Fearnow v. Ridenour Swenson Cleere and Evans – 7/18/2006
Arizona Supreme Court Holds that an Agreement Requiring Departing Lawyers to Forfeit Monetary Contribution to Law Firm is Permissible if Reasonable.
In a case sure to impact the structure of Arizona law firm partnership agreements, the Arizona Supreme Court, following California’s lead, held that lawyers may enter into reasonable withdrawal agreements that require departing lawyers to tender stock or other capital contributions for no compensation. At issue was a Shareholder Agreement entered into by shareholders (including plaintiff William Fearnow) of the Ridenour, Swenson, Cleere & Evans firm (“Ridenour”). The Shareholder Agreement required departing attorneys who continue to practice privately to tender their share in the corporation for no compensation. When Fearnow left Ridenour to join another Phoenix firm, he demanded payment for his share. Ridenour refused, citing the terms of the Shareholder Agreement. Fearnow sued, claiming that the Shareholder Agreement violated ER 5.6, which prohibits an “agreement that restricts the right of a lawyer to practice [law] after termination of [a lawyer firm] relationship.” Such agreements are prohibited because they limit a lawyer’s professional autonomy and interfere with client choice. Fearnow argued that the financial disincentive imposed by requiring departing attorneys to tender shares for no compensation discourages the departing attorney from competing with the law firm or representing former clients, thereby becoming a de facto restriction on the attorney’s right to practice law.
The trial court held that the provision in the Shareholder Agreement violated ER 5.6 and was unenforceable. The appellate court agreed but found that Fearnow had no remedy under the Shareholder Agreement or Arizona’s Professional Corporation’s Act, forcing Fearnow to retain his virtually valueless share.
The Supreme Court reversed, holding that lawyer agreement that do not expressly or completely prohibit attorneys from practicing law or representing clients will be reviewed under the same reasonableness standard applied to restrictive covenants in other contexts. Noting that ER 5.6 prohibits only agreements “that restrict the right of a lawyer to practice law,” which was not the effect of the Shareholder Agreement at issue, the Court should not treat attorneys different than other professionals, such as doctors and accountants, who are permitted to enter into reasonable restrictive covenants. In doing so, Arizona rejected the per se rule advanced by Fearnow and adopted by jurisdictions such as New York, New Jersey, and Oregon, and instead adopted the reasonableness rule announced in Howard v. Babcock, 863 P.2d 150 (Cal. 1994). Because the trial court had not made a determination of reasonableness, the Supreme Court remanded for that determination, noting that such provisions may be reasonable based on such factors as the firm’s economic interest, investments, training, capital expenditures, hiring of associates, and marketing and other expenditures directly caused by departing lawyers. The Court noted that if the Shareholder Agreement is found unreasonable, the trial court should sever the voluntary withdrawal provision from the balance of the Shareholder Agreement, which would require that Ridenour repurchase Fearnow’s share for his original subscription price.
Justice Bales dissented. He would have struck down the financial disincentive provision under ER 5.6, but he agreed with the majority that Fearnow’s remedy was limited to repurchase of the share at the original subscription price.
Justice Hurwitz authored the opinion for the majority.