http://blogs.wsj.com/law/2012/05/25/profits-from-unfinished-business-belong-to-dissolved-law-firm-ny-judge-says/
A U.S. district court ruling on who can claim profits from a defunct law firm’s unfinished cases could mean trouble for firms who take on partners from the ailing New York firm Dewey & LeBoeuf LLP.
At issue is the so-called “unfinished business” claim, which bankruptcy trustees in charge of failed firms such as Brobeck, Phleger & Harrison LLP and Heller Ehrman LLP have used in California and elsewhere to recover millions of dollars from the new law firms where former partners end up. The argument is essentially this: when partners who leave a dissolved firm bring unresolved cases to their new firms, the money those matters then generate belongs to the original firm.
In this case, the trustee for former New York firm Coudert Brothers LLP had sued 10 firms that hired former Coudert partners in an effort to recover those profits. No dollar amount was specified, as the firms did not provide documents outlining how much money they made.
The defendants, which included Dechert LLP, Jones Day and Arent Fox LLP, argued that Coudert Brothers had no property interest in the unfinished matters.
On Thursday a federal judge in Manhattan ruled that that the proceeds from those cases did indeed belong to Coudert Brothers, whose estate is being administered by the restructuring and financial advisory firm Development Specialists Inc.
“Because the Client Matters belonged to Coudert on the Dissolution Date, and because the Coudert Partnership calls for the application of the Partnership Law to determine the post-dissolution rights of the partners, the Former Coudert Partners have a duty to account for profits they earned completing the Client Matters at the Firms,” according to the decision by District Judge Colleen McMahon.
Generally, the only way to avoid such claims would be if a law firm had inserted a specific waiver into its partnership agreement before it became insolvent, said Peter Gilhuly, a bankruptcy partner with Latham & Watkins LLP.
“This is a very significant opinion,” Mr. Gilhuly said of the Coudert Brothers case. He said the decision is a major affirmation of a ruling from a 1984 California case known as Jewel v. Boxer, which has since been adopted by a number of other states. “Now every case that would file in New York would cite this decision extensively.”
Claire Huene, a partner with Miller & Wrubel P.C. who represents law firm Dechert LLP in the case, said the decision marks the first time in New York that unfinished business claims have been upheld with respect to cases that are billed by the hour. Even in those cases involving post-dissolution ownership of contingency fees—where money is not paid out to a firm until the conclusion of a matter—New York law requires that the fee be split between the dissolved firm and former partner, she said.
The ruling also comes amid the public flameout of Dewey & LeBoeuf, which has hired restructuring advisors in advance of a possible bankruptcy filing that would rank as the largest U.S. law firm failure yet.
“If Dewey were to file for bankruptcy, the firms joined by former Dewey partners could well face these types of claims,” Ms. Huene said.
Dewey & LeBoeuf did not immediately respond to a request for comment.
In her opinion, the rationale of the decision could be extended to departures by partners from healthy firms. “The concept that a law firm has a property interest in its client matters, and is entitled to profits on hours worked on such matters by its former partners at new law firms, has significance for all law firms, and we believe should be certified for appeal.”
David Adler, a partner with McCarter & English LLP who represents Development Specialists Inc. in the Coudert Brothers case, said “we’re very pleased” with Judge McMahon’s decision, adding that it was “consistent with partnership law for the past 150 years.”
In an interesting twist, Dewey & LeBoeuf itself had hired Development Specialists Inc. several weeks ago as a financial advisor and oversee matters such as the sale of the firm’s Warsaw office, according to DSI President William Brandt. The firm is now passing the baton to another restructuring firm, Zolfo Cooper, which Brandt said had been hired at the behest of lenders and which is readying a possible bankruptcy-protection filing, according to people familiar to the matter.
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http://www.newyorklawjournal.com/PubArticleNY.jsp?id=1202556156758&slreturn=1
Although a string of law firms have filed for bankruptcy in recent years, Dewey & LeBoeuf yesterday became the largest to file for Chapter 11 and raises novel issues for creditors and the courts, bankruptcy lawyers say.
The departure of the management team along with nearly 300 Dewey partners left the firm's general counsel Janis Meyer and executive partner Stephen Horvath to wind down operations. Dewey & LeBoeuf has retained Albert Togut, a bankruptcy partner at Togut Segal & Segal. Joff Mitchell, a senior managing director of Zoflo Cooper, said in an e-mail that he is the firm's chief restructuring officer.
Issues that could complicate the Dewey bankruptcy include bond debt, unusual secured creditors, a criminal investigation and the firm's large global footprint, bankruptcy lawyers told the New York Law Journal.
Editor's Note: For the latest developments on this story, visit The American Lawyer.
A hearing is to be held before Southern District Bankuptcy Court Judge Martin Glenn to considers logistics and the firm's use of its remaining cash.
