When Law Firms Break Bad: The Valuation Battle Over Contingency Fees and Crypto Tokens

As both a practitioner and a close follower of New York business divorce caselaw, I’ve seen a recent uptick in disputes centered on the breakup of professional services firms and cryptocurrency businesses. Perhaps the crypto business part is a natural consequence of the industry’s recent rapid expansion. As for the professional services firms, your guess is as good as mine.

Whatever the cause of the trend, these disputes present some of the most compelling and difficult valuation questions for lawyers and the valuation experts they rely upon. How to value an owner’s interest in a professional services firm depends on the nature of the firm’s fee structure. And the more complex the fee structure of the firm—picture a law firm with contingency-fee and co-counsel engagements in potentially massive, but also wildly uncertain verdicts—the more complicated the valuation. And the legal world is just beginning to grapple with a basic understanding of blockchain technology, let alone the complex valuation questions that different cryptocurrency assets can raise.

Based on these complications, a law firm with high-upside contingency-fee cases that accepted payment in cryptocurrency tokens might be one of the most difficult companies to value—a final exam in a business valuation expert’s litigation crash course, 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 dispute begins with three former Boies Schiller attorneys: Roche, Freedman, and Cyrulnik. In the summer of 2019, Roche and Freedman left Boies Schiller and founded Roche Freedman LLP (the “Firm”). Almost immediately, they began aggressively recruiting Cyrulnik, who was senior to them at Boies Schiller. The Firm’s recruiting pitch to Cyrulnik promised him significant stakes in its high-upside contingency-fee litigation.

Cyrulnik ultimately agreed to join the Firm, and, in connection with Cyrulnik’s joining, the Firm’s six partners entered into a Memorandum of Understanding that outlined the Firm’s partnership and compensation structure. As to equity, the MOU gave Cyrulnik 27% of the Firm’s equity (the largest share) and a 25% fixed allocation of certain cryptocurrency tokens that the Firm had obtained as payment for services. As to compensation, the MOU outlined how the partners would be compensated for both its hourly and contingency-fee cases.

The MOU further specified that a “Founding Partner”—Cyrulnik included—could not be removed except for “cause” and upon the vote of two-thirds of the Firm’s equity partners. In the event of a removal for cause, the removed partner was entitled to his earned compensation pursuant to the MOU’s compensation structure, but was required to forfeit his equity back to the remaining partners.

The Contested Removal

In January 2021, according to Cyrulnik, the Firm’s remaining members orchestrated a scheme to oust him as a partner in order to cut him out of the Firm’s profits, particularly the crypto tokens, which had substantially increased in value. They convened a secret meeting and, two days later, advised Cyrulnik that he had been removed for cause. The Firm’s “cause” reads like a biglaw associate’s grievances; Cyrulnik stood accused of exercising “unilateral control over” staffing, and creating “unsustainable environments for associates.”

By February, the parties were in court. The Firm sued first, seeking among other relief a declaratory judgment confirming the validity of its removal of Cyrulnik. Cyrulnik fired back with claims for breach of the MOU, dissolution of the Firm, and for a fair value buyout of his 27% equity interest, among others.

Judge Koeltl Finds a Trial Is Necessary on Cause and Valuation

Both parties vigorously (and quickly) took discovery and submitted dueling summary judgment motions. By order dated November 24, 2023, Judge Koeltl granted in part and denied in part each of those summary judgment motions. A great read covering all sorts of fascinating issues concerning the enforceability of the MOU and the interplay between the MOU and Florida partnership law, the summary judgment decision narrowed the claims, but ultimately found issues of fact concerning (i) whether Cyrulnik was validly removed for cause, and—regardless of the answer to that question—(ii) the amount owed to Cyrulnik under the MOU as compensation or payment for his equity interest.

The second issue tees up a trial on some great valuation questions:

First, assuming Cyrulnik is entitled to some payment for his 27% equity interest in the firm, what is the value of that interest? That question gets particularly complicated because at the time of Cyrulnik’s ouster, the Firm’s greatest “assets” were its contingent-fee representation in several massive securities cases, which, if successful, would result in substantial fee awards for the firm.

