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Double Jeopardy for Law Firms: Jewel v Boxer


Double Jeopardy for Law Firms: Jewel v Boxer.

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Protecting a Law Firm’s Crown Jewels


Protecting a Law Firm’s Crown Jewels.

Protecting a Law Firm’s Crown Jewels


English: Replicas of Polish crown jewels, made...

English: Replicas of Polish crown jewels, made in 2003. Polski: Repliki polskich klejnotów koronacyjnych wykonane w 2003 roku. (Photo credit: Wikipedia)

Jerome Kowalski

Kowalski & Associates

June, 2012

 

The problem with the law firm business model, we are told repeatedly, is that its principal assets, namely, its productive partners, go down the elevator every night and may not return the next day. The issue arises out of our arrival to an era of law firm partners as free agents and a lack of institutional loyalty, a subject about which there is much railing.

But, those partners who take the elevator down and out and don’t return the next day are taking with them valuable assets that are the property of the law firm and which law firms as well their lenders and landlords need now consider preserving and protecting.  I refer to unfinished business that 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 equipment.  And, I’m not just referring to law firms in dissolution. These are recoverable assets of healthy thriving law firms.

One of the results of the recent spate of law firm bankruptcies was to alert lawyers that upon the dissolution of a law firm, profits from unfinished business can be clawed back under the doctrine now known as Jewel v Boxer. Judge Colleen McMahon of the United States District Court for the Southern District of New York, in a much publicized well reasoned and articulate opinion in the Coudert case explained the basis of the unfinished business doctrine. The essence of her ruling is that “A departing partner is not free to walk out of his firm’s office carrying a Jackson Pollack painting he ripped off the wall of the reception area.” Profits from unfinished business are akin to the Pollack painting and departing partners are statutorily obligated to return both the painting removed from the wall and profits from unfinished business. This has been the law in New York for a century.

Under the Uniform Partnership Act, absent an agreement to the contrary, a partnership goes into dissolution upon the death or withdrawal of a partner.   Thus, all modern partnership agreements typically provide for the continuation of the business of the partnership upon the death or withdrawal of a partner and these agreements go on to describe the rights, entitlements and obligations of the partnership and the partner on a going forward basis.  The overwhelming majority of law firm partnership agreements are completely silent on the issue of unfinished business that follows a partner that withdraws from a law firm. But it is completely within the fabric of the partnership fiduciary relationship, as articulated in Meinhard v Salmon, and further expounded upon by Judge McMahon, for law firms to require departing partners to account to the partnership for profits from unfinished business even absent a dissolution of the partnership. Moreover, the agreement can further obligate a withdrawing partner to inform his or her new law firm that profits from unfinished business belong to his or her former law firm. Fancy that. I know this is probably a shocker to most readers, but it’s clearly the law.

Intuitively, most lawyers will simply shudder when reading this. Their reaction, when I have previously spoken of this, is to instinctively say that this can’t be so; it constitutes an impermissible restriction on a lawyer’s ability to practice law, unbridled by covenants not to compete.  The Jewel v Boxer line of cases, as well as the long parade of authority cited by Judge McMahon makes clear that the unfinished business doctrine does not trample on that issue, even in New York which is completely restrictive on the prohibition barring any form of covenants not to compete and certainly not in states like California which does permit some restrictions in limited circumstances.

We certainly now know from Coudert and Dewey & LeBoeuf that principal assets of a law firm are unfinished business (although, in fairness, these claims were pursued in a host of other major law firm bankruptcies, with a tad less fanfare).   For the first time of which I am aware, in Dewey, the firm’s secured creditors have actually purported to take a security interest in the proceeds of unfinished business claims.

Thus, the question now emerges: Why shouldn’t law firms include in their partnership agreements provisions requiring withdrawing partners to account to the firm for unfinished business even absent dissolution?  The ancillary question is why wouldn’t lenders and law firm landlords mandate such provisions as a condition of borrowing or tenancy?  The short answer is that in due course, these provisions are likely to be standard fare.

Let’s turn to the likely effects on lateral partner recruiting.

