A disproportionate number of court decisions applying New York’s Partnership Law involve law firm partnerships. That’s because, while use of general partnerships in the business world at large has been eclipsed almost entirely by other closely-held business forms offering both limited liability and partnership taxation, those same features are available to law firms and certain other professional practices by organizing as limited liability partnerships under New York’s LLP statute enacted in 1994.

Other than its organizational and limited liability attributes, New York LLPs are governed by the same, arcane Partnership Law provisions applicable to all general partnerships. One of the most existentially critical of these provisions is found in Partnership Law § 62 [4] stating that dissolution of the partnership is caused “[b]y the death of any partner.” Courts in New York and elsewhere construe this provision, modeled on § 31 [4] of the 1914 Uniform Partnership Act, as a default rule, that is, subject to override in the partnership agreement.

The tragic, accidental death in 2008 of one of two partners in a Manhattan law firm called Donovan & Yee, LLP, triggered a lawsuit in which the estate of the deceased partner is contesting the surviving partner’s continuation of the firm. Earlier this month, in Le Bel v Donovan, 2014 NY Slip Op 03608 [App. Div. 1st Dept, May 20, 2014], a panel of appellate judges unanimously construed contested provisions in the partnership agreement as overriding Partnership Law § 62 [4]’s dissolution default rule, by authorizing continuation of the partnership if a new partner is admitted within 90 days after the death. At the same time, however, the panel remanded the case for trial to determine whether the newly admitted partner was actually an equity partner or, as the estate contended, was part of an alleged “sham transaction” making her a partner in name only to avoid paying the estate one-half of the law firm’s assets upon dissolution.

You have to admit, as dissolution lawsuits go, it doesn’t get much more interesting than that.

D&Y’s Formation

In 1997, lawyers Mary Donovan and Marya Lenn Yee (and a third partner who withdrew soon afterward) formed the law firm Donovan & Yee, LLP (“D&Y”) specializing in the field of intellectual property. Article Six of their 18-page Partnership Agreement (read here), entitled “Addition and Dissociation of Partners,” contains an “override” provision concerning dissolution in Section 6.8 (a) stating:

A voluntary dissolution (including any dissolution by law resulting from only one Partner in the Partnership following the death . . . of the other Partner(s)) and termination of the Partnership shall override any of the provisions of this Article VI then in effect . . .

On the heels of that provision is Section 6.8 (b) addressing continuation of the firm in lieu of dissolution following the death of a partner:

The death . . . of a Partner shall not cause the dissolution of the Partnership, unless following such death . . . only one Partner shall remain in the Partnership and no additional Partner shall be admitted within ninety (90) days following such death . . .. The remaining Partners, together with any new Partners, shall have the right, but not the obligation to continue use of the Partnership Name . . ..

In the event of a partner’s death not resulting in the firm’s dissolution, under Section 6.2 the deceased partner’s estate is entitled to be paid her Net Capital Account Balance defined as:

the Partner’s Pro-rata Share of the excess of the Partnership’s assets over its liabilities as determined by the certified public accountants regularly employed by the Partnership in accordance with OCBOA [“other comprehensive basis of accounting”] consistently applied . . . using the accounting methods used by the Partnership in the preparation of its financial statements.

Under Article Seven of the Partnership Agreement, if the firm dissolves by reason of the death of a partner or otherwise, the firm is to be wound up and its assets liquidated, with the proceeds to be distributed in standard fashion, i.e., in proportion to the partners’ equity percentages after discharging all debts and liabilities and returning partner capital.

D&Y Hires a Contract Partner

In its first decade Donovan and Yee were the firm’s only partners. In April 2008, D&Y hired lawyer Andrea Calvaruso as a non-equity or “contract” partner pursuant to a written agreement that allowed her to hold herself out to the world as a “partner” but expressly classified her as a W-2 employee for tax purposes with fixed salary and bonus. The agreement gave her no right to share in the firm’s profits and losses or to participate in firm management.

D&Y’s Continuation Following Yee’s Death

Eight months after Calvaruso came on board, in December 2008, Yee died from injuries suffered when the small plane in which she was a passenger crashed.

In February 2009, Donovan and Calvaruso executed an “Amended and Restated Partnership Agreement” made effective as of January 1, 2009 (read here), which admitted Calvaruso as a partner, gave her and Donovan, respectively, 5% and 95% partnership interests, and renamed the firm Donovan, Calvaruso & Yee, LLP.

The 2009 Partnership Agreement did not require Calvaruso to make a capital contribution. Section 5.4 of the agreement provided for “guaranteed payments” of $350,000 and $250,000 to Donovan and Calvaruso, respectively, with any “additional distributions” as determined by majority vote to be allocated based on their respective percentage interests.

