Geron v. Seyfarth Shaw LLP

OPINION OF THE COURT

The United States Court of Appeals for the Second Circuit has asked us two questions relating to “whether, for purposes of administering [a] . . . related bankruptcy, New York law treats a dissolved law firm’s pending hourly fee matters as its property” ( In re Thelen LLP, 736 F3d 213 , 216 [2d Cir 2013]). We hold that pending hourly fee matters are not partnership “property” or “unfinished business” within the meaning of New York’s Partnership Law. A law firm does not own a client or an engagement, and is only entitled to be paid for services actually rendered.

Thelen

On October 28, 2008, the partners of the law firm Thelen LLP (Thelen) voted to dissolve the firm, which was insolvent. In carrying out the dissolution, Thelen’s partners adopted the Fourth Amended and Restated Limited Liability Partnership Agreement (Fourth Partnership Agreement) and a written Plan of Dissolution. The Fourth Partnership Agreement provided that it was governed by California law and, unlike its predecessor agreements, included an “Unfinished Business Waiver.” The waiver recited that

“[n] either the Partners nor the Partnership shall have any claim or entitlement to clients, cases or matters ongoing at the time of the dissolution of the Partnership other than the entitlement for collection of amounts due for work performed by the Partners and other Partnership personnel prior to their departure from the Partnership. The provisions of this [section] are intended to expressly waive, opt out of and be in lieu of any rights any Partner or the Partnership may have to ‘unfinished business’ of the Partnership, as the term is defined in Jewel v. Boxer, 156 Cal.App.3d 171 [ 203 Cal Rptr 13 ] (Cal. App. 1 Dist. 1984), or as otherwise might be provided in the absence of this provision through the interpretation or application of the [California Uniform Partnership Act of 1994, as amended].”

This kind of waiver is referred to as a “Jewel Waiver,” after Jewel v Boxer ( 156 Cal App 3d 171 [Cal Ct App 1984]), the intermediate appellate court case that inspired it. Applying the Uniform Partnership Act (UPA), the Jewel court held that, absent an agreement to the contrary, profits derived from a law firm’s unfinished business are owed to the former partners in proportion to their partnership interests. The Thelen partnership adopted the waiver with the

“hope that [it would] serve as an inducement to encourage Partners to move their clients to other law firms and to move Associates and Staff with them, the effect of which will be to reduce expenses to the Partnership, and to assure that client matters are attended to in the most efficient and effec

tive manner possible, and to help ensure collection of existing accounts receivable and unbilled time with respect to such clients.”

Following Thelen’s dissolution, 11 Thelen partners joined Seyfarth Shaw LLP (Seyfarth) — 10 in its New York office and one in California. The former Thelen partners transferred unfinished matters to Seyfarth, which billed clients for their services. On September 18, 2009, Thelen filed a voluntary petition for relief under chapter 7 of the Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York.

After his appointment as the chapter 7 trustee of Thelen’s bankruptcy estate, Yann Geron (Geron) commenced an adversary proceeding against Seyfarth in the United States District Court for the Southern District of New York. Geron sought to avoid the “Unfinished Business Waiver” as a constructive fraudulent transfer under 11 USC §§ 544 and 548 (a) (1) (B) and California state law, and to recover the value of Thelen’s unfinished business for the benefit of the estate’s creditors. On the assumption that pending hourly matters were among a law firm’s assets, Geron argued that Thelen’s partners fraudulently transferred those assets to individual partners without consideration when they adopted the “Unfinished Business Waiver” on the eve of dissolution.

Seyfarth moved for judgment on the pleadings, arguing that New York rather than California law defined whether it received any “property interest.” In a decision dated September 4, 2012, the District Court Judge first agreed with Seyfarth that New York law governed. He then concluded that under New York law, the “unfinished business doctrine” does not apply to a dissolving law firm’s pending hourly fee matters, and that a partnership does not retain any property interest in such matters upon the firm’s dissolution. In the Judge’s view, to rule otherwise would “conflict[ ] with New York’s strong public policy in favor of client autonomy and attorney mobility” (Geron v Robinson & Cole LLP, 476 BR 732 , 742-743 [SD NY 2012]); and “result in an unjust windfall for the Thelen estate, as ‘compensating a former partner out of that fee would reduce the compensation of the attorneys performing the work’ ” (id. at 740, quoting Sheresky v Sheresky Aronson Mayefsky & Sloan, LLP, 35 Misc 3d 1201 [A], 2011 NY Slip Op 52504 [U], *6 [Sup Ct, NY County 2011]). He further observed that “[s]uch an expansion of the [unfinished business] doctrine would violate

By decision dated November 15, 2013, the Second Circuit agreed with the District Court that New York law governed the parties’ dispute, and asked us to answer two unresolved questions of New York law regarding the applicability and scope of the “unfinished business doctrine”; specifically,

“Under New York law, is a client matter that is billed on an hourly basis the property of a law firm, such that, upon dissolution and in related bankruptcy proceedings, the law firm is entitled to the profit earned on such matters as the ‘unfinished business’ of the firm?

