Fearnow v. RSCE

• Decision Date: 19 April 2005
• Docket Number: No. 1 CA-CV 03-0650.,1 CA-CV 03-0650.
• Parties: William D. FEARNOW and Elizabeth Fearnow, Plaintiffs-Appellees, v. RIDENOUR, SWENSON, CLEERE & EVANS, P.C., Defendants-Appellants.
• Court: Arizona Court of Appeals

110 P.3d 357

210 Ariz. 256

William D. FEARNOW and Elizabeth Fearnow, Plaintiffs-Appellees, v. RIDENOUR, SWENSON, CLEERE & EVANS, P.C., Defendants-Appellants.

No. -0650.

Court of Appeals of Arizona, Division 1, Department B.

April 19, 2005.

Damore Law, P.C. by David A. Damore, Scottsdale, Attorneys for Plaintiffs-Appellees.

Osborn Maledon P.A. by Mark I. Harrison, Phoenix, Attorneys for Defendants-Appellants.

OPINION

WEISBERG, Judge.

¶ 1 Ridenour, Swenson, Cleere & Evans, P.C. ("RSCE") appeals from the judgment awarding William and Elizabeth Fearnow $86,500.00 for William Fearnow's equity interest in RSCE. The trial court concluded that the "Voluntary Withdrawal" provision in the Shareholder Agreement between Fearnow and RSCE unlawfully restricted Fearnow's right to practice law. Accordingly, the court found the Shareholder Agreement invalid. The court further held that Fearnow could recoup his equity interest in RSCE under the Arizona Professional Corporations Act ("Act"),¹ as a "disqualified person" who could compel RSCE to acquire his share for its fair-market value.

¶ 2 For the following reasons, we conclude that the Voluntary Withdrawal provision of the Shareholder Agreement constitutes an unlawful restriction upon Fearnow's right to practice law, but we further conclude that Fearnow has no right to compensation under the Act.

FACTUAL AND PROCEDURAL BACKGROUND

¶ 3 In 1987, Fearnow became a partner in the law firm of Ridenour, Swensen, Cleere and Evans (the "Partnership"). Fearnow paid $33,674.42 for his partnership interest.

¶ 4 In 1991, the Partnership dissolved, and the prior partners formed the RSCE professional corporation. Fearnow received one share of stock in RSCE.

¶ 5 On November 27, 1997, RSCE executed the last version of its Shareholder Agreement, which included a section governing the "Withdrawal of Stockholders." This section included a provision for the "Voluntary Withdrawal" of Stockholders, which stated:

Other than retirement, a Stockholder who withdraws from the Corporation shall tender his or her Share to the Corporation for no compensation.

¶ 6 In February 1998, Fearnow voluntarily left RSCE to practice law at the firm of Walker Ellsworth, P.L.C., and took several of RSCE's clients with him. He then demanded that RSCE pay him $33,674.42 as compensation for his share of stock. When RSCE refused, the Fearnows filed this lawsuit seeking to invalidate the Voluntary Withdrawal provision of the Shareholder Agreement. The Fearnows also sought compensation from RSCE based on theories of unjust enrichment and conversion.

¶ 7 The parties filed cross-motions for summary judgment on the validity of the Voluntary Withdrawal provision of the Shareholder Agreement. The trial court (the Honorable Colin F. Campbell) ruled that the Voluntary Withdrawal provision of the Shareholder Agreement was a restriction on a lawyer's right to practice law, in violation of Ethical Rule 5.6, Arizona Rules of Supreme Court 42 ("ER 5.6").² The court concluded that the striking of the provision left a "large gap in the [S]hareholder [A]greement ... [with] no remaining term cover[ing] what happens in the event of voluntary withdrawal or retirement." Because the Shareholder Agreement had no severability clause and the court could not rewrite the stricken material terms for the parties, it held the entire agreement to be invalid. The court then ordered the parties to submit additional briefing on the issue of what would be the appropriate remedy.

¶ 8 The parties filed cross-motions for summary judgment on the remedy issue. RSCE reasoned that the Fearnows had no remedy because the Act afforded none. It asserted that the Act provided that a corporation's obligation to repurchase stock arose only upon the death, dissolution or disqualification of a shareholder. RSCE argued, therefore, that Fearnow was not entitled to the compulsory repurchase of his share because he was not dead, could not be dissolved, and was not a "disqualified person" under the Act. Fearnow conceded he had no remedy under the Act, but sought equitable relief from the court based on restitution. ¶ 9 The trial court held that Fearnow was a "disqualified person" under the Act and ordered the appraisal of his share. RSCE filed a motion for reconsideration on the "disqualified person" issue, which the court denied.

¶ 10 The valuation issue proceeded to a bench trial before the Honorable Anna Baca. The court determined that the fair value of Fearnow's equity interest was $86,500. The court entered final judgment to that effect, and awarded the Fearnows their attorneys' fees, expert fees and costs. RSCE timely filed this appeal. We have jurisdiction over this matter pursuant to A.R.S. § 12-2101(B)(2003).