Dewey "definitely" will face issues that other law firms in bankruptcy have not, said Allan Diamond, the Chapter 11 trustee in the Howrey bankruptcy. Diamond, the Houston based managing partner of Diamond McCarthy, said he expects to represent some parties in the bankruptcy.
He said Dewey will be the only bankrupt law firm that had issued bonds to support its finances. Dewey raised at least $125 million in a 2010 bond offering.
Rather than a more traditional scenario where the secured creditors are the banks, the Dewey bankruptcy willinvolve hundreds of millions of dollars of secured bank and bondholder debt. "That's your first major difference," he said.
Uncommon Creditors
According to a copy of the 2010 bond offering memorandum obtained by The New York Times, the notes rank "pari passu" or on an equal footing, with all current and future senior secured debt of the law firm.
Three of the four banks that have lent money to Dewey sold their share of the debt, according The Am Law Daily. Those three lenders—Citi Private Bank, Bank of America, and HSBC—were part of a consortium led by JPMorgan Chase that had collectively been owed roughly $75 million on a $100 million line of credit.
Also, the insurance companies that bought the bonds have sold some to hedge funds in the distressed debt market, according to media accounts, which also report that the debt was trading between 50 to 65 cents on the dollar.
If the bonds are trading at one half of their face value and bond debt and bank debt are on equal standing, Diamond said, "that tells me the collateral, which is primarily accounts receivable, is viewed by the distressed debt market as insufficient to fully retire the secured debt."
This indicates that the secured creditors, those with bank debt and new bondholders, may not be paid back in full solely from their collateral, he said, much less unsecured creditors and any former partners.
Banks are typically the secured creditors in a law firm bankruptcy, he said. "Now, you have multiple secured parties making decisions," Diamond said. "Given that they have equal rights in the collateral, there could be a lot of fighting between and amongst the secured creditors because they simply may not agree" on what actions to take.
A hedge fund, for example, could have a different approach than a traditional bank.
This would affect decisions requiring the approval of secured creditors, such as strategies for the sale or liquidation of assets, Diamond said.
Other Wrinkles
The Manhattan District Attorney's office investigation of former chairman Steven Davis for alleged misconduct may add "a major wrinkle to the bankruptcy," Diamond said.
"The interplay of criminal investigations, potential grand jury proceedings and any ultimate criminal prosecutions has the potential effect of delaying civil proceedings, changing the dynamics of witness testimonies, including rights against self-incrimination, cooperation between simultaneous bankruptcy, civil and criminal proceedings, and a myriad of other issues that otherwise would not be present in bankruptcy and civil proceedings alone," Diamond said.
Another difference in the Dewey bankruptcy is its size. Last year, the firm generated $782 million in gross revenue, according to revised financial figures from The American Lawyer.
In its filing, the firm said that it had assets of roughly $193.2 million against liabilities of $245.4 million—a deficit of more than $52 million., as of April 30.
The firm, with more than 1,000 lawyers at one point, had 25 offices, including 16 overseas. A press release issued by the firm noted that many of Dewey's foreign offices are excluded from the firm's U.S. bankruptcy filing, and that the London and Paris operation, which are a distinct legal entity, were placed into administration, the United Kingdom's version of Chapter 11, yesterday.
The Am Law Daily estimated that as of May 24, there were fewer than 20 partners remaining in Dewey's domestic offices.
No other law firm that filed for bankruptcy in recent years—including Brobeck, Phleger & Harrison; Coudert Brothers; Heller Ehrman; Howrey; and Thelen—has been close in size and global presence to Dewey.
Claims by multiple landlords and various arrangements for partnership in overseas locations may add more layers for a bankruptcy court to sort through, said Michael Blumenthal, a bankruptcy partner at Thompson & Knight.
"When I think of the firms that have filed in the last few years, this will be the most complicated," said Blumenthal, who represented partners in bankruptcies of Howrey and Finley, Kumble, Wagner, Underberg, Manley, Myerson & Casey.
Bankruptcy Advantages
Before yesterday's court action, Dewey had essentially a "de facto" dissolution, Diamond said, without a formal bankruptcy filing or dissolution vote.
But bankruptcy has some advantages, such as slowing litigation against the firm, which is facing several lawsuits, including those brought by an employee over the Worker Adjustment and Retraining Notification Act, pension fund regulators, a janitorial service and its Washington, D.C., landlord.
It could also prevent creditors, such as landlords, from seizing property subject to their liens.
Bankruptcy gives rise to rights for the recovery of assets for creditors, Diamond said. For instance, a trustee can pursue so-called clawback claims against former partners and their successor firms.
For example, almost all of Thelen's nearly 250 partners have been involved in settlement discussions over clawback claims that trustee Yann Geron pursued against the partners, Geron said.
Geron, a Fox Rothschild partner, has settled with about 150 partners so far, and he said he is hoping to settle with roughly 90 others.
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