Monday, January 25, 2016

Rule 5.6 and the Indirect Restraint

We lawyers love to make rules for ourselves.

As a regulated profession, lawyers are bound by their state's Code of Ethics. And while many of those provisions have nothing to do with competition, one rule in particular stands out. Model Rule 5.6 is the most widely known public-policy exception that invalidates non-competes. Through its text, Rule 5.6 prohibits a lawyer from entering into an agreement that "restricts the rights of a lawyer to practice after termination of the relationship, except an agreement concerning benefits upon retirement." Clients that come to me with a non-compete just love to hear that, legally, I can't even have one.

Despite the relatively clear nature of the rule, courts have not treated it uniformly and its bounds are not well-defined. Without fail, pure non-competition agreements are invalid. Therefore, lawyers cannot be bound by agreements that restrict their practice area or ability to service specific clients.

The more vexing question concerns the indirect restraint, known commonly as forfeiture-for-competition clauses. A typical forfeiture clause provides that an attorney who withdraws from the firm (normally an equity partner) suffers a reduction of what she otherwise is owed if she takes her clients with her. The contract, therefore, does not prohibit competition but amounts to an indirect restraint. It places a financial disincentive on competing directly for firm clients.

Is such an indirect restraint an impermissible restriction on the lawyer's right to practice. New York courts, for instance, have said "yes," that such clauses are unenforceable and against public policy. The state's Court of Appeals has said that a forfeiture-for-competition provision "would functionally and realistically discourages and foreclose a withdrawing partner from serving clients who might wish to continue to be represented by the withdrawing lawyer and would thus interfere with the client's choice of counsel."

One of the law's great anomalies is that the opposite view comes from the Supreme Court of California, where as a matter of policy non-competes are unenforceable in all lines of work. The Court in that case upheld a partnership provision that caused a withdrawing partner to forfeit withdrawal benefits if he practiced insurance defense work in a particular locale. The Court upheld the agreement, focusing on the changing nature of the law practice. In the Court's view, "these agreements address important business interests of law firms that can no longer be ignored." In fairness to this California decision and its seeming incongruity from the rest of non-compete law, the state's broad public policy restriction on non-competes does not apply to partnership contracts. So to this end, the state statute known as Section 16600 cannot provide a collateral source of rights for attorneys to attack forfeiture-for-competition clauses.

For its part, Maine goes further than California and declined to adopt an ethics rule similar to Rule 5.6. Lawyers, therefore, are free to sign non-competes without running afoul of that state's code of conduct. Just recently, a federal court in the District of Columbia - which had not addressed the scope of Rule 5.6 - predicted that it would follow New York's majority rule and bar indirect restraints.

Like many areas of non-compete law, this one is relatively unclear and varies from state to state. However, if lawyers are confused about the types of agreements to which they can be bound, they shouldn't expect sympathy from their clients in the real world. The landscape there is even more unsettled.

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