Opinion 90-10A Notes
You have asked the Professional Guidance Committee for an opinion as to whether your firm may, without running afoul of the Rules of Professional Conduct, take action to enforce the liquidated damages provision of the firm's shareholder agreement otherwise known as the "Executive Agreement" (hereinafter "the Agreement"). After considering the Agreement as a whole, including the liquidated damages provision, it is the opinion of the Committee that invocation of any of the remedies in the Agreement, including the liquidated damages clause, would be inconsistent with the Rules of Professional Conduct, specifically Rule 5.6(a).
The liquidated damages clause in question is embodied in Paragraph 13(C) of the Agreement. As we understand this clause, any attorney who, after being "terminated" from or by the firm1 either continues or, within one year after "termination," establishes an attorney-client relationship with an existing client of the firm, is liable for liquidated damages. A predicate for the assessment of such damages is language in the Agreement to the effect that any signatory to the Agreement acknowledges that any attorney who leaves the firm and either maintains or establishes an attorney-client relationship with a client of the firm has engaged in "wrongful conduct" and thereby "damaged" the firm. Liquidated damages under the Agreement are calculated as 80% of the preceding two years billing to the client in question, or, if the departing attorney is a stockholder, 80% of the billings to the particular client for each year of stock ownership, plus two additional years.
One immediate consideration is whether the liquidated damages provision transforms the Agreement into one "that restricts the rights of a lawyer to practice after termination of the relationship" in violation of the prohibition against such an agreement found in Rule 5.6(a)2. This Committee has already concluded, in Guidance Opinion 87-24, that a liquidated damages provision in the context of an employment or partnership agreement that does not directly restrict the right to practice is not violative per se of Rule 5.6(a). In that same Opinion, however, the Committee pointed out that the magnitude of a liquidated damages clause might provide guidance as to whether it tended toward a restriction on the right to practice and was, therefore, impermissible3. As the Committee noted:
In a given situation a disciplinary body reviewing the totality of the circumstances surrounding an agreement could find that the agreement results in a restriction on the right to practice. Accordingly, firms must be sensitive to the reasonableness of any financial arrangements between it and its employees. The higher the post termination payment, the more at risk is a firm for such arrangements. However, our Committee cannot make that determination because, in large part, it relates to the business realities rather than the ethical considerations.
Professional Guidance Opinion 87-24, Paragraph IV, p. 4.
In keeping with the comments articulated in Opinion 87-24, the Committee notes that an eighty percent liquidated damages clause carries with it a strong presumption that the implicit intent of the clause is to inhibit the firm's attorneys from practicing elsewhere. (This is true even though the agreement incorporates, in large measure, the aspirational language of Opinion 87-24. Notwithstanding this presumption, the Committee does not feel that an eighty percent liquidated damages clause is, under every circumstance, a restriction on the right to practice. The Committee does, however, believe that this particular liquidated damages provision, together with certain other restrictive provisions in Paragraph 13 of the Agreement, violate Rule 5.6(a).
Regardless of whether the very high percentage of liquidated damages mandated by the Agreement in and of itself restricts the right to practice, the basis for calculating those damages and the manner in which they are to be remitted are restrictive. While a quick reading of the liquidated damages provision suggests that departing attorneys would owe "only" eighty percent of two years billings for a particular client who chose to accompany them to another law practice, any departing attorney who also happened to be shareholder - and the touchstone of the Agreement as a whole is stock ownership - would owe that plus eighty percent of that client's billings for each year of stock ownership4. This is clearly a progressive disincentive to senior attorneys to practice elsewhere. Moreover, one-half of all monies owed under the Agreement would come due within three months of the time an attorney was notified by the firm of his liquidated damages obligation. The Committee strongly suspects that such notification would be nearly simultaneous with a notice of termination. Thus, the Agreement could, in practical effect, obligate a departing attorney to pay one-half of the total liquidated damages assessment within three months of termination.
