Significant Victory in Challenge Against Unfinished Business Rule’s Application to Hourly Fee Matters in California

On June 11, 2014, U.S. District Judge Charles Breyer issued a significant ruling in favor of several large law firms in the ongoing fight regarding whether and if a dissolved law firm has the right to profits from unfinished legal work its former partners brought to their new firms.  In his Order granting summary judgment in favor of the law firms and against the Trustee for the defunct Heller Ehrman LLP, Judge Breyer was reviewing de novo an earlier Bankruptcy Court order that went against the law firms and in favor of the Heller Ehrman Trustee.  In a case of first impression, Judge Breyer concluded that under the facts presented in this case, “neither law, equity, nor policy recognizes a law firm’s property interest in hourly fee matters.”

The Trustee’s primary basis for asserting a property interest in pending hourly matters relies on Jewel v.Boxer(1984) 156 Cal. App. 3d 171, (“Jewel case”).  The June 11, 2014 Order analyzes the Jewel casein great detail, and distinguishes Jewel from the pending matters for five key reasons. (Order, 7:7-8:24) First, the dissolution of the firm at issue in Jewel was voluntary, while Heller’s dissolution was forced when Bank of America withdrew the firm’s credit line. Second, in Jewel the new firms represented clients under fee agreements entered into between the client and the old firm, whereas here, the clients signed new retainer agreements.  Third, in Jewelthe new firms consisted entirely of partners from the old firm.  In this matter, the defendants are “pre-existing third-party firms” that provided significant resources and capital for their services. Fourth, Jewel treated hourly fee matters and contingency fee matters as indistinguishable. There are no contingency fee matters at issue in this case.  Finally, and perhaps most significantly, Judge Breyer noted that Jewel was decided in 1984 and applied the Uniform Partnership Act (“UPA”), which is materially different from the Revised Uniform Partnership Act (“RUPA.”)  The Court noted that the “RUPA, which applies after 1999 to all California partnerships, allows partners to obtain ‘reasonable compensation’ for helping to wind up partnership business, Cal. Corp. Code § 16401(h), and thus undermines the legal foundation on which Jewel rests.”  (Order, 7:26-8:2)

Ultimately, Judge Breyer concludes that Jewel, which is an intermediate state appellate court decision, “is notcontrolling under these facts and that no California Supreme Court decision supports such aresult.” (Order, 2:17-20.) Judge Breyer also notes that, “While this Court distinguishes Jewel v. Boxer on its facts, it is also of the opinion that the California Supreme Court would likely hold that hourly fee matters are not partnership property and therefore are not “unfinished business” subject to any duty to account.” (Order, 3:1-3)

The Order provides additional analysis as to why equity favored disallowing unfinished business claims for hourly rate matters under these circumstances.  The equity argument was articulated simply as, the “firm that does the work should keep the fees.” (Order, 9:6-7.) The Court observed that the Trustee couldn’t reasonably argue that defendants have received a windfall when it was the defendants that did the work.  Also, the Court observed that since the Trustee conceded that a Shareholder that left Heller prior to the dissolution would not have to account for unfinished business taken to another firm, absent a breach of fiduciary duty, the rule or result should not be any different simply because Heller had dissolved.  And that to apply such a rule, besides being illogical, would create perverse incentives that might ultimately contribute to the demise of a faltering, but viable law firm.

Judge Beyer also concluded that the public policy considerations supported this ruling and that the rationale articulated in Jewel did not apply to this fact pattern.  The Trustee’s suggestion that the Heller estate should be entitled to a share of all profits earned, even on litigation matters lasting long after it ceased to exist, was not equitable.  Nor did it favor public policy to require the new firms to contribute resources to represent clients if they were not entitled to the corresponding profits.

While it is likely to be appealed, Judge Breyer’s order is an important ruling on the application of the Unfinished Business Rule in California, the outcome of which is being followed by many in the legal community. For partners considering departing from a firm that is inadequately capitalized or has the possibility of dissolution, or for a firm acquiring lateral partners coming from such firms, it is important to closely analyze the application of the Unfinished Business Rule to that partner’s former partnership agreement and individual circumstance.

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