Colorado Court Divides Contingent Fee Between Attorney Members of Dissolved LLC Law Firm

Law firm breakups sometimes result in disputes between the lawyers over continuing legal work. Some of the most difficult disputes are those over contingent-fee cases that were started before the firm broke up and will be concluded after the breakup. A contingent-fee case may require thousands of hours of lawyer time and, regardless of the amount of time spent on the case, may result in a fee anywhere from zero to millions of dollars.

A Colorado court recently had to decide such a case involving the distribution of a contingent fee to two lawyers who had dissolved their two-member LLC law firm in the middle of a contingent-fee case. LaFond v. Sweeney, No. 10CA2005, 2012 WL 503655 (Colo. App. Feb. 16, 2012).

Background. Richard LaFond and Charlotte Sweeney formed a law firm as a Colorado LLC in 1999 and orally agreed to share equally in all the firm’s profits, without regard to who brought cases in or who did work on them. In 2008 their law firm dissolved. Id. at *1.

At the time of dissolution the law firm represented Bobby Maxwell in a qui tam whistle-blower action brought under the False Claims Act. LaFond continued to represent Maxwell in the qui tam suit after the LLC’s dissolution. LaFond and Sweeney could not agree on how to divide the fees that might ultimately be earned on the Maxwell case, and LaFond filed a suit for declaratory relief against Sweeney to determine how the contingent fee should be distributed.

Trial Court. The trial court ruled that the Maxwell case was an asset of the LLC and that its value was to be determined at the time of the dissolution. Because LaFond and Sweeney had agreed that any profit from the case would be divided equally, the court held that Sweeney would be entitled to one-half of any contingent fee recovered by LaFond, up to a ceiling based on the number of hours worked on the case before the LLC’s dissolution. Sweeney appealed, contending that the law firm was entitled to all of any contingent fee received and that she was therefore entitled to one-half of the total fee.

The Court of Appeals first noted that the Maxwell lawsuit had settled after the trial court’s decision. The settlement amount was not clear to the court from the pleadings, but the fact of settlement meant that the Court of Appeals only had to deal with a completed contingent-fee case and a determinable fee.

Contingent Fee. The court then discussed at length the law of contingent-fee cases and the attorney-client relationship, and derived three principles. First, said the court, “the case belongs to the client,” meaning that when an attorney with the primary responsibility for a case leaves a law firm, the client can choose to be represented by the law firm, to be represented by the departing attorney, or to hire new counsel. Id. at *3.

Second, a contingent-fee agreement provides the attorney with certain rights. Id. at *4. An agreement between attorney and client that calls for a fee contingent on the outcome of a case is generally enforceable, assuming the lawyer satisfies his or her professional ethics obligations.

The court’s third principle required a review of the Colorado LLC Act’s dissolution rules. After its dissolution, an LLC continues in existence for the purpose of winding up and liquidating its business and affairs. Colo. Rev. Stat. § 7-80-803(1). As part of the winding up process, the LLC completes its executory contracts, including pending contingent-fee cases. LaFond, 2012 WL 503655 at *7. Therefore, said the court, “[a]n attorney who carries on the representation of a client on an existing case after a law firm dissolves does so on the firm’s behalf.” Id. The court pointed out that under the LLC Act, a member must “[a]ccount to the [LLC] and hold as trustee for it any property, profit, or benefit derived by the member or manager in the conduct or winding up of the [LLC’s] business.” Id. (quoting Colo. Rev. Stat. § 7-80-404(1)(a)).

The court’s analysis – a pending contingent-fee case constitutes unfinished business of the law firm, and a former LLC member who completes the case does so on behalf of the LLC – led it to its third principle, that the fee ultimately earned in such a contingent-fee case belongs to the LLC.

The court next examined LaFond’s and Sweeney’s relative rights in the fee. The court looked to other jurisdictions and applied the majority partnership rule: “The great majority of states have concluded that contingent fees ultimately generated from cases that were pending at the time of dissolution of a law firm must be divided among the former law partners according to the fee-sharing arrangement that was in place when the firm dissolved.” Id. at *10.

Compensation for Post-Dissolution Work. The court then had to determine whether LaFond should be compensated for his work on the Maxwell case after the LLC’s dissolution, or whether the fee should be split equally without regard for his post-dissolution time spent on the case.

