December 15, 2020
Looking at Your Firm’s Balance Sheet: Law Firm Clients, and Lawyers, are Not Property
It has been almost two years since the California Supreme Court issued its decision in Heller Ehrman v. Davis Wright (2018) 4 Cal.5th 467, holding that a dissolved law firm has no property interest in fees generated after dissolution for hourly matters that were in progress when the firm dissolved. And earlier this year, on February 13, 2020, the District of Columbia Court of Appeals essentially made the same finding in Diamond v. Hogan Lovells US LLP (D.C. 2020) 18-SP-218. These cases put to bed – once and for all – the idea that a law firm is entitled to future profits from the firm’s clients as an ongoing property right.
It’s obvious. In a narrow sense, this means that a lawyer who leaves a dissolved law firm and takes clients to a new law firm does not have to give back profits earned on those matters at the new firm. But in a much broader sense, these courts reaffirmed something that should guide all lawyers and law firms managing partner or group departures: law firm clients are not property. This might sound obvious since clients have the right to choice of counsel and, in fact, this principle is part of what guided the court to reaffirm that law firms do not own clients.
But it’s not. On the other hand, this idea is counter-intuitive to some extent. After all, most companies that employ hundreds or thousands of people and generate millions, or even billions, of dollars in revenue per year — as law firms do — typically also own significant tangible property. Technology companies have patents, manufacturing companies have factories and equipment, and so on. It makes sense that large enterprises own things. And big things, not just a bunch of used desks and computers. And in fact, many lawyers still erroneously rely on this concept – that their client relationships represent property rights – when attempting to value their interest in a law firm or handle a partner’s departure.
Trash the rental. Law firms, however, are not like that. As the court made clear in Heller, revenue from any client, who can leave the firm at any time, is an expectation interest, but not a property interest. So law firms don’t own clients, although the revenue stream from clients is an asset of the firm, at least until it isn’t. Similarly, as the saying goes, at a law firm, the assets leave on the elevator every night. The minds, capabilities, and expertise of a law firm’s lawyers and staff, and the value they create for clients, are a law firm’s primary and most significant assets, at least until they aren’t. Law firms don’t own a lawyer’s practice.
This does not mean that the law firm or the lawyers don’t own anything. Either may own intellectual property, trademarks, and other property, depending on when and how it was generated and any agreements with their lawyers or others. But the fact that many of the firm’s assets are not property of the firm has some important implications for the way lawyers and law firms should think about and manage partner departures, as well as how they should value ownership interests in the firm, especially as part of succession planning and retirement.
Law firm reactions. For law firms, this generally means that the firm cannot constrain clients’ choice of counsel and should not try. Think day one of Property Law class: You typically don’t get to tell other people what to do with things you don’t own. This includes, for example, avoiding any effort to restrain departing lawyers from contacting clients. That’s not a bright idea in any event, from a risk management perspective, since in most circumstances lawyers have a duty to contact the clients, and the firm may not know what is happening in the affected client matters and probably won’t be able to take responsibility for those matters immediately anyway.
On the other hand, law firms have the right to fair competition with departing lawyers for those clients, and should hold the lawyers to their fiduciary duties and their contractual obligations under the partnership agreement. (By the way, does your firm’s partnership agreement adequately protect it in the event of a significant departure?) For example, the law firm should generally get notice of the departure before the clients are contacted. After that, the law firm can try to keep the clients and compete for them. But it’s not an automatic that they will stay, in the way that, say, the car you own should still be in your driveway in the morning. One you own. One you don’t.
Lawyer departures. For lawyers, the fact that the law firm doesn’t own the clients and doesn’t own the practices doesn’t mean that you have carte blanche to do as you wish when you are departing. You still owe fiduciary duties to your firm and you may have contractual obligations to the firm. Ultimately, you have the right to compete for the clients, just like the firm does, after you give notice of your departure. But you shouldn’t rig the system and compete for clients before the firm knows you are leaving. Also, if you are retiring or selling your interest in your firm, if you have not properly planned for that event, the value of your interest in the firm may be much different than you think.
A starting point. The Heller decision provides clarity for something that most knew a long time ago: clients are not property of the firm. Its rationale brings to mind another truth: lawyer practices aren’t really property of the firm either. These truths have been shaping up for some time, and now that the California Supreme Court has confirmed important aspects of these issues, it’s a good idea for lawyers and law firms to internalize this starting point and the implications in partner departures and law firm planning.
From there, firms and lawyers can analyze the right strategies to handle attorney departures. Law firms can develop strategies to protect their assets, even if they don’t own them. Departing lawyers can develop strategies to preserve their practices, even if they don’t own the clients. Both should compete fairly during the departure process. This all takes planning, advanced strategy, and real-time adjustments. Everything starts with the premise that California’s high court has confirmed. Focus on clients’ interests. And no one owns much.
Dena M. Roche
O’Rielly & Roche LLP