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When Law Firms Go Bad: The Battle Over Contingency Fee Valuations and Crypto Tokens | Farrell Fritz, PC
As both a professional and a close follower of New York business divorce jurisprudence, I have seen a recent increase in litigation centered on the dissolution of professional services firms and cryptocurrency businesses. Perhaps the cryptocurrency business part is a natural consequence of the recent rapid expansion of the industry. As far as professional services firms go, your guess is as good as mine.
Whatever the cause of this trend, these disputes pose some of the most challenging and difficult appraisal questions for lawyers and the appraisal experts they rely on. How to evaluate an owner’s interest in a professional services firm depends on the nature of the firm’s fee structure. And the more complex the firm’s fee structure – imagine a law firm with contingent fees and co-counsel assignments in potentially massive, but also extremely uncertain verdicts – the more complicated the valuation. And the legal world is just starting to grapple with a basic understanding of blockchain technology, not to mention the complex valuation issues that different cryptocurrency assets can raise.
Based on these complications, a law firm with high contingency fee cases that accepts payments in cryptocurrency tokens could be one of the most difficult companies to value: a final exam in a crash course in litigation from a business valuation expert, for so to speak. For some lawyers and experts, the results are in: Freedman Normand Friedland LLP v. Cyrulnik, 21-CV-1746 (JGK) (SDNY May 15, 2024).
Roche Freedman and Cyrulnik
This controversy begins with three former Boies Schiller lawyers: Roche, Freedman and Cyrulnik. In the summer of 2019, Roche and Freedman left Boies Schiller and founded Roche Freedman LLP (the “Company”). Almost immediately they began to aggressively recruit Cyrulnik, who was senior to them at Boies Schiller. The firm’s recruiting pitch to Cyrulnik promised him a significant stake in his high-stakes contingency fee litigation.
Cyrulnik ultimately agreed to join the Firm, and in connection with Cyrulnik’s addition, the Firm’s six partners entered into a Memorandum of Understanding outlining the Firm’s partnership and compensation structure. Regarding equity capital, the MOU assigned Cyrulnik 27% of the Company’s capital (the largest share) and a fixed allocation of 25% of certain cryptocurrency tokens that the Company had obtained as payment for services. Regarding compensation, the MOU outlined how partners would be compensated for both hourly rate and contingency rate cases.
The memorandum of understanding also specified that a “founding member” – including Cyrulnik – could not be removed except for “cause” and by a vote of two-thirds of the Company’s equity partners. If removed for cause, the removed partner was entitled to the compensation earned under the MOU’s compensation structure, but was required to return his or her assets to the remaining partners.
The disputed removal
In January 2021, according to Cyrulnik, the remaining members of the firm orchestrated a plan to oust him as a partner in order to exclude him from the firm’s profits, particularly from crypto tokens, which had substantially increased in value. They called a secret meeting and, two days later, informed Cyrulnik that he had been removed for cause. The firm’s “suit” resembles the complaints of a law associate; Cyrulnik was accused of exercising “unilateral control” over staff and creating “unsustainable environments for employees.”
The parties were in court in February. The firm filed suit first, seeking among other things a declaratory judgment confirming the validity of Cyrulnik’s removal. Cyrulnik responded by claiming, among other things, the violation of the MOU, the dissolution of the Company and the acquisition at fair value of its 27% equity interest.
Judge Koeltl believes a trial on cause and evaluation is necessary
Both sides vigorously (and quickly) realized and filed dueling summary judgment motions. From order of 24 November 2023, Judge Koeltl granted in part and denied in part each of these motions for summary judgment. A great read that covers all sorts of fascinating issues regarding the enforceability of the MOU and the interaction between the MOU and Florida partnership law, the summary judgment decision narrowed the claims, but ultimately found questions of facts concerning (i) whether Cyrulnik was validly removed for cause and, regardless of the answer to such question, (ii) the amount owed to Cyrulnik under the MOU as compensation or payment for his participation.
The second issue starts a process on some important evaluation questions:
First, assuming Cyrulnik is entitled to payment for his 27% stake in the business, what is the value of that interest? The issue becomes especially complicated because at the time of Cyrulnik’s ouster, the firm’s greatest “asset” was his contingent fee representation in several mass securities cases, which, if successful, would result in substantial payouts for the company.
Second, what is the value of the cryptocurrency “tokens” held by the Company at the time of Cyrulnik’s ouster? The matter was complicated by the fact that crypto tokens were not freely traded and many had not yet been vested in the Company under the terms of the crypto-paying customer agreement.