Second, what is the value of the cryptocurrency “tokens” held by the Firm at the time of Cyrulnik’s ouster? This question was complicated by the fact that the crypto tokens were not freely traded, and many had not yet vested with the Firm pursuant to the terms of the agreement with the crypto-paying client.

Cyrulnik’s Proffered Valuation Testimony

To value the Firm’s contingency-fee caseload, Cyrulnik offered the opinion of a well-credentialed valuation expert. That expert developed a methodology loosely based on BVR’s Ten Steps to Value Law Firm Contingency Cases, in which he calculated the value of the contingency cases in a few simple steps:

The Firm’s Motions to Preclude

The Firm moved to preclude Cyrulnik’s valuation experts.

As to the contingency-fee caseload, the Firm focused on Cyrulnik’s expert’s inputs to his multi-step process. The expert was not a lawyer, nor did he have any experience in valuing litigations. So, argued the Firm, how could Cyrulnik’s expert purport to calculate the “Estimated Probable Damages,” the “Estimated Probability of a Successful Outcome,” or any of the other inputs to his formula.

As to the crypto tokens, the Firm argued that Cyrulnik’s expert’s valuation of the vested tokens should be excluded because it was basic arithmetic: multiply the token price on a given date by the amount of tokens held by the Firm. As to the unvested tokens, the Firm argued that Cyrulnik’s expert should be precluded because “courts have repeatedly held that damages flowing from unvested options are ‘impermissibly speculative.’”

The Decision

By Opinion and Order dated May 15, 2024, Judge Koeltl granted the Firm’s motion to preclude Cyrulnik’s expert’s valuation of the contingency cases. The Court held that the expert lacked the experience and legal ability to calculate the necessary inputs to his methodology:

Jenkins’ test is highly specific to the individual litigations and depends on an analysis of the probable damages in each case and the probability of success, but Jenkins provides no basis for his alleged expertise in determining the accuracy of these assumptions. Instead, Jenkins’ assumptions, and the inputs upon which he relies, come down to his own “ipse dixit” for which he offers no support.”

The Court was particularly critical of the expert’s reliance on the pleadings and, in one case, newspaper articles, to arrive at his inputs:

Regarding the Tether case, Jenkins estimated that the damages were $850,000,000, but this was based on newspaper accounts without any indication of the reliability of those accounts, and he estimated the chances of recovery to be 50%, Jenkins lacked the expertise to make that assessment.”

In the same Order, the Court denied the Firm’s motion to preclude Cyrulnik’s crypto valuation expert. The Court held that the expert’s valuation of the vested tokens was not “basic arithmetic,” because the expert’s testimony was required to explain certain assumptions about “why it was appropriate to use the high and low price of the tokens on each valuation date, rather than the average of the opening and closing prices on the relevant dates.”

As to the unvested tokens, the Court held that Cyrulnik’s interest in the unvested tokens is not analogous to an employee with unvested stock options. Rather, the tokens were specific consideration for the MOU, and that consideration was not too speculative to be valued. In all events, said the Court, the tokens were in fact awarded to the Firm, and therefore they may properly be valued as amounts due to Cyrulnik.

So in a relatively tidy decision, Judge Koeltl sheds valuable light on the valuation standards for two of the most complicated (and trending) assets: contingency-fee litigations and cryptocurrency tokens.

A Valuation Trial Unfolds

Judge Koeltl’s decision also defines the contours of what will be a very interesting trial later this summer. I’ll be watching for a few reasons.

First, to see how deftly Cyrulnik can toe the line between fact and expert witness. With his case valuation expert excluded, you can bet Cyrulink will offer his own testimony—as one of the lead lawyers on the cases—about the Firm’s contingency-fee cases. Can Cyrulnik’s fact testimony stand in for his precluded expert’s opinions?

Second, to see the Court absorb, credit, and discredit the competing experts’ opinions concerning the value of the crypto tokens. Crypto valuation litigation remains in its infancy, and this trial stands poised to resolve several questions of first impression.

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When Law Firms Break Bad: The Valuation Battle Over Contingency Fees and Crypto Tokens | JD Supra (2024)