It is a standard practice in lateral partner recruiting for a law firm to prepare a pro forma analysis of income and expenses derived from a lateral candidate. In analyzing this pro forma, law firms make informed decisions as to the likely profitability of any candidate. With the recent unfortunate spate of law firm failures and the increased recourse to Jewel v Boxer recoveries, I have regularly counseled every law firm client to include in its pro forma examination a projection of any possible unfinished business remittances and to pay particular heed to this analysis when   there is evidence that the candidate is from a law firm suspected to be in difficult financial circumstances. In doing so, it must be remembered that Jewel v Boxer remittances are only for the profits derived from the unfinished business. Even the former partner can bill for his time in a unique metric, as Judge McMahon noted, based not on standard hourly rates, but based on his or her “efforts, skill, and diligence.” Thus, neither the former partner nor his or her new firm is forced into indentured servitude.   They are simply barred from deriving a profit for any of the particular matters the new partner brings along with him or her.

This last point require some emphasis: it is only the particular discrete matters that fall into the rubric of unfinished business. As Judge McMahon said in Coudert:

“’ Unfinished business” must be distinguished from “finished business” – business that has been completed prior to dissolution (the merger done and documented; the lawsuit tried to verdict or settled). If a firm has finished a piece of business but has not collected its fee, in whole or in part, the resulting receivable is, obviously, an asset of the firm. If the firm liquidates, the fee has to be collected for the benefit of the members of the firm in liquidation. Jackson v. Hunt, Hill & Betts, 7 N.Y.2d 180, 183 (1959). 23 “New business” is an entirely new contract or engagement to do a piece of work. New business that is contracted for and undertaken only after a partnership dissolves – even business from a client of the dissolved firm – is not an asset of the dissolved firm, because a partnership has no more than an expectation of obtaining future business from a client. For that reason, the attorney who conducts the business and collects the resulting fee owes no duty to his former partners to account for any profit he may earn. Stem, 227 N.Y. at 550; see also Conolly v Thuillez, 26 A.D.3d 720, 723 (3d Dep’t 2006); In re Brobeck, Phleger & Harrison LLP, 408 B.R. 318, 333 (Bnkr. N.D. Cal. 2009) (applying California law). Retainers from former clients on new matters – even matters, like appeals, that are related to finished representations – have been treated as “new” business and are not subject to the duty to account. See, e.g., Talley, 100 N.Y.S.2d at 117-18 (no duty to account for fees earned on appeals from matters originally handled as partnership business).5

Between “finished business” and “new business” lies unfinished business: executory contracts to perform services, begun but not fully performed by the partnership on the date of its dissolution. Unfinished business is presumptively treated as a partnership asset subject to distribution.”

 

Thus, the new firm must make an informed decision as to whether it is prepared to make an investment in the new partner and his or her clients until it can start earning a profit on those clients coming along.  The cost of the investment is largely an opportunity cost; namely, the lost opportunity to bill profitable time on different clients and matters.

Will this dampen the lateral partner market?  Quite likely, but, frankly, not in a material way, I suspect and certainly not long term as such contractual provisions begin to metastasize, at the instance of lenders and landlords, as well as law firm leadership, separately incentivized to dampen the enthusiasm of profitable and productive partners to seek a higher bidder. In due course, there will likely develop an open market in which firms will both be remitting and collecting unfinished business remittances.  And, I am sure, the market will ultimately require law firms to simply arrive at negotiated deals early on as valuable free agents rise to their highest level and less productive partners eased out the door.

These results are all inevitable. Well informed lawyers will counsel lenders and landlords on these issues and these clients, who have bargaining leverage will require unfinished business recoveries as a staple of law firm partnership agreements. Law firms will being compelled to pay unfinished business remittances will in turn take steps to keep its assets corralled by requiring the same of its partners.

In coming months, law firm leaders will be sitting across the table from lenders and landlords requiring law firms to include unfinished recoveries in their partnership agreements. Partners will be presented with proposed amendments to their partnership agreements containing these provisions.

Now is the time to begin considering your bargaining position.

© Jerome Kowalski, June, 2012. All Rights reserved.

Jerry Kowalski is the founder of Kowalski & Associates, a consulting firm serving the legal profession exclusively. Jerry is a regular contributor to a variety of publications and is a frequent (always engaging and often humorous) speaker to a variety of forums. Jerry can be reached at jkowalski@kowalskiassociates.com or at 212 832 9070, Extension 310

 

For Law Firm Liquidators, There’s a Lot of Gold in Them Thar Hills Aside from Jewels


For Law Firm Liquidators, There’s a Lot of Gold in Them Thar Hills Aside from Jewels.

