Lawyers recounting their experiences with Hurricane Sandy shared a general sentiment: ‘We lost power for a week, and some trees came down, but we are more or less back to normal. It could have been a lot worse for us. Overall, when we see the news, we feel very lucky.’

This repeated refrain in the wake of Hurricane Sandy, a storm previously unprecedented for New Yorkers including New York lawyers, was commonplace over the last few weeks, among law firm partners as well as adversaries, who were mostly happy to get back to work after a forced “vacation” from the problems and concerns of clients.

The year 2012, of course, also had its share of storms and squalls in the legal world, the largest of which was the unprecedented and unfortunate bankruptcy of Dewey & LeBoeuf. The firm’s demise, among other things, caused legal professionals to seek “higher ground” in the safety of what had previously been Dewey’s competitors. While we plainly have not seen all of the aftermath of the Dewey bankruptcy, several developments this year in law firm bankruptcies are noteworthy and will be explored here.

Unrelated to the Dewey bankruptcy, the year also brought some interesting decisions concerning the possible investment by non-lawyers in law firms as well as an out-of-state decision that calls into question some commonplace provisions in law firm partnership agreement arbitration provisions.

Law Firm Bankruptcies

This year saw two important but diametrically conflicting decisions concerning the treatment of “unfinished business” in the context of law firm bankruptcies.

In May, U.S. District Judge Colleen McMahon permitted claims for “unfinished business” in the context of hourly fees in the bankruptcy of Coudert Brothers in a case titled Development Specialists v. Akin Gump Strauss Hauer & Feld (DSI).1 In September, in Geron v. Robinson & Cole,2 Judge William Pauley ruled that such claims were impermissible.

In DSI, the federal district court held that Coudert Brothers could share in the profit of matters billed on an hourly basis which were at Coudert prior to its dissolution but which were finished at other law firms after its dissolution.

The court found that the hourly billed matters were Coudert assets on the date of dissolution, and held 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.

The decision in part relies upon the premise that partners of a dissolved firm owe one another fiduciary duties in the winding up of the partnership which thus 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….” This rule contemplates that partners are not entitled to be compensated for their efforts in winding up a dissolved partnership.

Pauley disagreed with the DSI court and found, in Geron, that, unlike in the contingency fee context, applying the unfinished business doctrine in the hourly fee context would result in a windfall to the dissolved firm because it would reduce the compensation of the attorneys who were actually performing the work at their new firms. He also found that expanding the “unfinished business” doctrine to hourly cases would violate New York’s public policy against restrictions on the practice of law.

Finally, Pauley based his decision upon the fundamental differences between hourly and contingent matters. The court reasoned that, since New York cases deem contingency fee matters to be “assets” of a dissolved firm only where the fee derives from surviving partners’ post-dissolution “efforts, skill and diligence,” and because all post-dissolution hourly fees are the result of that lawyer’s “post-dissolution efforts, skill and diligence” at his new firm, hourly fees generated from those efforts are not assets of the dissolved firm.

In context of the Dewey bankruptcy, it is submitted that the uncertainty of an “unfinished business” decision should make it harder for Dewey to collect unfinished business fees from its former partners and it is also unclear how that will affect the ultimate liability of former Dewey partners. Moreover, as we have written in previous columns, because we believe ultimately New York will not and should not permit these claims in the hourly context, it may make it impossible for any bankrupt firm, including Dewey, to collect fees for hourly “unfinished business.”

Non-Lawyer Investment

This year the law firm of Jacoby & Meyers sought to challenge the rule prohibiting non-lawyer investment in law firms.

In Jacoby & Meyers,3 the law firm alleged that Jacoby & Meyers USA, LLC was formed for the express purpose of allowing non-lawyers to “own an interest” in the entity and fund its business plans, but that Rule 5.4 of the New York Rules of Professional Conduct has prevented it from “entertain[ing] the numerous offers it has received from prospective nonlawyer investors…who are prepared to invest capital in exchange for owning an interest in the firm.”

