New York Law’s Application of the “Unfinished-Business” Doctrine in the Thelen Liquidation

[1]The New York State Court of Appeals’ decision in Geron v. Seyfarth Shaw LLP[2] reflects the New York courts’ evolving view of the mobility of partners and their clients in large firms. In this decision, the court of appeals held that under New York law, pending hourly fee matters are not “property” or “unfinished business” of a dissolved law firm partnership. The court essentially nullified the so-called unfinished-business doctrine for partners practicing under New York law, starkly contrasting with a number of decisions in California and other jurisdictions. The events leading to this notable New York decision are worthy of review, as are its ramifications.

            On Oct. 28, 2008, the partners of Thelen LLP voted to dissolve the firm, which was insolvent. As part of the dissolution process, the partners adopted an amendment to the firm’s partnership agreement. This agreement included an “unfinished business waiver,” which purported to waive any accounting obligations of the partners to one another for unfinished hourly matters of the firm, which the partners could take with them to new firms. Eleven of Thelen’s approximately 250 partners went to Seyfarth Shaw, 10 in New York and one in California, taking their open matters (i.e., their unfinished business) with them. Significantly, the fees billed by Thelen on any client matters until the transfer of those matters were indisputably Thelen’s property and were not taken by Seyfarth.

            The trustee established and implemented a protocol for the collection of pre-petition fees owed to Thelen, whether billed or in the firm’s system as work-in-process (WIP). In contrast with receivables and WIP, “unfinished business” is the dissolved firm’s right to the profits generated on work done by the successor firm on client matters that had been opened by the transferring partners while they worked at the dissolved firm. Partnership law allows the partners to contract away this property right, provided that the waiver is adopted when the partnership is solvent. If that obligation is not waived, decisions (primarily from the California courts) have held that partners owe a duty to account for and remit all profits generated on matters that had been opened by the dissolved (predecessor) firm. The applicable statutes and decisions rendered to date do not specify how profits are measured. California courts have recognized the notion that the predecessor/dissolved firm has a property right in the profit that has been generated by the successor firm on matters (not client relationships, but matter files themselves) that are opened by the dissolved firm.[3]

            Thelen’s efforts to complete its liquidation out of court stalled after approximately one year when its secured lender halted the use of its cash collateral. On Sept. 18, 2009, Thelen filed a chapter 7 petition in New York and a chapter 7 trustee was appointed.[4] One of the trustee’s statutory duties was to pursue estate claims for the benefit of the estate’s creditors. After its secured creditor, Thelen’s largest group of creditors is comprised of its employees, who held millions of dollars in claims for unpaid wages and Worker Adjustment and Retraining Notification Act claims.

            In most instances, the law firms to which former Thelen partners migrated agreed to provide information to the trustee about the purported profits (or alleged lack thereof) derived from Thelen’s unfinished business. Using this information, the trustee was able to settle the majority of the estate’s unfinished-business claims with bankruptcy court approval, but Seyfarth Shaw did not participate in these settlement efforts. Thus, on Sept. 15, 2011, the trustee commenced an action in the U.S. District Court for the Southern District of New York, before Hon. William H. Pauley III, against Seyfarth seeking to avoid the unfinished-business waiver adopted on the eve of dissolution as a constructive-fraudulent conveyance and to recover the value of Thelen’s interest in its unfinished business for the benefit of Thelen’s creditors.

            Seyfarth moved for judgment on the pleadings, arguing that New York law governed and that under New York law, Seyfarth had not received any “property” of the Thelen bankruptcy estate, since hourly-fee client matters are not property of the dissolved firm. Judge Pauley agreed and granted Seyfarth’s motion. The matter was appealed to the U.S. Court of Appeals for the Second Circuit.

While the Thelen unfinished-business litigation was progressing, another judge in the same district issued an opinion affirming the bankruptcy court’s exhaustive analysis of the unfinished-business doctrine in the bankruptcy case of Coudert Brothers LLP. In that parallel case, both the bankruptcy and district courts concluded that unfinished business was property of the former law firm under New York law. The Coudert district court decision was also appealed to the Second Circuit Court of Appeals and consolidated for procedural purposes with the Thelen appeal. Thus, the Second Circuit was presented with the unusual situation of having two diametrically opposed decisions issued within months of each other by two judges in the same district. Both opinions sought to extrapolate what New York law would be on this issue, since no New York appellate court had analyzed the issue under New York law.

            Recognizing the absence of definitive interpretation of New York law by New York courts, the Second Circuit certified two questions to the New York State Court of Appeals. In essence, New York State’s highest court was asked to determine (1) whether a client matter that is billed on an hourly basis is property of the dissolved law firm, such that the trustee could pursue the profits on those matters for the benefit of the dissolved firm’s creditors; and (2) if so, what is a client matter for purposes of this analysis, and what are profits?

            The New York State Court of Appeals took extensive briefing on these issues, including amicus briefs from bar associations and large firms opposing the trustee’s claims, as well as from two other fiduciaries in pending large law firm bankruptcies supporting application of the unfinished-business doctrine to hourly-fee matters. On July 7, 2014, the New York State Court of Appeals issued a unanimous decision in both Thelen and Coudert, holding that under applicable law and for reasons of public policy, unfinished business is not property of the law firm under New York law. The court concluded that partnership law in New York does not provide that client matters are property of the partnership and that, in contrast to contingency-fee matters, hourly-billed matters are not property of the partnership for reasons of public policy, including that applying this doctrine would impermissibly restrict the portability of pending hourly matters in violation of the fundamental notion that clients have complete and unfettered freedom to select their counsel, including partners who have migrated to a new firm.

            The Geron v. Seyfarth decision appears to be the last word on the unfinished-business doctrine for lawyers practicing under New York law. While in New York that claim now appears to be precluded, there remain unanswered questions in connection with unfinished-business claims. For example, the Thelen decision applies solely under New York law, while there is a significant body of law in California and elsewhere that holds the opposite position. Does this mean that partners in large firms with offices in New York and California have different duties to the same partnership? In the absence of an unfinished-business waiver in the partnership agreement, upon dissolution, are pending hourly matters opened by a New York partner freely transferable to the successor firm while pending hourly matters opened by a California partner subject to the unfinished-business doctrine? Will this issue need to be hashed out in the highest courts of each state? Will the partnership agreement’s choice-of-law affect this analysis?

            Ultimately, the answer may not be so complicated in practice. As noted by each of the courts reviewing the unfinished-business doctrine in Thelen and Coudert, the unfinished-business doctrine is freely waivable by the partners in their partnership agreement when the partnership is solvent. Law partnerships wishing to avoid conflict of law or uncertainty as to the fate of unfinished business hourly matters in the event of dissolution can adopt a suitable waiver in their partnership agreement before economic tides shift against the firm. While the adoption of these waivers may implicate considerations of partner retention, lender relations, and law firm governance, if duly adopted, these waivers would eliminate any rights which creditors or the firm’s fiduciary may assert to unfinished business upon dissolution.