Anthony E. Davis
Anthony E. Davis ()

Editors’ Note: This article has been updated to reflect a Correction.

This article considers two recent developments relating to legal fees, and the latest, and apparently almost final installments of the “unfinished business” saga. The case and rule changes that address legal fees both highlight the critical need for lawyers and law firms to take care in the drafting of their engagement letters. Two just decided cases deal an apparent death blow to the “unfinished business” doctrine in both New York as well as in its birthplace, California.

Legal Fees

In Captain Lori Albunio v. The City of New York, 23 NY3d 65, the New York Court of Appeals reaffirmed the principle that an engagement letter will be strictly interpreted against the lawyer who drafted it. The decision focused on the wording of a series of engagement letters relating to a contingency fee case that also involved the award of statutory legal fees by a court. The underlying case concerned alleged violations of the New York City Human Rights Law (NYCHRL). The plaintiffs engaged an attorney who initially presented them with a contingency fee agreement providing only that she would receive “a contingency fee equal to 33-1/3 percent of the sum recovered, whether recovered by suit, settlement or otherwise.”

It went on to explain that “[s]uch percentage shall be computed on the net sum recovered after deducting taxable costs and disbursements,” and that, but for certain enumerated items, “there shall be no deduction in computing such percentages.” The agreement made no reference to the fact that, under the fee provision of the NYCHRL, a court may, in its discretion, award reasonable counsel fees to the prevailing party in certain civil rights actions, nor did it address the method by which the contingency fee would be calculated in the event that the court were to award statutory fees.

A jury ruled in the plaintiffs’ favor and awarded $986,671 in damages. In connection with the appeals that followed, the plaintiffs’ lawyer prepared two further engagement letters. Unlike the original agreement, these new agreements explicitly dealt with the distribution of statutory fees that could be awarded in conjunction with the appeals, and each provided that “In the event [the lawyer] is entitled to fees as a result of the outcome of the Appeal, she may apply to the Court for such fees and will be entitled to them in their entirety. In the event [the lawyer] is successful in the appeal in whole or in part, but no fees are awarded by the Court for work done on the appeal, or the fees awarded are less than $20,000, [the client] agrees to pay [the lawyer] the sum of $20,000 in consideration of such work or the difference between the fees awarded and $20,000. Successful, in whole or in part, shall be for anything less than dismissal of the action.”

In due course, upon successes at trial and in the initial appeal, the courts awarded the plaintiffs’ lawyer a combined total of approximately $530,000 in statutory legal fees. At that point a dispute arose as to how much the lawyer was entitled to receive. She then sought a declaratory judgment to enforce the three retainer agreements, now claiming that her one-third contingency fee should be calculated based on the total value of the statutory counsel fees for trial work plus the jury award. She argued that the initial contingency fee agreement’s reference to the “sum recovered” should be broadly construed to encompass statutory fees as well as the damage awards, and that the appellate statutory fees should not offset the contingency fee owed for her trial work. Both the trial court and the Appellate Division adopted her interpretation of the agreements, and awarded her the fees as she calculated them.

The Court of Appeals set aside the decisions of the lower courts. Writing for the court, Chief Judge Jonathan Lippman held that the terms of the initial agreement “do not unambiguously provide that any statutory fees are part of the ‘sum recovered’ and therefore subject to the one-third contingency fee.” By failing to “so much as mention the possibility of statutorily awarded fees, the existence of which the average client is presumably unaware,” the agreement should not be construed to include any such amounts within the scope of the contingency.

Most importantly, he held that “The general rule that ‘equivocal contracts will be construed against the drafters’ is subject to particularly rigorous enforcement in the context of attorney-client retainer agreements” (citations omitted), and that “[t]he importance of an attorney’s clear agreement with a client as to the essential terms of representation cannot be overstated. The client should be fully informed of all relevant facts and the basis of the fee charges, especially in contingent fee arrangements” (citations omitted).

