'Clawback Case' Ruling Marks a Step Backward

Published on: 
06/26/2014
Law is a business, and that fact should dictate legal outcomes in terms of financial matters. However, in the June "clawback" case Heller Ehrman LLP v. Davis, Wright, Tremaine, LLP, et al., the U.S. District Court for the Northern District of California neglected to recognize the business aspect of the profession of law.

In Heller Ehrman, a judge overturned a summary judgment of a U.S. Bankruptcy Court judge by ruling that a bankrupt estate such as Heller Ehrman cannot "claw back" profits that its members generate at new firms from business they had at previous firms.

In an earlier "clawback" case in 1984, Jewel v. Boxer, the California Court of Appeals found that the firm could indeed claw back profits. In Heller Ehrman, the court distinguished Jewel based on five points:

  • In Jewel, the dissolution of the firm was voluntary. In Heller Ehrman, the dissolution was forced by bankruptcy.

  • In Jewel, the retainer agreements with the new firm were the same as the old retainer agreements. In Heller Ehrman, the clients signed new agreements with new firms.

  • In Jewel, the new firms were comprised of lawyers from the old firms. In Heller Ehrman, the new firms were completely separate from the old firm.

  • In Jewel, there was no distinction between hourly fee matters and contingency fee matters. In Heller Ehrman, only hourly fee matters were involved.

  • Jewel took place when the Uniform Partnership Act was in place. That act has since been replaced by the Revised Uniform Partnership Act, under which partners may collect reasonable compensation for tying up the loose ends of a partnership business.

The underlying theory in Heller Ehrman is that clients have the right to have an attorney of their own choosing represent them, a truism clearly embedded in the rules of professional conduct.

It is also true, however, that lawyers have a fiduciary relationship to their former firms and should not be allowed to capture the business previously engaged in by the former firm without just compensation. In this case, the compensation can be measured by the profits from the former clients removed to the new firm.

The judge's ruling seems rooted in the older generation's belief that law is not a business — that goodwill is personal rather than firm-based and that it can be taken anywhere the lawyer goes without compensation to its source, the former firm:

"A law firm never owns its client matters. The client always owns the matter, and the most the law firm can be said to have is an expectation of future business. At the motion hearing the Trustee was unable to articulate a basis for calculating the value of this expected future business. The Trustee suggested that the value at issue here is 'good will,' which does not ordinarily appear on law firm balance sheets which are on a modified cash basis. In California, and beyond, professional law partnerships do not have a 'good will' asset."

I disagree with the reasoning behind the court's ruling. Law is a business, just as is every other personal service activity. It has accoutrements such as phone numbers, client lists and quality standards that are differentiating factors in our competitive world. Failure to acknowledge those elements moves us backward, not forward.

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