California Has Some Unfinished Business with Law Firm Bankruptcies

July 28, 2016, 1:29 PM

When partners leave a failed law firm, should their new firms reap the profits of client matters they take with them? Or does the profit belong to the fallen firm’s estate?

An appeals court in New York has already decided on the matter , ruling that hourly fees earned on client matters are not the property of their old firm. But out there in sunny California, courts are still grappling with the issue.

The 9th Circuit Court of Appeals on Wednesday sought some guidance, posing the question to the California Supreme Court and asking it to put the matter to bed once and for all.

Under California law, does a dissolved law firm have a property interest in legal matters that are in progress but not completed at the time the law firm is dissolved, when the dissolved law firm had been retained to handle the matters on an hourly basis?

The answer will decide whether four law firms — Jones Day, Orrick Herrington & Sutcliffe, Davis Wright Tremaine and Foley & Lardner — should pay the estate of defunct law firm Heller Ehrman for unfinished business its former partners took following the firm’s 2008 collapse.

Heller, which once staffed as many as 700 lawyers, went bankrupt after Bank of America and Citibank declared it in default of its loans. Twelve law firms settled lawsuits to satisfy creditors with the bankrupt firm’s trustee over unfinished business, according to the ruling.

The four law firms before the 9th Circuit, however, have refused to settle lawsuits filed against them by the bankruptcy trustee. They argue that when partners left Heller their new firms acquired their client matters, which they continued to work on.

“They, as a matter of principle, will never settle unfinished business claims,” said Cecily Dumas, a bankruptcy lawyer closely watching the case from Pillsbury Winthrop Shaw Pittman.

At the heart of the dispute is whether firms have a property interest in client matters billed on an hourly basis.

If so, the holdout firms argue, any partner who joined another firm would have to pay back profits on matters they started at their former firm. This could result in the lawyer dropping a client matter because he or she wouldn’t be paid for it at their new firm.

“These law firms believe that client choice would be impaired,” said Dumas.

The California cases have been kicking around federal and bankruptcy court and have produced conflicting rulings. In 2014, Judge Charles Breyer of the U.S. District Court in San Francisco ruled in a contrary review of a de novo bankruptcy judge ruling , saying that the trustee does not have the right to unfinished business. Heller appealed that ruling, though, and now the matter is before the 9th Circuit.

“We need guidance from the California Supreme Court to determine whether Heller has a property interest in its unfinished hourly fee matters upon dissolution,” said the 9th Circuit in its decision. “The Court’s decision determines the outcome of this appeal.”

Shay Dvoretzky, a lawyer for Jones Day who argued the case for the hiring firms, did not immediately respond to a request for comment.

Chris Sullivan, a lawyer for the trustee, said he was pleased with the outcome.

“We think that the California Supreme Court will follow the prior California decisions, and the reasoning upon which they are based, and resolve the issues of state law in our favor and find that dissolving law firms have a property right to the profits generated from the legal matters pending at the time of dissolution.”

Have a thought on the case? Write to us at biglawbusiness@bna.com.

(UPDATED: This story has been corrected. It was Judge Charles Breyer whose ruling Heller appealed, not Judge James Donato.)

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