Furthermore, Jacoby & Meyers alleged that the firm “requires a substantial infusion of new capital” and that traditional means of obtaining the necessary funds, such as capital contributions by partners and commercial bank loans, are too expensive or are unavailable to fund its business plans.

U.S. District Judge Lewis Kaplan dismissed the amended complaint, finding that Jacoby & Meyers lacked standing to challenge Rule 5.4 of the Rules of the New York Rules of Professional Conduct and that no opinion was permissible because it would be a purely advisory opinion in violation of Article III of the U.S. Constitution.

The firm appealed to the U.S. Court of Appeals for the Second Circuit. Although there is no decision, the firm may have gotten a “ray of hope.”4 Pursuant to the reports of the oral argument, while vigorously questioning both sides, the Second Circuit may remand the case to the district court to cure the defect in the pleading concerning standing.5

Regardless of the somewhat arcane procedural points currently at issue, we continue to believe that non-lawyer investment in a law firm is detrimental to both the profession and its clients and should not be permitted. Investment in law firms by non-lawyers would mean that the part owners of the law firm—who obviously cannot have an attorney-client or fiduciary relationship with clients or be subject to professional discipline—could nonetheless have a management role in the law firm, and, most troubling in contingency fee-based firms, presumably like Jacoby & Meyers, have an influence (directly or otherwise) in the management and resolution of attorney fees from cases.

This potential control in the professional decision-making of attorneys by non-attorneys, we believe, presents an irreconcilable conflict which is not subject to typical attorney regulation. Similarly, attorneys who have to answer to their non-attorney “partners,” who will undoubtedly expect a return on their investment, will be conflicted between the best interest of clients and the goals of their non-lawyer owners upon whom they depend for the success and expansion of their firm.

Arbitration

With the proliferation of arbitration provisions in law firm partnership agreements, it is not at all surprising that virtually every year there is a noteworthy decision concerning such provisions, and this year is no exception.

In DeGraff v. Perkins Coie,6 the U.S. District Court for the Northern District of California considered claims by a former law firm partner that the arbitration clause of the Perkins Coie partnership agreement was unconscionable and therefore unenforceable.

In DeGraff, the court found that there was procedural unconscionability in the execution of the law firm partnership agreement. The court stated: “Plaintiff declares that he was told he had to sign the Partnership Agreement and that he had no opportunity to negotiate the terms. Accordingly, the Court finds that Plaintiff had demonstrated the existence of procedural unconscionability.”7

The court also ruled that the requirement that the arbitration remain confidential was unconscionable and severed that provision. It supported its ruling upon the conclusion that Perkins Coie is the only party who would benefit from this provision “without receiving any negative impact in return.”8 The court based its decision upon its finding that “Perkins Coie has institutional knowledge of prior arbitrations. In contrast, individual litigants, such as Plaintiff, are deprived from obtaining information regarding any prior arbitrations.”

While the DeGraff decision is not law in New York, it should cause firms to, at a minimum, reevaluate the arbitration provisions in their partnership agreements to ensure that they remain enforceable.

Conclusion

As 2012 comes to a close, we wanted to thank the readers of this column for your very kind and encouraging words. We hope this year’s columns have been helpful and even somewhat enjoyable. Their writing remains a privilege. Thank you all very much!

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. 477 B.R. 318 (S.D.N.Y. 2012).

2. 476 B.R. 732 (S.D.N.Y. 2012).

3. Jacoby & Meyers v. The Presiding Justices of the First, Second, Third and Fourth Departments, Appellate Division of the Supreme Court of the State of New York, 847 F.Supp.2d 590 (S.D.N.Y. 2012).

4. Mark Hamblett, “Both Sides Take Heat in Jacoby & Meyers’ Suit Over Ban on Law Firm Investors,” NYLJ, Oct. 9, 2012.

5. Id.

6. DeGraff v. Perkins Coie, 2012 WL 3074982 (N.D. Ca. 2012).

7. Id.

8. Id.