Who owns unfinished business?

In a legal environment filled with merger mania, musical chairs for attorneys, and continued firm dissolutions, determining who has rights to "unfinished business" is a constant issue for managing partners.

The unfinished business issue arises when attorneys leave existing law firms and join new law firms, taking business and clients with them. Jewel v. Boxer, 156 Cal. App. 3d 171 (1994), provides guidance in California. Jewel effectively asked whether an existing law firm could collect from another law firm the fees for unfinished business that a partner changing law firms brought with them.

In California, most practitioners are familiar with a Jewel waiver. It is an agreement where partners agree to give up all rights for themselves and the partnership itself to the partnership's "unfinished business" claim when a partner leaves the firm. A litany of articles have addressed the pros and cons of Jewel waivers. Firms and courts around the country have considered, and sometimes decided, how best to address the issue.

A couple recent cases, one in New York and one in California, merit note. In re Thelen LLP, 2014 NY Slip Op. 04879 (N.Y. Ct. App., July 1, 2014), addressed whether hourly fee matters are the property of a law firm or its individual partners. Two weeks before the Thelen decision, a California federal district court addressed the same issue and came to a similar result. Heller Ehrman LLP v. Davis, Wright, Tremaine LLP, 527 B.R. 24 (N.D. Cal. 2014).

In re Thelen LLP

The issue in Thelen was "whether, for purposes of administering [a] ... related bankruptcy, New York law treats a dissolved law firm's pending hourly fee matters as its property." The case involved two firms that had dissolved and filed for bankruptcy. Upon the dissolution of those firms, their former partners joined other firms, and those firms were retained to work on hourly fee matters by clients of the dissolved firms. One of the dissolved firms had adopted a partnership agreement with a Jewel waiver. The trustee for that former firm sued the new firm that had acquired some of the former firm's hourly matters, alleging that the Jewel waiver constituted a fraudulent transfer of law firm assets. The estate administrator for the second dissolved firm sued based on the unfinished business doctrine.

The New York Court of Appeals explained that New York's Partnership Law does not distinguish whether a law firm's client matters constitute law firm property. Turning to case law, the court concluded that a law firm never has an interest in future hourly legal fees because those fees are contingent and too speculative in nature to constitute either a present or future property interest. It said a law firm does not own either a client or a legal engagement. Accordingly, a law firm may only assert a right to services that it actually has rendered.

This decision turned on the New York Court of Appeals' holding that pending hourly fee matters do not constitute either property of the legal partnership or unfinished business as defined by New York partnership law. This conclusion was anchored in New York law, which concludes - as other jurisdictions do - that legal clients have the right to terminate an attorney-client relationship at any time. Upon such termination, the client has an obligation only to compensate the client's now former attorney for work that has been completed. This compensation must be for the "fair and reasonable value" of those services.

Furthermore, when contingent legal matters are at issue, the dissolved firm is entitled not to the full value of the legal matter, but only the value of the legal matter at the time of the law firm's dissolution, plus interest. Again, the New York Court of Appeals emphasized that this is because the legal matter belongs to the client, not to an attorney or partnership.

The New York Court of Appeals also addressed the public policy implications that arise if a legal matter is treated as partnership property. It identified a number of potential issues that weighed against a finding that hourly matters are the property of partnership. The court said that such a finding would create an unjust windfall for the dissolved firm. It also explained that if an hourly legal matter is treated as firm property, partners would be encouraged to leave a firm as soon as possible prior to dissolution, taking the hourly matter with them, so that the new firm does not have to disgorge profits for the work done prior to dissolution. That result would encourage partners to leave before dissolution instead of staying and trying to help the law firm turn around. In addition, it would make it difficult for partners to find new jobs because the new employer would not be entitled to any profits from that attorney's hourly work. And if a firm does hire an attorney that brings along hourly work, those clients likely will be faced with the concern that their cases are not getting the attention they deserve because the new firm cannot earn any profit from them.

Heller Ehrman LLP v. Davis, Wright, Tremaine

A California federal district court reached similar conclusions about the unfinished business doctrine under California law. In Heller Ehrman, the district court reviewed a decision by the bankruptcy court that allowed the trustee for the defunct Heller Ehrman LLP law firm to pursue profits made by third-party firms under the unfinished business doctrine. The court addressed whether a dissolved law firm has a property interest in hourly fee matters pending at dissolution and found that a "law firm - and its attorneys - do not own the matters on which they perform their legal services. Their clients do."

The court analyzed Jewel in detail and said the California Supreme Court would be unlikely to find the case good law. And it distinguished Jewel on factual grounds: Jewel involved successor firms consisting entirely of partners from the defunct firms who continued to work on existing client matters under the old firms' fee agreements. In Heller, the new firms were "preexisting third-party" firms with substantial resources and service capabilities unrelated to the firm. The court also held that the Revised Uniform Partnership Act, which California adopted after the Jewel decision, has no provision "that gives the dissolved firm the right to demand an accounting for profits earned by its former partner under a new retainer agreement with a client."

Like the New York Court of Appeals, the court in Heller recognized many fairness and policy reasons to reject the unfinished business doctrine. The court found the Jewel decision unfair because it gives the fruits of the third-parties' hard work to a dissolved partnership that did nothing to earn those profits.

Partnership Implications

Using a Jewel waiver brings with it obvious risks, the most significant being that the provisions will be found inapplicable. Thus, every partnership should keep this recent decision in mind, both when negotiating partnership agreements and when considering dissolution and bankruptcy.