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May 2018 Ethically Speaking - The California Supreme Court Tackles Jewel v. Boxer and the Unfinished Business Doctrine

by Mary A. Dannelley

The dissolution and Chapter 11 bankruptcy of the global law firm Heller Ehrman LLP provided fertile ground for the California Supreme Court to re-visit the thirty-four-year-old holding of Jewel v. Boxer, 156 Cal. App. 3d 171 (1984). The “unfinished business” doctrine addressed in Jewel pertains to a dissolved law partnership’s right to share in post-dissolution fees generated by its former partners on unfinished matters still pending at the time of the partnership’s dissolution. In Heller Ehrman LLP v. Davis Wright Tremaine LLP, 4 Cal. 5th 467 (2018), the California Supreme Court answered a question certified by the United States Court of Appeal for the Ninth Circuit: Whether a dissolved law firm retains a property interest in legal matters that are in progress—but not completed (i.e., “unfinished business”)—at the time of dissolution. Id. at 471. Departing from the thirty-four-year-old holding in Jewel, the California Supreme Court held that, “under California law, a dissolved law firm has no property interest in legal matters handled on an hourly basis, and, therefore, no property interest in the profits generated by its former partners’ work on hourly fee matters pending at the time of the firm’s dissolution.” Id. at 471-72.

The holding in Heller has far-reaching implications for two reasons. First, Heller clarifies in no uncertain terms that a law partnership does not “own” a matter. Rather, every matter is owned by the client. In other words, at least with respect to hourly fee matters originated by a partnership, the partnership has no ownership stake in those matters or the profits generated from them if the client chooses to leave and retain the departing partner’s new firm. Thus, even if a former partner touted the old firm’s capacity, capabilities, and reputation in originating the matter, that firm does not have an expectation that it will continue to earn fees from that matter until its completion. Second, Heller left open whether the opinion in Jewel is still intact with respect to contingency fee matters. As set forth below, there is a strong argument that dissolved partnerships that originated contingency fee matters have a stake in post-dissolution fees for such matters, as the contingency fee necessarily compensates for work performed pre-dissolution with the hope and expectation that the investment will be recouped at the conclusion of the matter.

The California Supreme Court Needed to Re-Visit Jewel v. Boxer in Light of California’s Adoption of the Revised Uniform Partnership Act

In Jewel, the court applied the “unfinished business” doctrine under the Uniform Partnership Act (UPA) adopted by the California legislature in 1929, California Corporations Code sections 15001 to 15058 (repealed), to dissolving law partnerships. Four partners operated their practice as a partnership without any written partnership agreement at all, let alone a partnership agreement that spelled out how fees would be allocated from active cases upon dissolution of the partnership. Jewel, 156 Cal. App. 3d at 175. Upon dissolution of their old firm, the four partners formed two new firms, each with two of the former partners. Two of the former partners initiated an action against the other two former partners, seeking an accounting of the fees generated from active matters of the old firm transitioned to the new firm. Notably, these matters consisted largely of worker’s compensation and personal injury cases—many of which were contingency fee matters. Id. The suing former partners contended the fees being generated by their former partners at their new firm on matters transitioned from the old firm “were the assets of the dissolved partnership” and sought to recover their claimed shares in the fees. Id.

The Jewel court analyzed the rights of the former partners under the rules pertaining to the dissolution of partnerships generally under the UPA, finding no exception to the UPA for law partnerships. The court noted that “[u]nder the Uniform Partnership Act . . . , a dissolved partnership continues until the winding up of unfinished partnership business,” and “no partner (except a surviving partner) is entitled to extra compensation for services rendered in completing unfinished business.” Id. at 176. The court defined “extra compensation” as “receipt by a former partner of the dissolved partnership of an amount of compensation which is greater than would have been received as the former partner’s share of the dissolved partnership.” Id. at 176 n.2. Applying these principles, the court concluded that “in the absence of a partnership agreement, the Uniform Partnership Act requires that attorneys’ fees received on cases in progress upon dissolution of a law partnership are to be shared by the former partners according to their right to fees in the former partnership, regardless of which former partner provides legal services in the case after the dissolution.” Id. at 174, 176. In reaching this decision, the Jewel court reversed the lower court’s allocation of post-dissolution income generated from unfinished matters at the time of dissolution based on quantum meruit and remanded for further proceedings to allocate fees to all of the partners in accordance with their respective partnership interests in the old firm. Id. at 180.

