What happens when a law firm dies but its debt lives on?

It's a question that could come up more frequently as the grim economics of the legal industry forces firms to weigh all options – even if that means, alas, shuttering its doors.

One of our colleagues at Dow Jones Daily Bankruptcy Review, Jacqueline Palank, gets to the heart of this question in a very interesting story about what's been happening since San Francisco law firm Heller Ehrman dissolved three years ago. You may recall that the firm sought Chapter 11 bankruptcy protection in December 2008 several months after it announced its dissolution.

The firm's lawyers naturally dispersed and took positions in several dozen other law firms – but now those firms are being asked to pay for Heller Ehrman's old debts, Jacqueline writes in her story.

Why? Under the so-called unfinished business doctrine, a bankruptcy trustee has the right to sue for profits generated by work that partners took on at their old firms and then brought with them to their new jobs. (Here's some background on the dispute involving another defunct firm, Coudert Brothers, which went into liquidation five years ago, by AmLaw and Reuters)

Sam Alberts, a partner in SNR Denton's restructuring and insolvency practice, tells Jacqueline that trustees can sue both the individual partners and their new law firms.

"These departing partners and the new law firms that they joined are a prime target for the bankruptcy trustees," adds Paul A. Rubin, a bankruptcy and litigation partner at Herrick, Feinstein. "What can the trustee do to maximize value for the creditors, and what is the liability of the new law firms that take on these lawyers?"

So far, Heller Ehrman has struck settlements with about 40 defendants in unfinished business lawsuits that would bring in more than $8m for creditors. One settlement with eight firms was worth $2.3m.

Chris Sullivan of Trepel Greenfield Sullivan & Draa, one of the attorneys working on the lawsuits for Heller Ehrman, said in court papers that the amount of that settlement is about 7% of the gross revenues from the business the firms won following Heller Ehrman's demise. While the attorney acknowledged the percentage is "slightly lower" than what was agreed upon in other deals, he said the cost and risk of continuing these eight lawsuits isn't worth it.

Many unfinished business lawsuits don't advance to the trial stage. Rubin said there's little case law, leaving many unanswered questions on just how to go about declaring a numerical value for the damages sought. "Given the cost and risk of litigation, these matters tend to settle," he said.

What makes these types of lawsuits notable these days is that they're now being filed in the bankruptcy liquidations of large national or international law firms against equally large, if not larger, firms, she says in the story. As the competitive legal industry continues its shakeout, the firms absorbing the attorneys who jump ship can expect to face — and fight — similar litigation.

(Published by WSJ - October 21, 2011)