Financial Penalties as Restrictions

Rule 5.6(a) forbids a lawyer to offer or make a partnership, shareholders, operating, employment, or similar agreement that restricts the right to practice after the relationship ends, and it excepts only an agreement concerning benefits upon retirement.¹ The clauses covered earlier in this chapter close the door outright. They bar a departing lawyer from a territory, a practice area, or the firm’s clients. A financial penalty leaves the door open and charges for walking through it, and the question here is whether the charge is itself a restriction.

That question decides real disputes because a firm can come close to the effect of a ban by pricing competition. A lawyer weighing a request from a former client must subtract the forfeiture from what the engagement is worth, and a large enough forfeiture can work as a prohibition in practice. Courts therefore divide over whether Rule 5.6(a) looks at what a clause says or at what it does to the lawyer’s choices and to the clients who might follow.

The rule’s wording anchors one side. Rule 5.6(a) reaches an agreement that restricts the right to practice; it does not say an agreement that prohibits it.² A restriction is the broader idea, since a term can burden a lawyer’s practice without forbidding any part of it, and the majority of courts rely on that breadth to treat a financial penalty on competition as a restriction. The first subsection teaches the majority approach. The second covers the minority, which tests such penalties by reasonableness. An exam stem on this topic will usually describe an agreement that never says “shall not practice,” so begin by asking what the agreement does to the departing lawyer’s choices.

Penalties Count as Restrictions

The leading majority decision is Cohen v. Lord, Day & Lord, in which the New York Court of Appeals applied a disciplinary rule, DR 2-108(A), that barred agreements restricting a lawyer’s right to practice and exempted agreements among partners dealing with retirement benefits.³ The partnership agreement there contained a forfeiture-for-competition clause, and the court held that the clause could not stand. Rule 5.6(a) uses the same operative verb, restricts, and carries the same retirement exception, so the reasoning carries over.⁴

The firm defended the clause on the ground that DR 2-108(A) and the ABA opinions construing it condemn only blanket prohibitions on practicing in a community, and that a forfeiture-for-competition clause, being an economic disincentive, does not stop the lawyer from practicing.⁵ The argument has surface appeal because the lawyer keeps a real choice: she can practice elsewhere, or practice locally and bear the cost. The court nonetheless said the argument did not withstand scrutiny, and it answered in two ways, first from earlier decisions and then from the rule’s own wording.

The earlier decisions had treated penalties as restraints. In Matter of Silverberg (Schwartz), the only New York case on the subject, the Appellate Division held unenforceable an agreement under which neither partner could represent the other’s clients for eighteen months after the partnership ended unless the client directed otherwise in writing, and a partner who did so owed eighty percent of the gross fees to the client’s original attorney. Stating that “[l]awyers should not traffic in clients,” the court concluded that the agreement amounted to a covenant restricting the practice of a lawyer.⁶ The Oregon Court of Appeals reached a similar result in Gray v. Martin, where it invalidated an agreement requiring a withdrawing lawyer to forfeit financial benefits for practicing in a designated three-county area.⁷ Each clause leaves the client reachable and makes reaching the client expensive.

That expense matters because of what the rule protects. A client is always entitled to be represented by counsel of the client’s own choosing; the attorney-client relationship is consensual and highly fiduciary, and no concept of the practice of law is more deeply rooted.⁸ A penalty on taking the client puts that entitlement under pressure, because economic disincentives of this kind may encourage the lawyer to give up the clients, interfering with the lawyer-client relationship and, more importantly, with the clients’ free choice of counsel.⁹

The rule’s wording supplies the second answer, in two parts. The first concerns the verb. To restrict is to restrain or confine within bounds, and to prohibit is to prevent or forbid; the two terms are not synonymous.¹⁰ A forfeiture confines a lawyer’s practice without forbidding any part of it, so it fits the broader verb. The second part is the surplusage argument. Cohen reasoned that a court should give meaning and effect to every word of a rule, and that the exemption for retirement benefits would be superfluous if financial disincentives did not restrict practice in the first place.¹¹ Rule 5.6(a) has the same structure, a ban on restrictive agreements followed by an exception for retirement benefits, so the argument transfers intact.¹² Whether a firm’s departure payout qualifies for that exception is a separate question, taken up in the next section.

The weight of authority sits behind this reading. The California Supreme Court’s decision in Howard v. Babcock, which went the other way, itself collected out-of-state decisions that read comparable rules to bar agreements that merely assess a cost for competition. Iowa’s Dwyer decision voided a forfeiture of a partnership interest imposed on a partner who withdrew and competed. New Jersey’s Jacob v. Norris voided an agreement that denied compensation to withdrawing partners who represented firm clients within a year, though it allowed a firm to reduce payment for goodwill if the departure hurt the firm’s goodwill value.¹³ The goodwill allowance deserves notice because it ties a reduction to harm the departure actually causes the firm.

Meehan v. Shaughnessy shows the same policy at work in interpretation, with no penalty clause to strike down. The Massachusetts court construed a partnership agreement to let departing partners represent the firm’s clients, so as to avoid violating the rule against anticompetitive agreements.¹⁴ Its reason was that the strong public interest in allowing clients to retain counsel of their choice outweighs any professional benefit from a restrictive covenant, so the partners could not restrict a departing partner’s right to remove any clients who freely choose that lawyer.¹⁵ Cohen strikes a clause that plainly penalizes competition; Meehan construes an agreement in favor of the client’s choice. Both treat the economic terms of a partnership agreement as subject to the rule.

