to its collapse in 2005. Thelen, which collapsed in 2008, employed approximately 600 lawyers prior to dissolution. In the case of both firms, lawyers moved on to new firms post-dissolution and brought client matters with them. Following those moves, the bankruptcy estates of their former firms pursued unfinished-business claims for any profits derived from those pending hourly matters that accompanied them. On July 1, 2014, the New York’s highest court weighed in on this issue and sided with the Thelen district court, unanimously concluding that

pending hourly-fee matters are not partnership “property” or “unfinished business” within the meaning of New York’s Partnership Law. A law firm does not own a client or an engagement, and is only entitled to be paid for services [that were] actually rendered.[19]

Specifically, the court found that partnership law “does not define property; rather, it supplies default rules for how a partnership upon dissolution divides property as elsewhere in state law.”[20] The court concluded that the trustee’s reliance on partnership law to define the scope of partnership property was “misplaced” because “no law firm has a property interest in future hourly legal fees because they are ‘too contingent in nature and speculative to create a present or future property interest’ given the client’s unfettered right to hire and fire counsel.”[21]

The court rejected the trustees’ reliance on Stem v. Warren, a nearly 100-year-old breach-of-fiduciary-duty opinion by the New York Court of Appeals, in which one joint venturer “underhandedly” cut another surviving joint venturer out of a contract post-dissolution, noting that the opinion did not define unfinished client engagements as partnership property.[22] Unlike the facts of Stem, the court reasoned, Coudert and Thelen did not involve a theft or misappropriation of the hourly-fee matters because the dissolution of such firms left no employment opportunities for their former attorneys upon dissolution.

Beyond the principles of partnership law, the court also considered public policy, which it found supported its decision against the unfinished-business claims.[23] Similar to the Heller appellate court, the court emphasized that “[t]‌reating a dissolved firm’s pending hourly-fee matters as partnership property, as the trustees urge, would have numerous perverse effects, and conflicts with basic principles that govern the attorney/client relationship under New York law and the Rules of Professional Conduct.”[24] The court further found that “[b]‌y allowing former partners of a dissolved firm to profit from work [that] they [did] not perform, all at the expense of a former partner and his new firm,” an “unjust windfall” would result.[25] The court questioned the policy that was advanced by unfinished-business claims, charging that the doctrine, when applied to law firms, promotes a “run-on-the-bank mentality” that encourages lawyers to leave prior to dissolution and makes it less likely for the firm to recover from its financial struggles.[26]

The court focused on the effect of unfinished-business claims on attorneys and clients alike. “Attorneys who wait too long” to leave, the court explained, are placed in a difficult position with their clients, who they might no longer be able to afford to represent.[27] In addition, such attorneys might find it difficult to secure new employment because new firms may be hesitant to hire an attorney whose potential profits would belong to their old law firm.[28] The court continued, “[t]‌he notion that law firms will hire departing partners or accept client engagements without the promise of compensation ignores common sense and marketplace realities.”[29] Moreover, the court was concerned about clients who may question how a lack of profit from client matters may affect an attorney’s level of attention in representing them. Ultimately, the court concluded, “[w]‌hat the trustees ask us to endorse conflicts with New York’s strong public policy encouraging client choice and, concomitantly, attorney mobility.”[30]

Finally, the New York state court did not limit its ruling to hourly-fee matters, similarly finding that law firms do not own contingency-fee cases. Instead, the court concluded that contingency fees are only an “asset” of a dissolved partnership in the sense that “as between the departing partner and the partnership, the partnership is entitled to an accounting for the value of the cases as of the date of the dissolution.”[31]

Where Do We Go From Here?
While the possibility of an appeal to the Ninth Circuit Court of Appeals still looms for the Heller Ehrman decision, the fate of “unfinished-business” claims under New York law appears to be sealed with decisions in Thelen and Coudert from the New York Court of Appeals. These issues are still being litigated in numerous other law firm bankruptcy cases, including the cases of Dewey & LeBoeuf and Howry.

[1] U.P.A. § 101(6).

[2] U.P.A. § 404(b)(1).

[3] Jewel v. Boxer, 156 Cal. App. 3d 171 (1984).

[4] Id. at 179.

[5] In re Coudert Bros., 477 B.R. 318 (S.D.N.Y. 2012).

[6] In re Thelen LLP, 476 B.R. 732 (S.D.N.Y. 2012).

[7] Id. at 742-43.

[8] In re Heller Ehrman LLP, 2013 WL 951706 (Bankr. N.D. Cal. 2013).

[9] Heller Ehrman v. Davis, Wright, Tremaine LLP, 2014 WL 2609743 (N.D. Cal. June 11, 2014).

[10] Id. at *4.

[11] R.U.P.A. § 404, cmt. 2.

[12] Heller Ehrman v. Davis, Wright, Tremaine LLP at *8.