Since 1988, when Finley Kumble filed for bankruptcy protection, some 32 major law firms have failed. In each of those cases, liabilities far exceeded assets and in most of these cases, partners of the defunct firm and the new firms they joined wound up paying money back to the bankrupt estate. Much of these clawbacks arise from the Jewel v Boxer or “unfinished business” doctrine. I do not know of a single instance where partners of a defunct firm received any money from the liquidation process.
The long term ramifications of a law firm failure go much deeper than the clawbacks of the “unfinished business” doctrine. They also include clawbacks sought from partners by a trustee or a liquidation committee for compensation paid to partners during the period the law firm was found to be insolvent. In addition, law firm partners not only face a loss of their capital accounts, but in addition, recognition of phantom income as capital accounts are zeroed out as well as in some instances, forgiveness of debt. Added to this financial quagmire is the reputational issue: Clients asking “how can I trust you to guide me in managing my business, when you couldn’t manage yours.” A more in depth look at the issues can be found at http://kowalskiandassociatesblog.com/2011/02/03/the-financial-and-legal-consequences-of-a-law-firm-dissolution-on-the-partners-of-the-defunct-firm/
In a number of cases, law firms tried to resolve the “unfinished business” (also known as “Jewel v Boxer”) issues by drafting provisions in their partnership agreements waiving the “Jewel v Boxer” rules. Every court that has addressed these provisions, particularly Judge Dennis Montali of the Bankruptcy Court for the Northern District of California (who is presiding over Howrey, Heller Ehrmann and Thelen) have found these provisions void as constituting a preference.
We have very recently seen a slight reverse trend: Some law firms have included a provision in their partnership agreements which requires a departing partner to refund 10 to 20% of fees he or she earns from clients he or she has taken with him or her which had been clients of the law firm over a stipulated period of years. These clauses are very new and have not been tested in any court. These clauses pose a separate set of issues since, if they are indeed enforceable, they severely restrict partner mobility. It is that unintended consequence which will inevitably test the viability of the provision, particularly since Jewel v Boxer claims only arise in the context of a firm dissolution.
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