Summary
denying the defendants' motions to dismiss
Summary of this case from Heller Ehrman LLP v. Arnold & Porter, LLPOpinion
Bankruptcy Case No. 08-32514DM, Adversary Proceeding No. 10-3203DM.
April 22, 2011
MEMORANDUM DECISION ON MOTION TO DISMISS
I. INTRODUCTION
Plaintiff ("Debtor") filed a complaint for avoidance of fraudulent transfers, seeking to recover from Defendant law firm the value of profits received by it with respect to unfinished business that was being handled by the Debtor at the time of its dissolution. Under documents that governed Debtor, its corporate partners and the attorney Shareholders of the corporate partners, Debtor retained the right to all profits and fees (including "unbilled fees, work in progress . . . or clientele") derived from legal services to its clients, even upon departure of the attorney handling much matters. However, as part of its dissolution process, Debtor agreed to waive its rights underJewel v. Boxer, 156 Cal. App. 3d 171 (1984) ("Jewel"), to recover fees associated with such unfinished business and generated by its attorneys after their departure. Debtor seeks to avoid this waiver as constructive or actually fraudulent transfer.
Debtor filed sixteen similar adversary proceedings against sixteen law firms. The complaints are virtually identical as to the allegations and the theories of recovery; they differ as to each particular defendant's "unfinished business" discussed in the text, infra. The adversary proceedings are: 10-3203; 10-3210; 10-3213; 10-3216; 10-3219; 10-3221; 10-3234; 10-3235; 10-3238; 10-3239; 10-3243; 10-3244; 10-3251; 10-3253; 10-3254; and 10-3263.
In Jewel, the court held that, in the absence of a partnership agreement, the Uniform Partnership Act requires that attorney fees received on cases in progress upon dissolution belong to all partners of the dissolved partnership, even when a former partner is substituted in as counsel for the dissolved firm. Debtor had a partnership agreement, but as explained in the text, it retained certain potentially valuable rights.
In the First Claim For Relief, Debtor seeks to avoid and recover intentional fraudulent transfers under the Bankruptcy Code; in the Second Claim For Relief, Debtor seeks to avoid and recover the same transfers as constructive fraudulent transfers under the Bankruptcy Code; in the Third Claim For Relief, it seeks to avoid and recover actual fraudulent transfers under the California Uniform Fraudulent Transfer Act ("CUFTA"); in the Fourth Claim For Relief, it seeks to avoid and recover constructive fraudulent transfers under CUFTA.
Defendant filed a motion to dismiss ("Motion"). For the reasons explained below, the Motion will be granted, in part, although Debtor will be given leave to amend the Complaint as to the First Claim For Relief and the Third Claim For Relief; in all other respects the Motion will be denied.
All defendants in the adversary proceedings listed in footnote 1 filed motions to dismiss that were fully briefed, then argued and submitted on March 31, 2011. While some defendants argued issues that others did not, the court deals with all issues as though they had been raised by all defendants. The court disposes of the sixteen motions by identical Memorandum Decisions and Orders on Motion to Dismiss filed in those sixteen matters this date.
II. ISSUES
A. Did the doctrine of Jewel apply given the organizational structure adopted by Debtor no later than January 1, 1994?
B. Assuming Jewel applies, did Debtor's Basic Documents operate to waive all or any of Debtor's rights to demand an accounting by, or recover unfinished business profits from, attorneys who left the firm and retained unfinished business?
For purposes of the Motion and this Memorandum Decision, the Basic Documents are the Partnership Agreement ("PA") (revised, as amended, effective January 1, 1994); Shareholders Agreement ("SHA") (revised, as amended, effective September 28, 2005); Employment Agreement ("EA") (revised, as amended, effective September 28, 2005); Glossary (as amended and restated as of June 1, 2006).
C. Assuming Jewel applies and Debtor did not waive its rights under the Basic Documents, did paragraph VI(F) (the "Jewel Waiver") of Debtor's dissolution plan effective September 26, 2008 (the "Plan of Dissolution") constitute a transfer of Debtor's property that the Debtor may seek to avoid and recover, in whole or in part, by the Complaint?
