The handwriting was on the wall, but now it’s official in California, and probably everywhere else: Profits earned on unfinished hourly business after a law firm dissolves are not property of the “old” firm and can be retained by the new firm that completes the work.
Answering a certified question from the Ninth Circuit, the California Supreme Court held on March 5 that “a dissolved law firm’s property interest in hourly fee matters is limited to the right to be paid for the work it performs before dissolution.” A “narrow” exception allows the old firm to collect for work performed before dissolution and to be paid for preserving and transferring hourly fee matters to new counsel of the client’s choice.
The state’s high court did not rest its conclusion on a tortured analysis of the Revised Uniform Partnership Law or impressive-sounding legal mumbo jumbo. Instead, the state Supreme Court relied on logical conclusions based on common experience and longstanding principles. For instance, the court said that the dissolved firm cannot claim “a legitimate interest in the hourly matters on which it is not working — and on which it cannot work.” [Emphasis in original.]
The result emanated principally from two value judgments: The law should not intrude “without justification on clients’ choice of counsel” nor limit “lawyers’ mobility postdissolution.”
The Heller Ehrman Liquidation
A firm that once had 700 lawyers, Heller Ehrman LLP was liquidated in chapter 11. The confirmed plan created a trust that sued 16 firms for income that lawyers from the liquidated firm earned at their new firms in completing hourly matters originated at Heller Ehrman. All but four firms settled. The bankruptcy court granted summary judgment in favor of the trustee and against the four firms.
The bankruptcy court based its decision on Jewel v. Boxer, a 1984 decision by an intermediate California appellate court, which said that profits earned on unfinished business belong to the “old” firm. The Jewel court allowed the new firm to recover only its overhead and rejected arguments based on clients’ rights to select attorneys of their choice. Jewel had been followed in one other California appellate decision, but the issue had not previously reached the state’s highest court.
Jewel was attractive for trustees in law firm bankruptcies because asserting the principle brought in settlements generating assets that otherwise would be few and far between.
After the Heller Ehrman bankruptcy court ruled in favor of the trustee, District Judge Charles R. Breyer of San Francisco withdrew the reference. Reviewing the bankruptcy court’s rulings de novo, he granted summary judgment for the law firms. The trustee appealed.
After hearing oral argument in June 2016, the Ninth Circuit issued an order the next month certifying the question to the California Supreme Court. The Ninth Circuit pointed out that California’s highest court has never directly addressed the Jewel issue. The appeals court also alluded to Jewel litigation in New York.
On a certified question from the Second Circuit, the New York Court of Appeals held in July 2014 that Jewel is not the law in New York. The New York court ruled that there is no property interest in hourly unfinished business because it is “too contingent in nature and speculative to create a present or future property interest.” The New York decision stemmed from the bankruptcies of Coudert Brothers LP and Thelen LLP.
In addition to citing the New York decision, the Ninth Circuit pointed out that California revised its partnership law in 1996, 12 years after Jewel.
Judge Breyer was not the only district judge to undermine Jewel. Granting an interlocutory appeal, District Judge James J. Donato of San Francisco reversed the bankruptcy court and held in favor of lawyers who went to new firms. He ruled that they could retain what they bill at their new firms.
Judge Donato issued his decision in the liquidation of Howrey LLP. On appeal, the Ninth Circuit certified the question to the District of Columbia Court of Appeals in February because the case turns on D.C. law, not California law.
The California Court’s Analysis
The certified question was argued in the state’s high court in December 2017. The March 5 opinion by Justice Mariano-Florentino Cuéllar went to the heart of the issue immediately. He said that a dissolved law firm has “no property interest in legal matters handled on an hourly basis, and therefore, no property interest in the profits generated by its former partners’ work on hourly fee matters pending at the time of the firm’s dissolution.”
There is no property interest, he said, because the old firm “has no more than an expectation” that “may be dashed at any time by a client’s choice to remove its business.” He explained that the “mere possibility of unearned, prospective fees . . . cannot constitute a property interest.”
Rather than tease the result from the Revised Uniform Partnership Act, or RUPA, Justice Cuéllar based the decision on a “sensible interpretation” of state law and “practical implications” to conclude that “the dissolved firm’s property interest here is quite narrow.”
Policy implications were paramount. The outcome should “protect the client’s choice of counsel” and comport “with our policy of encouraging labor mobility while minimizing firm instability.” He said that neither previous cases nor “specific statutory provisions . . . resolve the question before us.”
In the law firm context, a property interest is grounded on a “sufficiently strong expectation.” That expectation “requires a legitimate, objectively reasonable assurance rather than a mere unilaterally-held presumption.”
The old firm, Justice Cuéllar said, claims an “interest in the hourly matters on which it is not working — and on which it cannot work” and “seeks remuneration for work that someone else must undertake.” [Emphasis in original.] Given that neither clients nor lawyers would share that view, he said that the old firm’s “expectation is best understood as essentially unilateral.” He went on to add that the old firm’s “hopes were speculative, given the client’s right to terminate counsel at any time, with or without cause. As such, they do not amount to a property interest.”
Again focusing on policy considerations, Judge Cuéllar recognized that former partners in a dissolved firm “may face limited mobility in bringing unfinished business to replacement firms.” Similarly, recognizing a property interest in unfinished business “would also risk impinging on the client’s right to discharge an attorney at will.” He therefore affirmed the principle “that client matters belong to the clients, not the law firms.”
Judge Cuéllar said that the principle in Jewel was unnecessary to prevent lawyers from jumping ship prematurely because the California Supreme Court had upheld the enforceability of a law partnership’s noncompetition agreement.
Rather than basing the conclusion on RUPA, Judge Cuéllar said that “[n]othing else in RUPA cuts against our holding.”
Judge Cuéllar pointedly declined to say whether overruling Jewel with regard to hourly matters would also apply to contingencies.