HOWARD v. BABCOCK

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Court of Appeal, Fourth District, Division 3, California.

Theodore R. HOWARD et al., Plaintiffs and Appellants, v. George H. BABCOCK et al., Defendants and Respondents.

No. G009931.

Decided: April 30, 1992

Layman, Jones & Dye, Stanley R. Jones and Ren R. Hayhurst, Irvine, for plaintiffs and appellants. Morgan, Wenzel & McNicholas and Thomas H. Vickers, Los Angeles, for defendants and appellants.

OPINION

Theodore R. Howard, Robert J. Moss, James E. Loveder and Michael J. Strickroth appeal from a judgment in favor of George Babcock, Preston Craig Combs, Gary E. Kinnett, Thomas L. Waddell, Robert H. Bergsten, Arthur T. Schaertel, Stephen H. Osborne, Lynn J. Cicotte, Douglass H. Mori, and John D. Barrett, Jr.

I

Howard, Moss, Babcock, Combs, Kinnett, Waddell and Bergsten were general partners in a law firm with offices in Los Angeles and Orange Counties.   On January 1, 1981, Loveder and Schaertel joined the firm as participating partners receiving profit draws prior to profit distribution but holding no equity position.   On December 15, 1982, all of the nine lawyers executed a written partnership agreement reflecting their financial arrangements.

In January 1984, Loveder and Schaertel were admitted to the partnership as general partners and Osborne and Cicotte were admitted as participating partners.   A year later, Strickroth and Mori became participating partners;  Barrett joined the firm in the same capacity in January 1986.2  The firm's practice was principally confined to insurance defense litigation.

Peace on earth did not prevail.   On December 8, 1986, Howard, Moss, Loveder and Strickroth (Appellants) gave written notice they were leaving the firm.   On December 12, the firm (Respondents) responded that Appellants' violation of the partnership noncompetition covenant resulted in a forfeiture of their withdrawal benefits.

Appellants proceeded with their plans, commencing their new practice in Orange County.   Respondents continued to practice in Orange, San Bernardino and Los Angeles counties.   When the parties could not agree on who owed what to whom, Appellants filed the underlying lawsuit seeking an accounting, damages, and an order declaring the rights of the parties in connection with the December 15, 1982 partnership agreement.   The Respondents' cross-complaint alleged breach of the partnership agreement, breach of the covenant of good faith and fair dealing, a bad faith denial of the existence of the partnership agreement, breach of fiduciary duties, fraud and a common count and requested declaratory relief in connection with the partnership agreement and an accounting.

The court concluded the noncompetition clause “was valid and enforceable under California law and was not contrary to public policy․”  It was later determined that Appellants owed the firm $382,686.

II

Article X of the partnership agreement provides in part:  “Should more than one partner, associate or individual withdraw from the firm prior to age sixty-five (65) and thereafter within a period of one year practice law as hereinabove described, together or in combination with others, including former partners or associates of this firm, in a practice engaged in the handling of liability insurance defense work as aforesaid within the Los Angeles or Orange County Court system, said partner or partners shall be subject, at the sole discretion of the remaining non-withdrawing partners to forfeiture of all their rights to withdrawal benefits other than capital as provided for in Article V herein.”

Article V provides in part:  “If after the withdrawal ․ of a general partner ․ the remaining partners, or some of them, elect to continue the partnership, the withdrawn partner ․ shall be paid by the continuing partners ․ sums computed as follows:  [¶] a) The sums, representing the withdrawn ․ partner's share in the good will of the firm and his contributions thereto, that shall be equal to the share in the net profit of the firm that the withdrawn ․ partner would have received during the first twelve months following the withdrawal ․ if he had remained with the firm ․ during the said twelve month period.   The sums referred to hereinabove include the aforesaid monthly drawing right of the withdrawn ․ partner if the profits during the said period of twelve months permit the payment of the said monthly draw.”

The trial court upheld the validity of Article X.   As a result, Appellants were able to withdraw their share of the firm's capital but forfeited their other withdrawal benefits.   Specifically, they lost their share of the firm's work in progress (work completed but not yet billed) and accounts receivable (work billed but payment not yet received).   Moreover, they had to account for and pay to Respondents the net profits of monies received for work they completed for former firm clients.3  Respondents paid Appellants nothing for work done for clients retained by them.

