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A Jewel [v. Boxer] is a Law Firm Bankruptcy Trustee’s Best Friend; Unfinished Law Firm Business Taxes Departing Partners and Their New Law Firms for Years

Boxer                                                                           

  Jerome Kowalski

 Kowalski & Associates

 November, 2011

In a recent post on these pages dealing with the consequences of a law firm failure on the firm’s partners, I described the clawback provisions of Jewel v Boxer, sometimes called the “unfinished business” doctrine:

[A] line of cases in California beginning with Jewel v Boxer state that the law “requires that attorneys’ fees 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 legal services in the case after the 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.” In short, Boxer holds that fees received by a partner and his or her firm in connection with a case which was started at the now dissolved law firm belongs to the former firm. The Boxer case and its progeny have been heavily criticized and are not followed in many jurisdictions, but they do provide mighty weapons to a receiver or a dissolution committee.

Yesterday’s Wall Street Journal breathlessly described the long tail of the Jewel v Boxer clawbacks as if this were news. A number of commentators seemed rather surprised, indeed, even offended, that these clawbacks exist, including Professor Larry Ribstein and Ed Poll.

These clawbacks have been with us for quite some time. Nor is the doctrine an aberrant anomaly of California law, as a recent decision in the Coudert case demonstrates. In Coudert, a Southern District of New York case, three years after confirmation of the firm’s plan of liquidation, which itself had a five year gestation period, numerous Jewel v Boxer claims are still being actively litigated, involving “unfinished business” that spans the globe.

Law firm partnerships cannot, as Professor Ribstein suggests, contractually write their way out of Jewel v Boxer.  Bankruptcy Judge Dennis Montali of the Northern District of California, the jurist with the most experience in law firm dissolutions, having presided over Brobeck, Heller Ehrman, Thelen and now Howrey, has plainly ruled that so called “Jewel waivers” are unenforceable and has so held in several cases. As an aside, in several law firm dissolutions, as some law firms see the inevitable end as being around  some firms have attempted to create life preservers for their partners by amending their partnership agreements to include “Jewel waivers”  in the waning days of the firm.  Unfortunately, for these partners and the firms they join, last minute “Jewel Waivers” are simply voidable preferences and unenforceable.

Well then, what to do?  With some strong likelihood that the next 24 months will see at least several further law firm dissolutions, the prospect for lateral partners bringing along with them  nintended Jewel v Boxer liabilities as their former firms sink under the waves, is a material consequence that law firms must consider.  I am afraid that there is no way around it.  In assessing a potential new lateral partner candidate, law firms need to consider the prospect that they may be required to disgorge revenues brought along by the new partner should his or her former firm fail. Sometimes, the potential of a law firm is obvious from either media reports or simply based on the fact that a law firm is suddenly inundated with a raft of partner resumes from a particular firm. In these instances, I suggest that potential candidates be queried about the financial strength and viability of his or her former law firm.  In the ordinary course of risk and reward assessment, the otential exposure of Jewel v Boxer claims simply must be part of the calculus.

We have recently seen some law firms address the issue in a different fashion:  They have inserted provisions in their partnership agreements a provision which would require a partner upon withdrawal from the firm remit amounts ranging from 10 to 20% of revenues they derive from clients of the firm that follow them to their new firms for a period of one or two years.  The purpose of these provisions, it seems to me, is to attach mathematical certainty to Jewel v Boxer claims.  The unintended consequence is that lawyers burdened by these contractual provisions are essentially unmarketable. It is highly unlikely that a new firm would assume that kind of liability.  Additionally, that departure tax is a hefty and prohibitive additional tax for an individual partner to bear.

But, on the positive side, such departure taxes aren’t all bad.  In the 32 large law firm bankruptcies since Finley Kumble filed in 1988, the coup de grace has uniformly been the massive defections of partners with books of business. These departure taxes will necessarily provoke a “why can’t we all just all get along” dialogue with a view towards all working in synch to resolve what ails the firm.  And these departure taxes will provide potent shark repellent and keep those who would draw the lifeblood of a law firm at bay.

