Ethics Experts Say Former Partners Could Face Liability

Ethics Experts Say Former Partners Could Face Liability
The New York Law Journal by Noeleen G. Walder - February 2, 2009

When partners at Dreier LLP heard in early December that the firm's jailed sole equity partner, Marc S. Dreier, might have been dipping into escrow accounts, many quickly abandoned ship. "The firm was over in two or three days," according to former Dreier partner Bruce F. Bronster, who is now a member of Windels Marx Lane & Mittendorf. In the last month, "everybody's found new homes in a shotgun manner. It's kind of like finding a spouse with a gun to your head . . . you date as much as you can," Mr. Bronster remarked.

But while Dreier partners might have hoped to make a clean break with their disgraced former partner, they could face legal issues arising from their time at the firm, according to some attorneys who are familiar with bankruptcy law, professional responsibility and law firm partnerships. The departed partners might be held liable for any of the firm's debts, and also face disciplinary action for any missing escrow funds. Further, they might be asked to return income they received from clients for work on unfinished matters they took with them when they left the now-defunct firm. Mr. Dreier was indicted last week by a federal grand jury on charges that he had cheated hedge funds and other investors of more than $400 million. He has been held without bail since his Dec. 7 arrest in New York on wire and securities fraud charges, which followed a Dec. 2 arrest for criminal impersonation in Toronto.

The 58-year-old Mr. Dreier, a Harvard Law School graduate, allegedly was "sole signatory on all of the firm's thirteen to fourteen escrow accounts," according to court papers.  Some firm attorneys and its comptroller expressed concern to the Securities and Exchange Commission in the wake of Mr. Dreier's quickly developing legal problems that client escrow accounts had been depleted (NYLJ, Dec. 11). The indictment made public last week alleged that Mr. Dreier had misappropriated client funds, including funds placed into an escrow account and money obtained in the settlement of a client lawsuit.  Like Mr. Bronster, many of Dreier's contract partners have either been absorbed by new firms or have hung out their own shingles. And they have taken their clients with them, according to several ex-Dreier lawyers.

Brad Lowary, a legal secretary who worked at Dreier for 18 months earning close to six figures, said that when attorneys learned that client money was missing "the smart partners just immediately left." (Read Mr. Lowary's account of life at the firm.) Led by Seth H. Ostrow, the intellectual property group was the first to organize and leave the firm, he added. Other practice groups quickly followed suit.  Only two attorneys remained at the firm immediately following its bankruptcy filing, according to court papers filed in the proceeding, one of whom Mr. Lowary said is associate Marc H. Simon. "One of the things about Dreier, people came in various groups and left in various groups," said Eric Osterberg, a partner in Dreier's former 15-attorney Stamford, Conn., office.  According to Mr. Osterberg, Mr. Dreier formed a group of affiliated firms, which essentially operated under one umbrella. Approximately 160 of its 238 attorneys worked out of the main office, Dreier LLP, at 499 Park Ave., while others were based in Stamford, Pittsburgh, Albany, and California.

Except for Mr. Dreier, other partners received a base compensation plus a bonus based on the amount of business they generated.  Mr. Osterberg was in the midst of a trial in Boston when he and Joseph M. Pastore III heard about Mr. Dreier's arrest in Canada. At the time, Mr. Osterberg was "too busy" to think much about it, but when the firm failed to make payroll, he realized he and his colleagues had "better form some type of entity" to continue serving their clients. By Dec. 15, Pastore Osterberg was up and running in Stamford.  Mr. Osterberg said he has kept the clients he had at Dreier. However, it is unclear whether his new firm will continue as a stand-alone or merge with a larger firm. Steven R. Gursky, who came to Dreier with his own group of lawyers and left for Olshan Grundman Rosenzweigh & Wolosky with "substantially the same core" of attorneys, said that what once seemed like a major upheaval now almost feels like a "momentary inconvenience."

