The “Clawback” Danger in a Lateral Move

Published January 7, 2014

Hiring lateral partners with an existing book of business remains one of the hottest growth trends at larger law firms. That trend has accelerated as the actual or impending demise of large firms has put greater numbers of skilled lawyers on the market, many of whom seek to retain their existing clients. But law firms that go into bankruptcy must collect funds to pay their creditors, and can argue that the receivables of a departed lawyer belong to the originating firm that provided the resources to help earn the billing. The only protection for the lateral lawyer is to ensure that the details of “who gets what” are specified in the partnership agreement.

Recent developments suggest, however, that even this protection might not be sufficient to trump the U.S. Bankruptcy Code. It has been reported in the legal press [see 1 and 2] that the bankruptcy trustees for two defunct law firms, Heller Ehrman and Howrey, have been seeking “clawbacks” from former partners of those firms who have landed at prestigious new ones. Until now, such partners have been considered protected by the so-called Jewel waiver. This is based on the seminal 1984 California case Jewel v. Boxer, which held that former partners in a firm were entitled to their partnership share of income generated by the work of other former partners on cases that were active upon the firm’s dissolution.

However the bankruptcy court ruled in the Heller Ehrman case that although Heller’s partners signed Jewel waivers, their shifting of client work from the dissolved firm constituted a fraudulent transfer under the Bankruptcy Code because the attorneys did not give the Heller partnership anything of value in exchange for the waiver, leaving the bankruptcy estate depleted. In the Howrey case, the trustee is staking a claim to “distributions” made to Howrey partners while they were still at the firm and has sought recovery from individual partners and their new firms for violating their partnership agreements.

This definitely has the potential to take the punchbowl away from the lateral hiring party. The prospect of litigation from a bankruptcy estate could conceivably be extended to litigation from any lateral hire’s former firm. Firms looking for laterals may decide that name partners or highly regarded rainmakers with hefty books of business are worth the risk, but they may be less willing to consider lower-level partners who, as owners of their firms, are still accountable to fellow partners – and the courts.

Categorized in: Ethics, Financial and Cash Flow Management

Audience type: Large Law Firms, Small Law Firms, Sole Practitioners