D. Would any recovery on the Complaint by Debtor constitute an illegal sharing of fees under the California Rules of Professional Conduct or violate any other applicable law?
E. May Debtor recover on the Complaint against Defendant, rather than individuals who were Members of Debtor's professional corporate partners and later joined Defendant?
F. Do the First Claim For Relief and the Third Claim For Relief adequately allege sufficient facts to establish essential elements of actual fraudulent transfers?
III. DISCUSSION
All facts referred to in this Memorandum Decision are drawn from the Complaint or the Basic Documents, and assumed true for purposes of the Motion. al-Kidd v. Ashcroft, 580 F.3d 949, 956 (9th Cir. 2009). The court rejects as unpersuasive arguments as to any issue raised in the Motion and not specifically addressed in this Memorandum Decision.
A. Jewel applies despite Debtor's organizational structure.
Defendant argues that Jewel cannot apply because of Debtor's organizational structure. Debtor is a California limited liability partnership with a California professional corporation as its managing general partner and several other professional corporations (incorporated in California and other states) as its remaining partners. The individual attorneys who practiced law under the business of Debtor were Members (viz., Shareholders) of those professional corporations pursuant to various versions of the SHA. Those individuals also were employed by their respective professional corporations pursuant to versions of the EA.
The parties do not disagree that Debtor was organized under the California Revised Uniform Limited Partnership Act (Cal. Corp. Code §§ 16100- 16962) ("RUPA"), and that the corporate partners of Debtor were not. Likewise, the Shareholder-employees of those corporate partners are not governed by RUPA. Defendant therefore argues that the duty of partners to account to one another under RUPA does not govern the relationships here, and even of it did, the "reasonable compensation" rule of RUPA means that Debtor had nothing to transfer via the Jewel Waiver. Defendant also contends that Jewel has no applicability because it dealt with individuals who practiced law as partners in a law partnership. Even though the court agrees that RUPA is inapplicable, it disagrees with Defendant's contention that — absent the Jewel waiver — the Shareholders had no duty to account for profits from unfinished business.
Defendant relies on Debtor's two-tier structure in an effort to distinguish Fox v. Abrams, 163 Cal. App. 3d 610 (1985), in which the California Court of Appeals rejected the argument that Jewel does not apply to parties who practice law together in a law corporation. The Fox court pointed out that Jewel was not based solely on partnership law, but rather on a sound public policy preventing lawyers who practice law together for competing for the most remunerative cases in anticipation that they might retain those cases should the law firm dissolve. The doctrine discourages former members of the firm from scrambling to take physical possession of files and seeking personal gain by soliciting existing clients.
The policy announced by the Fox court was unequivocal:
There is no reason to hold that when lawyers decide to practice together in corporate form rather than partnership, they are relieved of fiduciary obligations toward each other with respect to the corporation's business.
* * *
What we do say, however, is that attorneys practicing together in a law corporation owe each other fiduciary duties very similar to those owed by law partners and therefore the fact that a law corporation is involved is no reason to disregard the fair and reasonable principles of Jewel v. Boxer or to interpret the parties' agreement in a manner favoring one group over another.
Fox, 163 Cal. App. 3d at 617 (emphasis added). See also Rothman v. Dolan, 20 Cal. App. 4th 755, 757 (1993); Grossman v. Davis, 28 Cal. App. 4th 1833, 1835 (1994).
The application of the Jewel principle to law firms formed as corporations has been recognized in other jurisdictions as well.Sullivan, Bodney Hammond v. Bodney 16 Kan. App. 2d 208, 820 P.2d 1248 (1991); Sullivan, Bodney Hammond v. Houston General Insurance Co., 2 F.3d 824 (8th Cir. 1993) ("We do not believe that the Supreme Court of Missouri would allow members of the Missouri bar to expand their rights against litigation clients and adversaries simply by conducting business in the corporate form").
The cornerstone of Defendant's argument is that the Shareholders had no fiduciary duty to Debtor. This ignores the principles announced in Jewel and extended in Fox to attorneys practicing within a professional corporation. This court will apply those principles to a partnership consisting of corporations that are owned by the attorney-employees who give them professional life and meaning.