Authority Issue

But partners looking to put the Dreier debacle behind them might be in for a rude awakening, according to some sources knowledgeable about law firm partnership. "When law firms dissolve, the court wants one thing and one thing only. They want money put back in the estate to pay back the creditors," especially when there are clients who have lost money, said an attorney who specializes in law firm ethics and professional responsibility who asked to remain unnamed.  "In connection with partners in law firms, the interplay between the limited liability statute and the bankruptcy law is not entirely clear so that any partner who was being held out to the public as a partner is under some risk of having liability," he added. Robert W. Hillman, a professor at University of California Davis School of Law, who specializes in ethics and partnership law, agreed that the issue comes down to one of "apparent authority." "The problem is many firms hold [contract partners] out to the world as partners and the consequences of that is that they assume liabilities they don't know they have," Mr. Hillman explained. "If they are truly partners," they have an obligation to monitor each other to make sure there are not crooks in their midst and a fiduciary obligation to protect clients, Mr. Hillman said.

Former Dreier attorneys will counter that they were employees, not partners. And even assuming they were partners, they will maintain that since Dreier was a limited liability partnership, they cannot be held liable for the misdeeds of Mr. Dreier, Mr. Hillman suggested. Roy D. Simon Jr., a legal ethics professor at Hofstra University School of Law, said that the limited control ex-Dreier partners reportedly had over the firm could go a long way to shield them from exposure to liability. "Based on my limited understanding . . . it's very difficult to say that they should have known [about Dreier's alleged fraud] since the structure of the firm made them a lot like associates," Mr. Simon said. According to Les D. Corwin, who chairs Greenberg Traurig's business dispute group, to truly assess liability, the bankruptcy trustee will have to understand the "corporate structure" and the "nature of the underlying agreements" between Mr. Dreier and the contract partners.  "The key is in the agreement," he said.

Leonard J. Elmore, who played professional basketball before becoming an attorney and joined Dreier just three months prior to its collapse, said his contract clearly states he was a firm employee.  "How do you go after people who had no input into how the company was run?" asked Mr. Elmore, who had none of his own clients at Dreier and is now working as an ESPN analyst. But this argument might not fly, particularly when clients make certain assumptions about partners and their responsibilities, according to Mr. Hillman. And while an LLP might shield a partner from liability when another partner commits malpractice, it "doesn't relieve partners of responsibility to ensure that assets are controlled and escrow accounts are properly monitored," Mr. Hillman said. The legal ethics expert who asked to remain unnamed agreed that missing escrow funds could be a cause for concern.

"The place where so-called partners have the greatest exposure is with respect to money belonging to clients and held in the firm's client, trust or escrow accounts, and especially so when it involves lawyers' own clients and transactions," the ethics lawyer said in an e-mail. "In those circumstances, at least in connection with professional discipline, and possibly even with respect to fiduciary duty liability, the limited liability law probably does not operate to protect those lawyers, even if they were not themselves signatories on the accounts," he added.  Citing the case of Matter of Robert J. Ponzini, the expert said that attorneys who held themselves out as "partners" could face disciplinary action if the loss of client money is shown. In Ponzini, 268 A.D.2d 478 (2000), the Appellate Division, Second Department, suspended an attorney because he "knew or should have known that a negative balance existed" in the firm's escrow account.  Under that theory, "anyone held out as a partner may be treated as his brother's keeper," the ethics attorney explained.

Creditor Claims

In addition, partners could be on the hook for client fees they bill as a result of ongoing matters they took with them to other firms. Although the bankruptcy proceeding against Dreier LLP is still "in its infancy," Tracy L. Klestadt of Klestadt & Winters, who serves as counsel to the creditors' committee in the Chapter 11, said there is precedent under the California case of Jewel v. Boxer, 156 Cal. App. 3d 171 (1984), that "the profits of an unfinished business in the absence of a partner agreement" belong to the partnership that originated the business. Creditors in the Coudert Brothers bankruptcy have invoked that theory, said Mr. Klestadt, who served as debtor's counsel in that case.  Mr. Klestadt said there would be no need for the bankruptcy trustee to target the former contract partners if the firm's assets exceed its liabilities. But the unnamed ethics expert said that was highly unlikely. "Let's be real," he said. The only way the firm would wind up not being insolvent is if "someone finds a pot of gold." Noeleen.Walder@incisivemedia.com