III

 Rules of Professional Conduct, rule 1–500 4 bans any agreement, by a member of the state bar, which restricts the right of any member to practice law.   The rule is applicable to agreements which not only prohibit competition but which limit one's right to practice.   Article X severely and financially punishes partners who wish to practice in the same field of law in the same geographic area.5  We deem this clause, as a matter of law, to violate California public policy.

 Respondents' arguments to the contrary are unimpressive.   First they contend rule 1–500 does not necessarily invalidate Article X.   Specifically, they point to language which permits restrictive agreements if they do not survive the term of the partnership.   Relying on Corporations Code section 15030, they argue that because the partnership was not terminated, rule 1–500 is inapt.   One has only to read the rule to realize the absurdity of this argument.

The rule commences with the statement that “[a] member shall not be a party to or participate in offering or making an agreement, whether in connection with the settlement of a lawsuit or otherwise, if the agreement restricts the right of a member to practice law.”  (Italics added.)   The rule provides that such a restriction is valid if it “[i]s a part of an employment, shareholders', or partnership agreement among members provided the restrictive agreement does not survive the termination of the employment, shareholder, or partnership relationship․”

In other words, lawyers may agree to devote their professional efforts exclusively to a law partnership, but the termination of the partnership ends the restrictions.   This concept is significantly different from limiting the right to compete after the partnership ceases.   The former restriction applies while the partnership is in existence.   The latter applies only when it is terminated.   The first restriction is allowed, the second is not.   And it is the second which the respondents seek to enforce.   They cannot suggest Article X was meant to be operative only while they were still all practicing together.   If so, this lawsuit was unnecessary.   If Article X is inoperative past the time the group practiced together, then there is nothing about which to argue.   Appellants can compete without penalty.

 Respondents next maintain Article X is validated by Business and Professions Code section 16602, which allows partners to agree that upon partnership dissolution, those leaving the firm will not maintain a similar practice within a specified area.6  Since section 16602 was in existence before rule 2–109 was first enacted and has not been amended, they contend section 16602 controls.   They remind us the rules “are not intended to supersede existing law.”  (Discussion, 23 pt. 2 West's Ann.Rules Prof.Conduct (1992 supp. pamp.) rule 1–100, p. 567.)   In short, they argue that to the extent there is a conflict between the code section and the rule, the code section governs.

We first note Business and Professions Code section 16600 provides “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”   And although section 16602 allows limited exceptions to this general rule, we conclude it is inapplicable to lawyers.

Indeed, only one California case has applied section 16602 to lawyers.   In Haight, Brown & Bonesteel v. Superior Court (1991) 234 Cal.App.3d 963, 285 Cal.Rptr. 845, the court reviewed the validity of a partnership agreement, which provided that if a partner “ ‘withdraws or voluntarily retires from the Partnership, he [or she] will not engage in any area of the practice of law regularly practiced by the law firm and in so doing represent or become associated with any firm that represents any client represented by this law firm within a twelve (12) month period prior to said person leaving the firm, within the Counties of Los Angeles, Ventura, Orange, Riverside or San Bernardino nor within any City in such Counties for a period of three (3) years from the date of withdrawal or retirement, so long as continuing members of this firm engage in practice in the same areas of law.’  [¶] Paragraph (13)(c)(4) provides as follows:  [¶] ‘A Partner ․ may violate this Section 13.   However, by so doing, he [or she] forfeits any and all rights and interests, financial and otherwise, to which he [or she] would otherwise be thereafter entitled as a departing Partner under the terms of this Agreement.’  [¶] Also contained within paragraph 13 is the following language:  ‘It is the intent of the Partnership in this Section 13(c) to comply with and take advantage of the provisions of California Business and Professions Code [italics in original] section 16602.’ ”  (Id. at p. 966–967, 285 Cal.Rptr. 845.)

