Prior to filing bankruptcy, in order to facilitate an orderly liquidation and movement of attorneys to other firms, the law firm of Brobeck, Phleger & Harrison, LLP (“Brobeck”) amended its partnership agreement to include a waiver of the rights of the firm and its partners to any “unfinished business” of the firm, as that term is defined in Jewel v. Boxer.
In In re Brobeck, Phleger & Harrison, LLP (Greenspan v. Orrick, Herrington & Sutcliffe LLP), __ B.R. __, 2009 WL 2045344 (Bankr. N.D. Cal. July 2, 2009), the bankruptcy court held that the provision was valid as a matter of California partnership law but was a fraudulent transfer because it was a transfer of interests in Brobeck’s property that was made while Brobeck was insolvent and without the receipt by Brobeck of any value in return.
In Jewel v. Boxer, 156 Cal.App.3d 171, 203 Cal.Rptr. 13 (1984), a California court of appeals held that, in the absence of an agreement otherwise, when a partnership dissolves, the partners have a duty to account to the dissolved firm and their former partners for profits earned on the dissolved firm’s unfinished business after deducting for overhead and reasonable compensation. The Jewel case involved contingency fee matters, but later cases made clear that the rule also applies to hourly rate matters. Many Brobeck partners were familiar with the Jewel duty to account because a law firm had recently sued Brobeck for an accounting of profits earned on unfinished business completed by former partners of that firm who went to Brobeck. As the dissolution of Brobeck loomed, the Brobeck policy committee thus recommended that the partnership agreement be amended to include a provision waiving Jewel claims that Brobeck would have against its former partners or their new firms except for two specified matters. The amendment received the requisite approval of the partners, and Brobeck proceeded to dissolve. After Brobeck entered involuntary bankruptcy, the trustee asserted various claims against the Brobeck partners and several firms who had hired Brobeck partners. The trustee settled with most of the partners and the two firms to which most Brobeck partners moved, but certain Jewel claims were not settled, and the trustee asserted these claims against two firms and ten former Brobeck partners who moved to those firms.
The court first analyzed whether the Jewel waiver was valid under California partnership law. The court concluded that the partners were not only free to adopt such a provision, but were, in fact, encouraged by the case law in this area to adopt an agreement as to how to handle unfinished business in a way that immediately disposes of unfinished business and minimizes the disruptive impact of the dissolution. The court rejected the trustee’s arguments that the waiver ran afoul of the RUPA provision permitting modification of the duty of loyalty by identifying “specific types or categories of activities that do not violate the duty of loyalty” so long as the modification is not “manifestly unreasonable.” The trustee argued that the provision was not specific enough because it did not refer to the partners’ duty of loyalty, but the court stated that specific reference to the duty of loyalty, while “it may be a prudent exercise,” is not required for a valid modification of the duty under RUPA. The court also rejected the trustee’s argument that the provision was “manifestly unreasonable.” The court stated that it was left to rely on its common sense in the absence of case law defining the term, and the court concluded that the Jewel waiver was not “manifestly unreasonable.” The court reasoned that the waiver did not eliminate the duty of loyalty, but merely modified the duty to account, which is just one of the three duties of loyalty set forth in RUPA. The court stated that Brobeck’s insolvency at the time of adoption of the waiver did not affect its validity under RUPA because RUPA does not govern the relationship of the partnership or its partners to third parties, such as creditors.
While the court determined that the Jewel waiver was lawful and valid under RUPA, the court ultimately determined that the waiver was avoidable as a fraudulent transfer. The court held that profits from unfinished business amounted to property of Brobeck and that the waiver effected a transfer of that property to the partners. Although the court concluded that the trustee failed to meet his summary judgment burden with respect to actual intent to hinder, delay, or defraud a creditor, the court concluded that the trustee was entitled to summary judgment that the Jewel waiver was a constructively fraudulent transfer. The parties did not dispute that Brobeck was insolvent when the waiver was approved, and the court concluded that there was no evidence that Brobeck received anything of value in exchange for the waiver. Thus, the waiver was avoidable as a fraudulent transfer, and the partners, as initial transferees, and their new firms, as immediate transferees, were liable to the extent of profits received on Brobeck’s unfinished business.