Evaluation testimony offered by Cyrulnik
To evaluate the Firm’s contingency fee workload, Cyrulnik offered the advice of a credentialed valuation expert. That expert developed a methodology loosely based on BVR’s ten steps to evaluate law firm emergency casesin which he calculated the value of contingency cases in a few simple steps:
- Multiply the estimated probable damages by the estimated probability of a successful outcome to arrive at the probability-adjusted gross premium;
- Consider the probability-adjusted gross premium and applicable retention/co-advisor agreements to achieve the achievable recovery for the business;
- Subtract the amounts owed to any litigation financiers from the recoverable amount to the company to reach the net recoverable amount to the company;
- Adjust the enterprise’s Net Achievable Recovery for overhead and apply the MOU compensation structure to the enterprise’s Adjusted Net Achievable Recovery.
To evaluate the company’s crypto tokens, Cyrulnik offered expert testimony from cryptocurrency veteran Vikram Kapoor. He valued the Company’s acquired tokens at their highest interim value during a reasonable period following Cyrulnik’s discovery that Roche and Freedman had not remitted Cyrulnik’s share. And Kapoor’s assessment of unmatured tokens adequately considered the risk that such tokens may not mature.
The company’s exclusion proposals
The company moved to exclude Cyrulnik’s valuation experts.
Regarding the contingency fee workload, the study focused on Cyrulnik’s expert input into its multi-step process. The expert was not a lawyer, nor did he have any experience in assessing disputes. AS, supported the Societyhow could Cyrulnik’s expert purport to calculate the “estimated probable damages”, the “estimated probability of a positive outcome”, or any other input to his formula.
As for crypto tokens, supported the Society that Cyrulnik’s expert’s valuation of the acquired tokens should be ruled out because it was basic arithmetic: multiplying the price of the token on a given date by the quantity of tokens held by the Company. With respect to unvested tokens, the Company argued that Cyrulnik’s expert should be excluded because “courts have repeatedly found that damages from unvested options are ‘impermissibly speculative.'”
The decision
From Opinion and order of 15 May 2024, Judge Koeltl granted the firm’s request to prevent the evaluation of contingent cases by Cyrulnik’s expert. The Court found that the expert did not have the experience and legal capacity to calculate the necessary inputs to his methodology:
The Jenkins test is highly specific to individual disputes and depends on an analysis of the likely damages in each case and the likelihood of success, but Jenkins provides no basis for its purported experience in determining the accuracy of these assumptions. Instead, Jenkins’ assumptions and the inputs he relies on boil down to his “ipse dixit” for which he offers no support.
The Court was particularly critical of the fact that the expert relied on pleadings and, in one case, newspaper articles, to arrive at his input:
Regarding the Tether case, Jenkins estimated that the damages amounted to $850,000,000, but this was based on newspaper reports with no indication of the reliability of such reports and estimated that the chances of recovery were 50%. Jenkins did not have the experience to make such an assessment. .”
In the same order, the Court denied the company’s motion to disqualify Cyrulnik’s crypto valuation expert. The Court found that the expert’s valuation of the acquired tokens was not “basic arithmetic”, since the expert’s testimony was necessary to explain some assumptions about “why it was appropriate to use the high and low price of the tokens in each valuation date, rather than the average of the opening and closing prices on the relevant dates.”
With respect to the unvested tokens, the Court found that Cyrulnik’s interest in the unvested tokens is not analogous to that of an employee with unvested stock options. Rather, the tokens constituted specific consideration for the MOU and such consideration was not too speculative to value. In any case, the Court stated, the tokens were indeed awarded to the Company and therefore can be properly assessed as amounts owed to Cyrulnik.
Then, in a relatively tidy decision, Judge Koeltl sheds valuable light on valuation standards for two of the trickiest (and trending) assets: contingency fee disputes and cryptocurrency tokens.
An evaluation process takes place
Judge Koeltl’s decision also sets the contours of what will be a very interesting trial later this summer. I will watch it for a few reasons.
First, to see how agility Cyrulnik manages to maintain the line between fact and expert testimony. Excluding its case evaluation expert, you can bet that Cyrulink will offer testimony, as one of the lead case lawyers, on the Firm’s contingency fee cases. Can Cyrulnik’s testimony replace the expert opinions that were denied to him?
Second, to see the Court absorb, credit, and discredit the opinions of competing experts regarding the value of crypto tokens. Cryptocurrency valuation litigation is still in its infancy, and this process is poised to resolve several questions of first impression.
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