The trial court found the provisions void, concluding they constituted a forfeiture.   The Court of Appeal reversed.   It first relied on Business and Professions Code section 16602 and then found the provisions in question did not, as a matter of law and on their face, exact a significant monetary penalty and thus did not constitute an impermissible restriction on the practice of law in violation of rule 1–500.   The court said:  “We do not construe rule 1–500 in such a narrow fashion.   In our opinion, the rule simply provides that an attorney may not enter into an agreement to refrain altogether from the practice of law.   The rule does not, however, prohibit a withdrawing partner from agreeing to compensate his [or her] former partners in the event he [or she] chooses to represent clients previously represented by the firm from which he [or she] has withdrawn.   Such a construction represents a balance between competing interests.   On the one hand, it enables departing attorneys to withdraw from a partnership and continue to practice law anywhere within the state, and to be able to accept employment should he [or she] choose to so do from any client who desires to retain him [or her].   On the other hand, the remaining partners remain able to preserve the stability of the law firm by making available the withdrawing partner's share of capital and accounts receivable to replace the loss of the stream of income from the clients taken by the withdrawing partner to support the partnership's debts.”   (Haight, Brown & Bonesteel v. Superior Court, supra, 234 Cal.App.3d at pp. 969–970, 285 Cal.Rptr. 845.)

For several reasons, we believe Haight is wrong.   Its reliance on Business and Professions Code section 16602 is misplaced.   Lawyers cannot be treated the same as business people or other professionals.   Abraham Lincoln said it best:  “Lawyers' time and advice are [their] stock in trade.”  “A lawyer's clients are neither chattels nor merchandise, and his [or her] practice and good will may not be offered for sale.”  (Dwyer v. Jung (1975) 133 N.J.Super. 343, 336 A.2d 498, 499.)

The Haight court relied on Farthing v. San Mateo Clinic (1956) 143 Cal.App.2d 385, 299 P.2d 977.   In Farthing, physicians agreed that a departing partner would not compete and, if he did so, he would waive any rights he had to share in the firm's accounts receivable.   The court, citing Business and Professions Code section 16602, observed that while an agreement not to practice could be void, an agreement not to compete is acceptable.

The Farthing court held the doctor could “contract that if he exercises [the] privilege [of practicing medicine anywhere in this state] he will compensate his former partners to some extent at least for the business which he expects to take from them.   Such agreement cannot be held to be without consideration, for respondent clinic has undoubtedly contributed in some degree to the establishment of appellant [doctor] in the community.”  (Id. at p. 394, 299 P.2d 977.)

The Haight court was mistaken in equating lawyers with doctors.   It should not have relied on Farthing.   Lawyers' ability to sell goodwill defined in Fraser v. Bogucki (1988) 203 Cal.App.3d 604, 610, 250 Cal.Rptr. 41 as “ ‘the expectation of continued public patronage․’ ” is limited.7  This concept, first enunciated by our Supreme Court in Little v. Caldwell (1894) 101 Cal. 553, 561, 36 P. 107, still controls today.   In Lyon v. Lyon (1966) 246 Cal.App.2d 519, 524, 54 Cal.Rptr. 829, the court explained:  “The nature of a professional partnership for the practice of law, the reputation of which depends on the skill, training and experience of each individual member, and the personal and confidential relationship existing between each such member and the client, places such a partnership in a class apart from other business and professional partnerships.   The legal profession stands in a peculiar relation to the public and the relationship existing between the members of the profession and those who seek its services cannot be likened to the relationship of a merchant to his [or her] customer.”

This concept makes sense.  “We fail to see why ․ lawyer[s] such as [respondents] should be permitted to share in ․ future profits from clients who have elected not to retain [their] services.   Nor do we savor the prospect of innumerable lawyers from defunct law firms suing each other because some of them were more successful than others in attracting new business from old clients following the dissolution of a partnership.”  (Fraser v. Bogucki, supra, 203 Cal.App.3d 604, 610, 250 Cal.Rptr. 41.)

The Fraser court also recognized:  “Payment for good will following the break-up of a law partnership is, moreover, barred by California's Rules of Professional Conduct.   Rule 2–108(A) prohibits the division of fees for legal services among lawyers who are not partners or associates within the same firm, unless the client consents in writing and the fee bears a reasonable relationship to the services rendered by all of them.   By demanding payment for good will, which Business and Professions Code section 14100 defines as ‘the expectation of continued public patronage,’ [respondents] seek[ ] to profit from services which may be rendered by [their] former partners, though [they] will have no professional responsibility for the handling of the cases.   The division of fees without regard to services actually rendered is contrary to the public policy stated in Rule 2–108.”  (Id. at p. 610, 250 Cal.Rptr. 41.)8

Cohen v. Lord, Day & Lord (1989) 75 N.Y.2d 95, 551 N.Y.S.2d 157, 550 N.E.2d 410 is instructive.   There, the court considered an agreement which mandated the forfeiture of an attorney's interest in the firm's net profits “ ‘collected thereafter, whether for services rendered before or after his [or her] withdrawal ’ ” (id. at p. 97, 551 N.Y.S.2d at p. 158, 550 N.E.2d at p. 411) if the lawyer left the firm but continued in practice in the area in which the firm maintained an office.

