Advertisements

Double Jeopardy for Law Firms: Jewel v Boxer


Seal of the United States District Court for t...

Seal of the United States District Court for the Southern District of New York (Photo credit: Wikipedia)

Jerome Kowalski

Kowalski & Associates

July, 2012

 

In the last month or so, BigLaw was jarred by two disruptive events:  First, there was the tragic collapse of Dewey & LeBoeuf and the second, the reasoned decision issued by the United 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 firm partnerships and that it does so with equal weight to both matters billed on an hourly basis as well as contingency fee work.  Both events have chilled the lateral partner market.

Added to that is the fact that liquidators of imploded law firms are also desperately seeking recoveries for creditors and are therefore anxiously investigating potential breach of fiduciary duty claims against former partners of the law firms, and, like Jewel claims, the reach of these claims is likely to put the law firms these former partners subsequently joined into their cross hairs. Deep pockets and all of that.

These events are occurring in the open for all to see. Unfortunately, too many managing partners, lateral hiring partners, law firm general counsels and risk managers have neither taken note nor taken adequate steps to protect their firms.

In light of recent events, law firms will be woefully remiss if they fail to include in their standard agreements for lateral partners language protecting and indemnifying the firm from Jewel v Boxer and breach of fiduciary duty claims.  If the firm has hired a lateral partner from a firm that is going through the throes of imploding, a la Dewey or if a lateral partner comes from a law firm that subsequently unwinds unexpectedly, there is some reasonable likelihood that the hiring firm will be targeted as a defendant should the liquidators of the defunct law firm form a reasonable basis to assert such claims.  The issue is that there is almost always a likelihood that such claims are lurking about. These skulking claims are all of the more problematic because they are typically not asserted for a couple of years after a law firm implodes.  When the pain comes, law firms should preserve the right to share some of that pain in a reasoned and rational way.

Law firm liquidators typically spend the first several months of their tenure tending to the gargantuan tasks of shutting down the law firm.  They simultaneously undertake a “sources and uses” analysis to determine what potential sources exist for payment of administration expenses and obligations due to creditors.  Because expenses and creditor typically far exceed the amounts available from monetizing accounts receivable and works in progress, successor law firms are more frequently found to be routinely available resources for adding to the honey pot. And nobody is more motivated to add to the honey pot than law firm liquidators whose fees are often contingent on maximizing recoveries; a primary resource for them has been pursuing clawbacks and claw forwards.  They are unrestrained by market place considerations which dampen the appetite of viable law firms to  go after other competing law firms who have hired laterally from its ranks because they would inevitably subject themselves to the very same claims, as they continue to drink the Kool Ade and hire laterally.

The problem is that it takes law firm liquidators an extended period of time to get their hands around the behemoth of the law firm that once was and is no longer. For example, one of the tasks typically undertaken by the liquidators is recasting the firm’s balance sheet and profit and loss statements retroactively, to among other things, determine when the law firm was first insolvent from a technical bankruptcy point of view.  Any payments made to partners during the insolvency period are gratuitous transfers and are subject to clawbacks. Determining the date of insolvency is both art and science and often requires extended analyses. Similarly, determining where former partners went and which firm assets (in the form of client files, other partners and associates) also takes time. Thus, we most often see that these claims are filed en masse upon the expiration of the statute of limitations, which is two years from the date of filing.

Here is the rub:  Law firms typically prudently pay new lateral partners in whole or in part during the course of that partner’s initial tenure at the law firm on a performance basis. One of the key drivers is most often cash generation and the metric law firms use in calculating the new partner’s entitlement is the law firm’s historical profit margins. To be sure, those margins do not include clawbacks. Thus, the typical scenario is that the new lateral partner is timely rewarded for production, with the law firm completely oblivious to the very real likelihood that two years or more down the road, law firm liquidators will be sending the law firm a due bill for all of the profits earned by the law firm (not just the new partner’s distributions) for unfinished business based on either Jewel v Boxer or breach of fiduciary duty claims. Successor law firms have not yet been the target for recovery of voidable transfers made during the insolvency period made to the new partner during his prior tenure at the now defunct law firm.

Thus, the new firm is in the unenviable position of having to pay twice for the same revenue generation: First, to the lateral partner and thereafter to the estate of the former law firm.

