September 20, 2012
Teaching BA Without Bankruptcy: The LLP as an Illusion?
Posted by Christine Hurt

OK, so I'm rethinking how I teach BA.  Gordon and I have taken on a few writings in the area of partnership, and we knew that it would deepen our current knowledge of partnerships.  But I didn't think it would complete change my thinking.

So, when I teach LLPs, I do it in the traditional way, and a quick perusal of the numerous BA texts tells me I have lots of company.  In limited liability partnerships, partners don't have personal liability for partnership obligations.  In most states, for both tort and contractual obligations.  Partners' capital is at risk, but partners never have to write a personal check out of their own funds, unless the liability arose out of their own behavior (or those they supervised, etc.).  So, if a creditor has a claim that isn't satisfied out of partnership assets, the creditor suffers a loss.  End of story.  Except I'm not sure now that it ever happens that way.

I suppose there are instances where insolvent LLPs just dissolve and their creditors go on their way, but another option is that the creditors would force the LLP into bankruptcy (or the LLP would voluntarily file for bankruptcy).  And bankruptcy has its own rules.

LLP Shield v. Clawback:  So, in bankruptcy, the trustee can claw back amounts distributed to partners within two years under certain circumstances.  Because of this right to clawback, partners have an incentive to settle so that they can move toward financial and professional certainty.  So, we've seen settlement agreements with partners in Brobeck, Coudert Brothers, and now Dewey.  The "L" in LLP seems to be a little "l" at best.  Partners who are sufficiently prescient to leave 2.5 years are more before filing seem to fare much better at shielding themselves, even though they are no longer in the shield.

LLP Shield v. Winding Up v. Unfinished Business Doctrine:  If I ever write a BA casebook, I'm going to feature In re Brobeck, Phleger & Harrison LLP, 408 B.R. 318 (N.D. Calif. 2009).  So, Brobeck is teetering toward its eventual bankruptcy (filed September 2003).  Some smart folks there know that there is a California state case, Jewel v. Boxer, that holds that "in the absence of an agreement to the contrary, partners have a duty to account to the dissolved firm and their former partners for profits they earn on the dissolved firm's "unfinished business," after deducting for overhead and reasonable compensation."  The only way these partners are going to work again is if other law firms think they are bringing a book of business.  So, it suits everyone in the about-to-dissolve firm fine if they all go ahead and waive this right on behalf of the partnership.  They know that the unfinished business profits would just be going to Citibank (their major creditor) anyway.  Months later, Brobeck is in bankruptcy and its partners are safely tucked into other firms, just like the "L" in LLP intended.  (Other non-California courts have followed both the Jewel doctrine and the Jewel-waiver as fraudulent conveyance reasoning.)

But, the trustee sued the new firms anyway.  The court did a funny thing.  The court upheld the Jewel waiver as valid.  However, the court held that the Jewel waiver transferred a property right of the partnership (the right to profits) too close to bankrutpcy, so the waiver was clawed back.

So, I'm not sure when partners in an LLP get to walk away, as I have so blithely suggested in my BA case.  The shield seems to work best when the entity has enough assets to satisfy claims or when the entity has had so little assets that it hasn't made a distribution in a very long time.  Hmm.

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