There is “a tragic misconception of time, from the strangely irrational notion that there is something in the very flow of time that will inevitably cure all ills.” Martin Luther King Jr., “Letter from Birmingham Jail”
2018, with all its political turmoil, has come and (not quite, but almost) gone. In this month’s column, as we have done since 2006, we celebrate the passing of the year by reviewing, in the annual roundup, some recent cases from around the country relevant to law firm partnerships. This year there are two cases of first impression.
On Dec. 12, 2017, the case of Floyd Finch and Bruce Campbell regarding a dispute over the dissolution of their law partnership was decided by the Missouri Court of Appeals, Western District. Finch v. Campbell, 2017 WL 6329924 (W.D. Mo. 2017).
The court decided a number of issues, one of which regarded whether a breach of fiduciary duty existed concerning a law partner’s refusal to record time despite demand from a partner or client. This was an issue of first impression for the Missouri appellate court. Id. at 4. The court opined that “Finch [the attorney in question] had a fiduciary duty to Campbell [his former partner],” for “[a] partner’s fiduciary duty includes the duty to be candid concerning business opportunities, the duty to be fair, the duty not to put self-interests before the interests of the partnership, and the duty not to compete with the partnership.” Id. at 5 (citing Matter of Cupples, 952 S.W.2d at 235-36). According to the evidence, the court determined that Finch had hurt his firm, for Campbell and the firm’s clients were unhappy with Finch’s billing methods. Id. at *5. Furthermore, according to Campbell, Finch purposely did not bill his clients so as to claim to have a lower income in his 2012 proceedings for divorce, and the court opined that Finch could not now claim that his income was higher in his dispute with his law partner. Id. at *5 & *11-12. The court ruled that “there is ample case law to support the contention that parties are not allowed to take clearly inconsistent positions in differing lawsuits.” Id. at *11. Finally, the court also held that, while Campbell breached his fiduciary duty insofar as he barred Finch from the firm, neither this, nor any of Campbell’s actions damaged or reduced the partnership’s assets. Id. at *8-9.
On March 5, 2018, the Supreme Court of California decided Heller Ehrman v. Davis Wright Tremane, 4 Cal. 5th 467 (2018). In Heller Ehrman, California’s high court found, like the New York Court of Appeals had previously ruled in In re Thelen, 995 N.Y.S.2d 534 (2014), that a dissolved law firm did not have a property interest in hourly matters for work performed after dissolution. Heller Ehrman, 4 Cal. 5th at 472-73.
The “certified question” to California’s highest court was “what property interest, if any, a dissolved law firm has in the legal matters, and therefore the profits, of cases that are in progress but not completed at the time of dissolution.” Id. at 467 & 473. The court succinctly answered the question and then presented its analysis of both the property interests of law firms and the impact on clients’ right to counsel of their choice, stating:
What we hold is 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. The partnership has no more than an expectation that it may continue to work on such matters, and that expectation may be dashed at any time by a client’s choice to remove its business. As such, the firm’s expectation—a mere possibility of unearned, prospective fees—cannot constitute a property interest. To the extent the law firm has a claim, its claim is limited to the work necessary for preserving legal matters so they can be transferred to new counsel of the client’s choice (or the client itself), effectuating such a transfer, or collecting on work done pretransfer.
Id. at *471.
The court, to a large extent, based its conclusion on what it perceived as a law firm’s “narrow” and “limited” property interest in client matters. Id. at *473. The court explained:
What we conclude is that a dissolved law partnership is not entitled to profits derived from its former partners’ work on unfinished hourly fee matters. Any expectation the law firm had in continuing the legal matters cannot be deemed sufficiently strong to constitute a property interest allowing it to have an ownership stake in fees earned by its former partners, now situated at new firms, working on what was formerly the dissolved firm’s cases. Any “property, profit, or benefit” accountable to a dissolved law firm derives only from a narrow range of activities: those associated with transferring the pending legal matters, collecting on work already performed, and liquidating the business.
The limited nature of the interest accorded to the dissolved law firm protects clients’ choice of counsel. It allows the clients to choose new law firms unburdened by the reach of the dissolved firm that has been paid in full and discharged. The rule also comports with our policy of encouraging labor mobility while minimizing firm instability. It accomplishes the former by making the pending matters, and those that work on them, attractive additions to new firms; it manages the latter by placing partners who depart after a firm’s dissolution at no disadvantage to those who leave earlier.
Finally, in this regard, the court concluded that “[t]he firm never owned such matters, and upon dissolution, cannot claim a property interest in the income streams that they generate.” Id. at *478. The California Court also identified a “host of difficulties” if it ruled otherwise. Id. These difficulties included the impediment to lawyer mobility as well as the negative impact to clients’ choice of counsel. Id. at 478-79.