Accordingly, as a matter of public policy, courts “cast[] the burden on attorneys who have drafted the retainer agreements to show that the contracts are fair, reasonable, and fully known and understood by their clients.” In the circumstances, the court held that the lawyer had failed to meet her burden with regard to the initial contingency fee agreement.

In a related development, there has been a significant change in the Rules of the Appellate Division, Second Department, relating to the computation of contingency fees in personal injury matters. The following is the blacklined version of Section 691.20(e) of those Rules, adopted in February 2014. The underlined portions reflect the changes and new language.

(3) Such percentage shall be computed by one of the following two methods, to be selected by the client in the retainer agreement or letter of engagement: (i) on the net sum recovered after deducting from the amount recovered expenses and disbursements for expert medical testimony and investigative or other services properly chargeable to the enforcement of the claim or prosecution of the action ; or (ii) in the event that the attorney agrees to pay costs and expenses of the action pursuant to Judiciary Law §488(2)(d), on the gross sum recovered before deducting expenses and disbursements. The retainer agreement or letter of engagement shall describe these alternative methods, explain the financial consequences of each, and clearly indicate the client’s selection. In computing the fee, the costs as taxed, including interest upon a judgment, shall be deemed part of the amount recovered. For the following or similar items there shall be no deduction in computing such percentages: Liens, assignments or claims in favor of hospitals, for medical care and treatment by doctors and nurses, or self-insurers or insurance carriers.

The other departments adopted parallel changes, albeit somewhat later than the Second Department, so that this rule is now in effect in all four departments (see First Department: Rule 603.7(e); Third Department: Rule 806.13(c); and Fourth Department: Rule 1022.31(c)). The rules in all four departments therefore now clearly require lawyers who undertake contingency fee work to revise their form engagement letters in order to give their clients the opportunity to select which of the two computational methods the clients wish to adopt.

‘Unfinished Business’

The “unfinished business” rule has been the subject of several previous articles in this column (see: “‘Unfinished Business’—Expanding Hurdle to Lateral Hiring,” Aug. 1, 2012; “More on Law Firms, Bankruptcy and ‘Unfinished Business,’” Nov. 2, 2012; and “Update on Fee Suits and Unfinished Business,” May 6, 2013).

The first of the two new decisions came from California, where the rule had appeared to be alive and well following a string of holdings in the context of the bankruptcies of several prominent firms. The new ruling, the first from a federal district court, utterly rejects the unfinished business doctrine under California law. In the bankruptcy proceedings involving the demise of Heller Ehrman LLP, the trustee of the Heller Ehrman firm had made successful “unfinished business” claims in the bankruptcy court against a number of prominent firms which former Heller Ehrman lawyers had joined after that firm’s collapse.

In Heller Ehrman v. Davis, Wright, Tremaine, 2014 WL 2609743 (N.D.Cal.), U.S. District Judge Charles R. Breyer issued an Order Re Summary Judgment in which he resoundingly rejected the rule as he understood and interpreted California law. Breyer posed the question before him thus: “whether a law firm—which has been dissolved by virtue of creditors terminating their financial support, thus rendering it impossible to continue to provide legal services in ongoing matters—is entitled to assert a property interest in hourly fee matters pending at the time of its dissolution.”

He answered the question succinctly:

“…under the facts presented here, neither law, equity, nor policy recognizes a law firm’s property interest in hourly fee matters.” First, as to the law, the Court finds that Jewel v. Boxer, 156 Cal.App.3d 171 (1984), an intermediate state appellate court decision, is not controlling under these facts and that no California Supreme Court decision supports such a result. Second, the equities clearly favor the Defendants (third-party law firms which earned the compensation paid to them) over the Heller Ehrman firm (which received full payment for its services). And finally, considering the policies favoring the primacy of the rights of clients over those of lawyers, it is essential to provide a market for legal services that is unencumbered by quarrelsome claims of disgruntled attorneys and their creditors. 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. (Other citations omitted.)

