Adam Lewis’ e-Bulletin re Heller Ehrman LLP v. Davis, Wright, Tremaine, LLP

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

On June 11, 2014, in Heller Ehrman LLP v. Davis, Wright, Tremaine, LLP, the United States District Court for the Northern District of California ruled that the trustee of the bankruptcy estate of the defunct law firm Heller Ehrman LLP (“Heller”) could not recover fees earned by other law firms on Heller matters that former Heller shareholders took with them to those new firms after Heller’s dissolution.  [Heller Ehrman LLP v. Davis, Wright, Tremaine, LLP, 2014 WL 2609743 (N.D. Cal. June 11, 2014)]. 

FACTS

Heller was a large international law firm.  In 2008, its lender declared it in default.  Heller’s shareholders voted to dissolve the firm and advised its clients that it could no longer provide services on their open matters.  Jewel v. Boxer, 156 Cal. App.3d 171 (1984), held that under the Uniform Partnership Act the partners of a dissolved law partnership had to account to each other (that is, to the partnership) for income from post-dissolution work with their new firms on former partnership matters.  The Heller dissolution resolution contained a “Jewel waiver” waiving Heller’s right to recover fees earned by firms employing former Heller shareholders who took Heller matters to those new firms post-dissolution.

Proceeding in the Bankruptcy Court, the Heller trustee sued several law firms to which former Heller shareholders took existing hourly fee matters after the dissolution, seeking recovery of profits earned from former Heller clients.  The trustee alleged that the Jewel waiver was avoidable as a constructive fraudulent conveyance made by Heller while it was insolvent without any consideration in return, leaving him free to sue the new firms under Jewel.  The parties made cross motions for summary judgment.  The Bankruptcy Court granted the trustee’s motion as either a final judgment or, if it lacked jurisdiction to enter a final judgment, as proposed findings and conclusions subject to de novo review by the District Court pursuant to 28 U.S.C. § 157(c)(1).  The defendant firms appealed. 

Relying on Executive Benefits Ins. Agency v. Arkison, decided by the Supreme Court just two days before, the District Court treated the matter as being subject to de novo review under 28 U.S.C. § 157(c)(1).  With the fundamental facts undisputed by the two sides, the District Court granted summary judgment for the defendant firms, rather than the trustee. 

REASONING

The District Court’s fundamental rationale was that a law firm does not have a property interest in prospective work, even on existing matters.  Such matters are owned, instead, by the client.  A client has an absolute right to terminate a firm, with the firm’s only remedy a quantum meruit claim for the reasonable value of services rendered to date.  There was, therefore, nothing for which the successor firms had to account to the Heller estate.[1]  The District Court further noted that equity and policy considerations further supported its decision.  To require successor firms to pay to a firm’s estate revenues generated from matters brought with them by the estate’s former partners would burden not only the employability of the former partners, but the ability of the clients to avoid having to hire counsel who would have to learn a case from scratch (and having to charge the client for doing so). 

The District Court then added a cascade of lesser reasons for its decision.  For example, it noted that, as the trustee admitted, Jewel, which only applies in the event of a dissolution, would not apply to partners who left thriving firms (though they might be liable for a breach of duty to the partnership under certain circumstances).  Similarly, if a firm simply took business from a distressed or collapsed firm without taking any of its partners, the latter would have no claim against the former.  The implication of these two points by the District Court was why should it make any difference that a dissolution has occurred?  Also of concern was that the Jewel rule would encourage partners to ditch firms at the first sign of trouble so that they could be out the door in time to avoid the Jewelconsequences of a collapse, something that such an exodus might precipitate unwittingly.  Finally, the District Court opined that it doubted that the California Supreme Court would stand by Jewel and that, in any event, Jewel differed from Heller factually in a number of important ways.[2] 

AUTHOR’S COMMENT

The author believes that the Heller decision is correct on both the property interest and policy rationales, and welcome.  In particular, the Jewel doctrine’s burden on the transition of lawyers and clients to new firms was a heavy one.  Moreover, since the Revised Uniform Partnership Act, which was passed after the Jewel decision, expressly permits waiver of a partnership’s Jewel rights, Heller is not cutting off otherwise ineluctable sources of recovery for creditors of defunct firms.[3]  Of course, this is just a District Court decision in the Northern District of California, as yet unpublished.  Moreover, it may be appealed to the Ninth Circuit.  Nevertheless, it may immediately be persuasive authority in New York and elsewhere where courts are wrestling with the same issues, sometimes complicated by differing underlying state partnership law. 

These materials were prepared by ILC member Adam A. Lewis (alewis@mofo.com) of Morrison & Foerster LLP, San Francisco, California.  Editorial contributions were provided by ILC member Doris A. Kaelin of Berliner Cohen, in San Jose, California.

Thank you for your continued support of the Committee.

Best regards,Insolvency Law Committee

[1] The District Court therefore skipped over the fraudulent conveyance issues entirely. Back

[2] It is not at all clear that these differences matter; the District Court’s reliance on them may give rise to claims that the decision is limited to its facts. Back

[3] The problem in Heller was that the shareholders waited until the last moment to adopt the Jewel waiver (included as part of the firm’s dissolution plan), thereby setting up the fraudulent conveyance claim that the trustee asserted to set aside the waiver so that he could sue on the Jewel rights.  Of course, on the other hand, partners who are getting together or who are joining an apparently healthy partnership may be reluctant to include a Jewel waiver in their partnerships.  Hence, Heller may yet be important in future situations. Back