D.C. Court of Appeals Rules That Forfeiture Provision in Law Firm Operating Agreement Violates Rule 5.6
Connie N. Bertram and D’Ontae Sylvertooth
On February 4, 2021, the D.C. Court of Appeals ruled in favor of a former partner concerning the equity interest owed to her upon exiting her law firm. The dispute in Jacobson Holman, PLLC v. Gentner, 19-cv-830 (D.C. App. Feb. 4, 2021), centered on provisions in the firm’s operating and partnership agreements that addressed equity payouts upon a partner’s exit from the firm. The appellate panel ruled that the law firm’s forfeiture provision was unenforceable against public policy because it violated Rule 5.6 of the D.C. Rules of Professional Conduct, the rule prohibiting restrictions on a lawyer’s right to practice.
Marsha Gentner was a partner at Jacobson Holman, PLLC for over 20 years. Initially, the firm’s partnership agreement provided that when a partner withdrew from the firm, their equity payment would be equal to their accrual basis account minus adjustments. The agreement provided that the adjustment amount would either: (1) be agreed upon by the withdrawing partner and the remaining partners, or (2) be subject to a mathematical calculation based on net profits over the previous two fiscal years preceding the withdrawal.
Several years later, the firm converted into a professional limited liability corporation and adopted an operating agreement that incorporated many of the provisions in the partnership agreement. The following year, the firm amended its operating agreement adding three new provisions impacting how an equity member would be paid out upon leaving the firm. One of those provisions, the forfeiture provision, expressly provided that:
In the event an Equity Member withdraws from the Company at any time after the date of this Amendment and takes client(s) of the Company, and the Company does not dissolve within three months of the Equity Member withdrawal date, then the withdrawing Equity Member will forfeit and give up to the Company fifty percent (50%) of his/her Accrual Basis Account.
In 2013, the two named partners of the firm notified the other equity partners of their intent to dissolve the firm and create a new entity. The named partners gave two options: join the new entity or leave the firm. Gentner chose the latter option (taking clients with her) and requested to receive her equity interest of $141,569 per the partnership agreement.
Because Gentner took clients with her upon her departure, the firm relied on its forfeiture clause in calculating her equity pay-out. After making the fifty percent reduction and accounting for additional debts the firm incurred due to members’ bonuses and other equity partners withdrawing, the firm determined that Gentner owed $22,000. Gentner sued her former firm for refusing to provide her with an equity interest payout after her departure. The lower court ruled in her favor, prompting the firm to appeal.
Although the Court of Appeal engaged in typical contract interpretation in evaluating the agreement, the court indicated that, concerning Rule 5.6, it has “never examined the affirmative reach of the rule’s prohibition on ‘restrict[ions]’ on ‘the rights of a lawyer to practice’ after terminating an employment relationship.” The rule states:
A lawyer shall not participate in offering or making:
- A partnership, shareholders, operating, employment, or other similar type of agreement that restricts the rights of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement;
- An agreement in which a restriction on the lawyer’s right to practice is part of the settlement of a controversy between parties.
As made evident by Comment 1, the Rule ensures that agreements do not limit a lawyer’s professional autonomy and a client’s ability to choose a lawyer. The Court of Appeals ruled that Rule 5.6 extends not only to those agreements that expressly restrict a lawyer’s ability to practice but also to agreements that have the effect of doing so, including, as was the case in Gentner, agreements which create a finance disincentive to competition. The court held that “an implied partial restriction on the practice of law, in the form of imposing a substantial financial penalty for representing clients previously represented by the firm, is invalid under Rule 5.6(a).”
The court did not identify an outer limit as to what is considered a substantial penalty. It held that a fifty percent forfeiture of a departing partner’s equity interest, even if only one client leaves with them, is a substantial penalty. In other contexts, courts have evaluated restrictions based on a series of factors to determine if the covenant is reasonable. The court ruled that because Rule 5.6 is a policy approved by the Court, it did not have to evaluate reasonableness factors as it would with other restrictive covenants. Instead, any provision incongruous with Rule 5.6 is unenforceable as against public policy.
Rule 5.6 protects lawyers’ ability to freely practice — irrespective of the firm with which they associate. Any agreement restricting this right may be void against public policy. Although the Gentner case focused on D.C.’s rule, the Court of Appeals made clear that a “majority of other jurisdictions that have considered [the same question] have likewise concluded that such restrictions violate their Rule 5.6 equivalent.”
Bertram LLP specializes in representing lawyers, executives and other professionals in “transition and turmoil.” If you are considering a lateral transition or facing a claim by your former firm, it is wise to retain counsel, like the attorneys at Bertram LLP, who know the business of practicing law, including partners’ ethical rights and obligations during lateral transitions.