United States: Court Decides That Rule Of Professional Conduct 5.6 Does Not Apply In Dispute Over Lawyer´s Employment Contract

A recent decision by the U.S. Court of Appeals for the District of Columbia Circuit held that Rule of Professional Conduct 5.6 does not invalidate a liquidated damages provision in a lawyer’s employment contract with his former law firm. In Ashcroft & Gerel v. Coady, 244 F.3d 948 (D.C.Cir. 2001), the Court of Appeals affirmed the District Court’s judgment in favor of a law firm whose attorney breached his employment contract by, inter alia, allegedly stealing clients, conspiring with other attorneys to defraud the firm and sabotaging firm computers, specifically finding that Rule of Professional Conduct 5.6 – which prohibits agreements restricting the right of attorneys to practice after leaving a firm – did not apply. Id. at 955.

In order to understand the decision, a summary of the details is needed. Coady was an attorney with Ashcroft & Gerel from 1989 to 1998. In early 1997 a dispute arose between Coady and Ashcroft & Gerel over the law firm’s alleged failure to pay him a bonus, a matter which Coady took to arbitration. At the same time, Ashcroft & Gerel sued Coady in District Court for breach of contact, breach of fiduciary duties and conversion. Id. at 949. The arbitration panel found in favor of Coady. A District Court upheld the panel’s ruling; however, the Court of Appeals reversed, holding that that the panel lacked jurisdiction to consider Coady’s breach of contract claim. Id. at 950.

The Court of Appeals also transferred Coady’s claim to the District Court which was considering Ashcroft & Gerel’s claim against him. The jury returned a verdict in favor of Ashcroft & Gerel’s breach of contract claim against Coady in the amount of $400,000, which corresponded with the liquidated damages provision in Coady’s employment contract. Id.

On appeal, Coady contended (1) that Ashcroft & Gerel’s conduct in attempting to deprive him of a bonus was a material breach and so relieved Coady of any obligation to perform his duties under his employment contract; (2) that the District Court wrongfully prevented Coady from introducing certain evidence of Ashcroft & Gerel’s material breach; and (3) that the District Court erred in refusing to strike Ashcroft & Gerel’s claim for liquidated damages. The Court of Appeals affirmed the District Court as to Ashcroft & Gerel’s conduct not relieving Coady of his employment obligations and the propriety of the liquidated damages award. However, the Court of Appeals determined that Coady had been prejudiced by the District Court denying him an opportunity to introduce evidence which might have demonstrated Ashcroft & Gerel’s material breach, and so reversed the judgment and remanded the case to the District Court. Id. at 956.

Notably, the Court of Appeals upheld the liquidated damages provision in Coady’s employment contract, finding that the $400,000 amount was neither unenforceable on public policy grounds nor was it a penalty, inasmuch as the amount set forth in the contract had no relationship to the amount of actual damages.Id. at 955. The Court of Appeals concluded otherwise, finding that Coady’s employment contract had routinely been amended to increase the amount of liquidated damages as he became more valuable to the law firm, to a point where Ashcroft & Gerel lost between $1 million and $1.5 as a result of his termination. Id.

In his opposition to the liquidated damages award, Coady relied upon District of Columbia Rule of Professional Conduct 5.6, which prohibits a law firm from restricting "the rights of a lawyer to practice after termination of the [employment] relationship." Id. The Court of Appeals rejected Coady’s argument, concluding that Rule 5.6 "is inapplicable because the liquidated damages were not linked to Coady’s decision to compete with the firm." Id. The Court of Appeals further remarked that "the terms of the employment contract are readily distinguishable from a contract not to compete." Id.

Significantly, the Court of Appeals, finding Rule 5.6 inapplicable, did not defer to trial testimony by an Ashcroft & Gerel partner that the liquidated damages provision was, in fact, designed to penalize attorneys who, upon leaving the law firm, hoped to compete with their former firm. Id. Had the Court given this testimony greater deference, it may very well have concluded that Rule 5.6 precluded an award of liquidated damages. In any event, it is foreseeable that cases may come down the road that apply Rule 5.6 to similar facts and conclude that a liquidated damages provision, such as that found in Coady, violates Rule 5.6.

1 It should be noted that the ABA Ethics 2000 Commission Report on the Evaluation of the Model Rules of Professional Conduct, a comprehensive study of the Model Rules, did not recommend any substantive changes to Rule 5.6.

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