For Law Firm Liquidators, There’s a Lot of Gold in Them Thar Hills Aside from Jewels


Super Pit gold mine at Kalgoorlie in Western A...

Super Pit gold mine at Kalgoorlie in Western Australia is Australia’s largest open-pit mine (Photo credit: Wikipedia)

Jerome Kowalski

Kowalski & Associates

June, 2012

 

There may be trouble ahead

 

            Marshalling the assets of a law firm that has imploded and paying its creditors requires an admonition similar to that often given to vacationers:  Pack half as much clothing and bring along twice as much money as originally planned. In the case of too many failed law firms, the value of the remaining assets is often half or less than originally estimated, the amount of liabilities is often a multiple of those originally anticipated and the length of the process takes many years longer than projected. A principal focus of those charged with marshalling assets of defunct law firms (as well as former partners of the law firm who are personally incentivized to maximize assets recovered not coming out of their own wallets) is therefore maximizing the value of estate assets marshaled.

Rarely has the gap between assets and liabilities of a failed law firm been as wide as they appear to be in Dewey & LeBoeuf’s case: As of the filing date, Dewey reported liabilities of $315,000,000 and assets of $215,000,000, with fees due from clients accounting for most, if not virtually all of the latter. A more detailed filing of assets and liabilities is expected in about 45 days. Previously, in the Howrey case, the subsequent more detailed statement of assets and liabilities posted after filing and after more detailed study contained stunning decreased assets and whopping increases in liabilities.  As one expert noted, the Dewey accounts receivable are unlikely to yield as much as forty cents on the dollar. Nor does this calculus include the likely enormous costs of bankruptcy administration, which will come off the top and certainly aggregate eight figures, once the shooting is done. The listed debt also does not include amounts purportedly due to former employees under the  WARN Act (which may amount to many millions more), amounts due to landlords for rejected leases (again, likely am eight figure amount) or amounts due to former partner under deferred compensation agreements, which may add as much as an additional $100,000,00, if these claims are allowed. Finally, no listing of potential malpractice claimants have yet been publicly identified. Law firm failures beget malpractice claims and with Dewey being self insured for $2,000,000 per claim, the exposure to Dewey will be considerable in the aggregate.  We assume that prior to filing for bankruptcy relief, Dewey identified every potential claim then known or suspected to exist against Dewey to its carrier, since its coverage is extended on a “claims made” basis and it was in Dewey’s best interests to identify each potential claim to its carrier while coverage was still in existence. The public record does not disclose whether “tail” insurance was obtained (in the absence of tail coverage, former partners are in for some more serious real pain).   With secured debt amounting to some $225,000,000, there doesn’t seem anything left for unsecured general creditors. Ed Reeser, a brilliant analyst,  succinctly observed that Dewey is likely a zero asset estate.  No previously reported case of an imploded law firm has the incentive to find assets to pay down debt been greater. Here, former partners looking at a world of pain, are even now scrambling to limit or divert that pain.

Much 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 the United States District Court for the Southern District of New York recently rendered a comprehensive, well reasoned and thoughtful opinion in In re Coudert which she held that Jewel v Boxer principles applied in New York, an unsurprising result, given a fair amount of prior authority to the same effect in New York and no contrary authority.

The likely coming battlefields

As the lawyers who were formerly partners at Dewey & LeBoeuf lawyer up (if the firm’s general counsel gets her own lawyer, will that mean that the lawyers’ lawyer has a lawyer?), we address briefly the additional claims and defenses that these professionals are likely focusing on during these warm spring days.

First, we start with one of New York’s seminal cases, Graubard Mollen v Moskovitz. In that case, the law firm of Graubard Mollen sought to ensure that it would continue to have the benefit of the substantial client base of name partner Moskovitz, who was approaching retirement age. Thus, the firm entered into an agreement with Moskoviz under which Moskovitz received substantial compensation in his final three years with the law firm and agreed that Moskowitz would insure that his largest clients would remain with the law firm upon his retirement.  At the conclusion of the three year wind down and payout, Moskovitz joined another law firm (ironically, LeBoeuf, Lamb, Leiby & MacRae) and took all of his major clients with him. Graubard Mollen sued for breach of contract and breach of fiduciary duty. The contractual claim was given short shrift by the court given the ethical proscriptions extant regarding contractual proscriptions on limitations of a lawyer to practice law. But the court held that it was a breach of a partner’s obligations to law firm to have met with and solicited clients he originated to join a new firm he plans on joining. Moscovitz was alleged to have met with his major clients to solicit them to join him at his new firm and to have even brought along LeBoeuf partners to at least one of those meetings, all while he was still a partner at Graubard and before he announced his plans. Such conduct, if proved to be true, was actionable and subjects the straying partner to damages.