DISCUSSION

¶ 11 On appeal, RSCE challenges the trial court's partial summary judgment rulings regarding both the invalidity of the Shareholder Agreement and Fearnow's status as a "disqualified person" under the Act. We review the grant of summary judgment de novo, viewing the evidence and any reasonable inferences therefrom in the light most favorable to the party against whom judgment was entered. Great Am. Mortg., Inc. v. Statewide Ins. Co., 189 Ariz. 123, 124-25, 938 P.2d 1124, 1125-26 (App.1997). Also, the interpretation of a contract involves questions of law which we review de novo, as we do the interpretation and construction of the ethical rules governing attorney conduct. Tobel v. Travelers Ins. Co., 195 Ariz. 363, 366, ¶ 13, 988 P.2d 148, 151 (App.1999) (interpretation of contract is subject to de novo review); Perguson v. Tamis, 188 Ariz. 425, 427, 937 P.2d 347, 349 (App.1996) (interpretation and meaning of court rule is question of law subject to de novo review).

I

¶ 12 We first consider whether the Shareholder Agreement is enforceable. The trial court concluded that section 3(c) of the Shareholder Agreement was an unlawful restriction on the right of Fearnow to practice law and therefore, in violation of ER 5.6(a). At the time of the trial court proceedings, ER 5.6(a) provided:

Restrictions on Right to Practice

A lawyer shall not participate in offering or making:

(a) a partnership[³] or employment agreement that restricts the rights of a lawyer to practice after termination of the relationship except an agreement concerning benefits upon retirement;....

ER 5.6.⁴

¶ 13 The ethical rule guarding against restrictive covenants among lawyers was created to "prevent[ ] lawyers from `bartering in clients,' thereby protecting the client's freedom to choose, discharge, or replace a lawyer at will." Anderson v. Aspelmeier, Fisch, Power, Warner & Engberg, 461 N.W.2d 598, 601 (Iowa 1990) (citations omitted); see also Cmt. [1] to 2003 Amendment to ER 5.6 ("An agreement restricting the right of lawyers to practice after leaving a firm not only limits their professional autonomy but also limits the freedom of clients to choose a lawyer.") (emphasis added).

¶ 14 Arizona courts have not directly addressed ER 5.6's prohibition on restrictive covenants. However, in Valley Medical Specialists v. Farber, 194 Ariz. 363, 982 P.2d 1277 (1999),⁵ a case invalidating a restrictive covenant between a doctor and his professional corporation, our supreme court analogized the medical profession and a patient's right to the doctor of his/her choice to the legal profession and a client's right to the attorney of his/her choice. Id. at 368-69, ¶¶ 16-18, 982 P.2d at 1282-83 (noting that the principle of protecting client choice justified prohibiting restrictive covenants among lawyers). The court concluded that public policy required that the special doctor-patient relationship, like the attorney-client relationship, was entitled to unique protection, and could not be unduly restricted. Id. at 369, ¶ 19, 982 P.2d at 1283.

¶ 15 Several jurisdictions have held that any financial disincentive imposed upon a departing lawyer is an invalid restriction on the right to practice law in violation of applicable ethical rules. See Dowd & Dowd, Ltd. v. Gleason, 181 Ill.2d 460, 230 Ill.Dec. 229, 693 N.E.2d 358 (1998)

; Anderson, 461 N.W.2d 598; Cohen v. Lord, Day & Lord, 75 N.Y.2d 95, 551 N.Y.S.2d 157, 550 N.E.2d 410 (1989). The rationale of this position is that ethical rules prevent any restrictions by lawyers that limit the ability of a person to choose his or her attorney. Cohen, 551 N.Y.S.2d 157,

550 N.E.2d at 411-12; see also Restatement (Third) of Law Governing Lawyers § 13 cmt. b (2000).

¶ 16 Meanwhile, other jurisdictions have adopted a more permissive approach, holding that reasonable financial penalties for departing lawyers do not restrict the lawyer's right to practice. See Howard v. Babcock, 6 Cal.4th 409, 25 Cal.Rptr.2d 80, 863 P.2d 150, 156 (1993)

; Pettingell v. Morrison, Mahoney & Miller, 426 Mass. 253, 687 N.E.2d 1237, 1240 (1997). Under this approach, financial penalties are enforceable when they are reasonably linked to the actual loss suffered by the firm that is attributable to the lawyer's departure. Howard, 25 Cal.Rptr.2d 80,

863 P.2d at 156 (restriction valid if a "reasonable cost against a partner who chooses to compete with his or her former partners"); Pettingell, 687 N.E.2d at 1240 (financial penalty valid if "reasonable recognition of a law firm's loss due to the departure of a partner").

¶ 17 In the instant case, however, we need not decide which standard applies in Arizona because the subject financial penalty provision is invalid under even the more permissive standard. The financial disincentive here was not based upon any actual loss suffered by RSCE due to Fearnow's departure. On the contrary, the Agreement required Fearnow to forfeit all of his capital contribution regardless of whether he actually took with him any of RSCE's clients.⁶ We, therefore, affirm the trial court's holding that the Agreement is unenforceable.

II

¶ 18 Next, we turn to the issue of compensation. Both parties agree that Fearnow was properly issued his...