The Unfinished Business Rule in Law Firm Dissolution
Lawyers are not immune from the travails of business divorce. They must address the same issues that any small business must address when business partners no longer want to be in business with one another. They must decide whether one or more of the partners will continue the law firm or dissolve the law firm. This article looks at one of the most contentious matters in law firm dissolutions: what happens to pending matters when a law firm dissolves.
You may have thought that lawyers, being trained as lawyers, would have thought this through when they negotiated their partnership or operating agreement. If they did, they are ahead of the game and they would have clear guideposts on what to do when they decide to part ways. If they didn’t, then when one partner announces that he or she is leaving, there can be some acrimony that ensues.
Ethical considerations should be taken into account first
The most important factor that lawyers should take into account are ethical considerations in law firm dissolutions. The American Bar Association and individual state bar associations have issued numerous opinions that guide lawyers through issues such as notice to clients and third parties, what happens to open and closed client files and changes to the firm’s the website. The ethical considerations should first and foremost guide the conduct of the members of the firm. But after that things can get sticky.
Unfinished business rule explained
The lawyers are parting ways but what happens to the unfinished business of the law firm? “Unfinished business” refers to transactions that remain ongoing at the time a business is dissolved. On dissolution of a partnership, partners have a duty to wrap up pending partnership business and to account for any profits from that business. In the law firm context, the unfinished business of the law firm includes open client matters. These open client matters can be the subject of contentious disputes.
In the ordinary course, if one of the lawyers brought in a large matter, the lawyer fees are divided up according to the partnership or operating agreement. But at the time of the law firm’s dissolution, and if the matter has not been concluded, what happens to the fees? Do the fees belong to the dissolving law firm or to the partner who works on the matter after dissolution?
The leading case to address this common issue was a California case, Jewel v. Boxer, 156 Cal.App.3d 171 (Cal. Ct. App. 1984). The Jewel court held that when a partnership dissolves and the unfinished business of the firm is subsequently brought to completion, the fees for the completion of the unfinished business are assets of the dissolved partnership.
The partners of the dissolved partnership share the attorneys’ fees received on cases in progress upon dissolution of a law firm according to the right to fees in the former partnership, regardless of which former partner provides legal services in the case after the dissolution. What that means is that if a lawyer has a 50/50 partnership and she assumes responsibility for the case when the partnership dissolves, then regardless of how much additional effort she puts into the case than her partner, the other partner still is entitled to a 50% share.
The court rejected the argument that the lawyers should split the fees based on their respective time spent on the matter (quantum meruit approach). The Jewel court pointed out that the unfinished business rule “prevents partners from competing for the most remunerative cases during the life of the partnership in anticipation that they might retain those cases should the partnership dissolve.” The rule prevents partners from competing for the most remunerative cases during the life of the partnership in anticipation that they might retain those cases should the partnership dissolve. The court also cited the sound public policy to prevent “former partners from scrambling to take physical possession of files and seeking personal gain by soliciting a firm’s existing clients upon dissolution.”
If the lawyers don’t have an agreement that addresses unfinished business on dissolution, then they split the fees from the cases in accordance with their agreement. Let’s say that the case goes to trial and then is appealed. Let’s say that it takes a huge amount of time and effort of just one of the partners to collect a large judgment. Despite the disproportionate effort in obtaining a huge recovery, the net proceeds from the judgment are divided up between the partners in accordance with the partnership agreement.
The unfinished business rule spreads throughout the United States.
Courts embraced the unfinished business rule throughout the United States. The District of Columbia, for example, in Beckman v. Farmer, 579 A.2d 618 (D.C. 1990) held that unfinished client representations are partnership assets, the use of which by one former partner renders her liable to account to her former partners.
In accordance with Beckman, earnings received on cases in progress upon dissolution of a law partnership are to be shared by the former partners according to their right to fees in the former partnership, regardless of which former partner provides the legal services in the case after dissolution. The fact that the client substitutes one of the former partners as attorney of record in place of the former partnership does not affect this result.
Courts have not distinguished between law firms organized as professional corporations, limited liability companies or partnerships. Similarly, until recently, courts have not distinguished between hourly matters pending at the time of dissolution and contingency fee matters. That has changed.
The tide is shifting away from the unfinished business rule in hourly matters
Up until recently, the unfinished business rule has been applied to the dissolution of a law firm regardless of whether the pending cases at dissolution were hourly or contingent fee matters. Robinson v. Nussbaum, 11 F. Supp.2d 1 (D.D.C. 1997). But the tide has shifted in the past few years.