The court first compared the winding-up provisions of Colorado’s LLC Act with its Partnership Act. The Partnership Act states that “[a] partner is not entitled to remuneration for services performed for the partnership except for reasonable compensation for services rendered in winding up the business of the partnership.” Id. at *13 (quoting Colo. Rev. Stat. § 7-64-401(8)) (emphasis added by the court). In contrast, the winding-up section of the LLC Act does not authorize or even refer to compensation for services rendered in winding up the LLC. Colo. Rev. Stat. § 7-80-803.3.

Because Colorado’s LLC Act was modeled in part on its Partnership Act, the court viewed the exclusion of compensation language from the LLC Act as an intentional legislative choice, and read the LLC Act to mean that an LLC member is not entitled to compensation for services rendered in winding up the business of the LLC. LaFond, 2012 WL 503655 at *13.

The court also relied on the reasoning of Jewel v. Boxer, 203 Cal. Rptr. 13 (Ct. App. 1984), quoting from its opinion:

At first glance, strict application of the rule against extra compensation might appear to have unjust results (e.g., where a former partner obtains a highly remunerative case just before dissolution, and nearly all work is performed after dissolution). But undue hardship should be prevented by two basic fiduciary duties owed between the former partners. First, each former partner has a duty to wind up and complete the unfinished business of the dissolved partnership…. Second, no former partner may take any action with respect to unfinished business which leads to purely personal gain. … If there is any disproportionate burden of completing unfinished business here, it results from the parties' failure to have entered into a partnership agreement which could have assured such a result would not occur. The former partners must bear the consequences of their failure to provide for dissolution in a partnership agreement.

Id. at 18-19.

Consistent with the Jewel approach, the court held that LaFond and Sweeney were each entitled to one-half of the contingent fee obtained by LaFond in the Maxwell case, without any reduction for compensation to LaFond for his post-dissolution work.

Comment. On the facts of the case this is not a terrible result, since LaFond’s hours spent on the Maxwell case after dissolution only amounted to about 4% of the total. But the court did not rely on that, and by extrapolation its holding would have yielded the same result, i.e., a 50-50 split of the fee, even if most of the work on the case had been performed after dissolution. That clearly would have been an inequitable result.

The court relied in part on a perceived duty for LaFond to wind up and complete the unfinished business of the dissolved LLC, including working on the Maxwell case: “We conclude that LaFond had a duty to wind up unfinished business of the dissolved law firm, including continuing to represent Maxwell.” LaFond, 2012 WL 503655 at *14. The source of this duty is not made clear in the opinion, but presumably it lies in either (i) the contingent-fee agreement with Maxwell, (ii) the LLC Act, or (iii) the fiduciary duty of a member.

The Contract. Maxwell’s contingent-fee agreement was with the LLC, not with LaFond. As the court said, “[a] contingent fee case that is pending at the time a law firm dissolves is a form of executory contract between the law firm and the client.” Id. at *7. The LLC, not LaFond, was obligated to represent Maxwell in his suit.

LLC Act. The LLC Act limits the activities of an LLC after dissolution to those appropriate to wind up and liquidate its business and affairs, but it imposes no duty on members to wind up the LLC after its dissolution. “After dissolution, the manager or, if there is no manager, any member may wind up the limited liability company’s business.” Colo. Rev. Stat. § 7-80-803.3(1) (emphasis added). The statute empowers the members to conduct the winding up, but does not obligate any member to do so.

Fiduciary Obligations. As an LLC member, LaFond had fiduciary obligations to the LLC’s other member, Sweeney, just as Sweeney had fiduciary obligations to LaFond. LaFond, 2012 WL 503655 at *6. Mutual fiduciary obligations would not obligate LaFond to handle the case after dissolution without compensation any more than they would obligate Sweeney. LaFond’s failure to insist on an Alphonse-and-Gaston routine with Sweeney should not doom him to non-recognition of his successful efforts to complete the contingent-fee case.

The LaFond case was easy in one respect – by the time the case went up on appeal it involved a dispute over a fully earned contingent fee, because by that time the Maxwell case was over. The fairest approach in such a case probably would be to divide the contingent fee into two portions pro rata, based on the hours spent on the case pre-dissolution and the hours spent post-dissolution. The pre-dissolution portion of the fee would be distributed to the members (50-50 in LaFond), and the post-dissolution portion would go to the member who worked on the case.

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