In Gibbs v Breed Abbott,  the chairman of a law firm’s trusts and estates department decided to leave his firm and solicited another partner to join him at a new firm. These two partners, during their interviewing process, provided their new firm with detailed billing and personnel information concerning associates they proposed to bring along with them. The court assessed these former partners with damages of some $1,861,045. The award was made because of the improper solicitation by one partner of another to leave the firm and the providing of law firm personnel and billing information to a prospective new law firm.

Of course, we also must pay particular homage to Judge Cardozo’s admonition in Meinhard v Salmon, in which the noted jurist set forth the enduring standard that partners, and most especially managing partners, are “held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior… the level of conduct for fiduciaries [has] been kept at a level higher than that trodden by the crowd.”

While Professor Steven Harper regularly takes BigLaw to task because of the “corporatization” of the practice, its focus on short term profits, distracted attention to metrics, top down management and more, Meinhard remains the law and I assume that Steve Harper takes some comfort in that.

Longstanding substantial authority also provides that a law firm partner holding a management level position is barred from seeking alternative employment without first resigning from his or her management role. Managing partners who failed to heed this basic maxim have confronted serious claims, as have the firms they ultimately join.

There seems little reasonable doubt here that Dewy partners, fleeing for safety, solicited other partners and associates to join with them in new safer climes, proprietary law firm information was shared with prospective new employers and management partners actively sought new positions without first stepping down from their management roles. The rather unique eleventh hour pronouncement by Dewey senior management “encouraging” partners to leave may well be actionable in and of itself, since no authority exists which we have found that permits a managing partner to promote massive breaches of fiduciary duties, particularly in the absence of any dissolution vote. Said management at the time when most of the horses had already left the barn, “Dissolution vote?  Why would we do that?”    Perhaps because the New York Partnership Law seems to mandate doing so under these circumstances and the rights and duties of the parties are thereafter described. We have little doubt that the standards of conduct actually practiced by management level partners will be scrutinized through the prism described by Judge Cardozo, particularly where issues of lack of candor and inadequate management oversight seem evident from the limited record made public thus far.

Lawyers, long trained to follow the money, have always asserted Jewel v Boxer claims against both former partners and their new law firms.  Thus to the extent that that these breach of fiduciary claims are pursued, they will doubtless often name as additional parties defendant the new firms which former Dewey partners call home. Procedural conundrums will likely ensue as Dewey partners are presumably subject to mandatory arbitration, while successor law firms are not.

To be sure, breach of fiduciary claims against former partners of an imploded law firm have rarely been instituted and as far as we can determine none have ever been tried to conclusion. All seem to have settled either under the threat of litigation or after suit was actually instituted. In all events, the real battleground has now been clearly identified here; namely the clawbacks, clawforwards and potential claims against the dozens of law firms that provided lifeboats for Dewey partners. And the need to maximize assets available for distribution to creditors has never been greater.

In the past, in most law firm implosions, after much finger pointing, threats, recriminations, anger and infighting, claims against former partners and their new law firms have been resolved using a relatively straightforward calculus:  Clawbacks from former partners were calculated on the basis of an algorithm in which certain factors were included.  These included fixing the date when the firm was first actually insolvent from applying bankruptcy law definitions, which, in Dewey’s case may be at or about the very beginning of the merger between Dewey and LeBoeuf, the amounts actually paid to each partner during that period, the role played by each partner in management and finally, the net worth of each partner. Al Togut, Dewey’s bankruptcy lawyer, a capable seasoned veteran of similar wars, who first emerged on these battlefields as counsel for the creditors’ committee in Finley Kumble in 1988, is intimately familiar with this calculus, which was utilized first in Finley Kumble.  Clawforwards – the Jewel v Boxer claims — are also relatively easily calculable and have until now always been settled since successor firms have been disinclined to take the litigation risk. That may change as the Coudert antagonists (and Seyfarth Shaw in the Thelen bankruptcy) are battling it out, seemingly looking to go the full fifteen rounds.

