Covering Your Assets: the Unfinished Business Rule and Bankrupt Law Firms

• Jurisdiction: United States,Federal
• Publication year: 2014
• Citation: Vol. 30 No. 3

Covering Your Assets: The Unfinished Business Rule and Bankrupt Law Firms

Ashley Worrell

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COVERING YOUR ASSETS: THE UNFINISHED BUSINESS RULE AND BANKRUPT LAW FIRMS

Ashley Worrell^*

Table of Contents

Introduction.........................................................................826

I. An Attorney's Baggage: The Incomplete History of the Unfinished Business Rule........................................830

A. The Birth of the Unfinished Business Rule: Partnership Acts and Fiduciary Duties..........................................831
B. When One Door Closes Another Door Opens . . . But It Will Cost You: Jewel v. Boxer....................................834

II. Hourly Fees and the Unfinished Business Rule: An Attempt at Fairness or a Never Ending Duty?.........837

A. "Quaint" Principles in Modern Practice: Including Hourly Fees in the Unfinished Business Rule...........838

1. Labrum & Doak, LLP...........................................838
2. Coudert Brothers, LLP.........................................839

B. A Lesson in Public Policy: Excluding Hourly Fees From the Unfinished Business Rule...........................843

1. Sheresky Aronson Mayefsky & Sloan...................844
2. Thelen LLP...........................................................845

C. "Doctrinal Uncertainty" Continues: The Second Circuit's Decision in Thelen......................................847

III. A Plea for Client Protection: Removing Hourly Fees From the Reach of the Unfinished Business Rule ... 849

A. Overcompensation at the Client's Expense...............849
B. Preserving the Client's Right to Choose Counsel......851
C. Protecting the Attorney's Right to Practice...............853
D. The Law of Unintended Consequences in Bankruptcy Court...........................................................................856

Conclusion............................................................................857

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INTRODUCTION

Dewey & LeBoeuf, once one of the largest firms in the world, employed more than 1,300 lawyers in twelve countries.¹ A prime example of the prototypical American law firm, Dewey & LeBoeuf attracted some of the best lawyers in the country with its prestige and promises of multi-million dollar bonuses.² However, in what is called "the largest law firm failure in U.S. history," Dewey & LeBoeuf filed Chapter 11 bankruptcy on May 28, 2012.³ As one former federal judge put it, "'[t]his is a very sad day for the legal profession, . . . Dewey is a fabled firm with a lot of great lawyers and a demise of this magnitude is unprecedented.'"⁴

Just two months earlier, amidst speculation and inconsistencies in news reports, the American Lawyer announced that it would revise its 2010 and 2011 financial reports for Dewey & LeBoeuf's revenue and profitability.⁵ By then, many of Dewey & LeBoeuf's partners already

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left the firm, and the firm announced cuts to attorneys' rank and administrative staff, reorganized its management structure, and relocated from New York to London.⁶ Almost immediately after the American Lawyer made its announcement, another twenty-three partners left, bringing the total number of departures to sixty-seven since the beginning of the year.⁷ In late April, Dewey & LeBoeuf informed its partners that the Manhattan District Attorney's Office was investigating the firm for financial misconduct of its chairman, Steven Davis.⁸ Over the next five days, Dewey & LeBoeuf desperately tried to keep the firm afloat by entering merger discussions with two law firms to no avail.⁹ With more than one third of Dewey & LeBoeuf's partners gone, the firm announced that it would close its doors and file for bankruptcy.¹⁰ On March 6, 2014, Steven Davis and others were indicted on more than 100 counts, including grand larceny, falsifying business records, and securities fraud.¹¹

Unfortunately, as is the case with many businesses, Dewey &

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LeBoeuf was unable to recover from the 2008 financial crisis, and by the time it filed bankruptcy, Dewey & LeBoeuf owed more than $300 million to banks and other creditors and had more than $200 million in outstanding client billings, with at least $60 million in unfinished work taken to new firms.¹² When Dewey & LeBoeuf and its creditors reached a settlement deal to avoid potential clawback claims, it seemed as though the troubles were behind the deflated firm and its partners, pending court approval.¹³ The deal involved a $71 million payout from more than 400 partners' profits to the estate in exchange for immunity from future lawsuits.¹⁴ However, the partners, and even their future employers, will still be liable for any "unfinished business" of the firm, irrespective of any settlement deal.¹⁵

