What happens to a law firm’s work after the firm dies?

Larry Ribstein —  7 November 2011

Today’s WSJ covers the Howrey bankruptcy and specifically the ex-partners’ and their new firms’ potential liabilities for unfinished business taken from Howrey.

As the article says, Howrey’s bankruptcy trustee, the custodian of its claims under state law, “has the right to sue for profits generated by work that partners started at their old law firms and took to their new positions, such as continuing cases.” The defendants can include the new firms the partners joined, including Dewey & LeBoeuf, Baker Botts and Arent Fox, which “may have the deepest pockets.”

This may be Howrey’s most important asset because, according to the old saw the article quotes, a law firm’s “most valuable assets of a law firm go home every night.”

A similar fight is happening over the remains of Heller Erhman.  The article says that the defendant law firms in the Heller case are “arguing that clients have a right to take their business where they choose.”

Of course that’s true, but it doesn’t end the legal complications.  As discussed in The Source, §7.08(e) (footnotes omitted):

All of the partners of the dissolved firm, however, are generally entitled to share in fees for pre-dissolution work-in-process paid after dissolution to the dissolved partnership or to withdrawing partners, even if the client has exercised a right to discharge the attorney or attorneys who are sharing in the fees.* * *

Moreover, depending on the applicable law, the partner or firm completing the case may not be entitled to extra compensation for completing the case.  Rather, the case is treated as an asset of the prior firm and shared among the partners of that firm on the same basis that they shared fees while the firm was still alive.  As discussed in Bromberg & Ribstein, this reflects the difficulty of figuring out an alternative basis for dividing the free, the assumption that the partnership continues on the pre-dissolution basis until winding up is completed, and the need to encourage partners to stay with the firm.  Of course there are strong policy arguments on the other side:  giving partners freedom to move and the risks to the client if the lawyer isn’t paid for extra work.

But note that these are only default rules.  Thus, my book notes (footnotes omitted):

The partners can and should anticipate the above problems in their agreement. The partners should be careful to define the situations in which the work-in-process provision applies.

Often, however, there is no clear agreement, and the lawyers and their lawyers are left to hash out the issues at substantial cost.

I have two questions:

  1. Would it really be so bad if the practice of law were put on sounder financial footing by permitting non-lawyer capital? These bankruptcies illustrate the instability and insubstantiality of these weak cooperatives we call “firms.”  See Death of Big Law.  The dissolutions are likely to increase as Big Law devolves, and clients are caught in the middle.
  2. Why aren’t these matters dealt with more definitively in agreements among lawyers who write agreements for others for a living?

Larry Ribstein

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Professor of Law, University of Illinois College of Law

4 responses to What happens to a law firm’s work after the firm dies?

  1. 

    I agree that the partners can and should anticipate the above problems in their agreement and that the partners should be careful to define the situations in which the work-in-process provision applies. However it’s a case to case basis and requires foresight in knowing which areas to detail. They may have never anticipated what happened so that they didn’t clear out which areas needed to be cleared out.

  2. 

    Jerry Kowalski has really put his finger on the pulse of this issue. The law firm LLP structure that is favored by so many practices, is still a General Partnership under the UPA or RUPA as adopted in many states. This establishes a fiduciary duty upon all of the partners to the partnership to be accountable for the assets of the estate (whether that be a desk, a practice treatise, or “unfinished business”) for the fair value of what they have taken. The consideration for those assets goes into the “bucket” of assets of the firm that are applied to the creditors first, then to the partners in accord with the partnership agreement’s distribution provisions were the partnership ongoing. The problem is there are rarely going to be assets sufficient to pay the claims of creditors in full when the large firms fail, so all of these moniesgo to creditors.

    If one takes about thirty seconds to reflect, the partners in a general partnership, where ever they go, would have this liability follow them. It isn’t a restraint on their right to practice, but the consequences of participating in a bad business arrangement. It is a legal obligation to pay their contractually incurred debts. It is terrible, but it is what the state of the law for general partnerships, all general partnerships, has been for a very long time. The partners have to pay the obligations one way or another in the general partnership, so paying for it with income earned from the cases taken was pretty much a given. And if that was not enough then everything else one earned income from as well.

    The shock that is coming to the forefront is that many law firm partners have had a misperception of what the Limited Liability Partnership election actually means to them in the law firm meltdown scenario.

    A conundrum is that if a “Jewel waiver” is adopted by an LLP, and far enough in advance of a firm failure to not become characterized as a voidable preference, it could actually hasten the demise of the law firm by facilitating a rush to the door by partners who can quantify the economic decision in their personal best interest with lessened personal consequences. On the other hand, to apply an identical formula for measuring the price of assets taken in a voluntary departure that is not involving a firm failure….is unproven as enforceable because of the restriction on practice issue. In the law firm failure scenario that argument of restriction on mobility has not carried the day when balanced against the obligation to pay one’s debts to creditors. So what’s the difference….why should it be allowed in the failure of a firm, but not in a voluntary departure, if the partners have agreed and it is less of a burden than in the failure of a firm? Hard situation.

    And if a firm does have the ability to restrict the exposure of the partners by adopting an effective “Jewel waiver”, would not the creditors, especially the lenders and landlords, then insist on partner guarantees to cover the now avoidable “clawback” tools that protect to a limited degree the creditors in a bankruptcy? Otherwise, the scope of credit law firms should recive to operate their businsess as currently done would be reduced almost to zero.

  3. 

    Since 1988, when Finley Kumble filed for bankruptcy protection, some 32 major law firms have failed. In each of those cases, liabilities far exceeded assets and in most of these cases, partners of the defunct firm wound up paying money back to the bankrupt estate. I do not know of a single instance where partners of a defunct firm received any money from the liquidation process.

    The long term ramifications of a law firm failure go much deeper than the clawbacks of the “unfinished business” doctrine. They also include clawbacks sought from partners by a trustee or a liquidation for compensation paid to partners during the period the law firm was found to be insolvent. In addition, law firm partners not only face a loss of their capital accounts, but in addition, recognition of phantom income as capital accounts are zeroed out as well as in some instances, forgiveness of debt. Added to this financial quagmire is the reputational issue: Clients asking “how can I trust you to guide me in managing my business, when you couldn’t manage yours.” A more in depth look at the issues can be found at http://kowalskiandassociatesblog.com/2011/02/03/the-financial-and-legal-consequences-of-a-law-firm-dissolution-on-the-partners-of-the-defunct-firm/

    In a number of cases, law firms tried to resolve the “unfinished business” (also known as “Jewel v Boxer”) issues by drafting provisions in their partnership agreements waiving the “Jewel v Boxer” rules. Every court that has addressed these provisions, particularly Judge Dennis Montali of the Bankruptcy Court for the Northern District of California (who is presiding over Howrey, Heller Ehrmann and Thelen) have found these provisions void as constituting a preference.

    We have very recently seen a slight reverse trend: Some law firms have included a provision in their partnership agreements which requires a departing partner to refund 10 to 20% of fees he or she earns from clients he or she has taken with him or her which had been clients of the law firm over a stipulated period of years. These clauses are very new and have not been tested in any court. These clauses pose a separate set of issues since, if they are indeed enforceable, they severely restrict partner mobility. It is that unintended consequence which will inevitably test the viability of the provision, particularly since Jewel v Boxer claims only arise in the context of a firm dissolution.

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