United States: Bankrupt Law Firm Unfinished Business Question To California Supreme Court

Reproduced with permission from BNA's Bankruptcy Law Reporter, 28 BBLR 980 (Aug. 4, 2016). Copyright 2016 by The Bureau of National Affairs, Inc. (800-372-1033) [http://www.bna.com]

  • 9th Circuit sends question to California Supreme Court for answers
  • Who owns what in clawback action hanging in Heller Ehrman, Howrey estate fights?

By Joyce E. Cutler

July 29 –The multimillion-dollar answer of who owns the rights to unfinished business when law firms fail rests with the California Supreme Court ( Heller Ehrman LLP v. Davis Wright Tremaine LLP (In re Heller Ehrman LLP), 2016 BL 241328, 9th Cir., No. 14-16318, 7/27/16).

The U.S. Court of Appeals for the Ninth Circuit certified July 27 to the state court the question of whether a dissolved law firm has a property interest in uncompleted hourly legal matters at the time the firm is dissolved.

"This issue is significant for California lawyers and law firms, as well as for their clients. Partners in California law firms need clarity regarding their obligations after a law firm dissolves. Absent guidance from the California Supreme Court, law firms will have difficulty predicting their entitlement to revenue from completing the unfinished business of dissolving law firms," the panel said.

Clients also may be "disadvantaged by this ambiguity, as it may be unclear how their matters will be handled at a new law firm, if the hourly fees from their matters must be shared with a dissolved law firm," the appeals court said. And lawyers in dissolving firms may have difficulty advising on the effect on client matters.

Quick Turnaround.

The Ninth Circuit's request comes six weeks after oral arguments in the Heller Ehrman LLP estate fight with three law firms. The firms argue clients' interest in their business and counsel of choice outweigh a shuttered law firm's interest in billing.

Under Jewel v. Boxer, 156 Cal. App. 3d 171 (1984), absent a partnership agreement, attorneys' fees received on cases in progress upon dissolution must be shared by the former partners. The California appellate ruling hasn't until now reached the California Supreme Court.

Foley & Lardner LLP, Jones Day and Orrick Herrington & Sutcliffe LLP, which the estate sued for fraudulent transfer, contend Heller shouldn't get a pay day for not representing clients already harmed when Heller failed.

"This whole dispute is not really over whether the firm has a property interest in the legal matter. That's a red herring. The question is not really there's a property interest in the legal matter. That is under the client's control," said Thomas Rutledge, Stoll Kennon Ogden PLLC in Louisville, Ky., and former chairman of American Bar Association Section on Business Law Committee on LLCs, Partnerships and Unincorporated Entities.

"The real question is who has the right to the fruits of the work done," Rutledge told Bloomberg BNA July 28.

Howrey in the Wings.

The California court hasn't yet responded to the question, which is under state partnership law for the San Francisco-based Heller.

It's a question the Howrey LLP estate needs answered. Howrey's winding down its Chapter 7, and a chunk of the money coming in depends on unfinished business, trustee Allan Diamond told Judge Dennis Montali, U.S. Bankruptcy Court for the Northern District of California at a July 15 hearing (In re Howrey LLP,, Bankr. N. Cal., No. 11-31376, fee application order filed 7/25/16.

Yet the answer to Howrey's unfinished business may lie in the District of Columbia Court of Appeals. Attorneys representing eight law firms and the Howrey estate suggested the Ninth Circuit ask the D.C. court to determine who owns the proceeds from business left over when a law firm goes belly up ( Diamond v. Jones Day , 9th Cir. , No. 15-16333 , reply brief 4/4/16).

The California Supreme Court decision will be controlling in Heller and influential in the Howrey case, which will be decided under D.C. law, said Christopher Sullivan, a partner with Diamond McCarthy LLP in San Francisco representing the trustee in Diamond in in Heller and the estate in Howrey.

"But the D.C. law followed the California law, so what the California Supreme Court says will be at the very least will be persuasive in deciding D.C. law," Sullivan told Bloomberg BNA.

"Every time I dig myself into these briefs I become more convinced that [Bankruptcy] Judge[Dennis] Montali got it right," Sullivan said July 29.

"This is what we're waiting for. And I think the certification to the California Supreme Court was inevitable," Robert Hillman, University of California Davis law professor who has extensively written about lawyer mobility, said July 27. "People who were expecting the Ninth Circuit to resolve this issue were pretty naive, especially after Thelen in New York."

New York and RUPA.

The New York Court of Appeals, ruling on a question from the Second Circuit in the Thelen LLP bankruptcy, held profits from completing pending matters belong to the lawyers and successor firms and aren't the "property" of the defunct firm creditors can claim ( In re Thelen LLP, 2014 BL 183428, 24 N.Y.3d 16 ( N.Y. 2014)).

"Are law firms special? They are in New York because the New York Court of Appeals ran roughshod over the partnership statute in its efforts to develop special new rules over just for law firms," Hillman told Bloomberg BNA.

Thelen was decided under the Uniform Partnership Act, which said firms are not entitled to compensation, while California adopted the Revised Uniform Partnership Act. "Under RUPA you're entitled to reasonable compensation for the work you do. Now I doubt reasonable will ever be 100 percent," Rutledge said.

Partnerships or limited liability partnerships are widely used forms for doctors, dentists, architects and all forms of organizations. "And the rule that they're going to dictate is going to govern all of them, so it's of crucial importance. It isn't just about a couple of thousand law firms," Rutledge said. "RUPA governs everybody. There's no separate law that governs law firm partnerships versus other partnerships."

Rutledge and Hillman signed on to an amicus in the Howrey fight arguing the Ninth Circuit reverse the trial court, reject law firm and ABA arguments and find unfinished business has no material effect on client choice law firms.

Howrey, like Heller, "relates to the obligation of partners, whether or not they are in law firm, to satisfy the obligations they have undertaken to one another and their creditors."

'Price of Admission.'

"The California Supreme Court could establish a classy precedent if it held that part of the price of admission to operate as a 'partnership' was a commitment among the partners to provide for the debts of the partnership," said Scott McNutt, McNutt Law Group LLC, San Francisco, who represented Brobeck, Phleger & Harrison LLP employees.

"Lawyers love the idea of partnership, but only as to one aspect of partnership, the sharing of profits. As to all other aspects of partnership, they want to be employees, because employees have no obligations to the enterprise and can pick up and leave at will," McNutt said in a July 27 e-mail to Bloomberg BNA.

The appeals court's reference "makes clear that all the Ninth Circuit is worried about is that defecting lawyers are free to tell their clients that there will be no headaches associated with changing firms," McNutt said.

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