[Update: On May 24, 2012, Judge Colleen McMahon, ruling in the Coudert bankruptcy proceeding in the United States District Court for the Southern District of New York, ruled that Jewel v Boxer is the law in New York and that the liquidating trustee of the Coudert estate may recover from each former partner the profits derived from each case that followed each partner to his or her new law firm. The court ruled: “Under the [New York] partnership law, the client matters are presumed to be Coudert’s assets on the dissolution date, .. Because they are Coudert assets, the former Coudert partners are obligated to account for any profits they earned while winding the client matters up at the firms.” A link to the full opinion can be found at the foot of this article.]

© Jerome Kowalski, November, 2011.  All Rights Reserved.

 

Jerry Kowalski, who provides consulting services to law firms, is also a dynamic (and often humorous) speaker on topics of interest to the profession and can be reached at
jkowalski@kowalskiassociates.com
.

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24 Responses

  1. Very powerful observations, and ones that I suspect the vast majority of equity partners in law firm LLPs do not understand fully, or even are aware of.

    The court in Jewel did note that law firm partnerships could agree to modify their fiduciary duties to the firm and each other in their partnership agreements. The problem of course is that by the time law firm partners recognize that their firm is declining and this would be a way to reduce their loss exposure to creditors, it is too late and the adoption of the “Jewel Waiver” is itself a voidable preference transfer. With a two year federal time window on such preferences, and many state laws being four years, it becomes unavailable.

    The flip side is that if a law firm does adopt a Jewel waiver when it is financially sound, it creates a potentially less stable environment and encourages departures later just when one would expect it is critical to rally the partners and work through a challenge.

    Another pragmatic observation is: if banks and landlords are confronted with a clear risk that their rights as creditors in a bankruptcy are materially impacted negatively by the existence of a Jewel Waiver in the partnership agreement, they will as a matter of course seek to protect their interests by demanding full or partial personal guarantees of the partners. Managements of law firms that understand this, know that to do so puts them in a very difficult position compared to now, when they have the signature power on behalf of the firm to put massive amounts of partner net worth on the line for their expansion/growth business plans. Once guarantees are required, approvals are likely to be much more difficult to obtain or to solicit.

    The next shoe to drop is as you have described will be in the lateral partner transfer scenario and provisions to protect firms from economic loss caused by them. The issue was recognized in California more than sixteen years ago in an advisory opinion from the LA County Bar Association. But it has not been litigated. Yet. Below is that opinion.

    Subject: Fw: This is California’s approach, which is still not fully resolved, but is recognized in the ethics arena in this state

    LOS ANGELES COUNTY BAR ASSOCIATION
    PROFESSIONAL RESPONSIBILITY AND ETHICS COMMITTEE

    FORMAL OPINION NO. 480: March 7, 1995

    SUMMARY

    RESTRICTION ON LAWYER COMPETITION — A law partnership agreement may impose a reasonable cost on departing partners who compete with the law firm in a limited geographical area, and this does not violate Rule 1-500 of the Rules of Professional Conduct.

    AUTHORITIES CITED:

    Howard v. Babcock, 6 Cal.4th 409 (1993)
    Haight, Brown & Bonesteel v. Superior Court, 234 Cal.App.2d 963 (1991)
    Champion v. Superior Court, 201 Cal.App.3d 777 (1988)
    Fox v. Abrams, 163 Cal.App.3d 610 (1985)
    Jewel v. Boxer, 156 Cal.App.3d 171 (1984)
    Fracasse v. Brent, 6 Cal.3d 784 (1972)
    Rules of Professional Conduct 1-500, 2-200, and 4-200
    Business & Professions Code §§16600, et seq.

    A law partnership has asked for our opinion on the following provision from their partnership agreement:

    “If any Partner withdraws from the Partnership and is thereafter engaged to render legal services for any individual or entity which has received legal services from the Partnership within the twelve months immediately preceding said withdrawal, said Partner shall pay to the Partnership a consulting fee in a sum which is equal to twenty-five percent (25%) of the total of all legal fees collected from that individual or entity for services rendered during the twelve (12) months immediately following that Partner’s withdrawal from the Partnership.”

    This provision appears modeled on the partnership provision ruled upon in Champion v. Superior Court, 201 Cal.App.3d 777 (1988). Although this issue now is controlled by Howard v. Babcock, 6 Cal.4th 409 (1993) and Haight, Brown & Bonesteel v. Superior Court, 234 Cal.App.2d 963 (1991), we begin our analysis with Champion.