When a law firm files bankruptcy or voluntarily dissolves, the partners are subject to the unfinished business rule.¹⁶ This rule makes it possible for a partner's future fees derived from the dissolved firm's "unfinished business" to be taken back as property of the estate—even if the partner completes the business while employed at a new firm.¹⁷

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As one court described it, unfinished business is "any business covered by retainer agreements between the firm and its clients for the performance of partnership services that existed at the time of dissolution."¹⁸ Stated another way, when a partnership dissolves, the client matters do not automatically dissolve with it.¹⁹ Attorneys go their separate ways, each taking a piece of the partnership with them in the form of clients, and to the extent that a partner works on a client matter that was "unfinished" at the time of dissolution, that partner must account to his fellow partners, or the estate, for that amount.²⁰

Despite its decades-long history, two parts of the law are entirely unsettled with courts, some even within the same district reaching opposite conclusions.²¹ The first unanswered question asks what types of client billing qualify as "unfinished" for purposes of applying the rule, and more specifically, whether hourly fees should be included in that calculation.²² Some courts argue that including hourly fees will improperly impede the attorney-client relationship by treating the client as nothing more than property of the estate.²³ Other courts argue that hourly fees should be included because one could not distinguish

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hourly from contingency fees, which are included.²⁴ The second question asks what level of compensation attorneys should be entitled to receive for their services.²⁵

Part I of this Note explains the foundation for the unfinished business rule through the Uniform Partnership Act, fiduciary duties, and Jewel v. Boxer, the seminal case interpreting the unfinished business rule in law firm dissolutions.²⁶ Part II addresses the recent split among courts regarding whether hourly cases should be included as part of the rule.²⁷ Part III proposes hourly fees be excluded from the unfinished business rule given the inclusion's detrimental effect on public policy.²⁸

I. An Attorney's Baggage: The Incomplete History of the Unfinished Business Rule

Lawyers seem to universally view the unfinished business rule as both impactful and burdensome.²⁹ Some have called the rule an "imperfect rule [that] law firms have to live with," while others have gone much further, comparing its application in modern practice to

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"'watching an accident in slow motion.'"³⁰ Not only can departing partners face litigation from creditors and the trustee seeking to claw back any profits from the bankrupt firm's unfinished business, a partner's future employer can face the same liability if it receives profits through the unfinished business of the bankrupt firm.³¹ For that reason, it is important, if not vital, for law firms to beware of the rule and put clear partnership agreements in place.³²

A. The Birth of the Unfinished Business Rule: Partnership Acts and Fiduciary Duties

The unfinished business rule developed through a long, and often unmentioned road, with its origin in fiduciary duties owed through partnership law.³³ Partners owe fiduciary duties not only to each other, but also to the partnership as a whole.³⁴ The rationale for these duties encourages, if not requires, implementation of rules that "circumscribe the exercise of the partners' managerial discretion."³⁵

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In the majority of states, the Uniform Partnership Act (UPA), or its successor, the Revised Uniform Partnership Act (RUPA),³⁶ governs partnerships.³⁷ The UPA does not explicitly provide any duty of care in the partnership context; in fact, it says almost nothing about what specific duties partners owe to one another.³⁸ According to the Uniform Law Commission,

[t]he 1914 Act has very little to say about a partner's responsibilities to the other partners. A partner is a fiduciary who "must account to the partnership for any benefit, and hold as a trustee for it any profit derived by him without the consent of the other partners . . . " There is a full duty of disclosure between partners, but the 1914 Act is otherwise silent on the fiduciary responsibilities of each partner to the other partners.³⁹

In stark contrast, the RUPA explicitly provides for both a duty of care and a duty of loyalty to fellow partners and the partnership.⁴⁰

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Further, RUPA does not allow parties to waive these duties of loyalty and care, even with partnership agreements to the contrary.⁴¹ The duty of care, in the context of law firm dissolutions, refers to a duty owed "to the partnership and the other partners in the conduct and winding up of the partnership business" and requires partners to refrain "from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law."⁴²

More relevant within the context of the unfinished business rule is the duty of loyalty, which is the primary justification for the rule.⁴³ This duty is generally defined as "[a] person's duty not to engage in...