Defendant offers no authority suggesting that the partnership-corporation-shareholder structure of Debtor immunizes it from the Jewel analysis. While Debtor has not cited cases applying Jewel to any law firm structured in a two-tier setting such as Debtor, the principles are the same and this court will not ignore the substance of Debtor's existence in blind deference to the form of it. Jewel and its progeny apply these sound principles to attorneys who practice law together. The attorneys who came together and created Debtor to be the institution that it once was did so by the carefully drafted Basic Documents, and they worked together as attorneys, representing clients, sharing the good with the bad, and quite importantly, trusting one another as fellow members of the same law firm.
The rules of RUPA (governing the partnership structure of Debtor) and the applicable governing professional corporate laws (whether those of California or another state) creating Debtor's corporate partners provide the structure and means of governance of the entities and compensation of the Members. Those Members are themselves attorneys practicing an honored and respected profession, and they are governed by yet another set of rules that bind those professionals together. Those are the rules of trust, confidence and loyalty, rules that apply to attorneys representing clients together, fiduciary ones to be sure. Jewel, 156 Cal. App. 3d at 179. The choice of California law by the partners is not without consequences. Jewel applies, regardless whether RUPA does. Under Jewel, attorneys practicing together need to establish their respective rights and duties by their agreements.
California partners were formed under the Moscone-Knox Professional Corporation Act (Cal. Corp. Code § 13400, et seq.). Corporate partners formed elsewhere would have been created under comparable but different provisions of their respective state's laws.
More importantly, Defendant's argument ignores the Basic Documents themselves. Attached to this Memorandum Decision is an appendix that sets forth the portions of the Basic Documents that support the court's conclusion that Debtor was a law firm organized through an integrated set of interrelated documents. It was a law firm of lawyers who chose the way they practiced law together. That they chose to do it in the form they did, and because they preserved to the Debtor the rights they did, they are governed by California law and the principles of Jewel and Fox.
As illustrated in the appendix, Debtor retained to itself several rights, including unbilled fees, work in process and rights and access to clientele. The final sentence of Paragraph 9.5 of the Employment Agreement confirms forcefully the nature of the relationship:
Employee [a practicing attorney with Debtor] understands and agrees that, so long as Employee remains employed by the Company [the Professional corporate partner of Debtor], Employee's solicitation of clients to terminate their client relationship with the [Debtor] in whole or in part involves fiduciary principles on the part of the Employee and requires prior consent of the Company.
If the drafters of "involves fiduciary principles" meant to mean something less than the fiduciary relationships that theJewel and Fox courts recognized, they failed.
In sum, the court is satisfied that, just as the Fox court extended Jewel to the professional corporation, the same rules and consequences should follow and apply to Debtor's two-tier structure.
B. The Basic Documents did not waive Debtor's rights under Jewel.
Defendant seeks dismissal of the adversary proceeding because Debtor had no right to bring claims against the Shareholders or the corporate partners for unfinished business profits and thus the Jewel Waiver transferred no property of Debtor in the first instance. In other words, Debtor had no rights in unfinished business to waive. The court is not persuaded; the Basic Documents provided Debtor — at least until the Jewel Waiver was executed — with the right to claim profits from such unfinished business after the departure of Shareholder attorneys completing such business. Debtor's Members were quite experienced, and plainly knew about Jewel and Brobeck when they drafted the Plan of Dissolution and the Jewel Waiver.
See discussion in III(C), infra.
As shown specifically in the attached appendix, no corporate partner or Shareholder had a right to Debtor's unbilled time or its work in process. Debtor did not waive (either explicitly or inferentially by those documents) such rights or the right to compel an accounting from departed Members, at least not until the execution of the Jewel Waiver, when Debtor was insolvent and bankruptcy was three months in the future.
The language of the Basic Documents, by reserving to Debtor the unbilled fees, the work in process and the access to the clientele, convinces the court that whatever vitality may have once existed by virtue of Jacobson v. Wikholm, 29 Cal. 2d 24 (1946), suggesting that the surviving partner who completes the work in progress keeps all of the profits, was abrogated by the parties' agreements.