After first reviewing the undisputed facts relating to the demise of the Heller Ehrman firm, and the trustee’s claims, Breyer noted that the bankruptcy court’s decisions favoring the trustee rested entirely upon that court’s interpretation of the Jewel decision, which held that, absent an agreement to the contrary, profits derived from a law firm’s unfinished business are owed to the former partners in proportion to their partnership interests. He then rejected the bankruptcy court’s conclusion and reasoning, holding that:

Jewel is different from the cases here for five key, related reasons. 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 line of credit.…Second, in Jewel, “[t]he new firms represented the clients under fee agreements entered into between the client and the old firm.” Id. at 175. Here, the clients signed new retainer agreements with the new firms. Third, in Jewel, the new firms consisted entirely of partners from the old firms…Here, Defendants are preexisting third-party firms that provided substantively new representation, requiring significant resources, personnel, capital, and services well beyond the capacity of either Heller or its individual Shareholders.…Fourth, Jewel treated hourly fee matters and contingency fee matters as indistinguishable. Here, there are no contingency fee cases at issue. Finally, Jewel was decided in 1984 and thus applied the Uniform Partnership Act… which the materially different Revised Uniform Partnership Act (the “RUPA”) has since superseded. 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.

After detailed discussion of the differences between the two statutes, he concluded that

…there is no provision of the RUPA that gives the dissolved firm the right to demand an accounting for profits earned by its former partner under a new retainer agreement with a client. Moreover, here, the new retainer agreements were not even signed between former Heller clients and former Heller Shareholders but rather between the clients and new, third-party firms.

Breyer then turned to consider the equities of the case, and again trenchantly rejected all of the trustee’s claims that the former Heller Ehrman firm lawyers had a fiduciary duty to account to that firm’s estate for profits their new firms earned from work on former Heller matters.

But perhaps the most significant element of Breyer’s decision came when he addressed the question of the ownership of client matters. He held that “A law firm never owns its client matters. The client always owns the matter, and the most the law firm can be said to have is an expectation of future business.”

Finally, Breyer addressed the numerous public policy claims the trustee asserted as to why the rule should be applied in favor of the Heller Ehrman firm’s estate. His conclusion was emphatic:

Such a holding would discourage third-party firms from hiring former partners of dissolved firms and discourage third-party firms from accepting new clients formerly represented by dissolved firms. It is not in the public interest to make it more difficult for partners leaving a struggling firm to find new employment, or to limit the representation choices a client has available, by establishing a rule that prevents third-party firms from earning a profit off of labor and capital investment they make in a matter previously handled by a dissolved firm.

The second decision comes from the New York Court of Appeals, and reaches the same conclusion as Judge Breyer’s in the Heller Ehrman case. The applicability of the rule to hourly fee cases in New York arrived at the New York Court of Appeals as a result of the referral from the U.S. Court of Appeals for the Second Circuit following the appeals of two conflicting decisions from the U.S. District Court for the Southern District of New York. In Development Specialists v. Akin Gump, 462 B.R. 457, decided by Judge Colleen McMahon in connection with the bankruptcy of the Coudert Brothers firm, McMahon concluded that the unfinished business rule does apply under New York law, while in Geron v. Robinson & Cole, 2012 WL 3800766 (S.D.N.Y., Sept. 4, 2012) in connection with the bankruptcy of the Thelen firm, Judge William Pauley III concluded that it does not.

The decision of the Court of Appeals, In re: Thelen LLP, was handed down on July 1, 2014. (Readers should note that the opinion is marked as “uncorrected and subject to revision before publication in the New York Reports.” Accordingly, quotes from the decision below may change when it is published officially.)

The first paragraph of the court’s opinion, authored by Judge Susan P. Read, lays out the question posed by the Second Circuit and the Court of Appeals’ answer—which, in reaching the same conclusion as Judge Breyer, is as unambiguous and emphatic as Breyer’s decision:

The United States Court of Appeals for the Second Circuit has asked us two questions relating to “whether, for purposes of administering [a]…related bankruptcy, New York law treats a dissolved law firm’s pending hourly fee matters as its property” (In re: Thelen LLP [Geron v. Seyfarth Shaw LLP], 736 F3d 213, 216 [2d Cir. 2013]). We hold that pending hourly fee matters are not partnership “property” or “unfinished business” within the meaning of New York’s Partnership Law. A law firm does not own a client or an engagement, and is only entitled to be paid for services actually rendered.

