What’s Yours is Mine, and What’s Mine is Mine? SDNY Expands the “Unfinished Business” Doctrine to Include Non-Contingency Client Matters In Possible Dewey Preview

[authors: Michael A. Stevens]

The recent chapter 11 case of the storied New York law firm, Dewey & LeBoeuf LLP, will raise a host of issues attendant to the dissolution of a modern day “big law” firm partnership. Chief among these issues is likely to be whether the profits earned by former Dewey partners in completing Dewey’s open client matters belong to Dewey or the former Dewey partners.

The unfinished business doctrine establishes the general rule that, absent a contrary provision in the partnership agreement, any business that is unfinished on the date the partnership dissolves constitutes a partnership asset, and accordingly, each partner has a duty to account to the dissolved partnership for any profits derived from such business. In recent years, the United States Court of Appeals for the Second Circuit and three New York Appellate Divisions have found that open client matters of dissolved law firms constitute unfinished business for purposes of New York partnership law. Significantly, however, all of the client matters at issue in those decisions were billed on a contingency basis.

On May 24, 2012, Judge Colleen McMahon of the United States District Court for the Southern District of New York expanded the unfinished business doctrine to include open client matters that are billed on an hourly basis. Dev. Specialists, Inc. v. Akin Gump Strauss Hauer & Feld LLP, 2012 WL 1918705 (S.D.N.Y. May 24, 2012).  Aside from clarifying the general risks that law firms take in hiring former partners of a dissolved law partnership, Judge McMahon’s decision is particularly timely given that nearly 300 former Dewey partners have recently joined new law firms and, presumably, have taken with them certain open client matters – billable both by the hour and on a contingency basis. In light of this decision (and depending on the specific provisions of Dewey’s partnership agreement), those new law firms may face clawback litigation by the Dewey bankruptcy estate in an attempt to recover any profits earned from the Dewey client matters.

Background

On August 16, 2005, the law firm Coudert Brothers LLP, a partnership formed under New York law, dissolved in accordance with the terms of its partnership agreement. At the time of Coudert’s dissolution, certain of its client matters remained unfinished. After many of Coudert’s former partners joined new law firms, Coudert’s former clients retained those firms to complete the unfinished matters. In September 2006, Coudert filed for chapter 11 protection in the United States Bankruptcy Court for the Southern District of New York. On August 27, 2008, the Bankruptcy Court confirmed Coudert’s liquidation plan, and Development Specialists, Inc. (“DSI”) was thereafter appointed as the plan administrator.

DSI then brought thirteen separate adversary proceedings against law firms that had hired former Coudert partners, arguing that the law firms were liable to Coudert under the unfinished business doctrine for any profits earned while completing work on Coudert’s open client matters. The law firms moved to dismiss the complaints on the basis that the unfinished business doctrine did not apply to client matters billed on an hourly basis.

Following the Bankruptcy Court’s denial of the motions to dismiss, the District Court withdrew the reference of the adversary proceedings to the Bankruptcy Court. Shortly thereafter, the parties cross-moved for summary judgment on the issue of whether the unfinished business doctrine applies to client matters billed on an hourly basis.

Analysis

The law of partnerships in New York is codified in the New York Partnership Law (“NYPL”), which itself is a codification of the Uniform Partnership Act (“UPA”). N.Y. P’ship Law § 1. Significantly, the NYPL instructs New York courts to adopt interpretations of its provisions that conform with other UPA jurisdictions. Id. § 4(4).

The New York Court of Appeals has yet to address the issue of whether the unfinished business doctrine extends to non-contingency client matters. Accordingly, the District Court began its analysis by reviewing case law from New York courts that have addressed the issue in the context of contingency client matters, as well as pertinent case law from other UPA jurisdictions. Although New York courts, including the Second Circuit, had previously only applied the unfinished business doctrine to client matters billed on a contingency basis, the District Court discerned no meaningful difference between legal business that is billed by the hour versus handled on contingency. Additionally, the District Court found that “[e]very court in a UPA jurisdiction that has considered the precise question posed here has concluded that billable hours matters are partnership assets in the absence of any express intention that they should be treated otherwise.” 2012 WL 1918705, at *15. In light of the NYPL’s express requirement that New York courts harmonize their rulings with those of other UPA jurisdictions, the District Court determined that these UPA decisions were a “powerful reason” to conclude that the New York Court of Appeals would likely reach the same result.

Having determined that the New York Court of Appeals would likely expand the unfinished business doctrine to include client matters that are billed by the hour, the District Court turned its attention to Coudert’s partnership agreement. In most instances, the NYPL establishes only default rules – partners are free to vary these rules by agreement. Thus, the District Court reviewed Coudert’s partnership agreement to determine whether the partners had indicated an intent to override the unfinished business doctrine with respect to open client matters. Coudert’s partnership agreement, as well as a “special authorization” adopted by the partners to facilitate Coudert’s dissolution, did not exclude open client matters from Coudert’s assets upon dissolution. To the contrary, Coudert’s partnership agreement and special authorization expressly incorporated the default dissolution provisions of the NYPL, and strongly indicated an intent that open client matters would remain partnership property in the event of dissolution. Accordingly, the District Court held that any open client matters as of Coudert’s dissolution date – regardless of how Coudert was to be compensated for the matters – were assets of the partnership, and therefore, the former Coudert partners were required to account for any profits earned while completing those matters.