A departure payout becomes a forbidden penalty when it turns on whether the lawyer competes.

A forfeiture clause changes the one thing that matters: it makes the same money depend on staying out of competition. The usual exam error is to reason that a lawyer who remains free to practice has suffered no restriction. That reasoning treats the rule as if it said prohibits, and the majority rejects it because a lawyer who loses benefits for practicing has had the right to practice burdened.

Reasonable-Cost Minority View

A minority of courts read a similar rule the other way, and the leading decision is Howard v. Babcock. The California Supreme Court held there that a partnership agreement assessing a reasonable cost against a partner who competes with former partners does not restrict the practice of law.¹⁷ California’s rule 1-500 closely resembles the Model Rule. It bars a member from participating in offering or making an agreement that restricts the right to practice law, with exceptions that include an agreement requiring payments upon retirement, and the majority still refused to read it as a ban on tolls.¹⁸ The court said it disagreed with the analysis of the courts that had read comparable rules the other way.¹⁹ Howard is therefore best learned as a recognized exception to the default analysis.

The facts show what a toll can cost. After the plaintiffs left the Parker firm, clients in approximately 200 cases chose to be represented by their new firm instead. The Parker firm offered to pay the plaintiffs their share of capital but refused to pay for their share of work in progress (work completed but not yet billed) and accounts receivable (work billed but not yet paid), and it refused to acknowledge any interest in the unfinished business of the firm.²⁰ The trial court ordered the plaintiffs to pay the Parker firm 82.5 percent of the net profits from work they performed for former Parker clients, and it found that the firm owed them nothing.²¹ The departing partners stayed free to take the clients, and most of the profit from that work went back to the firm they had left.

The majority began by characterizing the clause. An agreement that assesses a reasonable cost against a partner who competes, it said, does not restrict the practice of law; “[r]ather, it attaches an economic consequence to a departing partner’s unrestricted choice to pursue a particular kind of practice.”²² The court drew on the balance described in Haight, Brown & Bonesteel v. Superior Court. On one side, a departing lawyer may withdraw, practice anywhere in the state, and accept employment from any client who wants to retain her. On the other, the remaining partners may stabilize the firm by using the withdrawing partner’s share of capital and accounts receivable to replace the income lost on departing clients and to support the partnership’s debts.²³ On this view the clause is a price attached to a choice that stays open.

That balance limits how large the price may be. Under Haight, an agreement of this kind is valid or invalid according to whether it amounts to liquidated damages or to a forfeiture.²⁴ A sum fixed as liquidated damages for competition must represent a reasonable endeavor to estimate fair compensation for the loss the firm may sustain, and it must bear some reasonable relation to that loss.²⁵ The minority view therefore tolerates a charge that tracks the firm’s real loss, while a charge that outruns the loss operates as a forfeiture and fails.

The majority also found support in California’s statutory language on covenants not to compete among partners. Courts had relied on that language to enforce such covenants among accountants and physicians, and those agreements typically do not forbid competition but place a price on it. One court explained that a medical partnership cannot withhold the privilege of practicing medicine in the state, but a withdrawing partner “may contract that if he exercises that privilege he will compensate his former partners to some extent at least for the business which he expects to take from them.”²⁶ Applying the statute to law partners did not end the inquiry, because the court has inherent power to prescribe rules of professional conduct for attorneys.²⁷ The majority simply declined to read rule 1-500 as imposing a stricter standard on this point.

The court also invoked what it called a new reality in the practice of law, and it expressed confidence that recognizing that reality would have no deleterious effect on the ability of clients to retain loyal, competent counsel of their choice.²⁸ It rejected two arguments that other courts had accepted: that a lawyer must be free to choose when, where, and for whom to practice, and that law is not a business and clients are not commodities, so any effective toll on competition limits the client’s access to the lawyer of choice.²⁹ The Arizona Supreme Court took a similar position in Fearnow v. Ridenour.

The dissent in Howard would have enforced the rule according to the ordinary meaning of its terms, to bar all agreements by which established firms protect themselves against competition from attorneys who leave.³⁰ Language from the discussion accompanying rule 1-500 supports that reading. A shareholder, partner, or associate may agree not to have a separate practice while the relationship lasts, but upon termination, voluntary or involuntary, the member is free to practice law without any contractual restriction.³¹

The two camps disagree about what a toll does to the client. The minority view holds that client choice survives because the client may still hire the lawyer and the lawyer may still accept the engagement. The majority reading reasons that a lawyer who must pay for each client who follows will weigh that payment when deciding whom to serve, so the client’s access narrows even though no clause forbids anything.³² The size of the payment determines how much pressure the lawyer feels, which is why the amount matters even under the minority view.

General covenant law offers a useful contrast here. A covenant tied to the sale of a business does not ordinarily contemplate competition between the parties, because the sale signals one party’s exit from competition. A restraint on a former employee, by contrast, is inherently anticompetitive, and the parties typically bargain from unequal positions.³³ The question is where a departing law partner who keeps practicing belongs on that spectrum, and the two camps answer it differently.

Under the Model Rule reading both clauses fail, because each makes the departing lawyer pay for practicing. Only a court that has adopted the minority approach sorts the two firms differently, and even that court examines the amount. On an exam, apply the Model Rule reading first and treat a financial penalty on competition as a restriction under Rule 5.6(a). Reach for the toll analysis only when the problem places the dispute in a jurisdiction, such as California or Arizona, that has adopted it, or when the question asks expressly about a reasonable cost. Even then, check that the charge is proportionate to the firm’s loss.