The Dangers of a 'Clawback'

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The hiring of lateral partners with an existing book of business remains one of the hottest growth trends at larger law firms. The demise 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 consider what happens if a lateral has "escaped" from a firm nearing bankruptcy with the understanding of bringing over clients as well as any "unfinished business." 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 that even that protection might not be sufficient to trump the U.S. Bankruptcy Code. It has been reported in the legal press that the bankruptcy trustees for two defunct law firms, Heller Ehrman and Howrey, have been seeking "clawbacks" from former partners who have landed at prestigious new firms.

Until now, such partners have been considered protected by the so-called "Jewel waiver," 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, because the attorneys did not give the Heller partnership anything of value in exchange for the waiver and left the bankruptcy estate depleted.

In the Howrey case, the point has been taken further, with the trustee claiming that the firm was insolvent well before it actually declared bankruptcy. As a result, 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 for violating their partnership agreements.

Several of the largest firms in the country that likely felt they had scored a coup by hiring former Howrey talent have had to reach settlements with the trustee on behalf of their lateral hires.

Such developments have 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.

Lateral hiring at the volume it now occurs is a relatively recent phenomenon and reflects the fact that law firms have become more subject to the competitive dynamics of corporate America. That has brought the more active turnover of and placed the emphasis on profit-per-partner as the yardstick of lawyer and firm performance.

But unlike corporate executives, law firm partners are owners of their firms, accountable to fellow partners — and the courts.

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