On March 27, 2018, the New York Court of Appeals issued a decision which also includes a matter of first impression. Congel v. Malfitano, 31 N.Y.3d 272 (2018), concerned partners in a partnership that owned and operated a shopping mall. While Congel addressed a number of foundational partnership issues, it also ruled, as a matter of first impression, concerning the applicability of a minority discount to a partnership dissolution, which may impact future valuations of law firm partners’ interests in their firm upon dissolution.
As the court explained, a “minority discount is a standard tool in valuation of a financial interest, designed to reflect the fact that the price an investor is willing to pay for a minority ownership interest in a business, whether a corporation or a partnership, is less because the owner of a minority interest lacks control of the business.” Id. at 294-95. The Court of Appeals found unpersuasive defendants’ argument that a minority discount should not be applied in the valuation of a minority partner’s interest after the partners depart a business, which is a going concern. Id. at 295.
The Court of Appeals relied upon a case from the Supreme Judicial Court of Massachusetts, Anastos v. Sable, 443 Mass. 146 (2004). In Anastos, the plaintiff, like Malfitano in Congel, wrongfully dissolved a real estate partnership, but the partnership continued as a going concern. Id. at 147-48. Because, as in Congel, there was “no ready market” for the minority partner to sell his interest, and because there were, again like in Congel, contractual “limitations and restrictions” on the control a minority partner could exercise, the Massachusetts court found that the application of a minority discount was appropriate. Id. The Court of Appeals, applying Anastos to the facts of Congel, agreed and stated:
Here, similarly, Partnership Law§69(2)(c)(II) contemplates a valuation of a wrongfully dissolving partner’s interest based on treating the partnership as a going concern, rather than an asset to be liquidated. In other words, the statute does not contemplate a valuation of the entire business as if it were being sold on the open market, but rather a determination of the fair market value of the wrongfully dissolving partner’s interest as if that interest were being sold piecemeal and the rest of the business continuing as a going concern. Given that the focus is on one partner’s interest in a persisting concern, we agree with the Massachusetts high court that a minority discount is applicable, because a minority interest is worth less to anyone buying that interest alone.
Congel, 31 N.Y.3d at 296.
Finally, the majority noted that partnerships, which wished not to have a minority discount applied to departed partners in dissolution, could provide for such in their written partnership agreements. Id. at 298.
In a 10-page dissent, Judge Paul Feinman objected to the affirmance of the application of the minority discount. The dissent disagreed with the majority’s reliance on the proposition that the value of the partner’s interest is “‘the price at which [the interest] would change hands between a willing buyer and a willing seller’ ‘as if that interest were being sold piecemeal and the rest of the business continuing as a going concern.’” Id. at 300. The dissent relied upon the Revised Uniform Partnership Act (RUPA)—although not the law in New York—to support its position. RUPA permits a dissociated partner to be paid a proportionate share of the value of the business as a going concern set off against contractual damages. Id. at 301-02. That is, the focus of the value under RUPA is not on the value of the individual partner (as a willing seller), but on the sale of all the partnership’s assets, which may be explained by RUPA’s entity theory of partnership. Thus, according to the dissent, the application of a minority discount would be inappropriate. Id. at 302 (citations omitted).
Similarly, the dissent reasoned that the application of a minority discount in the wrongful dissolution context is inappropriate because the purchasers (the then current partners) are “merely consolidating and increasing whatever degree of control they already have over the business.” Id. at 305. Finally, the dissent, relying on the New York Partnership Law, concluded:
The structure of Partnership Law §69(2)(c)(II) already deters wrongful dissolution in two ways: by requiring the dissolving partner to pay damages, and by discounting the value of its partnership interests attributable to goodwill. A further discount for a lack of control is cumulative and unnecessary in light of these other provisions.
Id. at 310.
Rule 1.17 of the New York Rules of Professional Conduct, which permits the sale of a law practice, prohibits “piecemeal” sale; “[t]he Rule requires that the seller’s entire practice be sold.” New York Rule of Professional Conduct Rule 1.17, Official Comment . Accordingly, the majority decision’s consideration of the inclusion of a minority discount as if the partner’s interest were “sold piecemeal” may not be applicable to the valuation of a law firm partnership.
We wanted to thank the readers of this column for the very kind and encouraging words we heard throughout 2018. We hope this year’s columns have been helpful and even somewhat enjoyable. They are a labor of love and their writing remains a privilege.
Arthur J. Ciampi is the coauthor of the treatise ‘Law Firm Partnership Agreements’ and is the managing member of Ciampi LLC. Maria Ciampi, of counsel to Ciampi LLC, assisted in the preparation of this article.