The holding in Jewel stood for decades, and California and courts in other jurisdictions not only continued to apply the “unfinished business” doctrine to contingency fee matters, but also to hourly fee matters. See, e.g., Rothman v. Dolin, 20 Cal. App. 4th 755 (1993) (cited in Heller, 4 Cal. 5th at 475). However, as discussed in Heller, California adopted the Revised Uniform Partnership Act (RUPA), California Corporations Code sections 16100 to 16962, in 1997. RUPA contained some material revisions to the UPA that provided the underpinnings for Jewel. First, RUPA replaced former California Corporations Code section 15021(1), which addressed the duty to account for benefits and profits, with section 16404(b)(1). Section 16404(b)(1) provides only for a duty to account for profits or benefits derived by the partner (a) in the conduct or winding up of partnership business; or (b) from the use by the partner of “partnership property or information, including the appropriation of a partnership opportunity.” Cal. Corp. Code § 16404(b)(1) (cited in Heller, 4 Cal. 5th at 475). Second, RUPA included a new provision related to a partner’s fiduciary duty to refrain from competing, limiting the duty to refrain from partnership to the period before dissolution. Cal. Corp. Code § 16404(b)(3) (cited in Heller, 4 Cal. 5th at 475). Finally, RUPA changed the rule pertaining to partners’ post-dissolution rights to receive compensation for services provided in the winding up of partnership affairs. The Jewel court relied heavily on former California Corporations Code section 15018(f), which provided that no partner other than a surviving partner may receive compensation for services rendered in completing unfinished business. See Jewel, 156 Cal. App. 3d at 176. However, RUPA repealed section 15018(f) and replaced it with California Corporations Code section 16401(h), which expressly authorizes all partners to receive reasonable compensation for services rendered in the winding up of partnership affairs. Cal. Corp. Code § 16401(h) (cited in Heller, 4 Cal. 5th at 475).

Despite the fact that California revised the UPA and adopted RUPA in 1997, two decades have passed without the California Supreme Court’s weighing in on whether the holding and reasoning in Jewel required clarification given recent changes in the law. Heller and a certified question from the Ninth Circuit to the California Supreme Court provided a long-awaited opportunity for the California Supreme Court to opine on the open issue.

The California Supreme Court Opined in Heller That Dissolved Partnerships Have No Property Interest in Post-Dissolution Fees Received on Hourly Rate Matters

This brings us to the demise of Heller Ehrman LLP, and the bankruptcy plan administrator’s attempt to recoup for creditors of the firm fees received by the former shareholders of the firm who took active matters with them to some of the nation’s largest law firms. In October 2008, Heller announced it would be dissolving. The firm’s dissolution plan included a provision known as a Jewel waiver, which specifically purported “to waive any rights and claims Heller may have had to seek payment of legal fees generated after the departure date of any lawyer or group of lawyers for non-contingency/non-success fee matters only.” Heller, 4 Cal. 5th at 471. Former Heller partners took active matters with them to their new firms, and the clients signed new engagement agreements with the new firms.

When Heller filed for Chapter 11 bankruptcy protection, the plan administrator responsible for pursuing claims to recover assets for the benefit of Heller’s creditors filed an adversary proceeding against the law firms where former Heller shareholders landed after the dissolution, seeking to set aside the Jewel waiver on the basis of fraudulent transfer and recover post-dissolution fees paid to former shareholders at their new firms. Id. at 472. The district court reversed a decision of the bankruptcy judge in favor of the firm (i.e., the bankruptcy estate), determining that RUPA undermined Jewel, and holding that Heller did not have a property interest in hourly fee matters pending at dissolution. Thus, there had been no fraudulent transfer of those matters to new law firms. Heller appealed to the Ninth Circuit, which posed the question to the California Supreme Court “whether a dissolved law firm retains a property interest in such legal matters that are in progress—but not completed—at the time of dissolution.” Id. at 471.

