In July 2012, I wrote two blog pieces about a disturbing and growing problem: the claims of defunct law firms and their bankruptcy trustees to grab the fees earned by other law firms where the defunct firms' attorneys had migrated prior to bankruptcy, by asserting that the client matters that went with those migrating attorneys were "assets" of the defunct firms and that, as partners at the defunct firms, those attorneys had to account to their former partners for somehow misappropriating those assets for their individual benefit. The problems with this bankruptcy strategy were many, as I blogged about, but boiled down amount to a rather obvious contradiction: how can a bankrupt firm deserve to "recover" fees earned by another firm for work performed not by the bankrupt firm but by the other firm?
Thank goodness, the US District Court for the Southern District of New York -- the federal district court that sits in New York City and has a long history of crafting leading corporate, securities and business decisions -- ruled earlier this month in two related cases that such a result is absurd and -- here is the critical part -- based on a clearly erroneous interpretation of partnership law and partner fiduciary duty.
The bankruptcy law world has termed this maneuver the "unfinished business doctrine," and while it isn't completely bogus in its basic concept, it is the distortion and exaggeration of that doctrine in the law firm partnership context that is outrageous. To recap, bankruptcy trustees for sunk law firms -- like Dewey, Coudert and Howrey -- were demanding, and collecting, huge sums from third party law firms whose only offense had been to hire those bankrupt debtors' fleeing partners and then actually perform legal services for the clients who had followed those same partners to their new firms. The trustees claimed that ALL the fee income for the work performed for those clients on matters transferred from the bankruptcy firms to the new firms belonged to the old firms, as such matters constituted "unfinished business" of the prior firms. Consequently, the new firms did the legal work, completed the client projects, paid their own associate attorneys and staff for their efforts, and bore the risk and other expenses of completing the tasks, and THEN had to turn over the fruits of their labor -- the fee income -- to trustees who had done NOTHING to earn that income.
The SDNY found this wrong. While admitting that legal matters with contingent only payments might fall within the unfinished business doctrine (the first firm works hard at the project, then its partner leaves for financially brighter pastures and takes the matter with him, and the new firm completes the project and, at that point, the fee is earned, and to allow the successor firm to enjoy the benefits of something for which it didn't expend all the effort nor take the risk initially would be inequitable), the court ruled that legal matters paid for on a fixed hourly or similar basis flatly do NOT come within the unfinished business doctrine. The court wrote:"Unlike in the contingency fee context, applying the unfinished business doctrine to pending hourly fee matters would result in an unjust windfall for the [bankrupt law firm's] estate, as 'compensating a former partner out of that fee would reduce the compensation of the attorneys performing the work.'"
In addition, the court agreed with a public policy argument we espoused in those earlier blogs: the right of a client to select his attorney. "Such an expansion of the doctrine would violate New York's public policy restrictions on the practice of law" and would damage the relationship of attorney and client as "a pending client matter is not an ordinary article of commerce" and "the client, not the attorney, moves the matter to a new firm."
The court observed that the fiduciary underpinnings of the doctrine reside in partnership law, but that the doctrine emerged in California under a PRIOR version of its partnership statute; the revised California partnership statute, the court noted, which was the statute applicable to one of the bankrupt firms in front of the court, actually addressed what financial reimbursement a departing partner owes to a dissolved partnership for the use of partnership assets and that statutory change modifies the unfinished business doctrine in the partnership setting. Other courts addressing this issue have simply swallowed whole the "old" California rule judicially created under a different statutory scheme, and transferred it in its entirety (and without examination) to New York state, not bothering to consider whether or not the doctrine, in any form, actually applies under New York partnership law. (The other case before the SDNY involved a NY domiciled partnership and the court ruled that NY partnership law and NY attorney ethics rules clearly fall in favor of the successor law firm and not the bankruptcy trustee for the defunct firm.)
So what's the situation right now?
The dispute between the SDNY's rulings and the contrary earlier Coudert ruling by a different US District Court in New York state will wind up before the Second Circuit Court of Appeals in New York, probably in 2013. Meanwhile, interpretations of California and New York partnership law (one of the defunct firms involved here was domiciled in that state) may be submitted to the state supreme courts of those respective states.