Testa Aviods Bankruptcy Hearing –

Testa, Hurwitz & Thibeault LLP will not be plunged into bankruptcy against its will, after a federal judge last month rejected an involuntary bankruptcy petition filed by eight former Testa Hurwitz partners. The ruling likely means that the petitioners will air their grievances in front of an arbitration panel, while Testa Hurwitz will continue to implement its own dissolution plan.

“We are pleased that the Court found that this matter should be settled in arbitration,” said George Thibeault, a firm co-founder who is overseeing the dissolution. “We can now continue the important process of winding down the partnership’s affairs in an orderly fashion.”

Boston-based Testa Hurwitz spent most of the past three decades as the East Coast’s dominant private equity law firm, but began suffering a steady stream of partner defections following the unexpected death of firm patriarch Dick Testa in late 2002. Each partner who left-with one exception, who made a verbal agreement-signed an exit agreement that included a five-year payment plan for any money remaining in their restricted capital accounts (82% of each active partner’s profits went into an unrestricted capital account that they could withdraw from at any time, while the other 18% was directed to restricted capital accounts that required partnership approval to access).

The steady stream, however, turned into a flood last December, when 10 partners simultaneously announced their intention to leave. Seven of the defectors-including private equity group co-heads Robin Painter and David Tegeler-headed to Proskauer Rose, where a trio of former Testa Hurwitz IP attorneys had opened a Boston office several months earlier. The other three went to Bingham McCutchen.

Headhunters immediately began making calls, and Testa Hurwitz desperately searched for a merger partner. On January 4, the remaining partners gave themselves a $3.5 million distribution from the unrestricted capital accounts, ostensibly to cover tax obligations. Ten days later, they voted to disband.

At the time, the combined restricted capital account of Testa Hurwitz was valued at around $29 million, with most partners being owed hundreds of thousandsif not millionsof dollars. Moreover, partners were well aware that they would be viewed as junior creditors, which would make it unlikely that they’d receive anywhere near that $29 million. They opted for dissolution anyway.

Testa Hurwitz immediately began settling up accounts with various vendors, and also reached a favorable agreement with its high-priced landlord. Former partners got down to work with their new firms, and were told that there eventually would be about $7.1 million left to pay off at least some of the restricted capital accounts.

This restricted account discount, however, did not sit well with several partners who had left Testa Hurwitz prior to the dissolution vote. Specifically, they felt that their equity had essentially been converted to debt when they left the active partnership and, as such, that they should be considered creditors on par with others. Moreover, even thought they were not to be considered senior creditors, they still did not trust the finances to Thibeault, preferring instead that the entire process be overseen by a bankruptcy court-appointed trustee.

Edwin Miller, who had left Testa Hurwitz last November, retained counsel, and recruited seven other like-minded former partners (several others opted not to join). Combined, they had just over $1.98 million remaining in their capital accounts. Among them was Leslie Davis, who had left back in February 2001; John Hession, who left in July 2003; and Tom Beaudoin, whose last day was Oct. 6, 2004. Eric Deutsche was owed the most with $504,220, while Richard Sanders’ account had just $19,186 remaining.

The septet filed their involuntary bankruptcy petition on Feb. 17, and attorneys for both sides attended a court hearing on March 21. Among the most contentious arguments was Testa Hurwitz’s claim that the original partnership agreement had required binding and mandatory arbitration of any controversy of claim related to the partnership. The petitioners countered by saying that such an agreement was no longer valid once an individual left the partnership, as the partnership itself no longer existed as originally constituted.

The hearing itself, however, was marred by the fact that neither attorney had brought copies of the exit agreements, nor had they brought an original partnership agreement.

The decision was handed down at the end of March, and denied the petitioners’ requests. In her 27-page opinion, U.S. Bankruptcy Court Judge Joan Feeney wrote that “the terms of the exit agreement do not expressly elevate the claims of the petitioners from equity to debt, and the Court is not persuaded that agreements were intended to effect such a reclassification.” She added that “the wind-down of the affairs of THT through the Plan of Dissolution is an appropriate, efficient and economical means of concluding the affairs of THT, and that no economic benefit to creditors will accrue by keeping the case in bankruptcy.”

John Monaghan, who represented the petitioners, did not return an email requesting comment on the ruling. During the hearing, he had suggested that the petitioners might seek other legal remedies if the judge turned down their petition. It is unclear if any of the seven will follow that course of action. Also unknown as of press-time was whether or not Testa Hurwitz would put the petitioner’s $1.98 million into an escrow account, pending the decision of an arbitration panel. The firm claims to have made that offer several months ago, and reiterated it during the hearing.