The issue with breach of fiduciary claims is far more devious and invidious. Among other things, we know full well that the rule is that a partner may not solicit a client, associate or partner to join him or her at a new firm until he or she has given notice. Nor can a partner share with another law firm confidential billing and collection information of his or her current law firm, Yet, we can all take judicial notice that no sane partner on the prowl will accept an offer from a new firm before he or she has received adequate assurances from his or her clients will be following him or her. Similarly, every hiring law firm demands assurances that the clients will indeed be coming along. By the same token, when a group leaves a law firm simultaneously to the same new climes, it is readily apparent that a partner, typically the group leader, has engaged in actionable recruiting of partners and associates prior to giving notice. The new law firm is clearly complicit, since it almost always interviews partners in the group at length before an offer is extended and even where associates are first interviewed after the partners give notice, it is more often the case than not that these associates were advised by law firm partners to start packing – again, actionable conduct. Even where the successor law firm gives a potential lateral recruit written admonitions not to violate any fiduciary obligations or partnership agreements and somehow feigns ignorance of any fiduciary breaches, at best, it is most often clear that it has simply engaged in willful (and often dubious) blindness and may be subject to some serious claims.

Dewey broke the mold in oh so many ways

Dewey’s implosion was unprecedented in too many ways to count.

One unique aspect of the Dewey collapse was its failure to hold a formal dissolution vote. One Dewey law firm leader, when asked about a formal vote of dissolution as the firm was plainly at the tail end of its death spiral, blithely and rather incredibly denied that the firm was going to vote to dissolve, even Quixotically asking his interlocutor, “why would he do that?” even as he presumably was actively looking for a new home and subsequent to the time that he issued an email in his official capacity to other partners encouraging them to leave. The answer to the question sort of seems obvious:  The reason you would take a dissolution vote is because the law requires you to do so and the firm’s managing partners, as fiduciaries of other partners as well as of the firm’s other creditors, have a duty to call for such a vote as the firm, in fact, is actually in a state of very real dissolution.

The issue may well be that Dewey’s leaders, very smart lawyers one and all, may well have wanted to protect their colleagues and themselves from Jewel v Boxer claims. You see, these claims arguably first arise once the partnership votes to dissolve.  In Coudert, the only partners (and their new law firms) sued for unfinished business profits were those who left after the dissolution vote. I certainly have no information to support the notion that this was the reason for the failure to formally vote to dissolve Dewey.  But, if this was the reason for the ploy, it seems unlikely that it will succeed.  First, it may be that a court of equity may determine that Dewey went into formal dissolution as it stumbled through various critical paths:  For example, when Dewey leadership tried to auction off pieces to other law firms, when those efforts failed, when the firm’s then sole managing partner advised the partnership in January 2012 that the firm was basically insolvent in that it couldn’t pay its debts when due, the date of the bankruptcy filing or some other earlier date. We are in largely uncharted waters here, folks.

But, the refusal to take a formal dissolution vote solved nothing and protects nobody. Every former partner and most of their new law firms are still subject to breach of fiduciary claims, violations of the partnership agreement and violations of the Revised Uniform Partners Law. Those in management are presumably more at risk.

Simply arguably eliminating Jewel v Boxer claims still leaves the door wide open for breach of fiduciary duty claims. We do not suggest that Jewel claims preclude breach of fiduciary duty claims. They are all still out there.  In short, it doesn’t matter whether you call it a “tax” or a “penalty”.  A clawback is still a clawback.

Protecting law firms who hire partners laterally

In light of all of the foregoing, it is critical that any law firm which hires laterally must include indemnities from new partners from both Jewel v Boxer and breach of fiduciary claims.  The full nature, scope and content of these indemnities must be left to the sound business judgment of law firm leadership.  It is likely that the amount of the precise amount for particular indemnities will first be the subject of negotiation after issue is formally joined on the claims.  Those indemnities should be standard issue in every lateral partner agreement. Every single one.

All such agreements should require binding confidential mediation and arbitration.

Moreover, as we continue to watch even an already bankrupt Dewey continue to fall, law firm risk managers must be engaged in active discussions with its insurance carriers to see what insurance might be available with regard to potential future Deweys and partners who leave those sinking ships to join new law firms. It may be too late to insure Dewey-related claims, but it isn’t too late to seek coverage for the next generation of imploded law firm refugees. These claims are certainly outside the scope of standard issue malpractice claims, but may well be within the scope of fiduciary insurance coverage or errors and omissions policies.  The real problem here is that most often, these claims specifically exclude work done by a partner at a former law firm.

I leave it to professional liability professionals to craft an insurance based solution.  But be forewarned, time is short; the next law firm implosion may be around the corner.

An important note: Those law firms which carefully assesses its likelihood of liability, includes the amount of exposure into its calculus (and may even have appropriate insurance) and then eschews the need for an indemnity, while extending a viable offer, puts itself at a competitive advantage for a desirable candidate. However, it does so at some risk and eliminates the ability to tell all comers that these indemnities are required of all lateral partners. At the same time, if a law firm picks and chooses which lateral candidates should be required to provide indemnities, there may be some explaining to do of and when it comes to pre-trial discovery in the inevitable Jewel or breach of fiduciary duty claims rears its head.