Calvaruso left D&Y at the end of 2009. She later testified that she left because she and Donovan were unable to come to agreement on the terms of their future partnership. D&Y subsequently issued her a Schedule K-1 for the 2009 tax year reflecting that she received around $224,000 in “guaranteed payments.”

Donovan took the position with Yee’s estate that Calvaruso’s admission as a partner within 90 days after Yee’s death satisfied the requirement for continuation of the firm under Section 6.8 (b) of the 1997 Partnership Agreement. Donovan paid to Yee’s heirs $500,000 in life insurance proceeds from a $1 million life insurance policy that Donovan maintained on Yee’s life. Donovan, who kept the other $500,000, asserted that under a 2006 oral agreement with Yee, the insurance payout was in lieu of any accounting and payment due Yee’s estate under Section 6.2 of the 1997 Partnership Agreement. Donovan also maintained that under Section 6.2 nothing was owed Yee’s estate in any event based on a financial statement prepared by the firm’s CPA, which utilized cash basis accounting, showing negative partners’ capital at year-end 2008.

Yee’s Estate Sues

In December 2010, the executrix of Yee’s estate sued Donovan and D&Y in Manhattan Supreme Court. The complaint (read here) contends that D&Y dissolved upon Yee’s death pursuant to Section 6.8 (a) of the 1997 Partnership Agreement which overrides the continuation provision in Section 6.8 (b); that Calvaruso never was a bona fide equity partner in any event, thereby mooting Donovan’s reliance on Section 6.8 (b); and that Yee’s estate was entitled to half the firm’s assets upon dissolution valued at least $207,000 based on a second financial statement also prepared by the firm’s CPA which used an accrual basis, inter alia, reflecting D&Y’s receivables.

In October 2011, Manhattan Commercial Division Justice Eileen Bransten denied the defendants’ motion to dismiss the estate’s claims for breach of contract and breach of fiduciary duty (read here), which was affirmed on appeal by the Appellate Division, First Department, in June 2012 (read here).

Justice Bransten’s 2013 Summary Judgment Ruling

Following discovery, in April 2013, Yee’s estate moved for summary judgment on its claim to declare D&Y dissolved as of the date of Yee’s death, ordering an accounting and enjoining Donovan from using Yee’s name in connection with Donovan’s law practice.

The estate’s supporting brief (read here) argued primarily that dissolution necessarily followed Yee’s death based on the “override” provision in Section 6.8 (a) of the 1997 Partnership Agreement. It further argued that, even if Section 6.8 (b) applied, the 2009 Partnership Agreement between Donovan and Calvaruso was a “sham” which did not make Calvaruso an “actual” partner since she exercised no management rights, received no money except guaranteed salary, made no capital contributions, and did not share in any losses or receive a share of firm profits.

Defendants’ opposing brief (read here) contended that under Section 6.8 (b) of the 1997 Partnership Agreement, the admission of Calvaruso as partner within 90 days after Yee’s death avoided dissolution and authorized the firm’s continuation using Yee’s name. They denied the 2009 Partnership Agreement was a “sham,” pointing to the provision in that agreement requiring profit and loss sharing. They further argued that whether Calvaruso in fact received profits or losses, or participated in firm management, was immaterial to the court’s analysis of her partner status.

In August 2013, Justice Bransten rendered a split decision (read here). On the one hand, she declared that D&Y did not dissolve after Yee’s death and she rejected the estate’s “strained” construction of Section 6.8 (a) and (b) of the 1997 Partnership Agreement, stating:

Subsection (a) merely provides that if the Firm dissolves because of, among other reasons, the death of one of the two partners, then all of the provisions of article 6 are overridden. It does not, however, mean that the death of one of two partners necessarily causes a dissolution by law. Thus, if a dissolution by law is avoided by the surviving partner by the addition of a new partner to the Firm within 90 days of the death, as Yee and Donovan provided for in subsection (b) of Section 6.8, there is no dissolution by law. [Italics in original.]

Justice Bransten also found that the estate had failed to raise a triable issue of fact regarding Calvaruso’s partner status, observing that the 2009 Partnership Agreement required her to share in D&Y’s profits and losses “up to [her] 5% interest” and that she was “treated by the Firm’s accountant as a partner and was issued a Schedule K-1 for 2009, not a W-2, and participated in the management of the Firm, even if she did not have ‘equal’ management rights with Donovan.”

