Robert T Abney & Associates Bankruptcy Law, Commercial Law: Ruling Limits Defunct Law Firms’ Claims to Unfinished Business

In a blow to law-firm bankruptcy trustees, New York’s high court ruled that defunct law firms cannot recoup profits from unfinished work taken by their former lawyers to new professional homes.

The unanimous decision by the New York Court of Appeals, released Tuesday, roundly rejects arguments brought by those unwinding the law firms Coudert Brothers LLP and Thelen LLP , who have long insisted the so-called unfinished business doctrine gives them authority to claw back money earned on pending legal matters for the benefit of creditors.

Instead, the court found, “A law firm does not own a client or an engagement, and is only entitled to be paid for services actually rendered.”

In siding with the law firms that hired lawyers from Coudert and Thelen, the court said that allowing profits from hourly fee matters to flow back to bankruptcy estates would have “numerous perverse effects” and conflict with basic principles governing the attorney-client relationship.

The threat of clawback claims following a lawyer to a new firm, the court argued, could cause partners to flee a struggling firm at the first sign of trouble. “Obviously, this run-on-the-bank mentality makes the turnaround of a struggling firm less likely,” the ruling, written by Judge Susan Phillips Read with the concurrence of the court’s six other judges, said.

The ruling, while only binding to law firms that operate in New York, is likely to have a broader reach, industry-watchers say—particularly in light of a decision reached last month by a federal judge in California who also found a bankrupt law firm could not collect profits on pending assignments.

“They wanted to put a stake in the heart of unfinished business claims around the country, and that’s what has been accomplished,” William Brandt, the plan administrator in the Coudert case, said of Tuesday’s ruling. “It’s a political and policy decision.”

The ruling will also directly impact the dozens of firms that hired lawyers from Dewey & LeBoeuf LLP around the time of its dramatic 2012 collapse. While no suits have been brought yet in Dewey’s bankruptcy, the defunct firm’s trustee has indicated he plans to pursue millions of dollars in unfinished business claims.

“It’s significant that the court unanimously recognized that clients, not lawyers or law firms, own client matters,” said Shay Dvoretzky, a Jones Day partner who represented his firm in the Coudert appeal. “And that a law firm has a right to be paid only for work that it performed, not for someone else’s work.” Several other firms also appeared in opposition to Coudert in the case, including Dechert LLP and K&L Gates LLP .

Thelen trustee Yann Geron said Tuesday that the decision marks the end of the road for his claims against Seyfarth Shaw LLP, which hired 11 partners from Thelen. “On behalf of creditors, we are disappointed by the court’s decision, but respect that it is a unanimous ruling which gives trustees and law firms a clear path forward in New York,” he said via email.

The pursuit of unfinished business claims has dragged on for years; Thelen dissolved in 2008, and Coudert Brothers closed in 2005. Both estates have already collected millions of dollars through settlements with other successor firms, a move that has also played out in other law firm bankruptcies.

New York’s high court took up the cases at the request of the Second U.S. Circuit Court of Appeals, which asked the court to provide clarity on the hourly fee issue from a state law perspective. New York law already recognizes that some fees should be shared on pending contingency fee matters, which weren’t at issue in the appeals.

During oral arguments in Albany last month, the judges questioned how the unfinished business rule makes sense in today’s legal landscape, one marked by the frequent poaching of top billers by competing firms.

That sentiment appears heavily in Tuesday’s ruling, which concludes: “In the end, the trustees’ theory simply does not comport with our profession’s traditions and the commercial realities of the practice of law today.”