When Debtor reconfigured itself under the Basic Documents or at some other time before bankruptcy loomed and it was insolvent, it could have surrendered those rights to its Partners or its Members, but it did not. Had it done so, whether wise law firm practice or not, the September 2008 Jewel Waiver would have been unnecessary and Debtor now would likely have no theory of fraudulent transfer to pursue.
C. The Jewel Waiver constitutes a transfer of Debtor's unfinished business.
Debtor does not challenge the efficacy of the Jewel Waiver itself, but only the consequence as a fraudulent transfer.
As noted above, the Jewel Waiver was part of Debtor's Plan of Dissolution. In the Jewel Waiver, Debtor, agreed to waive
. . . any rights and claims under the doctrine of [Jewel] to seek payment of legal fees generated after the departure date of any lawyer or group of lawyers with respect to non-contingency/non-success fee matters only. . . .
While the Jewel Waiver did not refer to "unfinished business," specifically, the court construes the Jewel Waiver to waive exactly that, namely Debtor's right to profits from a dissolved law firm's unfinished business as defined in Jewel and as reiterated by this court in Greenspan v. Orrick, Harrington Sutcliffe (In re Brobeck Phleger Harrison LLP) 408 B.R. 318 (Bankr. N.D. Cal. 2009) ("Brobeck").
As in Brobeck, the court does not construe the Complaint to extend to new business handled by former members of Debtor at new law firms.
For the reasons stated in Brobeck, the court treats Debtor's unfinished business as Debtor's property that was transferred by the Jewel Waiver, and that may be recovered under the Complaint. Even those rights, however, are subject to the reasonable compensation for completing the work in progress that RUPA (unlike the former Uniform Partnership Act) recognizes, this court in Brobeck recognized, and the Debtor in the Complaint recognizes.
To say that property that produced no profits was not property is circular, conflating what was transferred with its value. See Brobeck, 408 B.R. at 338.
D. Recovery by Debtor on the Complaint will not violate California Rules of Professional Conduct or other applicable law.
One Defendant contended in its briefing that a recovery by Debtor in these actions would violate the fee-sharing prohibitions of the California Rules of Professional Conduct. The court believes that a transfer of unbilled fees could be recovered without doing violence to any applicable California Rule of Professional Conduct or similar law.
First, no "sharing" of fees would occur. Rather, the "profit" on the unfinished business would be recovered as a matter of state or federal fraudulent transfer law. Second, to the extent the Debtor is proceeding under the Bankruptcy Code, the doctrine of federal preemption would overrule any apparently contrary state law or rule. Finally, the court believes that there is no prohibition on recovering assets transferred in actual or constructive fraud of creditors. The client would have paid the fees and the fees will have been reduced to cash or equivalent.
Had Debtor made a transfer in fraud of creditors of an account receivable due from a client for legal services rendered, surely a recovery under the fraudulent transfer laws would not be an impermissible sharing of fees. There is no difference with unbilled fees.
A related argument is that a policy permitting the bankruptcy estates of dissolved law firms to recover unfinished business profits would render former lawyers of those firms "toxic"; no firms would hire them given the potential loss of those profits. The court is sympathetic to this policy concern, but the policy of the fraudulent transfer laws — recovery for creditors what value is rightfully theirs — is far more compelling and is firmly established in both state and federal law.
In sum, no defendant has set forth persuasive authority to suggest a conflict sufficient to defeat the Debtor's theories of recovery.
E. Debtor may seek to recover fraudulent transfers from Defendant.
Law firms that take on attorneys from an insolvent firm that executed a Jewel Waiver in its dying days may be named as fraudulent transfer defendants based on 11 U.S.C. § 550(b)(1). See Brobeck, 408 B.R. 339, fn. 31 ("Therefore, if the Trustee can recover profits from Brobeck's Unfinished Business, he can recover from not only the Partner Defendants but from the Firms as well, subject to any defenses available to the Firms in [§] 550(b)(1)").
In Brobeck the plaintiff trustee named as defendants the individual former Brobeck partners who joined the firms he sued. Here Debtor has not done that. Nor does Debtor contend that the defendant was an initial transferee from Debtor by virtue of the Jewel Waiver. Instead, it contends in the alternative that the defendant is a subsequent transferee or that it may be an entity ". . . for whose benefit such transfer was made[.]" See 11 U.S.C. § 550(a)(1).