    The court in Champion pointed to three different rules that might be violated by a provision of the kind we face. These are Rules 2-107 (now Rule 4-200) which prohibit members from entering into agreements for, charging, or collecting any illegal or unconscionable fee; Rule 2-108 (now Rule 2-200) which restricts fee splitting between lawyers; and Rule 2-109 (now Rule 1-500) which prohibits agreements restricting the right of an attorney to practice law. The Champion court found that the unconscionability rule was dispositive of the provision before the Court, so it did not reach the issues of fee splitting and restriction of an attorney’s right to practice law.

    The Champion court pointed out the client’s absolute power to discharge an attorney, with or without cause, and the closely related client’s right to retain counsel of choice. The provision in question in this Opinion would permit the client to elect representation by a withdrawing partner but effectively restricts that right by the burden placed on the withdrawing partner; this provision requires the 25% consulting fee without regard to the amount of work, if any, performed by the firm.

    The fee is not intended as compensation for services rendered. The nature of the consulting fee and the inquiry show that the consulting fee is designed to satisfy the partnership’s desire to protect its expected profits, based on the assumption that the client relationship is an asset of the firm. However, the consulting fee applies without regard to the partnership’s, or the withdrawing partner’s, relationship with the client. For example, it might provide compensation to the partnership even if the client previously had terminated its attorney-client relationship with the partnership because of dissatisfaction with the work of the remaining partners. Similarly, it would apply to fees collected from clients whose relationship with the withdrawing partner preceded his or her relationship to the firm.

    Saying that it was motivated “. . . by public policy, which urges us to protect the interests of the partnership’s former clients.” (201 Cal.App.3d at 783), the Champion court invalidated the 25% consulting fee

    The court in Champion pointed out that the partnership is put to an election by the decision of a partner to withdraw. A withdrawing partner may represent a former client under the same terms as would an attorney who had never been a partner, controlled only by the quantum meruit requirement of Fracasse v. Brent, 6 Cal.3d 784 (1972), that he or she reimburse the partnership for its contribution to the case. If a partner leaves with less than his or her share of the lucrative cases, this approach is better for the partnership than a dissolution and still protects the clients’ interests. If a partner withdraws taking more than his or her share of the lucrative cases, the partnership can achieve a more favorable result by electing to dissolve and wind up its financial affairs under the principles of Fox v. Abrams, 163 Cal.App.3d 610 (1985) and Jewel v. Boxer, 156 Cal.App.3d 171 (1984). These cases apply a principle of partnership law that, absent an agreement to the contrary, no partner is entitled to extra compensation for services rendered in completing unfinished business of the partnership:

    “The former partners will receive, in addition to their partnership portion of such income, their partnership share of income generated by the work of the other former partners, without performing any post dissolution work on those cases. On balance, the allocation of fees according to each partner’s interest in the former partnership should not work an undue hardship as to any partner where each partner completes work on the partnership’s cases which are active upon its dissolution.” Jewel, supra, 156 Cal.App.3d at 179.

    The court in Jewel noted two basic fiduciary obligations of former partners, the duty to wind up and complete the unfinished business of the dissolved partnership, and the principle that no former partner may take any action with respect to unfinished business which leads to purely personal gain (Ibid.). Under these principles, the former partners are obligated to insure that a disproportionate burden of completing unfinished business does not fall on one former partner or one group of former partners (Ibid.). Thus, the partnership controls the decision whether to permit the withdrawing partner to represent the clients as would a stranger to the partnership or to wind up the partnership with a sharing of the fees and of the work on the unfinished cases. The recent opinion of the California Supreme Court in the Howard case takes a completely different approach. Without citing the Champion case, the court concludes that there is no reason to distinguish the legal profession from all other professions, which already are subject to the general rule that a partnership agreement may provide against competition by withdrawing partners in a limited geographical area. See Business & Professions Code §§16600, et seq. The court cites with approval the analysis of the Haight case that the validity of the non-competition agreement depends on whether it “amounts to an agreement for liquidated damages or an agreement resulting in a forfeiture.” Haight, supra, at 972.

    The Court stated: “We hold that an agreement among partners imposing a reasonable cost on departing partners who compete with the law firm in a limited geographical area is not inconsistent with rule 1-500 and is not void on its face as against public policy.” Howard, supra, at 425.