Is this a fight you really want to get into?

 

It isn’t very surprising that every Jewel v Boxer and breach of fiduciary duty claim previously brought under these circumstances involving BigLaw has settled prior to trial. Many settle before the first pleading is served. The balance settle well prior to trial. Several are still pending in the pleading phases in Thelen and in Coudert with the antagonists vowing to fight on to trial and through the appellate process, never to give in. Never. We’ll see.

The real problem here is the fact that pretrial discovery will be brutishly invasive and certainly expensive.  Remember, that the Jewel v Boxer rule is that the plaintiff has an entitlement to recover the profits not the gross fees from unfinished business. Thus, discovery will necessarily include minute details of a law firm’s most sensitive and confidential pricing and profitability information, stuff that even in the most transparent of law firms do not regularly share even with partners.

Sure, we all love confidentiality agreements and protective orders and advocate for them all of the time both to the courts and to our skeptical and justifiably paranoid clients. But, today, the shoe is on the other foot: Do you really want this information disclosed to your key competitors even under a protective order?  Can you, dear advocate, feel safe with a protective order? Bear in mind that at trial, the veil of confidentiality comes off and should any of these cases ever come to trial, the world at large will be informed of your most sensitive information, with journalists, bloggers and pundits at the ready in the courthouse to report information never previously having seen the faint light of day.

Is it time for some rule changes?

 

While getting the American Bar Association and fifty-one agencies to change extant provisions of the Model Code of Professional Responsibility is a Herculean task, which, at best, would proceed at a glacial pace, it is time to at least begin to consider those issues.

First, since the skein of precedent and statute in the area of fiduciary laws governing partnerships is a foolhardy a mission hardly imaginable, let’s for the moment, at least, forget about undoing Jewel v Boxer under the rubric of amending a century or more of common law and statutory mandates and suggesting that we are simply modifying rules of professional conduct. Instead, an initial focus should be on the question of lateral partner movement. We all know what the rules say and we all concede that these rules are far more honored in the breach.  A new set of rules are critical and should, even reluctantly, yield to the realities created by the marketplace: Partners are free agents, just as law firms freely de-equitize partners and otherwise treat them as employees at will. Market realities create lateral movement.  The marketplace also has required client solicitation before partnership withdrawal, disclosure of historical billing and collection history and even solicitation of associates and other partners. The ethical rules need to be amended to yield to these market realities. The issue here is not those fiduciary rules of partnership described in the Jewel line of cases and in the Coudert decision. Rather, the rules that need to be addressed relate to those fairly unique to the profession; namely, those rules primarily regarding client solicitations in a free agency market.

More significantly, given the likelihood of a torrent of post Dewey Jewel v Boxer and breach of fiduciary claims, as well as a next round of similar claims from the inevitable next BigLaw failures, the rules should require that all disputes between law firms and their successors and assigns be arbitrated before a panel of those appointed in each jurisdiction to review lawyer conduct.

Until the rules are actually amended, BigLaw should consider acting on its own: I would propose a compact by and among the nation’s largest law firms under which any disputes among the signatories of the compact, inter se,  be finally resolved through mediation and then arbitration by a designated panel of arbitrators,  consisting of retired jurists as well as present and past BigLaw partners.  This compact should specifically bind the signing law firms as well as their successors and assigns.  It would take only a relatively small number of numbers of law firms to seize such an initiative and then some prodding to get other law firms to join in.

Waves of litigation brought by law firm liquidators seem inevitable.  A uniquely qualified panel of arbitrators are perhaps the most efficient way to handle these issues. At the same time, this panel could also be designated to be the forum in which disputes among partners inter se, as well as between a partner and his or her former law firm can be most efficiently finally resolved.

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 Jerome_kowalski@me.com or at  jkowalski@kowalskiassociates.com or at 212 832 9070, Extension 310

 

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

Advertisements

Alternative Fee Arrangements and Value Billing: Lesson IV – Drafting the Alternative Fee Arrangement Agreement


English: Discussion about the text Français : ...

Image via Wikipedia

Jerome Kowalski

Kowalski & Associates

March, 2011

Like the legendary barefooted children of the cobbler, lawyers simply too often fail to adequately document the details of an alternative fee arrangements at the outset of an AFA engagement to their own detriment. Accordingly, moving forward from my prior primers on the subject, I now turn to the issue of the importance of meticulous drafting of an alternative fee agreement.