While Defendant seeks to dismiss or at least pin down Debtor on which of these alternate theories it relies, the court is satisfied that Debtor's alternate pleading here may survive the Motion. The development of the factual record will establish which theory prevails, and thus what defenses are available to defendant.
One Defendant has argued that Debtor cannot demonstrate that the Jewel Waiver was given for less than a reasonably equivalent value. This is a fact question not appropriate for resolution in the context of a Rule 7012 motion to dismiss. Further, the language of the Jewel Waiver is not clear as to what consideration, if any, was exchanged.
F. The First Claim for Relief and the Third Claim for Relief lack specificity and should be amended.
Defendant argues that Debtor's four fraudulent transfer claims lack the specificity and detail required by Fed.R.Civ.P. 9, incorporated by Fed.R.Bankr.P. 7009. It also argues that under the general rules of pleadings of Fed.R.Civ.P. 8, incorporated by Fed.R.Bankr.P. 7008, and recent Supreme Court precedents, that Debtor's theories must have plausibility, not merely possibility, and should fail because the circumstances of the Jewel Waiver were completely explainable as part of Debtor's Plan of Dissolution.
Fed.R.Civ.P. 9(b) provides that:
In alleging fraud or mistakes, a party must state with particularity the circumstances constituting fraud or mistake.
See Ashcroft v. Iqbal, ___ U.S. ___ 129 S.Ct. 1937 (2009) andBell Atlantic Corp. v. Twombley, 550 U.S. 544 (2007).
The court disagrees with Defendant concerning Debtor's Second Claim for Relief and Fourth Claim for Relief (constructive fraudulent transfers). Attacking a transfer as a constructively fraudulent transfer is not the same as alleging fraud. A constructively fraudulent transfer has nothing to do with the conduct of the transferee. Stated otherwise, the transfer itself is what is "fraudulent," because of its impact on the creditors of an insolvent transferor. Accordingly, the court will not dismiss these claims for relief or even require that they be amended.
As to the First Claim for Relief and the Third Claim for Relief (actual fraudulent transfers), the fraudulent conduct that is necessary to state a claim on these theories requires actual conduct by the transferor, and no particular involvement by the transferee. That is not to say that in appropriate circumstances a transferee may not be a participant to an actual fraudulent transfer, but no such conduct is suggested in the Complaint.
The gravamen of these two counts is that somehow attorney members of Debtor, in connection with the execution of the Jewel Waiver, intended to hinder, delay or defraud Debtor's creditors. Not only are those serious allegations for Debtor to make, they lack specificity under each of the two rules cited above. Accordingly, the court will grant the Motion but will give Debtor thirty days from the date the order is issued on this Memorandum Decision to amend those claims for relief.
IV. CONCLUSION
Concurrently with the entry of this Memorandum Decision the court is issuing an order denying the Motion as to the Second Claim For Relief and the Fourth Claim For Relief, and granting the Motion as to the First Claim For Relief and Third Claim For Relief, with Debtor given thirty days to amend either or both of those claims for relief.