    The Court goes on to explain that an absolute ban on competition with the partnership would be per se unreasonable and inconsistent with the legitimate concerns of assuring client choice of counsel and assuring attorneys of the right to practice their profession. This results in an analysis comparable to a traditional liquidated damage analysis in which trial courts will be required to distinguish between a reasonable cost, that would be enforceable, and an excessive cost, that would be categorized as an unenforceable penalty.

    The partnership agreement in Howard provided for a forfeiture of all withdrawal benefits, other than the right to a return of capital, if more than one partner or associate withdrew from the firm before the age of 65 and within one year thereafter engaged in the practice of law within Los Angeles or Orange Counties in the firm’s specialty of liability insurance defense work.[1] This was a forfeiture only, and did not involve any payments from the former partners to the firm, so the court therefore was not required to deal with Rule 2-200 or Rule 4-200.

    If the partnership imposes only reasonable costs on the departing partner the agreement will be enforceable under B&P C. §§16600, et seq. If so, it appears from the opinion in Howard that the agreement is not subject to analysis under concepts of fee splitting or of unconscionable fees (but we cannot conclude this with certainty from the opinion in Howard because it deals only with a limited forfeiture of economic rights). If the partnership agreement does not survive analysis under B&P C. §§16600 et seq., then the attorneys involved may face Rules 1-500, 2-200, and 4-200.

    We finally conclude that in the absence of a partnership agreement that imposes only reasonable costs on former partners who compete with the partnership, the relationship between the partnership and its former partners will continue to be governed by the traditional partnership analysis of Fracasse v. Brent, supra, Fox v. Abrams, supra, and Jewel v. Boxer, supra.

    This opinion is advisory only. The Committee acts on specific questions submitted ex parte and its opinion is based on such facts only as are set forth in the inquiry submitted.

    [1] The Haight opinion, which was approved in Howard, validated a partnership provision under which the departing partner also forfeited his capital in the partnership.

    • Extremely instructive and quite helpful, Ed.

      I wonder how many California — or, indeed, firms located anywhere — have such provisions in their partnership agreements.

      The point is that Jewel v Boxer is an invidous concept; including Jewel waivers before a firm is in trouble promotes the free agenct concept of partnership. Including a Jewel waiver as a firm is in trouble is simply futile and hastens partner defections.

      As I have often said, law firm leaders who are in the unfortunate position of being at the helm as a firm hits rocky shoals would be well served to explain Jewel v Boxer and other post dissolution ramificiations to the partnership and thereby encourage cohesion and unity in the face of some rather dire consequences.

  2. Jerry:
    It is often a knee jerk response for a lawyer to see a case opinion under state law from another state and react with “well that is there and this is here and we are different”. The challenge here is that we are dealing with a general partnership (LLPs are general partnerships that meet a few preconditions for being eligible to make an election to be an LLP), and these are governed by the Uniform Partnership Act/Revised Uniform Partnership Act in the vast majority of states. The provisions in RUPA that deal with dissolution, and in UPA for the Jewel case, are almost identical word for word in every state the act(s) were adopted. So while the case may be sourced elsewhere, the reasoning is appropriate and relevant and applicable to take note.

    A second factor to take note of is that as a general partner of a general partnership that goes defunct, it is a basic proposition that all of the partners are jointly and severally liable for all of the debts of the partnership. Accordingly, whether the unfinished business ‘assets’ that are relocated to other firms are sufficient to pay the obligations of the defunct partnership or not, the partners still have to pay off all those debts. If the assets of the firm are enough on collapse to pay off all the creditors, well that is super. Then the monies from the cases that are ‘unfinished business’ come to the defunct firm, and then are distributed back out to the departed partners in accord with the agreement that was in place before the firm’s demise. But if the assets are not sufficient, then the income that is collected from unfinished business goes to pay the creditors until they are paid off. If the unfinished business is ultimately inadequate to pay off the creditors, then other assets of the partners are, and always were, subject to collection action by creditors. That is the backdrop of the simple logic of Jewel v. Boxer.