Other aspects of the Agreement are also troubling. The Committee feels that the legal fiction of "wrongful conduct" and "damages" occasioned thereby which are built into the Agreement as a predicate for liquidated damages unnecessarily exposes departing attorneys to legal and reputational liabilities which may have a direct impact on that attorney's practice elsewhere.
The Committee also wishes to take issue with Paragraph 13(A) and 13(B) entitled "Limited Restriction" and "Equitable Relief," respectively. These two clauses, standing alone or in tandem, impinge directly on an attorney's right to practice. The Rules of Professional Conduct impose certain restrictions on communications between lawyers and prospective clients but, those restrictions specifically exempt communication with prospective clients with whom the attorney has had a prior professional relationship. These are exactly the kind of attorney-client relationships which the restrictive aspects of Paragraph 13 of this Agreement seek to address. To permit a departing attorney to have no communication with a client of the firm with whom he or she has had a prior professional relationship except for announcing his or her departure from the firm and identifying his or her new place of practice, and at the same time subjecting that attorney to possible equitable relief for doing more, clearly restricts the attorney's right to build a practice, a right which is inherent in the right to practice generally, and, at the same time, despite the high minded aspirational wording in the Agreement, directly interferes with the client's recognized right to choose his or her own attorney.
In the same vein, Paragraph 15 of the Agreement, entitled "Files and Records," is likewise inconsistent with Rule 5.6(A). Whatever else the Agreement contemplates, it cannot mandate that a former client's files are the property of the firm subject only to limited photocopying upon some subsequent request. The Committee feels that if a client of the firm has chosen to take his business elsewhere and, specifically, with an attorney who is departing the firm, and has paid his statements for services rendered so as to defeat the existence of a charging lien, the files are clearly the property of the former client and must be turned over to him and to the attorney forthwith.
Finally, the Committee notes that the Agreement does not specifically address the requirements of Rule l.5(a)(l) and (2). This Rule and its relevant subsections provide:
(e) A lawyer shall not divide a fee for legal services with another lawyer who is not in the same firm unless:
(1) the client is advised of and does not object to the participation of all of the lawyers involved, and
(2) the total fee of the lawyers is not illegal or clearly excessive for all legal services they rendered the client.
Even though the liquidated damages provision of the Agreement is calculated on a client's previous billings and not on prospective fees, the reality of the matter is that the departing attorney, in whole or in part, could well be forced to satisfy his liquidated damages obligation out of fees earned from former clients of the firm after the attorney has left. In this instance; the practical effect would be to cause the firm and its former attorney to share fees from that client. Accordingly, it is the opinion of the Committee that even if this Agreement were somehow enforceable and not violative of Rule 5.6(a), any clients of the firm choosing to discharge the firm and place their business with the firm's former attorneys would have to clearly be advised of the operation and effect of the liquidated damages provision.
Paragraphs 13(A), (B), (C) and 15, taken as a whole, violate Rule 5.6(a) of the Rules of Professional Conduct in that they operate as an impermissible restriction on the rights of the firm's attorneys to practice law after they leave the firm. Since the Committee has concluded that the Agreement, as worded, violates Rule 5.6(a), it is unnecessary for the Committee to decide whether Rule 1.5(a) (1) and/or (2) is implicated under the Agreement except the Committee notes that were the Agreement not violative of the rules, the firm - and its departing attorneys -would have a clear obligation, at the very least, to notify clients of the existence and operative effect of the liquidated damages provision of the Agreement.
You have also asked the Committee to consider whether certain alternative formulations for liquidated damages might cure any potential violation of the Rules extant in the Agreement as worded. The Committee does not view such speculation as to curative language to be within its mandate and, accordingly, respectfully declines to address these questions. The Committee does note, however, that just as the concept of liquidated damages does not per se violate Rule 5.6(a), neither do less onerous liquidated damages percentages cure other aspects of a partnership or employment agreement which restrict an attorney's right to practice law subsequent to the termination of his or her relationship with the firm.