Consistent with the court's practice on adversary proceedings related to Debtor, rather than set a continued status conference, the court will simply leave this matter off calendar, subject to being reset if and when any party wishes to be heard on any motions or until either or both parties desire to bring the matter before the court for trial setting and other pretrial matters. Document Paragraph Language Court's Conclusions Business Draws Percentages Profits and Losses Interest in Partnership Clients Entire Agreement Relinquishment Governing Jewel Law; Consent to Jurisdiction Common Stock Preferred Stock Mechanics and Payment Alternative Medium of Payment; Set- Off Entire Agreement No Entitlements Governing Jewel Law; Consent to Jurisdiction Full Time Employment Compensation Compensation upon Termination Post- Termination Obligations Entire Agreement No Entitlement Governing Jewel Law; Consent to Jurisdiction
PA Background "This Agreement Debtor is the provides for the law firm; and continued practice its of law by the professional Partners . . .' corporations its partners. 2.2 "The business of the Partnership is to engage in the Same profession of law . . ." 3.2 ". . . the Compensation "Member" [not a Committee shall party to the determine a draw Partnership amount attributable Agreement] to each Member." refers to Shareholder of Partner (See Glossary). Not unlike other traditional law firm compensation determinations. 3.3(a) "the Compensation Committee shall determine a Same percentage amount . . . which is attributable to each Member . . ." 3.4(b) "The Percentage Interest of a Partner for a Fiscal Year shall be the Same sum of the Attributed Percentages of its Members." 3.5(a) ". . . no Partner and Debtor retained no Member shall have interests in any interest in unfinished . . . unbilled fees, business. work in progress, real or personal property . . ." 3.5(b) Describes Debtor retains entitlements of unbilled fees, withdrawing Partner work in or Member whose progress (i.e., employment by a unfinished Partner is business), real terminated. or personal property. 4.5 "All clients for Clients are the whom any Partner or Debtor's. Member provides legal services shall be clients of the Partnership . . ." 8.1 Integration See comments re provision covers ¶¶ 3.5(a) "terms and (b). conditions agreed upon by the Partners relating to their subject matters . . ." 8.4 Each Partner waives Debtor did not "the right to demand waive or an accounting of any relinquish Partnership business anything. It or . . . the right to retained right demand an interest to demand in or access accounting to . . . clientele . . ." and the "clientele." 8.7 California law applies. applies. SHA Background Each Shareholder [Member] licensed to practice with the professional corporation. 2.2 Formulas for Common stock 2.3 determining number calculations of shares of common not unlike stock in the other professional traditional corporation for each lawfirm attorney compensation Member/Shareholder determinations. based on, inter Preferred stock alia, determinations is a form of of Adjusted capital Attributed contribution. Percentages by the Compensation Committee. 3.4(b) Shareholder/Member Deferred who leaves other payment scheme [on than through death, for departing Termination of disability or Member under Employment] retirement paid for other Common and Preferred circumstances. Stock. 3.9(a) Deals with payout of Departing Member who provides attorney taking legal services, client not paid directly or though a out as well as new firm those who died, affiliation, to a retired or were client of the disabled. Debtor. Debtor may make payout, in lieu of cash, through assignment of accounts receivable or unbilled fees owed by prior client. 3.9(b) (e) Debtor may recover Set-off excess cash paid on available, but stock repurchase. not described Debtor may also set- as the sole off any amount owing remedy of to it or recovery from professional Member. corporation against amounts owing to departed Member. 5.1 Integration No waiver of provision covers Debtor's or "terms and Company's conditions agreed rights to upon by the unfinished Shareholder, the business. Company, the other Partners and the Partnership relating to their subject matters . . ." 5.4 "No Shareholder No waiver of shall have any right to interest, other than accounting by as a shareholder, Debtor or in . . . Company. unbilled fees, work Debtor retains in progress, real or right to personal unfinished property. . . ." "Each business. Shareholder relinquishes and waives . . . the right to demand an accounting of any Partnership business . . . or the right to demand an interest in or access to . . . clientele . . ." 5.7 California law applies. applies. EA Background Debtor and employee Consistent with [attorney] engaged recitals in in the practice of other law. agreements. 3.1 Employee to devote substantially all Same time to practice of law. 4 Base salary and Consistent with annual bonus recitals and provisions authorizations for fixing compensation in other agreements. 9.4 Provisions deal with entitlement to unpaid Base Salary Same and Annual and other bonuses, subject to payback of any excess. 9.5 ". . . Employee shall Debtor retains not be entitled to right to any share of future unfinished income from client business. work existing at the Recognition of effective date of fiduciary termination. . . . ." relationships. "Employee understands and agrees that, so long as Employee remains employed by the Company, Employee's solicitation of clients to terminate their client relationship with the [Debtor] in whole or in part involves fiduciary principles on the part of the Employee and requires prior consent of the Company. 10.1 Integration Nothing about provision covers different "terms and rights upon conditions agreed dissolution. upon by Employee, the Company, the other Partners and the Partnership relating to their subject matters . . ." 10.4 "Employee . . . No waiver of relinquishes and right to waives . . . the right accounting by to demand an Debtor or accounting of any Company. Partnership business . . . or the right to demand an interest in or access to . . . clientele . . ." 10.7 California law applies. applies.