The New York court relied on Disciplinary Rule 2–108(A) of the New York Code of Professional Responsibility and found the clause restricted a withdrawing party's right to practice law and was unenforceable as against public policy.9  It recognized the financial hardship a firm may suffer upon its dissolution but cautioned that financial protection cannot outweigh ethical considerations.  “While a law firm has a legitimate interest in its own survival and economic well-being and in maintaining its clients, it cannot protect those interests by contracting for the forfeiture of earned revenues during the withdrawing partner's active tenure and participation and by, in effect, restricting the choices of the clients to retain and continue the withdrawing member as counsel.”  (Cohen v. Lord, Day & Lord, supra, 75 N.Y.2d at p. 101, 551 N.Y.S.2d at p. 160, 550 N.E.2d at p. 413, citations omitted.)  (See Hackett v. Milbank, Tweed, Hadley & McCloy (1992) 581 N.Y.S.2d 35.)

Haight, Brown & Bonesteel v. Superior Court, supra, 234 Cal.App.3d 963, 285 Cal.Rptr. 845, is the only reported case we have found which interprets rule 1–500 to allow this restriction.   Indeed, every out-of-state court which has ruled on a similar question has found such restrictive covenants void.  (See Dwyer v. Jung, supra, 133 N.J.Super. 343, 336 A.2d 498;  Anderson v. Aspelmeier, Fisch, Power, Warner & Engberg (Iowa 1990) 461 N.W.2d 598;  Cohen v. Lord, Day & Lord, supra, 75 N.Y.2d 95, 551 N.Y.S.2d 157, 550 N.E.2d 410;  Silverberg v. Schwartz (1980) 75 A.D.2d 817, 427 N.Y.S.2d 480;  Hagen v. O'Connell, Goyak & Ball (1984) 68 Or.App. 700, 683 P.2d 563;  Gray v. Martin (1983) 63 Or.App. 173, 663 P.2d 1285;  Spiegel v. Thomas, Mann & Smith, P.C. (Tenn.1991) 811 S.W.2d 528;  and Cohen v. Graham (1986) 44 Wash.App. 712, 722 P.2d 1388.) 10

IV & V *

VI

We conclude that Article X, because it violates California public policy, is void on its face.   The award to Respondents is affirmed.   But the matter must be remanded for an accounting of monies owed to Appellants pursuant to the partnership agreement and the formula articulated in Jewel v. Boxer (1984) 156 Cal.App.3d 171, 203 Cal.Rptr. 13.12  On remand, the court is also to try all other undetermined causes of action alleged by the parties.   The parties to bear their own costs.

FOOTNOTES

2.   There was no written amendment to the December 15, 1982 partnership agreement and no new partnership agreement was executed;  no one signed anything after December 15, 1982.

3.   The amount paid reflected their prior firm ownership.   In other words, Appellants had owned 17.5 percent of the firm.   They, therefore, had to pay to Respondents 82.5 percent of the net profits for work done for former firm clients.

4.   Further rule references are to the Rules of Professional Conduct.  Rule 1–500 was previously numbered 2–109.   Only minor changes in the wording occurred when in May 1989, the rule was instituted as rule 1–500.Rule 1–500 reads:  “(A) A member shall not be a party to or participate in offering or making an agreement, whether in connection with the settlement of a lawsuit or otherwise, if the agreement restricts the right of a member to practice law.“(B) Nothing in paragraph (A) of this rule shall be construed as prohibiting such a restrictive agreement which:“(1) Is a part of an employment, shareholders', or partnership agreement among members provided the restrictive agreement does not survive the termination of the employment, shareholder, or partnership relationship;  or“(2) Requires payments to a member upon the member's retirement from the practice of law.“(C) A member shall not be a party to or participate in offering or making an agreement which precludes the reporting of a violation of these rules.”As stated in 1 Witkin, California Procedure, Attorneys, section 368–I (3d ed., 1990 pocket supp.):  “Rule 1–500 substantially restates former Rule 2–109, but adds the prohibition on agreements precluding reporting violations of the rules.”  (Italics added.)We refer to rule 1–500.