But Dewey may well change all of the rules; it was not simply be too big to to fail, it may be too big to fail in the relatively orderly way others before it failed.

© Jerome Kowalski, June, 2012. All Rights reserved.

Jerry Kowalski is the founder of Kowalski & Associates, a consulting firm serving the legal profession exclusively. Jerry is a regular contributor to a variety of publications and is a frequent (always engaging and often humorous) speaker to a variety of forums. Jerry can be reached at jkowalski@kowalskiassociates.com or at 212 832 9070, Extension 310

Saving Dewey & LeBoeuf


Saving Dewey & LeBoeuf.

Saving Dewey & LeBoeuf


Dewey

Dewey (Photo credit: Wikipedia)

Jerome Kowalski

Kowalski & Associates

May, 2012

The current state of the public record suggests that Dewey & LeBoeuf began its ill fated trip to disaster years ago. It appears that by last winter, the partners knew that a brick wall was hurtling at them at 200+ miles an hour. The question nobody has yet asked is whether the firm could have been steered to safety at that late date.  I would suggest that with capable leadership, enjoying the confidence of the firm’s partners, associates and other stakeholders and a collaborative approach by the full partnership it was possible to avoid the oncoming brick wall.

The starting point would necessarily be the firm’s October, 2011 partners’ meeting at which the partners were first told that about a third of the firm’s 300 partners had special deals under which their compensation was guaranteed at fixed lucrative amounts, not pegged to the firm’s profitability. The net effect was what Professor Steve Harper and others called a fatal “partnership within a partnership” and a Ponzi scheme. Much ink and much of the Internet ether has already been spent on why this dubious compensation scheme just doesn’t work and I won’t add to that discussion here. The point here is that reasonably intelligent lawyers, hearing a state of facts that commands a single conclusion, namely, that their law firm was on a catastrophic course, had the capacity to make critical flight or fight decisions. It appearing that no viable or credible stay and fight decisions were presented, a critical mass of vital partners chose to begin heading for the exit ramps.

The survival course that was actually foisted on the gathered leaders had no appeal. The “Plan” was to reduce headcounts, including at the partner level, by some 5% and foist a deferral of guaranteed compensation agreements. That cannibalism just doesn’t instill confidence since any reasonably intelligent lawyer would (and apparently many if not most did) conclude that this “plan” sounds dumb and other personal options should be explored. The flaws in this “plan” were essentially a lack of confidence in the incumbent leadership, an historic lack of transparency in management which did not appear to be changing in any way, kicking the can down the road with a hope for a change in luck was recognized as the foolhardy aspiration of dice rollers on a losing streak, a fear of being kicked under the bus in inevitable subsequent partner reductions as the “plan” inevitably spun into failure.

Instead, the only viable plan required (a) a complete, detailed mea culpa  from the firm leadership; (b) a demonstrable and credible guarantee of  full transparency by firm leadership with a new reliable form of governance with appropriate checks and balances in place; (c) a detailed explanation of the disastrous personal consequences to each partner if the firm should implode; (d) implementation of a public relations crisis management plan;  and (e) a signed pledge by each partner to stay the course.

There was no acceptance of responsibility by incumbent management.  Rather, months later the firm’s managing partner was unceremoniously tossed under the bus.  The previous clandestine management style was replaced by an apparently equally stealthy “office of the chairman.” Partners did not fully appreciate that massive escapes to the exit doors were more likely to be collective defenestrations.  Subsequent media disclosures were replete with, shall we say, dissembling, to be kind.  And public claims and denials by the partners of the existence of a pledge made for mirth.

Would this plan have worked? It was only tried once before when the New York office of a national law firm (the New York office was itself previously a proud stand alone law firm)  confronted with the fact that the law firm was destined for implosion because of claimed improprieties at other branch offices. The New York office adopted each element of the plan outlined above, with resounding success. But would this plan have worked for Dewey & LeBoeuf? We’ll never know. But we do know the “plan” it chose was an abject and tragic failure.

© Jerome Kowalski, May, 2012. All Rights reserved.

Jerry Kowalski is the founder of Kowalski & Associates, a consulting firm serving the legal profession exclusively. Jerry is a regular contributor to a variety of publications and is a frequent (always engaging and often humorous) speaker to a variety of forums. Jerry can be reached at jkowalski@kowalskiassociates.com or at 212 832 9070, Extension 310

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