A New York Court declined to apply the unfinished business rule to hourly cases. In re Thelen, 20 N.E.3d 264, 268 (N.Y. 2014). In Thelen, the issue before the New York Court of Appeals was the following: “Under New York law, is a client matter that is billed on an hourly basis the property of a law firm, such that, upon dissolution and in related bankruptcy proceedings, the law firm is entitled to the profit earned on such matters as the ‘unfinished business’ of the firm?” The court answered no.
The California Supreme Court unanimously held last year that a dissolved law firm does not retain a property interest in hourly matters that are in progress, but not completed, at the time of dissolution. Heller Ehrman LLP v. Davis Wright Tremaine LLP, 411 P.3d 548 (Cal. 2018). As the Court stated that if it decided otherwise, it would risk “intruding without justification on clients’ choice of counsel, as it would change the value associated with retaining former partners—who must share the clients’ fees with their old firm—relative to lawyers unassociated with the firm at its time of dissolution who could capture the entire fee amount for themselves or their current employers.” The court continued, “Allowing the dissolved firm to retain control of such matters also risks limiting lawyers’ mobility postdissolution, incentivizing partners’ departures predissolution, and perhaps even increasing the risk of a partnership’s dissolution.”
In a closely watched case in the District of Columbia Court of Appeals, the court is considering, among other issues the following question that was referred to it by the Ninth Circuit Court of Appeals: “Under District of Columbia law what interest, if any, does a dissolved law firm have in profits earned on legal matters that were in progress but not completed at the time the law firm was dissolved, where the dissolved law firm had been retained to handle the matters on an hourly basis, and where those matters were completed at different pre-existing firms that hired partners of the dissolved firm post-dissolution?” Diamond v. Hogan Lovells US LLP, 883 F.3d 1140 (9th Cir., 2018).
The question is framed in a manner suggesting that the Ninth Circuit wants to elicit the answer that a dissolved law firm should not have any interest in hourly matters.
Contingent fee matters are an entirely different story
For contingency fee matters, the courts have barely budged from the unfinished rule in Jewel. For courts throughout the country that have considered the issue, there is almost unanimity that contingency fee cases are the unfinished business of a dissolved law firm and any profit derived from such cases belongs to the law firm.
In LaFond v. Sweeney, 343 P.3d 939 (Colo. 2015), the Colorado Supreme Court was persuaded by the cogent reasoning of unfinished business rule to extend its reach to law firms organized as limited liability companies. In LaFond, two attorneys LaFond and Sweeney organized a law firm as a limited liability company. The LLC represented a client with the assistance of co-counsel on a whistleblower case. The attorneys jointly sent a letter to the firm’s clients and, according to the court, “did what they were professionally obligated to do. They notified [the client] that the firm was being dissolved and gave him the choice to decide which of them would continue to represent him . . .”
At the time of the dissolution, LaFond was handling a large matter for the firm. His former law partner Sweeney did not perform any work on the matter after dissolution. LaFond obtained a sizable recovery and a dispute ensued regarding whether the attorneys’ fees were assets of the dissolved firm. The trial court held that the case was an asset of the firm but calculated the value of the case by utilizing a quantum meruit approach–multiplying the number of hours worked pre-dissolution by the hourly billing rate.
The Colorado Supreme Court disagreed with this approach, stating that: “The majority of jurisdictions confronted with these issues have followed Jewel in concluding that pending contingency fee cases are the unfinished business of a dissolved law firm; therefore, any profit derived from such cases belongs to the law firm and not to an individual winding up partner. The Colorado Supreme Court accordingly held that upon dissolution, pending contingency fee cases were an asset of the LLC. Absent an agreement to the contrary, all profits derived from winding up the LLC’s business belonged to the LLC to be distributed in accordance with the lawyers’ profit sharing agreement.
In another recent case, in Horner v. Bagnell, 324 Conn. 695 (2017), the Connecticut Supreme Court held that “in the absence of a contract between the partners providing to the contrary, a contingency fee matter pending at the time of dissolution is an asset of the partnership; the dissolved partnership is, therefore, entitled to share in the fee when it is paid to a former member of that partnership who has litigated the matter to completion.”
Calculation of overhead is subject to debate
Even if the lawyer who handled the matter post-dissolution must fork up a portion of the fees to the dissolved law firm, there is an open question regarding the extent to which overhead expenses may be deducted from the fees remitted to the dissolved firm. And even more importantly, what is considered overhead. Judges and arbitrators have taken vastly different views on what should be included in overhead.
Plan before you jump: include a Jewel waiver
If law partners do not intend for the unfinished business rule to apply, then they can include a “Jewel waiver” in their partnership or operating agreement. As articulated clearly by the Beckman court, the unfinished business rule is a creature of statute and “attempts by courts to evade it are inappropriate.” Partners could have entered into an agreement that would have assured that the unfinished business rule did not apply. If they don’t plan, then law partners will have to live with the uncertainty of how courts will apply the unfinished business rule.