In a continuing series, Peter Garry advises on the benefits of clearly written agreements between business parties when dividing partnership assets
Misappropriation of goodwill from a legal practice
When partners leave firms, taking key clients with them, the loss of revenue can have a severe impact on profits for the remaining partners. The immediate pursuit of any available remedies may become imperative.
The recent case of Woodfull v Lindsley and anor [2004] 2 BCLC 131 reminds us that in such circumstances it is important to distinguish between acts that found a claim in damages and acts giving rise to a claim for an account for breach of fiduciary duty.
The following situation could arise in any firm of solicitors. A partner unexpectedly gives notice to retire from the partnership. Shortly afterwards, a number of valuable clients terminate or do not renew their retainers with the firm, and take their work to the retiring partner's intended new firm. On his retirement, the retired partner joins that firm and, in clear breach of his non-acting covenant, starts acting for the clients. It may well be that he will receive a significant share of profit based on his introduction of those clients. It is unknown whether he approached the clients prior to his retirement, and actively encouraged their defection, and the former clients will not comment on that.
Evidence of what he did prior to retirement might be available, for example, through the recovery and forensic analysis of information retained in the firm's computer network, or from members of staff who may have accompanied the retired partner at pre-retirement meetings with the clients concerned. Surveillance of a partner prior to retirement is not unheard of. But there is often reluctance within a firm to pursue such enquiries on grounds of time, expense and staff morale, and because all enquiries may be little more than speculative. Just how important is it to be able to establish pre-retirement solicitation, rather than relying solely on post-retirement acting? Any approach to clients made by the retiring partner before his retirement, with the intention or likely effect of procuring their defection to his intended new firm, would have been contrary to his duty of good faith; his duty not to make a secret profit from his partnership connection; and probably his duty not to compete with the firm, in respect of which he would have to account as a fiduciary for profits so realised (see sections 29(1) and 30 of the Partnership Act 1890 and Dean v MacDowell (1878) LR 8 Ch D 345 (CA)). After retirement, he would have no such duties, but his non-acting covenant would apply. In limited liability partnerships, the position is likely to be broadly the same.
Non-acting covenants are often attacked as being too wide, and thus unenforceable, but former partners frequently contend that preventing a client from instructing their solicitor of choice is contrary to professional rules (see Law Society practice rule 3.12).
An additional difficulty with pursuing a covenant claim is that, being contractual in nature, it is necessary to establish loss flowing from the breach. Former clients may indicate that they would not under any circumstances continue to instruct the firm, for example, because, following the departure of the partner concerned, the firm no longer has the required expertise. Thus, it can be difficult to establish that the firm has suffered any loss in consequence of the retired partner acting for clients in breach of covenant, and only nominal damages would be recoverable (see Dean v MacDowell (supra at 355)). An interim injunction to restrain a former partner from acting for certain clients may either not be granted or, if granted, may be a Pyrrhic victory, as rarely in such circumstances will clients return to the original firm.
The firm may be at risk of paying cross-undertaking damages if any injunction is later found to have been inappropriate. Even where there is an arbitration clause, permitting claims to be pursued in private, recourse to the court for an injunction may well be required (see generally section 44 of the Arbitration Act 1996), and a public airing will be regarded as unwelcome. In Woodfull, before Mr Woodfull retired he had, unknown to his partners, misappropriated (into his own limited company) a business opportunity belonging to the partnership, with the possibility of annual renewals. There were subsequently four annual renewals of the contract in favour of Mr Woodfull's company, up to 2002.
The Court of Appeal, which heard the case in 2004, was asked to determine whether the account of profits should cover the period up to the date of his retirement in 1998, or whether the account of profits period should continue indefinitely until there had been a final account of the profits or an agreement between the parties. The argument for imposition of an indefinite accounting period was based by analogy on the case of Don King Productions Inc v Warren [2000] Ch 291, in which it was found that in the absence of contrary agreement a partnership was entitled to the benefit of contracts for the management and promotion of boxers not only up to dissolution but also until the contract expired or was properly disposed of in the winding up of the partnership. Furthermore, where contracts were entered into with boxers by one partner after the date of dissolution, but before completion of the winding up, the benefit of such contracts was also held on trust for the partnership. The Court of Appeal in Woodfull noted that the Don King case concerned dissolution, whereas Woodfull concerned retirement. Mr Woodfull had no continuing duties to his partners following his retirement in 1998.
In any event, the firm had in correspondence agreed not to press its claim past the retirement date. Accordingly, Mr Woodfull was only liable to account for 'the value as at [the retirement date in 1998] of the goodwill, opportunity and advantage derived by [Mr Woodfull's company] from the contracts ...' Elucidating on the valuation process to be conducted, Lady Justice Arden held that the amount to be paid should include:
Furthermore, were it not for the fact that the firm had agreed to draw a line as at the retirement date, an account of all of the continuing profits after the retirement date would have been ordered, rather than merely a valuation of the opportunity to renew. And Mr Woodfull was entitled to an allowance for his personal skill and labour (citing Phipps v Boardman [1967] 2 AC 46). Firms that find themselves considering whether to bring a breach of covenant claim against former partners, owing to significant client loss associated with their departure, need to look carefully at the potential recovery under different heads of claim. The limitation period is six years, so a delay during which the quantum of the claim may in effect be proving itself is no bad thing. However, in the meantime, it is essential, as soon as possible, to gather and preserve evidence of pre-retirement solicitation, which may be crucial to establish liability to account for profits made or received.
Peter Garry is head of the partnerships and professional practices group at south-east law firm Cripps Harries Hall
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