Several recent cases illustrate the point.

First we begin with the basic proposition that all fee agreements are subject to judicial scrutiny and can be set aside by the court if the court finds them to be unconscionable, unfair (to the client)
or are over-reaching.  That point was driven home in a fierce and long fought lawsuit between New York law firm Graubard Miller and the Estate of Alice Lawrence. In that case, as recently reported, the law firm originally was retained in connection with a dispute regarding the decedent’s late husband’s estate and billed on its customary hourly basis.  By the time the firm had billed and collected  some $18,000,000, the client and firm entered in to a new contingent fee arrangement.  The matter was ultimately resolved and under the terms of the new fee agreement, the firm claimed an ntitlement to an additional $44,000,000.  After a torturous trail from the trial court to the highest appellate court in the state, the trial court reduced the firm’s fee request to less than $16,000,000.  Significantly, had the firm billed on its hourly basis, its fees would have been some $1,600,000; had the firm collected on the full contingent fee, its hourly rate would have approached $11,000 an
hour.  As we know, bad facts create bad law.  Here, the case was further complicated by the fact that three of the law firm’s partners had privately received from the client a “gift” of some $5,000,000 (apparently not shared with the firm’s other partners), which the court required the recipients to return.

In Meyer Suozzi v Vista Maro, decided in Nassau County, New York, the client and the law firm agreed that the law firm would handle several pending and festering  litigations to conclusion for a fixed fee of $300,000, plus costs, payable in three equal installments.  The law firm apparently adeptly and adroitly handled the litigation and the client refused to pay more than one-half of the agreed upon fee.  The law firm sued to recover the balance.  The trial court ruled that the fixed fee agreement “is a non-refundable retainer agreement and as such, is unenforceable” under New York law.”  Similarly, in Indiana, that state’s highest court found that charging flat fees violated the Code of Professional Responsibility for which a public reprimand was appropriate.

The client apparently already had a long history of protracted and expensive litigation with its antagonist and apparently did not want to keep throwing money in to the black hole of litigation. Along came Meyer Suozzi and after reviewing the file, made what was then apparently an irresistible offer to the client, namely, essentially saying “we’ll solve the problem and your total exposure for legal fees will be $300,000.  If we run up more than $300,000 in time solving the problem we’ll eat the overage.  But if we beat the clock, we get to pocket a premium.”

The actual facts are that Meyer Suozzi, a leading Long Island, New York law firm, did beat the clock in resolving the client’s problem. But the trial court, in ruling on a motion for summary judgment, lost the forest for the trees.  She apparently got hung up on the notion that, as she read the agreement, there was a basic inequity and perhaps illegality to an agreement that would have created a condition in which the client could have simply discharged Meyer Suozzi the day after the agreement was executed and the client would still be on the hook for the full $300,000 fee.  Of course that did not happen and in popular parlance, the court threw the baby out with the bath water, limiting the law firm to recovery on a quantum meruit basis (I frankly believe that in such a trial, the finder of fact should conclude that reasonable fee would be the stipulated amount in the retainer agreement, constituting the best evidence of the parties’ understanding of what would constitute a reasonable fee).  But, more adroit drafting of the initial retainer agreement would have avoided the necessity of a trial.

Another case, Kassowitz Benson v Duane Reade is also instructive. In that case, the plaintiff Kasowitz law firm alleged in its complaint said it had entered into an alternative fee arrangement, under which the client paid a $1 million flat fee to handle certain litigations and that the law firm was to receive an additional 20 percent of any recovery exceeding $4 million. Duane Reade, the client, ultimately denied that it had such an arrangement.  The pleadings indicate that there is a genuine dispute concerning the very existence of a written AFA.  Nonetheless, Kasowitz contends that under the AFA, it is entitled to a premium of $7.000,000

Based on its understanding of the AFA, the Kasowitz firm proceeded to litigate vigorously, as is its wont, and, apparently shortly before the matters were concluded, the defendant replaced its in-house corporate general counsel, and the new GC, who knew not Kasowitz (compare: Exodus 1:8), discharged the firm and favorably settled the matter, apparently using a different law firm.  And, of course, the new GC denied that Kasowitz had any entitlement to the premium fee. On March 22, 2011, the court granted Duane Reade’s motion to for summary judgment, essentially holding that the legal work for which Kasowitz sought recovery of a premium fee was not within the scope of the existing agreement.

Getting the details of the AFA fee arrangement and the scope of the engagement memorialized in writing are certainly lessons taught by the Kasowitz decision.  Yet another important lesson is that the agreement by a duly authorized agent of the client whose authority to act on behalf of the client is verified.  That lesson derives from a recent Texas case entitled Shamoun & Norman v Hill, where a client defended against a claim by a law firm seeking to recover a premium due on an AFA arrangement on the grounds that the agreement was not signed by a duly authorized agent.