“If so, how does New York law define a ‘client matter’ for purposes of the unfinished business doctrine and what proportion of the profit derived from an ongoing hourly matter may the new law firm retain?” ( 736 F3d at 225 ).

Coudert

On August 16, 2005, the law firm Coudert Brothers LLP (Coudert) dissolved in accordance with the terms of its partnership agreement. That same day, the equity partners adopted a “Special Authorization,” whereby the equity partners authorized

“the Executive Board ... to take such actions as it may deem necessary and appropriate, including, without limitation, the granting of waivers, notwithstanding any provisions to the contrary in the Partnership Agreement ... , in order to:

“a. . . . sell all or substantially all of the assets of . . . the Firm to other firms or service providers, in order to maximize the value of the Firm’s assets and business;

“b. wind down the business of the Firm with a view to continuing the provision of legal services to clients and the orderly transition of client matters

to other firms or service providers, in order to maximize the value of the Firm’s assets and business to the extent practicable.”

Coudert partners were subsequently hired by several different firms. As of the date of the firm’s dissolution, there remained between Coudert and its clients partly performed contracts for the provision of legal services. When former Coudert partners joined other firms, those firms were retained by Coudert’s former clients to conclude these unfinished legal matters. The client matters were completed by the new firms on an hourly basis, with only two exceptions.

In September 2006, Coudert filed for protection from its creditors pursuant to chapter 11 of the Bankruptcy Code. Developmental Specialists, Inc. (DSI), as administrator of Coudert’s bankruptcy estate, brought 13 separate adversary proceedings against the firms that had hired the former Coudert partners. These lawsuits were premised on the unfinished business doctrine. More specifically, DSI argued that the defendant firms were liable to Coudert for any profits derived from completing the client matters that the former Coudert partners brought to those firms. The firms moved for summary judgment, arguing that the unfinished business doctrine did not apply to matters billed on an hourly basis. DSI cross-moved for a declaration that the unfinished client matters were Coudert’s property on the day it dissolved.

In a decision dated May 24, 2012, the District Court denied the firms’ motion for summary judgment and granted DSI’s cross motion. The Judge agreed with DSI that

“[ujnder the Partnership Law, the Client Matters are presumed to be Coudert’s assets on the Dissolution Date. While the Coudert Partnership Agreement could have provided otherwise, it does not; on the contrary, it confirms the statutory presumption, as does the text of the Special Authorization adopted by the partners who voted to dissolve the firm. In the absence of any evidence that Coudert’s partners intended to exclude pending but uncompleted client representations from the firm’s assets, DSI is entitled to a declaration that the Client Matters were Coudert assets on the Dissolution Date. Because they are Coudert assets, the Former Coudert Partners are obligated to account for any profits they earned while winding the Client Matters up at

The Contingency Fee Cases

Moreover, contrary to the trustees’ contentions, New York courts have never suggested that a law firm owns anything with respect to a client matter other than yet-unpaid compensation for legal services already provided. Appellate Division decisions dealing with unfinished business claims in the context of contingency fee arrangements uniformly conclude that the dissolved partnership is entitled only to the “value” of its services (see Grant v Heit, 263 AD2d 388 , 389 [1st Dept 1999]; Shandell v Katz, 217 AD2d 472 , 473 [1st Dept 1995]; DelCasino v Koeppel, 207 AD2d 374 , 374 [2d Dept 1994]; Dwyer v Nicholson, 193 AD2d 70 , 73 [2d Dept 1993]; Kirsch v Leventhal, 181 AD2d 222 [3d Dept 1992, Levine, J.]).

The Appellate Division has occasionally referred to a contingency fee case as an “asset” subject to distribution (see e.g. Shandell, 217 AD2d at 473 ; Kirsch, 181 AD2d at 225 ). But as then-Justice Levine stressed in Kirsch, a former partner “is only entitled to ‘the value of his interest at the date of dissolution . . . with interest’ ” (id. at 226, quoting Partnership Law § 73; see also Santalucia v Sebright Transp., Inc., 232 F3d 293 , 298 [2d Cir 2000] [“(I)n a case where a lawyer departs from a dissolved partnership and takes with him a contingent fee case which he then litigates to settlement, the dissolved firm is entitled only to the value of the case at the date of dissolution, with interest. Stated conversely, the lawyer must remit to his former firm the settlement value, less that amount attributable to the lawyer’s efforts after the firm’s dissolution”], citing Kirsch, 181 AD2d at 225-226 ). The trustees have not cited any New York case in which the law firm was awarded the client matter itself, or any fee not earned by the law firm’s own work. This is hardly surprising since, as already discussed, a client’s legal matter belongs to the client, not the lawyer.

And notably, these cases have involved disputes between a dissolved partnership and a departing partner, not outside third parties. In this context, statements that contingency fee cases are “assets” of the partnership subject to distribution simply means that, as between the departing partner and the partnership, the partnership is entitled to an accounting for the value

Stem v Warren

The trustees rely heavily on our decision in Stem v Warren ( 227 NY 538 [1920]), as did the District Court Judge in DSI. But Stem involved claims for breach of fiduciary duty; we did not hold “that executory contracts to perform professional services are partnership assets unless a contrary intention appears” (DSI, 477 BR at 333 ), or define unfinished client engagements as partnership property.

