Law Firm Bankruptcy and The Property Of “Unfinished Business”

Howrey LLP was a global law firm that practiced antitrust, international litigation and intellectual property law. According to Wikipedia, at its peak Howrey had more than 500 attorneys in 16 locations worldwide. About 60 attorneys departed from Howrey in the year before January 2011, crippling the firm and prompting its creditors to force it into involuntary bankruptcy. Those partners took client work with them that had been originated at Howrey and now the Chapter 11 trustee wants to recover the profits from that work.

Last week the US Bankruptcy Court for the Northern District of California granted the trustee the right to seek comprehensive documents from 70 former Howrey partners. Because these profits belong to Howrey’s creditors, the ex-partners should expect to write checks for significant amounts in order to settle the claims.

Under California law, the work that remains when a law firm dissolves is called “Unfinished Business”, and profits from that work represent a property interest of the firm. Departing lawyers are free to decide amongst themselves that the work can be taken and the dissolving firm may waive its rights in that work. However, courts have ruled that such waiver constitutes a transfer of the old firm’s profits interest in the unfinished business.

That technical ruling means little, unless the dissolved firm is insolvent, that is its assets are insufficient to pay its debts. In that event, the departing partners are enjoying profits that should have belonged to the creditors of the defunct firm. Although the context is unusual, the bird’s eye view of these transactions reveals the truth of the matter: the transfer of unfinished business to the new firm is a garden variety fraudulent conveyance, avoidable by the trustee in bankruptcy.

Applying the fraudulent conveyance label does not by itself bring the dollars back into the Howrey bankruptcy estate. The partners and their new firms will argue that Howrey was not insolvent at the time of the transfers, and according to the schedules filed with the Court, the value of Howrey’s assets did allegedly exceed the amount of its liabilities. The partners will also argue that the new firms gave equivalent value for the lost profits, another defense to fraudulent conveyance actions. Whatever is argued, it seems as if there’s plenty of litigation to go around.

This kind of trustee action usually becomes a full employment act for lawyers, but not when all the defendants are high powered lawyers themselves. They will likely provide their own defense to these actions. For his part, the Chapter 11 trustee will also hire his own law firm, with the critical difference being that he will be paid from any litigation recovery. As a result, only one thing is for certain: unless there’s a home run for Howrey’s creditors, it’s possible that the only real winner will be the Chapter 11 trustee.

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