In 2013, a number of law firms will not survive. Some are already in the process of dissolution. Other practices are teetering on the edge of insolvency. Certainly, some practices like real estate and corporate law have suffered more than others. Most firms have felt the pinch of the economic slowdown.
As the daily legal news confirms, the breaking apart of law firms will impact firms of all sizes, from the very large (like Dewey & LeBoeuf), where practice groups and then whole firms dissolve, to small firms in which the partners quietly close their doors. Some firms will manage the dissolution with the least amount of expense and time. For others, it will lead to ongoing litigation that will cost partners legal fees, time and expense that they can ill afford.
The key to avoiding problems is foresight and planning. Yet, most firms do not consider these issues until it is too late and disagreements or other problems arise. The best practice is to consider these issues long before a law firm’s demise becomes inevitable.
Like marriage, no law firm starts with the expectation that it will fail. Also like marriage, the best opportunity to plan for the unexpected (and unwanted) is before the partnership begins. In that way, a partnership agreement acts like a prenuptial agreement. The agreement can prescribe how money and other assets are distributed and what the parties’ responsibilities will be during and after the end of the relationship. Unfortunately, many firms do not realize this until it is too late.
Fortunately, the inception of the partnership is not the last opportunity to address dissolution. Instead, until insolvency, law firms can and should adopt specific dissolution procedures.
In the absence of specific provisions in a law firm’s partnership agreement, courts will apply general partnership and fiduciary law. Fact-intensive inquiries involved in the application of general fiduciary principles usually make dissolution in those cases expensive and lengthy. Rather than making money in a new law practice, partners spend inordinate time and resources litigating with each other. Nothing good follows.
Healthy law firms and not-so-healthy law firms—including those struggling but not yet insolvent—should stop now and take a look at their partnership agreements. Make sure that the partnership agreement addresses insolvency and dissolution in an expedient, fair, efficient, economical and tax-advantageous way.
More importantly, make sure that any dissolution procedures included in the partnership agreement comply with the ethical obligations imposed by the Rules and Regulations of the State Bar of Georgia. Procedures that violate bar rules are unenforceable—even if approved unanimously by the partnership.
Even for firms with dissolution procedures in place, new exposures arising out of some recent large law firm failures merit a fresh look at the partnership agreement. As a general rule, absent an agreement to the contrary, all partners have an interest in any income received after dissolution.
But what about fees generated from matters that partners take to other firms upon dissolution? Bankruptcy courts have in some cases applied a new concept for attaching dissolved law firm liabilities to former partners of failed law firms and the law firms that hire them.
This right to “unfinished business” has become a hot topic. When firms dissolve, the partners often move their respective practices to other firms and take with them clients and pending matters that began prior to dissolution. The partners will continue to work on those matters at their new firms and to bill their clients for that work. But under the “unfinished business” doctrine, the fees collected on those matters that began prior to dissolution belong to the dissolved partnership, not the partners or their new firms, even for work performed after the move to the new firm.
This new liability is called a “Jewel Liability,” named after the case of Jewel v. Boxer, 156 Cal. App. 3d 171 (Cal. Ct. App. 1984). In Jewel, the court held that “absent a contrary agreement, any income generated through the winding up of unfinished business is allocated to the former partners according to their respective interests in the partnership.”
As a result, law firms that hired the partners of a failed law firm could be ordered to disgorge profits from client relationships that the hired partner brings from the failed law firm. The sheer size of the liability in such circumstances is notable.
Importantly, the “unfinished business” doctrine is a default rule that applies only when there is no provision in the partnership agreement governing the allocation of fees after dissolution. The solution to the “Jewel Liability” on a prospective basis has been a “Jewel Waiver.” This is a provision adopted by the partnership prior to insolvency in which the firm waives its rights to attach future profits from firms hiring departing partners. Such provisions must be carefully worded to comply with both the requirements of debtor/creditor law and the ethical obligations imposed by courts and the bar.
Whether to adopt such a waiver is a question for each individual partnership. Some firms have decided that they do not want to give up such an asset. On the other hand, many partners who make up such firms have concluded that such a waiver is in their individual best interest. Regardless of which decision firms and partners make, it is a decision that must be made before a law firm reaches the point of insolvency. Such a waiver—executed after insolvency—is ineffective.
One of the biggest issues facing a dissolving law partnership is how income received and debt remaining after the date of dissolution will be allocated. In those circumstances, attorneys have three different fiduciary obligations to balance. They obviously have a fiduciary obligation to their clients. Second, they have a fiduciary obligation to their partners. Third, after insolvency, they have fiduciary obligations to the firm’s creditors. Balancing the interests of all three is challenging in the best of circumstances.
When the various fiduciary obligations conflict, the safest course for a law firm is to seek professional assistance. This may include the appointment of a receiver or trustee. Practicing law and managing an insolvent law firm rarely works. Ignoring the numbers and hoping that things turn around is also not a solution. It is not the advice that an attorney would give, and it is not the solution that attorneys should follow.
Last year, the Georgia Supreme Court decided a case that illustrated just how complicated law firm dissolutions can be. In Jordan v. Moses, 291 Ga. 39 (2012), the court reaffirmed that partners must act in good faith when dissolving their partnership, and held that a partner can be liable for wrongful dissolution when that partner “attempt[s] to appropriate, through the dissolution, the assets or business of the partnership, which may include prospective business, without adequate compensation to the remaining partners.”
Notwithstanding its ruling, the case between the partners to the firm went on —costing more time, more money and more resources.
There is a better answer. Either address it specifically in the partnership agreement, or hire someone to help solve the problem. In the end, no one is ever happy with the aftermath of a failed firm. Yet there is no reason to let a financial setback become an economic death spiral for partners who have most of their careers still ahead of them.