In Stem, one architectural partnership (Reed & Stem) entered into an agreement with another architectural partnership (Warren & Wetmore) for the purpose of “securing] a contract for architectural services in the construction of the Grand Central Station and buildings in connection therewith” (Stem, 227 NY at 542 ). The agreement stated that the partnerships would “share and share alike as firms and not as individuals the profits and losses” (id. at 543). On the same day, the joint venture entered into a separate contract with the railroad company agreeing, among other things, to jointly act as architects for the company. It was the clear intent of the parties that the contract was to be performed notwithstanding the death of Reed, the “executive head” of the joint venture, if this should occur; that is, the agreement between the partnerships contemplated that the joint venture would survive either partnership’s dissolution and that the contract with the railroad company would be performed by the survivors.

The joint venture worked on the Grand Central Station project for over seven years before Reed died. The trial court found that, without consent from Reed’s surviving partner or his estate, Wetmore sent the railroad company a proposed new contract that was, in substance, the same as the joint venture’s existing contract, except that the partnership of Warren & Wet-more was named sole architect. The railroad company immediately terminated its contract with the joint venture and entered into the new, identical contract exclusively with Warren & Wetmore.

Stem, the surviving partner, filed suit to recover one half of the profits on two separate projects of the joint venture: the

Next, because the trustees disclaim any basis for recovery of profits from the pending client matters of a former partner who leaves a troubled law firm before dissolution, their approach would encourage partners to get out the door, with clients in tow, before it is too late, rather than remain and work to bolster the firm’s prospects. Obviously, this run-on-the-bank mentality makes the turnaround of a struggling firm less likely.

And attorneys who wait too long are placed in a very difficult position. They might advise their clients that they can no longer afford to represent them, a major inconvenience for the clients and a practical restriction on a client’s right to choose counsel. Or, more likely, these attorneys would simply find it difficult to secure a position in a new law firm because any profits from their work for existing clients would be due their old law firms, not their new employers.

The trustees answer that clients do not care whether they pay one law firm or another, so long as their legal affairs are handled properly, and that requiring law firms to forfeit the fees earned by their lawyers’ efforts has no impact on attorneys or clients. We disagree for the reasons already mentioned. Additionally, clients might worry that their hourly fee matters are not getting as much attention as they deserve if the law firm is prevented from profiting from its work on them. The notion that law firms will hire departing partners or accept client engagements without the promise of compensation ignores common sense and marketplace imperatives. Followed to its logical conclusion, the trustees’ approach would cause clients, lawyers and law firms to suffer, all without producing the desired financial rewards for the estates of bankrupt firms.

Ultimately, what the trustees ask us to endorse conflicts with New York’s strong public policy encouraging client choice and, concomitantly, attorney mobility. In Cohen v Lord, Day & Lord ( 75 NY2d 95 , 96 [1989]), the partnership agreement provided that a departing partner forfeited his right to departure compensation if he practiced law in competition with his former firm. The lower court held that the provision was a “valid . . . financial disincentive to competition and did not prevent plaintiff from practicing law in New York or in any other jurisdiction” (id. at 97 [internal quotation marks omitted]).

We reversed, holding that these financial penalties impermissibly interfered with clients’ choice of counsel — i.e., “[t]he

“[c]bents are not merchandise. Lawyers are not tradesmen. They have nothing to sell but personal service. An attempt, therefore, to barter in clients, would appear to be inconsistent with the best concepts of our professional status” (id. at 98; see also Denburg v Parker Chapin Flattau & Klimpl, 82 NY2d 375 , 381 [1993] [finding unacceptable a provision in a partnership agreement that “improperly deter(red) competition and thus impinge(d) upon clients’ choice of counsel” by creating an incentive for a partner changing firms to discourage a Parker Chapin client from coming along]).

Finally, the trustees seek to entice us to hold in their favor on the ground that a law firm may always avoid the unfinished business doctrine by placing a well-crafted Jewel waiver in the partnership agreement. This suggestion fails to consider the possibility that classifying clients’ pending hourly fee matters as firm property may lead to untoward unintended consequences. For example, the trustees, as noted before, limit their sought-after recoveries to client matters that remain unresolved as of the date of a law firm’s dissolution. As Seyfarth pointed out, though, if a client’s pending matter is partnership property, why doesn’t every lawyer whose clients follow him to a new firm breach fiduciary duties owed his former law firm and partners? In the end, the trustees’ theory simply does not comport with our profession’s traditions and the commercial realities of the practice of law today, a deficiency beyond the capacity of a Jewel waiver to cure.

Accordingly, the first certified question should be answered in the negative, and the second certified question should not be answered as it is unnecessary to do so.

Chief Judge Lippman and Judges Graffeo, Smith, Pigott, Rivera and Abdus-Saiaam concur.