Bankruptcy Court finds that Unfinished Business Rule is Valid in California and May Apply to Hourly Rate Matters

There has been a lot of recent press about the validity of Unfinished Business Claims in California (also known as Clawback claims) following a ruling earlier this year by U.S. Bankruptcy Judge Dennis Montali in San Francisco related to the Howrey, Simon, Arnold & White LLP (“Howrey”) bankruptcy.  At issue, was whether the trustee of a bankrupt firm had any basis to proceed against the firm’s former partners to recover profits from unfinished legal business matters that followed former partners to their new firms, even if those profits apply to hourly rate matters.  Although other jurisdictions have litigated this issue (both D.C. and New York), no California court has expressly interpreted the Unfinished Business Rule, as set forth in Jewel v. Boxer (1994) 156 Cal. App. 3d 171 (“Jewel”), as applying to hourly rate matters upon partnership dissolution.

In Judge Montali’s February 14, 2014 Memorandum of Decision on Motions to Dismiss, he held that the “entitlement of partners to recover profits from a dissolved firm’s unfinished business (the “Unfinished Business Rule”) is well-established under California law.”  (See Memorandum of Decision on Motions to Dismiss (“Memo”), page 3, lines 1-4, citing Jewel.)  In the case at issue, Howrey’s partnership agreement was governed by the laws of the District of Columbia (“D.C.”), but Judge Montali concluded that the D.C. law pertaining to the Unfinished Business Rule is similar to that of California.  He defined unfinished business of a law partnership as, “any business covered by retainer agreements between the firm and its clients for the performance of partnership services that existed at the time of dissolution,” and he held that the Unfinished Business Rule applies to hourly rate matters.  The Unfinished Business Rule, however, does not extend to business created after dissolution, even if that business comes from a client of a dissolved firm.  (Memo, pages 2-3)Judge Montali, in denying Defendants’ Motion to Dismiss the Howrey Trustee’s unfinished business claims, goes through a detailed analysis of case law in the District of Columbia related to the Unfinished Business Rule.  While Defendants argued that the Unfinished Business Rule applies in D.C. only as to contingency fee matters, the Court cited several D.C. cases that support application of the Unfinished Business Rule to matters handled on an hourly basis, and found that “those cases, read together, are decisive.” See Beckman v. Farmer, 579 A.2d 618 (App. D.C. 1990), Young v. Delaney, 647 A.2d 784 (App. D.C. 1994), and Robinson v. Nussbaum, 11 F. Supp. 2d 1 (D.D.C. 1997).

The Court noted that the Beckman Court was “unequivocal in its statement that the fiduciary obligations of partners runs throughout the liquidation to the conclusion of the winding up, and applies to ‘any transaction connected with the conduct, or liquidation of the partnership. . . .’ (citing Beckman, 579 A.2d at 636.)  The Beckman court was also clear that “all work performed on partnership business unfinished at the date of dissolution . . . was done for the benefit of the dissolved partnership.” Id. at 639 (emphasis added.) Citing Jewel (among other cases), the Beckman court also observed that “pending cases are uncompleted transactions requiring winding up . . . and are therefore assets of the partnership subject to post-dissolution distribution.” Id. at 636.  “It follows that any profits from the completion of such unfinished business inure to the partnership’s benefit, even if received after dissolution.” Id.

Both Young and Robinson rely on Beckman and also reached the same conclusion.  In Robinson, for example, one partner of a dissolved law firm filed a claim against his former partners’ new law firm, seeking a share of “hourly fees earned by [the new firm] which stem from client matters which were pending but uncompleted at the time of dissolution.” Robinson, 11 F. Supp. 2d at 5. The district court granted summary judgment in his favor, holding:

“The Partnership Act, as interpreted in Beckman, requires that former partners share all profits earned from completing client matters that were pending at the time of dissolution. As explained below, how the firm’s clients were billed — either at an hourly rate or on a contingency fee basis — does not change the status of their work as partnership property.”  Robinson at 5-6.

On the Motions to Dismiss, Judge Montali rejected the argument that application of the Unfinished Business Rule would impair lawyer mobility, citing the Beckman court which held, “The duty to wind up partnership business does not disable the former partners in a law firm from accepting employment from former clients of the dissolved partnership, provided the new employment does not relate to work in progress at the time of dissolution.”  Beckman at 638.

As a whole, the Court’s analysis of the application of the Unfinished Business Rule turned on various provision of the Uniform Partnership Act (“UPA”) (and the case law interpreting it) and whether the Howrey partners carved out any exceptions to the UPA in the Howrey partnership agreement regarding partnership dissolution — which the Court found it did not. The Court agreed with the Beckman Court’s conclusion that the Unfinished Business Rule “is a creature of statute and attempts by courts to evade it are inappropriate,” especially where partners could have “entered a partnership agreement which could have assured” the doctrine did not apply unless the firm and its partners so desired.  Beckman at 640 (citing Jewel, 156 Cal. App. 3d, at 180).

It is critical to remember that the portion of this ruling analyzed here, relating to the viability of Unfinished Business Claims in the event of a partnership dissolution and their application to hourly rates matters, is that the claims have survived the motion to dismiss stage.  The Court did not rule on how the scope of the pending client matters would be calculated or interpreted for damages purposes, or how much the Howrey Trustee would be entitled to in profits from the unfinished business.

For partners considering departing from a firm that is inadequately capitalized or has the possibility of dissolution, or for a firm acquiring lateral partners coming from these circumstances, it is important to closely analysis the application of the Unfinished Business Rule to the departing partners’ former partnership agreement. Understanding how the Unfinished Business Rule may apply to any client matters pending at the time of departure where a partnership dissolution has occurred or is likely is essential to navigating a smooth transition to a new partnership for all involved parties.