5.   Appellants explain:  “In the face of the provisions of Article X, a partner in the Firm, if he or she chose to leave the Firm, was faced with the following ‘Hobson's choice’:  [¶] • Stop practicing law altogether (retire entirely or find another way to make a living).  [¶] • Stop the practice of liability defense work (even though a partner may have done nothing else for his or her entire professional life—tantamount, of course, to stopping the practice of law)․  [¶] • Move away from Los Angeles and Orange counties and begin a liability defense practice somewhere else (by anyone's thinking, a restriction on one's right to practice law).  [¶] • Forfeit a significant portion of the value of his or her interest in the Firm (for which they had worked most, if not all, of their professional career).”

6.   Business and Professions Code section 16602 provides:  “Any partner may, upon or in anticipation of a dissolution of the partnership, agree that he [or she] will not carry on a similar business within a specified county or counties, city or cities, or a part thereof, where the partnership business has been transacted, so long as any other member of the partnership, or any person deriving title to the business or its goodwill from any such other member of the partnership, carries on a like business therein.”

7.   We note the trial court concluded goodwill was not transferred here.   However, the agreement itself speaks of goodwill.  (See Article V of the partnership agreement, ante.)   Moreover, the facts speak the loudest of all.   Whatever is alleged and however the issue is framed, it is goodwill which is sought.  (Fraser v. Bogucki, supra, 203 Cal.App.3d 604, 607, 250 Cal.Rptr. 41.)

8.   And there is another public policy consideration.   Rule 4–200(A) provides that a member of the State Bar “shall not enter into an agreement for, charge, or collect an illegal or unconscionable fee.”   Appellants maintain, relying on Champion v. Superior Court (1988) 201 Cal.App.3d 777, 247 Cal.Rptr. 624, that this rule applies to law firm partnerships.Appellants argue the same unconscionable fee resulted here.   They billed $1,432,489 for completing the firm's unfinished business.   At the $90 average-per-hour billed by Appellants, that reflected 15,917 billable hours.   Of the $463,862 profit, the judgment compelled them to pay to Respondents $382,686.15, keeping for themselves only $81,175.85.   Appellants were compensated, therefore, only $5.10 per hour for completing the unfinished business.   The agreement we consider and the results are almost identical to the one reviewed in Champion and the facts which emerged.   The division of the fees bears no relationship to the amount of services provided.Respondents suggest we cannot consider rule 4–200(A) because it was raised for the first time on appeal.   It does not matter.   The result is the same.   Article X, with or without a consideration of rule 4–200(A), violates California public policy.   As recognized in Champion, the agreement infringes upon a client's right to choose.   If a clause such as the one examined in Champion violates one rule, it most likely violates several.   If it is restrictive of one's right to practice, it also infringes upon the clients' rights to representation by an attorney of their choice.

9.   Rule 2–108(A) of the New York Code of Professional Responsibility is similar to our rule 1–500.

10.   Appellants also complain that although the partners, after January 1, 1984, continued doing “business as usual,” they did not specifically agree to be bound by Article X.   And since the trial court correctly concluded the 1982 agreement had terminated, the only controlling agreement would be one specifically agreed to by the parties.   Having found Article X void on its face, this issue is moot.

FOOTNOTE.   See footnote 1, ante.

12.   “[T]he Uniform Partnership Act requires that attorneys' fees received on cases in progress upon dissolution of a law partnership are to be shared by the former partners according to their right to fees in the former partnership, regardless of which former partner provides legal services in the case after the dissolution.”  (Jewel v. Boxer, supra, at p. 174, 203 Cal.Rptr. 13;  see also Fox v. Abrams (1985) 163 Cal.App.3d 610, 614, 210 Cal.Rptr. 260.)

SONENSHINE, Associate Justice.

MOORE, Acting P.J., and WALLIN, J., concur.

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