June 7, 2019, Northern District of California– Last week, the defunct San Francisco-based law firm Sedgwick, LLP, filed a motion pursuant to Rule 9019 of the Federal Rules of Bankruptcy Procedure and Section 877.6 of the California Code of Civil Procedure, for approval of a compromise among the Debtor and certain former equity partners of the Debtor relating to the constructive fraudulent transfer claims arising from the Debtors’ ordinary course cash distributions to its partners as either compensation, draws, or return of capital and any claims arising from its partners alleged breach of fiduciary duty to the debtor.
The defunct law firm requested a federal bankruptcy judge to approve a clawback settlement with its 45 former partners who have agreed to return a total of $1.595 million paid to them during the firm’s 2017 collapse. According to the Debtor firm, the settlement will expedite the resolution of Chapter 11 proceedings in the Northern District of California, which began in October 2018. The settlement payment represented a recovery against the settling partners that is equal to 142.3% of the claims against such partner using August 31, 2017, an insolvency date proxy.
According to the Debtor, further negotiation or active litigation against the settling partners will not increase the cash available for distributions to creditors but will only dissipate cash that could otherwise be used to pay the allowed claims of unsecured creditors. According to the filing, the Debtor has liabilities of between $10 million and $50 million, much of which consisted of unpaid lease obligations.
By way of background, the Debtor stopped providing legal services on December 31, 2017, and immediately commenced the voluntary dissolution of the firm. During 2017, the Debtor made certain distributions in cash to its current and former equity partners as either compensation or draws for their services or a return of capital (as the firm returned capital to former equity partners in the normal course). The Debtor acknowledged that distributions of cash to the firm’s then current and former equity partners give rise to potential claw-back claims as constructively fraudulent transfers (subject to applicable defenses of reasonably equivalent value) but the seminal issue establishing such claims and their amounts depended on the fact-intensive determination of when the Debtor became insolvent.
The bankruptcy filing by Sedgwick came after the set of former partners on the firm’s dissolution committee hit a roadblock in discussions with a group of 12 of the defunct firm’s largest creditors.
According to the filings in the court, the creditors’ committee is likely to object to the settlement and may seek discovery in connection with the settlement motion, and seek additional affirmative relief. The creditors requested the Court to convert a previously scheduled hearing for June 13 into a scheduling conference for the pending fight. But the Honorable Judge Hannah L. Blumenstiel who is presiding the case said that the scheduling and other details would be handled at a hearing now set for July 1.