On the other hand, Justice Bransten sided with the estate on the issue whether D&Y owes Yee’s estate any money. First, she found a triable issue whether Yee and Donovan orally amended the 1997 Partnership Agreement in 2006 by agreeing to fund a payout upon death with insurance proceeds in lieu of the accounting provision in Section 6.2. Second, assuming no such amendment, she also found a triable issue based on the two financial statements prepared by the firm’s accountant for the year ending 2008 — one using cash basis showing negative partners’ capital accounts, and the other showing over $400,000 in partners’ capital on an accrual basis. As Justice Bransten explained:

If, as [the firm’s accountant] maintains, the Firm’s regular financial statements were prepared on a cash basis, he does not explain why his firm prepared a financial statement based on an accrual basis for the year ending 2008. Thus, a question of fact remains as to whether Yee’s estate is owed any monies pursuant to the 1997 Partnership Agreement.

The Appellate Court’s Ruling

Yee’s estate appealed Justice Bransten’s ruling insofar as it validated Calvaruso’s partner status and declared that D&Y had not dissolved upon Yee’s death. In its decision earlier this month, the Appellate Division, First Department, agreed with Justice Bransten’s construction of Section 6.8 (a) and (b) of the 1997 Partnership Agreement, stating as follows:

The motion court correctly reconciled apparently conflicting provisions of the partnership agreement, giving meaning to both. Contrary to plaintiff’s contention, the provision that appears first does not automatically govern, as New York has not adopted the “first clause” doctrine of contract interpretation. Further, as plaintiff concedes, her interpretation of the contract renders section 6.8(b) superfluous, depriving it of all effect. Section 6.8(a) provides that “[a]; voluntary dissolution (including any dissolution by law resulting from only one Partner remaining . . . following the death . . . of the other Partner(s)) and termination of the Partnership shall override any of the provisions of this Article VI . . . .” Section 6.8(b) of the agreement provides that the partnership will survive the death of a partner if a new partner is admitted no more than 90 days after the death. When read together, these sections provide for dissolution upon the death of a partner unless a new partner is admitted within 90 days. [Citations omitted.]

The estate nonetheless achieved an interim victory, convincing the appellate panel that Justice Bransten should not have granted summary judgment on the issue of Calvaruso’s status as a genuine partner. The court wrote:

An issue of fact exists, however, as to whether Andrea Calvaruso, the new partner, was actually an equity partner. While the new partnership agreement referred to her as an equity partner and purported to give her a 5% interest in the firm, Calvaruso made no capital contribution to the firm and received monthly guaranteed payments as a salary. Further, she only nominally shared in 5% of the firm’s potential profits and losses. These facts preclude judgment for either side on this issue. [Citation omitted.]

The case now returns to Justice Bransten for trial unless, of course, the parties settle out of court as one would expect in a case of this sort.

Le Bel‘s Drafting Lessons

I can imagine the schadenfreude that some might enjoy watching lawyers litigate over their own partnership agreement. We nonetheless all can draw the following lessons from the drafting mistakes or omissions in the 1997 Partnership Agreement in the Le Bel case:

  • The appellate decision referred to subsections (a) and (b) of Section 6.8 as “apparently conflicting,” which easily could have been avoided by adding the following, bolded language in Section 6.8 (a):

    A voluntary dissolution (including any dissolution by law resulting from only one Partner in the Partnership following the death . . . of the other Partner(s) without the timely admission of a new Partner pursuant to Section 6.8 (b) hereof) and termination of the Partnership shall override any of the provisions of this Article VI then in effect . . .

  • One of the issues pegged for trial is whether the 1997 Partnership Agreement was orally amended by Donovan and Yee in 2006 to replace Section 6.2’s provision for an accounting-based payout upon a partner’s death with an insurance-funded payout, as Donovan alleged and as Yee is no longer present to contest. As Justice Bransten’s 2013 decision observed in a footnote at page 11, “[n]othing in the 1997 Partnership  Agreement requires that amendments or modifications thereto be in writing.” The absence of what should be a standard provision, requiring amendments to be made in writing signed by the parties, is surprising to say the least in an otherwise comprehensive, 18-page, single-spaced contract of this sort.
  • At any given moment in the life cycle of a law firm, the firm’s accounts receivable and work-in-progress likely constitute its single most valuable asset when accounted for on an accrual basis — but not on a cash basis. It also is common for a law firm’s accountants to prepare financial statements on both a cash and accrual basis, to be used for different purposes. Section 6.2 of D&Y’s 1997 Partnership Agreement, providing for payment to the estate of a deceased partner based on the partner’s Net Capital Account Balance, defined that term vaguely by reference to the “accounting methods used by the Partnership in the preparation of its financial statements.” Depending which accounting method prevails at trial, Yee’s estate either will take nothing (cash basis) or over $200,000 presumably with 9% interest since date of death (accrual basis). Had Section 6.2 specified the more commonly-used accrual basis, likely it would have made little difference to Yee’s estate at least financially whether the firm dissolved or continued.