The defendants argued that (i) Coudert’s interest in any open, non-contingency client matters should be limited to just Coudert’s receivables (unbilled and billed but unpaid) for services rendered on the matters prior to dissolution and (ii) application of the unfinished business doctrine to non-contingency client matters violates New York public policy favoring unfettered client choice of counsel. The District Court rejected each of these arguments.

The District Court found that the defendant law firms’ quantum meruit argument confused a law firm’s rights against its clients for the payment of fees with the rights of former partners amongst each other regarding the use of partnership property – issues which New York courts have previously held to be distinct. Therefore, the District Court held that the manner in which a client had agreed to pay for a firm’s services in no way alters the proposition that “every partner must account to her former partners for profits realized from the use of what was, on the date of dissolution, a partnership asset.” 2012 WL 1918705, at *17.

The District Court ultimately rejected the defendant law firms’ New York public policy argument as well, after acknowledging that it was “by far the . . . most powerful argument”. The District Court began by noting that none of the cases addressing New York’s public policy supporting unfettered client choice of counsel involved the dissolution of a partnership – which is governed by statute (the NYPL), and thus, unlikely to violate public policy. More importantly, however, the District Court found that none of the New York courts, including the Second Circuit, that applied the unfinished business doctrine to contingency client matters expressed any concern that the doctrine conflicted with a client’s right to choose his or her attorney. Having already found no basis to distinguish between non-contingency and contingency client matters, the District Court held that application of the unfinished business doctrine to Coudert’s open, non-contingency client matters did not contravene New York public policy supporting unfettered client choice of counsel.

As a fall back argument, the defendant law firms contended that, even if the open, non-contingency client matters constitute Coudert partnership assets, Coudert is not entitled to any recovery because the profits derived from such matters were entirely the result of the former Coudert partners’ “efforts, skill and diligence”.

Pursuant to the NYPL, a partner is not entitled to compensation for his or her post-dissolution efforts in winding up the partnership’s business. N.Y. P’ship Law § 40(6). Other UPA jurisdictions enforce this “no compensation” rule rigidly, even when the result is harsh – for example, when a departing partner takes an open client matter from the dissolving firm and achieves an extraordinary result almost entirely through his efforts at a new firm. In an apparent effort to mitigate such results, the New York courts, including the Second Circuit, that applied the unfinished business doctrine to contingency client matters have recognized an exception to the “no compensation” rule. Specifically, these courts did not allow the dissolved law firm to participate in any value attributable to a former partner’s post-dissolution “efforts, skill and diligence”. The courts justified this departure from both the plain language of the NYPL and case law in other UPA jurisdictions by reasoning that such value is not on account of the former partner’s use of partnership property, but solely due to the partner’s own efforts.

Similar to the issue of whether the unfinished business doctrine applies to open, non-contingency client matters, the New York Court of Appeals has yet to consider whether the judicially-recognized “efforts, skill and diligence” exception violates the NYPL. In considering the issue, the District Court began by observing that profits attributable to the “use” of a dissolved law firm’s asset versus profits attributable to a former partner’s “efforts, skill and diligence” with respect to that asset is likely a distinction without a difference. For this reason, as well as the fact that other UPA jurisdictions have not recognized the exception, the District Court “doubt[ed] whether the New York Court of Appeals would [recognize the exception] in either context” – non-contingency or contingency client matters. However, because the Second Circuit had applied the “efforts, skill and diligence” exception to contingency client matters and the District Court had previously concluded there was no meaningful distinction between non-contingency and contingency client matters in the context of the unfinished business doctrine, it felt “constrained” to apply the exception to non-contingency client matters as well. While acknowledging that “the situation needs sorting out”, the District Court concluded that the task “is ultimately the job for the New York Court of Appeals.”

Conclusion

The Coudert decision puts law firms that hire former partners of dissolved law partnerships on notice of the potential for clawback litigation with respect to profits derived from completing any of the dissolved partnership’s open client matters – regardless of how such matters are compensated. Although Coudert expanded the unfinished business doctrine to include client matters that are billable on an hourly basis, it softened the blow by recognizing the “efforts, skill and diligence” exception previously applied by New York courts in the context of contingency client matters.

The issues raised in the Coudert decision are likely to be the subject of further litigation, as Dewey’s chapter 11 cases progress and the bankruptcy estate explores potential avenues of recovery. Additionally, throughout the decision, the District Court underscored the need for the New York Court of Appeals to address certain issues related to the unfinished business doctrine – in particular, New York courts’ recognition of the “efforts, skill and diligence exception. It is not surprising then, that the District Court concluded the decision by indicating that it would grant a motion to certify an interlocutory appeal to the Second Circuit, which would in turn have the opportunity to certify the issues to the New York Court of Appeals. As of the date of this post, the defendant law firms had filed a joint motion for certification of the District Court’s decision for appeal to the Second Circuit, but the District Court had yet to rule on the motion. The Restructuring Review will continue to track this case and report on any notable developments.