Second Circuit Punts on Unfinished Business Doctrine
In a unanimous decision related to the Thelen bankruptcy, a three-judge federal appellate panel ruled Friday that a New York appeals court should decide whether the remnants of law firms that dissolve in the state have an ownership right to fees earned from hourly matters taken by their former partners to new firms.
Writing for a panel of the U.S. Court of Appeals for the Second Circuit, Judge Gerard Lynch underscored the importance of creating clarity on the issue, saying "the bankruptcy of major law firms is, sadly, a phenomenon that has occurred with distressing frequency in recent years." In addition to Thelen, other Am Law 200 firms to fail in recent years include Heller Ehrman, Howrey, and the biggest of them all, Dewey& LeBoeuf, which filed for Chapter 11 protection in May 2012. In each case, trustees seeking to recover funds for creditors have pressed so-called unfinished business claims against firms that inherited income-generating work when they hired lawyers from the failing firms.
Friday's ruling stems from a closely watched case brought by Thelen trustee Yann Geron against Seyfarth Shaw, which hired 11 partners from the firm following its October 2008 dissolution (The firm filed for Chapter 7 bankruptcy protection in New York a year later). In addition to seeking an unspecified amount of money from work those partners took to Seyfarth, Geron argues that a waiver the partners signed once the firm knew it was dissolving in an effort to shield themselves from unfinished business claims should be considered a constructive fraudulent transfer.
In September 2012, U.S. District Judge William Pauley of the Southern District of New York handed Seyfarth Shaw a win in the case, ruling that the unfinished business doctrine does not apply to a dissolving law firm's pending hourly fee matters. Thelen appealed Pauley's decision, and the Second Circuit panel heard arguments from both sides in early October.
Friday's decision also applies to a similar challenge to the unfinished business doctrine raised in the Coudert Brothers bankruptcy that worked its way up to the same appellate court. In that case, Coudert, which filed for bankruptcy protection in 2006, secured a key win in May 2012, when U.S. District Judge Colleen McMahon, also in New York's Southern District, ruled that the firm's estate does have a property interest in unfinished business matters billed on an hourly basis. (When it comes to contingency matters, the law is clearer that profits need to be shared if the case is taken from a dissolving firm.)
The law firms sued by Coudert—a group including Dechert, Jones Day, and Akin Gump Strauss Hauer & Feld—challenged McMahon's ruling, but did not get the chance to argue their appeal after the Second Circuit decided that the Thelen arguments were sufficient to cover both cases.
In its ruling, the appellate panel—which in addition to Lynch included judges Denny Chin and Susan Carney—certified two questions for the New York Court of Appeals to answer—something the trio indicated it might do during the oral arguments. The first question turns on the issue of whether hourly matters are the property of a law firm under New York law, and if so, whether the firm is entitled to profits earned on such matters when in dissolution or bankruptcy. The second involves how New York law defines a "client matter" for the purposes of the unfinished business doctrine and what proportion of the profits derived from ongoing hourly matters should be kept by the new firm.
The Second Circuit panel said its decision was based on the fact that "there is scant New York authority" on whether the unfinished business rule applies to hourly fee matters. "There are strong legal and policy arguments on both sides of the issue," Lynch writes.
Creating different rules for contingency and hourly matters could be problematic, the court said, and "would undoubtedly encourage the view, now prevailing among many, that an individual partner's book of business is not an asset of the firm, but instead a piece of personal property to be guarded with a Cerebus-like ferociousness." On the other hand, the court suggested, creating property rights to legal matters could undermine client relationships and make it harder for partners to leave dissolving firms, which would disrupt client service.
Seyfarth's counsel, Thompson Hine partner Thomas Feher, did not immediately return a call seeking comment on the decision. Geron, a partner at Fox Rothschild, said Friday, "We are certainly pleased from the estate’s perspective that the Second Circuit clearly reviewed all of the issues at length." He added, "We also believe the court’s opinion recognized the strengths of the trustee’s argument" and that they look forward to seeing what happens next at the New York Court of Appeals.
Lawyers guiding law firm bankruptcies in California have had more success in collecting money on unfinished business matters, largely based on a precedent established in a 1980s state court case known as Jewel v. Boxer. With Jewel as ammunition, the Howrey estate, for example, collected $2.28 million in a single week in October from five firms that had hired former Howrey partners. Even so, a handful of other firms argued in court that same week that they should not have to pay Howrey anything.
The fight over unfinished business claims is beginning to percolate in the Dewey bankruptcy. Texas lawyer Allan Diamond of Diamond McCarthy, who is also serving as the trustee in the Howrey bankruptcy, has been hired to pursue such claims against some three dozen firms that hired Dewey partners. In October, a group of 28 firms filed an objection in New York bankruptcy court asking a judge to curb Diamond's investigation into unfinished business, calling such an investigation "premature" in light of the Thelen and Coudert appeals.