    What is shocking to many law firm partners is that LLP does not mean truly “Limited Liability” in the visceral reactive understanding of the phrase, which suggests like in the instance of a corporation, limited liability company, or limited partnership that absent guarantees or contribution covenants, all that a stakeholder has at risk is her/his capital. That just is not the case. And the scope of “clawbacks” of distributions made to equity partners for income draws or returns of capital, and of “clawforwards” for Jewel claims, plus loss of capital, plus potential continuing personal liability on loans from banks to have made those capital contributions to the defunct law firm, create potentially massive and personally devastating financial hardship.

    That is the boat that equity partners in law firms are holding a ticket for. It may not be the ride they envisioned, but it clearly is the ride they are on today.

    • I could not agree with you more, Ed.

      I happened to be in the courtroom while there was a pretrial conference concerning the Coudert Jewel claims. A dozen law firm defendants were present, many represented by other firms and there was nearly universal incredulity that Jewel v Boxer had any application outside California. As these cases now march towards trials (and cash settlements), reality is setting in.

      The issue of equity vs. non-equity partner liability is far from fully settled. There are a number of cases litigated over the past 30 years where creditors took the position, often successfully, that the partnership held out its non-equity partners as full partners and that they should also share some of the pain. And sometimes they did.

  3. Jerry:

    The other serious dynamic with this growing awareness is the impact that it should have with lateral recruitment of partners. On the one hand you have the firm bringing in a candidate who has a strong book of business with loyal clients. But what if she left a law firm that 18 months later goes bankrupt? On the other hand you have that same candidate going to a law firm that collapses a couple of years later….what level of information did she get that really allowed her to make a fully and properly informed decision? (In almost all cases that answer is clearly that she did not). And this is not some remote possibility, there were plenty of partners who left Brobeck and went to Heller, and who left Thelen and went to Howrey, who pulled the “losing ticket” on that double failure lottery and are experiencing the “clawback” on distributions and “clawforward” on unfinished business for the second time!

    With apologies, here is a short article in pdf format that was published in California’s Daily Journal touching on some of the aspects for the lateral partner transfer issue.

    http://www.jdsupra.com/post/documentViewer.aspx?fid=fbced89a-7351-4d90-b6c1-1d98ca6c0647

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  6. Cheers for this excellent article. I was wondering if you were thinking of writing similar posts to this one. .Keep up the great articles!

  7. […] Unfinished Business.  I recently discussed the long arm of Jewel v Boxer clawbacks. Under this doctrine, if a firm dissolves, the revenue derived by a partner of the defunct firm as […]

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  14. […] In addition,  a line of cases in California beginning with Jewel v Boxer  state that the law “requires that attorneys’ fees 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 legal services in the case after the 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.”  In short, Boxer holds that fees received by a partner and his or her firm in connection with a case which was started at the now dissolved law firm belongs to the former firm.   The Boxer case and its progeny have been heavily criticized and are not followed in many jurisdictions, but they do provide mighty weapons to a receiver or a dissolution committee.  (More on Jewel v Boxer  can be found here.) […]

  15. […] be repay fees generated by these laterals will need to be repaid to a bankruptcy trustee under the unfinished business doctrine articulated in Jewel v Boxer as well as the fact that the resources of many of these new partners will be sucked up by the […]

  16. […] The point is why did all of these very smart, accomplished and talented lawyers take on the visage of “equity partners,” when that was simply not the case? There doesn’t seem to be any rational explanation.  These soon to be former highly compensated Dewey equity partners are soon to have some of the torments of Dante’s financial inferno visited upon them, as, among other things, they will be subject to clawbacks, loss of capital, adverse tax consequences and clawforwards. […]

  17. This is a terrific and helpful analysis that ought to scare the beejezus out of firm management groups across the country. I’ve linked to it in my employment blog–thanks, again.

  18. […] public discourse on the subject has focused on the “unfinished business doctrine,” often referred to as Jewel v Boxer claims.  These discussions have recently been raised by several decibels since Judge Colleen McMahon of […]

  19. […] law firm partners take with them to new law firms. The simple fact is that the profits derived from unfinished business of a client of law firm partnership is the partnership’s asset, just as are the outstanding accounts receivable, work in process, furniture, artwork and […]

  20. […] States District Court for the Southern District of New York in the Coudert bankruptcy holding that the “unfinished business” doctrine, commonly known as Jewel v Boxer, applies to New York law fir…  Both events have chilled the lateral partner […]

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