The opinion considers the applicable provisions of the New York Partnership Law, noting most significantly that:

the Partnership Law does not define property; rather, it supplies default rules for how a partnership upon dissolution divides property as elsewhere defined in state law. As a result, the Partnership Law itself has nothing to say about whether a law firm’s “client matters” are partnership property. When discussing what constitutes “property,” we have explained that the “expectation of any continued or future business is too contingent in nature and speculative to create a present or future property interest.” Although property is often described as a “bundle of rights,” or “sticks,” with relational aspects…the ability to terminate the relationship at any time without penalty [] cannot support a finding that a transferrable property right existed. (Verizon New England v Transcom Enhanced Servs. (21 NY3d 66, 72 [2013] [emphases added by the court]).

From this base, the opinion moves to address the core issue in these cases:

“In New York, clients have always enjoyed the unqualified right to terminate the attorney-client relationship at any time” without any obligation other than to compensate the attorney for “the fair and reasonable value of the completed services” (In re Cooperman, 83 NY2d 465, 473 [1994] [emphasis added by the court]). In short, no law firm has a property interest in future hourly legal fees because they are “too contingent in nature and speculative to create a present or future property interest” (Verizon New England, 21 NY3d at 72), given the client’s unfettered right to hire and fire counsel. Because client matters are not partnership property, the trustees’ reliance on Partnership Law §4(4) is misplaced. As the District Court Judge in Geron pointed out, “[t]he purpose of [the] UPA is to harmonize partners’ duties regarding partnership property, not to delineate the scope of such property” (Geron, 476 BR at 742 [emphasis added by the court]).

Notably, the opinion then goes on to discuss whether the result is different in contingency fee cases, and adopts the decisions in several Appellate Division cases which “in the context of contingency fee arrangements uniformly conclude that the dissolved partnership is entitled only to the ‘value’ of its services.” The opinion goes on to adopt the language of the Appellate Division in a contingency fee case: “Stated conversely, the lawyer must remit to his former firm the settlement value, less that amount attributable to the lawyer’s efforts after the firm’s dissolution.” (citation omitted).

Finally, in this context, the opinion points out that “these [contingency fee] cases have involved disputes between a dissolved partnership and a departing partner, not outside third parties. In this context, statements that contingency fee cases are ‘assets’ of the partnership subject to distribution simply means that, as between the departing partner and the partnership, the partnership is entitled to an accounting for the value of the cases as of the date of the dissolution.” (Emphasis added by the author).

The opinion continues with a discussion of the earlier Court of Appeals decision in Stem v. Warren (227 NY 538 [1920]). Holding that the Stem case was about the scope of fiduciary duties, the court explicitly rejected the trustee’s assertions that the Stem case stands for the propositions “that executory contracts to perform professional services are partnership assets unless a contrary intention appears,” and that unfinished client engagements were defined as partnership property.

Finally, the opinion addresses the public policy questions, powerfully reaffirming the court’s (and New York’s) long history of supporting clients’ freedom to select counsel of their choice, and lawyer mobility.

While it remains for the Second Circuit to rule on the appeals from the Thelen and Coudert cases, it seems almost certain that its decision will be to uphold the decision in Thelen and overturn the decision in Coudert. By removing the threat that has been hanging over hiring firms of having to pay fees earned by those firms to the estate of the dissolved firms from which their laterally hired lawyers come, this outcome will please every law firm that regularly engages or plans to engage in lateral hiring in New York as part of its business strategy. Whether the outcome will ultimately be the same in California, only time—and, perhaps, further appeals—will tell. Hopefully (in the view of this writer), the reasoning of both the New York Court of Appeals and of Judge Breyer will ultimately prevail there also.

Anthony E. Davis is a partner at Hinshaw & Culbertson and a past president of the Association of Professional Responsibility Lawyers.