Dewey & LeBoeuf, TDRPC 1.15, Fiduciary Duty, Contract and Equity

Earlier this year, I posted an article on our FB account (which, when I trace it down, I will note here) about the trustee in a law firm bankruptcy winning its assertion that departed partners of the defunct law firm (debtor) AND THEIR NEW LAW FIRMS were obligated to account to the debtor for payments received from clients that had followed those partners to their new law firms, at least with respect to matters which had begun at the debtor and were carried over to the new law firms.  The trustee's claim was based on a notion of fiduciary duty owing by the departing partners to the debtor, which the court agreed resulted in the clients' payments constituting assets of the estate of the debtor held in trust by the new law firms.

I commented at the time that this reasoning would create a host of problems and a host of inequitable consequences to the departing partners, to their new firms, and to those clients involved.

The demise of Dewey & LeBoeuf brings this matter now front and center.

Last week, the Chief Restructuring Officer (a fancy title for a person acting, in effect, like a trustee but without the panoply of trustee powers imputed by statute and rule) for DL announced to the partners/former partners of DL that they should return to DL a portion of monies distributed to them (the press likes to call this a "clawback"); this announcement sounded more like a command or edict, made under circumstances that sounded very much like coercion and threat (among other things reported in The Wall Street Journal, the partners/former partners were informed that those who do not pay up "face years of aggressive litigation" and "could end up on the hook for millions of dollars" of DL's debt, but can avoid this catastrophe by accepting the CRO's offer "by July 24").

Some gossip among the partners/former partners suggests that while there is much grousing and resentment about the CRO's offer, the youngest and smallest (by percentage) partners are likely to see this as a way out of the bankruptcy mess as the sums the CRO wants them to pay over may be as small as $25 thousand, and the older and largest (by percentage) partners are also likely to accept the offer because the payments (capped at $3 million per partner) would be much smaller than their percentage shares of the liabilities of the debtor otherwise would be and because, absent this resolution, they would be the biggest targets for preferential transfer or other claims in bankruptcy.  This gossip goes on to say the most adversely affected and angriest partners are those in the middle, who, in the current economic disaster that is private legal practice today, lack the financial capacity to fund such payments, at least without severe distress, and who recognize or at least believe that they would be carrying the "fattest" partners under this arrangement and are being coerced to sign up to the plan.

But what I want to address is the CRO's mention that in addition to demanding that monies distributed to the DL partners/former partners prior to its bankruptcy petition be "clawed back" by the estate, he is "planning to pursue an estimated $60 million in profits from unfinished legal work that ex-partners took with them to their new firms."

DL had an office in Houston, so the Texas DRPC applies to the attorneys from that office.

To me, this whole approach is troubling on many fronts.

First, why does a departing partner have a fiduciary duty to account to his old firm for work performed AFTER he left that firm, when his reason for leaving was rooted in his old firm's collapse, an event which caused his old firm and its partners to fail in their fiduciary duty to him?  If Partner A joins Firm B because Firm B  is a BigLaw Firm, with many attorneys, paralegals and staff which Firm B promise will support Partner A in furnishing legal services to his Client C, then doesn't Partner A have a complaint against Firm B when its collapse renders its attorneys, paralegals and staff unable or unwilling to support Partner A's work to Client C?  And doesn't Partner A owe a duty to his Client C to consider leaving Firm B, if it no longer, in Partner A's professional judgment, can service Client C's legal needs?  Somehow, in the rush to collect money from every possible source, this issue has been tossed aside, and the bankruptcy court and trustee only consider the fiduciary duty owing FROM Partner A to Firm B and not fiduciary duties owing TO Partner A from Firm B and its other members.

Second, how is Partner A's ability to provide legal services to Client C affected by the trustee's action?  Isn't the trustee at least potentially interfering with Partner A's duty to serve Client C and Client C's right to receive effective legal representation from Partner A, by demanding that Partner A's successor firm (I will continue with the lettering system, and call it New Firm D) account to the trustee from profits from services performed by New Firm D?  New Firm D probably accepted Partner A on the basis of the legal work and clients he would bring them, not based on his sterling resume and exemplary law school credentials alone, and, like Firm B before, promised Partner A that at New Firm D, he would find additional attorneys, paralegals and staff to support his legal work for Client C.  Now the trustee is inserting himself into, and altering, that relationship: can  a court really be so naive as to think that New Firm D and its other attorneys will happily say "Let's all get behind Partner A, and work long, hard hours on this huge matter he brought in, so that 100% of the profits can be shipped out to Firm B; how great that we can spend weeks, months, perhaps years toiling for the financial wellbeing of that old, defunct firm.  We associates surely want to take advantage of this opportunity, so our labor will result in zero financial benefit for our employer New Firm D, a fact which we know our employer will not hold against us when it makes annual compensation decisions.  And we New Firm D partners recognize the wisdom of toiling for the financial gain of a defunct entity, instead of for our own benefit, because that is certainly the way to avoid having our New Firm D follow the same path as Firm B into bankruptcy."

Third, what is Client C to make of this mess?  He just wants his work done well and at reasonable cost; but Firm B has imploded, and now the attorneys and staff at New Firm D  may avoid working on his matter because doing so won't further their careers.  Client C has to wonder whether he needs to start all over with a new lawyer at another firm, wasting the time, effort and money already expended.

Fourth, Partner A wants to keep Client C, but admits that doing so will be a financial disaster for him: without support from New Firm D, Partner A will have to spend even more of his own time and effort than is prudent handling Client C's work, and therefore less on New Firm D's other clients (which will make Partner A less and less desirable in New Firm D's eyes), and every dollar of gain Partner A generates won't go into his pocket but will go back to the estate of Firm B.  And unlike the prepetition days of Firm B, Partner A cannot expect to reap any benefits from Firm B distributions: there won't be any distributions, because the monies turned over to the Firm B trustee by Partner A and all the other former Firm B partners will be paid out by the estate to its creditors in the order of priority established by bankruptcy law.

Fifth, under Rule 1.15 of the TX Disciplinary Rules of Professional  Conduct, which is applicable to the Houston office of DL, may Partner A invoke his right to terminate representation of Client C on the ground that continued representation "will result in an unreasonable financial burden on the lawyer," which the Comment to Rule 1.15 says permissible  "even though the withdrawal may have a material adverse effect upon the interests of the client"?

I could write more, but this entry has grown unusually long already.

The last question I will raise is this: Under TDRPC 1.15 and under the Model Rules, the ethical rules of all jurisdictions, and principles of professional ethics that predated and still underlie all ethical canons for attorneys, the client has an absolute right to discharge his attorney, with or without cause.  So how can a trustee, with a straight face, argue that Partner A possesses, for his own benefit and contrary to his fiduciary duty to Firm B, an "asset" of the estate of Firm B in the form of a legal matter for which Client C retained Firm B, when Client C has the unfettered right, unilaterally and without cause, to terminate the intangible asset, and cease its very existence?  The trustee apparently wants to contend that all payments made to Partner A or New Firm D constitute assets of the estate of Firm B, but the payments are only made in respect of work performed by Partner A AFTER his departure from Firm B (so Firm B in no way contributed to or earned those payments) and/or New Firm D (so obviously Firm B in no way contributed to or earned those payments); so is the trustee actually trying to argue that the payments are proceeds of an intangible asset of the estate of Firm B, so that Firm B's claim relates back to the inception of the legal matter and the "asset"?  Then read again the first part of this paragraph, which emphasizes that the client can destroy the asset by terminating the representation?

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