The California Supreme Court in Heller narrowed the question posed by the Ninth Circuit, addressing only whether a dissolved law firm retains a property interest in ongoing legal matters billed on an hourly basis. Id. at 473. The Heller bankruptcy trustee claimed an interest in matters on which the firm could not and would not work because the firm had dissolved, and it sought “remuneration for work that someone else must now undertake.” Id. at 477. The court held that Heller did not have any property interest in such fees because, even if Heller were a viable, ongoing business, the client “always owns the matter” and has the right to terminate counsel at any time with or without cause. Id. at 478. Thus, the court deemed any expectations of continuing to work on active hourly matters speculative and insufficient to create a property interest in work the partnership has not performed. Id. Turning to the express language of RUPA, the court held that Heller was entitled only to those fees that were incurred in connection with the “winding up of a law partnership’s hourly fee matters,” including for acts necessary to (a) preserve legal matters for transfer to new counsel or the client itself; (b) effectuate the transfer; and (c) collect on work done pre-transfer. Id. at 481.

The Heller opinion is rooted in three strong policy considerations noted by the court. First, the court noted that recognizing a profit interest in hourly matters would risk “impinging on the client’s right to discharge an attorney at will.” Id. at 479. As the court recognized, clients may view a mandate that a new firm substituted in has to share the client’s fees with a prior firm—in other words, work at a cut rate—as a disincentive to do their best for the client. The client may opt to move the case from the attorney of its choice and lose its investment in the attorney who worked on the matter for the old partnership in order to ensure the new attorney working on the matter is properly incentivized by the prospect of full payment of his or her hourly rate. Second, the court noted that recognizing a property interest in hourly fee matters would create incentives that are “perverse to the mobility of lawyers” because attorneys of a dissolved firm would face challenges bringing in unfinished business to prospective new firms if the fees from such matters had to be shared with the old firm. Id. at 478. Finally, the court pointed to the potential for creating partnership instability with partners’ incentive to “jump ship” at the first sign of trouble in a partnership in order to ensure they took matters with them prior to dissolution. Id. at 480.

Jewel May Still Make Sense in the Context of Contingency Fee Cases

In Heller, the California Supreme Court specifically declined to address whether its conclusion extends to contingency fee matters. Id. In dicta, however, the court noted that a contingency fee matter may be distinguishable because the dissolved firm invested time in the active matter, but would not be paid until the matter resolved. Id. at 481. Contingency fee matters involve an investment of time and money based on a risk assessment by the law firm as to whether it will be compensated by a return on its investment at the conclusion of the matter. In an hourly fee arrangement, the client presumably pays for the hours billed on a regular and ongoing basis and, therefore, the dissolving firm has no outstanding expectation of payment based on work previously invested in the matter. The holding in Heller that a dissolving firm holds no property interest in future hourly fees was based in part on its conclusion that the expectation of future work, and the compensation that would stem from that work, was speculative because the client could terminate the firm at any time and would be paid in full at that time. Applying this holding to contingency fee matters would not make sense where the investment, which could amount to years of work, already had occurred—i.e., the uncompensated work is in the past. Most contingency fee agreements, in fact, specifically contemplate that a client may choose to move to another firm, but the original firm remains entitled to the reasonable value of its services in the event of a future recovery or settlement. Thus, while the Heller court dodged the question of whether Jewel remains intact for contingency fee matters, there is a strong argument that a dissolving firm has a property interest in its investment in a contingency fee matter that is active at the time of dissolution and should be compensated for that investment to avoid a windfall to the new firm. That windfall simply does not exist in an hourly fee matter.

Mary A. Dannelley is a sole practitioner in Newport Beach, California. Ms. Dannelley practices in the areas of commercial and employment litigation. Ms. Dannelley also provides employment counseling to employers and conducts independent workplace investigations. Ms. Dannelley is a member of the OCBA Professionalism and Ethics Committee. Ms. Dannelley can be reached at mary@dannelleylaw.com.

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