So let’s review some basics in drafting an AFA (and I do emphasize that these are just some basics):

  • Without doubt, the most critical components of an AFA are a shared understanding of the scope of the engagement. The law firm and the client must have a detailed understanding of the precise scope of the engagement.  This must be the subject of both detailed discussions and memorialized carefully. The retainer agreement should also recite that if the law firm is requested to perform work outside the scope of the engagement,  such work will be performed in accordance with a separate change order reflecting a different fee arrangement.  We have frequently seen that details of the scope of work are included in an addendum to the retainer agreement.
  • Of at least equal significance is carefully memorializing the facts, circumstances that would give rise to the law firm’s entitlement to a premium or success fee.
  • Next, open your copy of the Rules of Professional Conduct to section 1.5 which governs the charging of legal fees and be guided by its language.
  • Include a recital to the following effect:   “The parties acknowledge and understand that they are entering into an Alternative Fee Arrangement, under which the law firm will not be charging and the client will not be paying legal fees based on the customary hourly rates the law firm charges and that a portion of the fees paid hereunder are contingent.  The client, after considering the nature of this AFA has consulted with independent counsel and has determined that the fee arrangements described  herein are fair and reasonable and that they are not excessive.  The client further acknowledges that this agreement was negotiated at arms’ length, without duress or compulsion and that the fees described herein reflect the client’s considered understanding that these fee arrangements reflect the value to the client of the legal services to be rendered hereunder. Among other things, the client has independently reviewed and considered (a) the amount of estimated time and labor required by the law firm in order for it to discharge its obligations hereunder; (b) the novelty and difficulty of the questions involved in this engagement; (c) the skills of the law firm in these matters; (d) the likelihood that the law firm, in undertaking this engagement, will be precluded from other employment; (e) the fees charged by other law firms in the locality for such legal engagements; (f) the amounts and issues involved and the value of to the client of the results to be obtained should the law firm achieve a result that would give rise to the payment of the premium fee to the law firm, as described herein;  (g) the time limitations in this matter; and (h) the nature and length of the professional relationship between the law firm and the client; the experience, reputation and ability of the lawyers to perform the services required hereunder. After independently reviewing all of the foregoing and consulting with other professionals, the client has concluded that the fees to be paid hereunder, including, without limitation, the premium success fees described herein are fair, reasonable and are not excessive”
  • Acknowledge that the client always retains the right to discharge the law firm. But, do include careful recitations that should the client discharge the law firm after the law firm has performed substantially all of the work necessary to achieve the milestone giving rise to the law firm’s entitlement to receive the premium success fee but before that result is actually received, the law firm retains the complete entitlement to receive the premium success fee. Yes, this provision does not contain the precision that lawyers prefer and certainly opens the door for either vigorous debate or even litigation, but, it is quite frankly the result of inherent constraints in the Rules of Professional Conduct.
  • Include a severability clause (you know the drill: “if any provision or portion of this agreement is adjudged to be invalid or illegal, ….”).  My own view is that some of the pending litigations between law firms and clients over AFA’s would have been obviated by this clause.
  • Include a choice of law provision (same type of boilerplate:  This Agreement shall be governed by and in accordance with the laws of ______________, without reference to principles of conflicts of laws).
  • Include a provision attesting to the fact that the AFA agreement is being signed by a duly authorized officer of the client or a duly authorized agent of the client. And be prudent in conducting due diligence in confirming that authority.

I have not included most of the standard recitals in retainer agreements; they do vary from state to state and are presumed to be matters with which lawyers have familiarity.

Finally, once the AFA agreement is signed, do not, under any circumstances refrain from recording your time.  I’ve previously addressed the necessity of accurate time keeping even in this world of AFA’s.  In addition, in the event your relationship with the client is severed, you may very well need to try a quantum meruit case in which time actually expended will be a focal point for the court and the parties.

[Update, the May 2011 Edition of ACC Docket contains a most interesting report regarding an ACC – ABA Litigation Section symposium on value billing in the litigation context, with candid discussions of the different agendas clients and law firms bring to the table in discussing an AFA arrangement.  Among the few areas where there was consensus was the fact a critical element for a successful AFA engagement was the need for active collaboration between client and counsel.  The point is again the critical  need to focus on details of the scope of the engagement, which, as I said, requires active attorney/client collaboration. ]

© Jerome Kowalski, March, 2011.  All rights reserved.

%d bloggers like this: