The doctrine of unfinished business received an unneeded, and hopefully only temporary, boost in May, in a decision by the U.S. District Court for the Southern District of New York titled Development Specialists v. Akin Gump Straus Hauer & Feld (DSI).1

In DSI, U.S. District Judge Colleen McMahon held that the dissolved law firm of Coudert Brothers LLP2 could share in the profit of matters billed on an hourly basis which were at Coudert prior to its dissolution but which were completed (finished) at other law firms after its dissolution. The decision is based upon the fact that the Coudert partnership agreement did not address the issue of unfinished business and on the court’s prediction of the likely outcome of New York law because the New York Court of Appeals has not ruled on this issue.

In this column, we offer law firms that wish to exclude unfinished business from post dissolution assets a suggested means of doing so. In addition, we provide an analysis of the DSI decision and an explanation of the reasons we believe that it does not reflect New York law and should not be adopted as the law of New York.

Avoiding Claims

In New York, the vast majority of the provisions of the Partnership Law are merely default provisions. Partners are permitted and encouraged (at least by this commentator) to draft a partnership agreement that fits their business needs. These agreements supplant the Partnership Law, and thereafter partners are governed by these agreements, not the Partnership Law.

The doctrine of unfinished business can be avoided by a relatively simple provision to a written partnership agreement. While some firms bridle at the notion of having to include this provision in their agreements and, therefore, delay its implementation, the burden is very small and the results of including such a provision are to eliminate the entire unfinished business issue which, if unresolved, further complicates the already difficult issue of dissolution. In short, if the Coudert firm had such a provision in its agreement,3 its partners and their new law firms would have avoided the headaches and costs they face in the DSI case. Such a provision needs to exclude from partnership assets related to unfinished business. An example of such a provision is as follows:

Waiver Concerning Unfinished Business. Neither the Partners nor any third parties shall have any claim or entitlement to any funds related to clients, cases or matters including, without limitation, those ongoing at the time of any bankruptcy, insolvency, dissolution or termination of the Partnership, other than the entitlement for collections of amounts due for work performed by the partners or other Partnership personnel on behalf of the Partnership prior to their departure from the Partnership or prior to, including, without limitation, any bankruptcy, insolvency, dissolution or termination of the Partnership. The provisions of this Paragraph are intended to and expressly waive, opt out of and are in lieu of any right any partner, the Partnership or a third-party may have to “unfinished business” of the Partnership.

Of course, firms that continue to function without written partnership agreements run the risk of unfinished business claims (as well as other risks). It is our hope that this decision will at least function as a “wake up” call to those firms to promptly enter into a written partnership agreement which includes the above language.

Analyzing ‘DSI’

In DSI, DSI, the appointed sole administrator of the bankrupt and dissolved law firm of Coudert, sued 10 law firms to collect from them hourly fees from matters which were worked on by Coudert prior to its dissolution and completed by former Coudert partners at the defendant firms. The firms moved for summary judgment, arguing that Coudert had no property interest in the client matters because the client matters were billed by the hour and the payment to Coudert was not subject to any contingency. DSI cross moved for summary judgment declaring that the client matters were Coudert assets because they were unfinished business of Coudert at the date of dissolution.

The court denied the firms’ motion, granted DSI’s motion, found that the hourly billed matters were Coudert assets on the date of dissolution, and found, that because the hourly billed matters were Coudert assets at the date of dissolution, they were Coudert assets for which the former Coudert partners’ new firms had to account.

Hourly vs. Contingent

The “unfinished business” doctrine has for many years been routinely applied to contingency fee cases in New York. DSI’s extension of this doctrine to matters billed on an hourly basis is problematic and, we contend, contrary to New York law and New York public policy concerning the practice of law.

The basic underpinning for the decision is that partners of a dissolved firm owe one another fiduciary duties in the winding up of the partnership4 which requires the former partners to account for all profits earned by whatever partner finishes the business the dissolved firm started. In addition, the decision relies upon the “no compensation rule” which provides at Partnership Law §40(6) that: “No partner is entitled to remuneration for acting in the partnership business….”5 This rule contemplates that partners are not entitled to be compensated for their efforts in winding up a dissolved partnership.

The DSI decision, however, gives short shrift and undue service to New York case law which has directly and indirectly addressed this issue. Based upon these cases and the application of the New York Rules of Professional Conduct, we believe that DSI is not correctly decided and that the New York Court of Appeals will ultimately rule that matters billed on an hourly basis will not be subject to the unfinished business rule.

First, wholly ignored by DSI is that the only case in New York to address whether the unfinished business rule applied to hourly cases found that it did not and dismissed such a claim. In Sheresky v. Sheresky Aronson Mayefsky & Sloan,6 Justice Eileen Bransten of the New York County Commercial Division dismissed a claim for unfinished business concerning hourly matters as inequitable7 and unethical; furthermore, the court stated that “[i]t is logical to distinguish between contingency fee arrangements and cases which are billed on the basis of hourly work.” (The author represented plaintiff Norman Sheresky in this matter.)

But Sheresky is just the beginning of New York state and federal authority which supports excluding matters billed by the hour from the “unfinished business doctrine.” Cases that have addressed the “unfinished business doctrine” in New York in the contingent fee context8 also support not applying the doctrine to matters billed on an hourly basis. DSI concludes, unfortunately we contend, that these cases from the First and Third departments and which have been applied by three of the four Appellate Divisions and the U.S. Court of Appeals for the Second Circuit were wrongly decided.9

In Santalucia, the Second Circuit addressed the issue of the distribution of fees earned by former partners of a dissolved law firm from contingency cases. The court plainly stated that, “to the extent that the ‘successful settlement of a pending contingent fee case post-dissolution is due to a surviving partner’s post dissolution efforts, skill and diligence,’ the dissolved firm had no cognizable property interest in the fee.”10

With hourly billing, the legal fees earned after dissolution are due purely to the efforts, skill, and diligence of the former partners at the new firm. Thus the dissolved firm, which exerted no applicable efforts, skill or diligence, can have “no cognizable property interest in the fee.” Accordingly, the dissolved firm should not be entitled to any portion of the fees generated from the “unfinished business” generated on an hourly basis.

Rules of Professional Conduct

In addition, it is submitted that DSI overlooked the ethical impediments to the application of the “unfinished business doctrine” to hourly cases. There are at least two ethical restraints which we also contend bar the application of this doctrine to unfinished business. One is the prohibition on actions that limit or impede, through financial disincentives, clients’ choice of counsel set forth in case law and the New York Rule of Professional Conduct 5.6, and the other is the limitation to fee sharing set forth in case law and the New York Rule of Professional Conduct 1.5.

Rule 5.6 of the Rules of Professional Conduct and the applicable case law should also prohibit the application of the unfinished business doctrine to matters billed on an hourly basis. New York courts have long held that financial disincentives to a lawyer’s continuing representation of a client improperly impinges on a client’s choice of counsel.11

It is submitted that applying the unfinished business doctrine to matters billed on an hourly basis creates such an improper financial disincentive which will cause lawyers not to pursue matters for clients because they will be required, if DSI becomes the law in New York, to forfeit the profit from such matters and would be forced to complete matters without profit. This burden may force lawyers to refuse to continue to work on client matters.

In DSI, all of the defendant firms were large institutional firms who might (although not at all necessarily) be able to float the unfinished work without profit in the hope of new business from the client in the future. In a small or solo firm environment, the impact of the forfeit of profit will be very real and would certainly unduly prejudice a client whose lawyer goes to a small firm or starts her own firm. Such lawyer will simply not be able to work for no profit and will be in the ethical quandary of having to refuse the client’s representation. This is precisely the situation Rule 5.6 and the cases construing it seek to avoid.

DSI does address Rule 5.6 but, it is submitted, the case’s reliance on the fact that this ethical deterrent was not discussed by the Second Circuit in Santalucia in the contingency fee context is a basis to conclude that it is not legitimately applied in hourly cases, we contend, misses the mark. In a contingent fee arrangement, the firms involved in the matter have a charging lien pursuant to the Judiciary Law for the work performed by them because they have not been compensated for their work. The application of the unfinished business doctrine to these contingent cases does not therefore add an additional financial burden to the matter or create a disincentive to subsequent representation. To the contrary, in an hourly case, when the dissolved firm has been paid, there is no such charging lien.

The application of the unfinished business doctrine to the hourly cases, therefore, does create a financial disincentive which otherwise did not burden the representation. Thus, we contend, this application creates an impermissible financial disincentive which violates the Rules of Professional Conduct and the applicable well-established New York law and public policy which encourages clients’ choice of counsel.

Rule 1.5 of the New York Rules of Professional Conduct is also an impediment to the application of the unfinished business rule and prohibits any fee sharing between the dissolved firm and the former partner’s new firm.12

1. Rule 1.5(g) states:

A lawyer shall not divide a fee for legal services with another lawyer who is not associated in the same law firm unless:

(1) the division is in proportion to the services performed by each lawyer or, by a writing given to the client, each lawyer assumes joint responsibility for the representation;

(2) the client agrees to employment of the other lawyer after full disclosure that a division of fees will be made, including the share each lawyer will receive, and the client’s agreement is confirmed in writing; and

(3) the total fee is not excessive (emphasis added).

In the case of a dissolved firm, none of the requirements of Rule 1.5 can be met and Rule 1.5 requires that all of the conditions be met. The dissolved firm and the former partner’s new firm are not “associated in the same law firm.” They are wholly separate legal entities. The hourly billable time would be performed entirely by the former partner’s new firm and the dissolved firm would have performed absolutely no services with regard to these matters. The dissolved firm cannot assume joint responsibility, cannot perform any legal services, or share responsibility for the representation or share legal fees of any kind because it is dissolved. Finally, the client will not likely agree to the sharing of fees with a dissolved firm.

Conclusion

We do not believe the unfinished business doctrine should apply to hourly billed matters. We think its application is inequitable, harms clients’ choice of counsel, and violates the fee sharing rules. For the time being, the New York Court of Appeals has not ruled on this subject. In the interim, we strongly encourage firms to promptly include a waiver, similar to the one above, in their agreements to avoid this problem until there is a definitive ruling.

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 the firm, assisted in the preparation of this article.

Endnotes:

1. 2012 WL 1918705 (S.D.N.Y. 2012).

2. Development Specialists, Inc. is the administrator of the bankruptcy estate of Coudert Brothers LLP.

3. The Coudert partnership agreement did not have such a waiver. To the contrary, Coudert adopted a “Special Authorization” that authorized the “orderly transition of client matters to other firms or service providers, in order to maximize the value of the Firm’s assets and business to the extent possible.” 2012 WL 1918705, at *3.

4. Ajettix v. Raub, 9 Misc.3d 908, 912 (Sup.Ct. Monroe County 2005).

5. N.Y. Partnership Law §40(6) (McKinney’s 2012).

6. 35 Misc.3d 1201(A) (Sup. Ct. New York Co. 2011).

7. Cofer v. Hearne, 459 S.W.2d 877, 880 (Tex. Civ. App. 1970). In Cofer, the court refused to apply the unfinished business rule based upon fairness grounds and in so doing provided an excellent illustration to support its conclusion.

To illustrate the harshness of the rule for which appellants contend, we quote from the testimony of Mr. Hume Cofer:

“Q: Now, let’s go for a minute, Mr. Cofer, to the contention that you and your father are making with respect to these fees that were collected after December 31st, 1967, when the partnership was dissolved. As I understand it, if a client had come into the office on December 31st, 1967, and had employed Mr. Hearne, a lifelong friend of Mr. Hearne’s, and had employed him to do some legal work, and if Mr. Hearne had accepted the employment and then had withdrawn from the firm and gone with the firm of Maloney, Black & Hearne, and had spent two years of his time thereafter working on that legal matter, and had finally realized out of it a fee of $10,000.00, that you and your father are entitled to two-thirds of that $10,000?

A: Yes, sir.”

We cannot bring ourselves to the voluntary acceptance of a rule which, in our opinion, is unconscionable and inequitable.

Id. at *881.

8. Santalucia v. Sebright Transp., 232 F.3d 293 (2d Cir. 2000); Shandell v. Katz, 217 A.D.2d 472, 629 N.Y.S.2d 437 (1st Dept. 1995); Kirsch v. Leventhal, 181 N.Y.S.2d 222, 586 N.Y.S.2d 330 (3d Dept. 1992).

9. DSI, 2012 WL 1918705, at *27 (questioning whether these New York and federal decisions correctly reconcile with the “no compensation rule” set forth in the New York Partnership Law).

10. 232 F.3d at 292 (emphasis added).

11. Denburg v. Parker Chapin Flattau & Klimpl, 82 N.Y.2d 375 (1993) (striking down financial disincentives in a law firm partnership agreement concerning departed partners).

12. In Sheresky, the court also found that sharing hourly fees as “unfinished business” would violate Rule 1.5. In so doing, the court stated: “New York State’s disciplinary rules specifically state that lawyers shall not divide fees for legal services with another lawyer who is not associated with the firm [unless Rule 1.5 is complied with].”