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Governo Law Firm, LLC v. CMBG3 Law, LLC

Superior Court of Massachusetts, Suffolk, Business Litigation Session

May 16, 2019

Governo Law Firm, LLC
CMBG3 Law, LLC et al.[1]

          Judge (with first initial, no space for Sullivan, Dorsey, and Walsh):Salinger, Kenneth W., J.


          Kenneth W. Salinger Justice of the Superior Court

          The Governo Law Firm, LLC is suing six of its former partners and their new law firm, CMBG3 Law, LLC. It claims that the individual defendants took copies of proprietary databases owned by the Governo Firm. Defendants contend that these materials belong to clients who transferred their legal representation to the new firm.

         The Court recently barred proposed expert damages testimony offered by the Governo Firm about an allegedly reasonable royalty for the disputed materials. It did so because both sides agreed that Defendants have made profits since they left the Governo Firm and started their own law firm. Under Massachusetts law, "the ‘reasonable royalty’ measure of damages is only appropriate where the defendant has made no actual profits and the plaintiff is unable to prove a specific loss." Curtiss-Wright Corp. v. Edel-Brown Tool & Die Co., 381 Mass. 1, 11 n.9 (1980), quoting Jet Spray Cooler, Inc. v. Crampton, 377 Mass. 159, 171 n.10 (1979) ("Jet Spray II ").

          Plaintiff seeks reconsideration of that ruling on the ground that the money earned by the Individual Defendants since leaving was treated as salaries and thus as expenses on the books of CMBG3, rather than as an allocation of profits, and that CMBG3’s income statements therefore show total net losses since 2016.

          The Court will DENY the motion for reconsideration because it improperly asks the Court to look at the reported profit or loss of CMBG3 in isolation, without considering whether Defendants as a whole have made money since leaving and starting their own law firm. The Court cannot ignore the economic realities of a law firm that is structured as a limited liability company and functions as a partnership.

          For the purposes of determining whether Defendants made actual profits during the relevant period, in order to apply Curtis-Wright and Jet Spray II, it cannot matter whether the earnings that CMBG3 passed through to its members (i.e., the Individual Defendants) was characterized on the law firm’s books as profits or salaries. Either way the Defendants earned money and their law firm was profitable over the relevant time period. Therefore, the Governo Firm may not seek a reasonable royalty as damages.

          Plaintiff argues that CMBG3 itself did not make any profits since the Individual Defendants left the Governo Firm. It points out that CMBG3’s own income statements show losses in some years and profits in others, and that the sum of those annual bottom lines shows that CMBG3 has incurred a total net loss of over $100,000 through March 31, 2019.

          The problem with this argument is that it ignores the very substantial salaries that the Individual Defendants have been paying themselves. The Governo Firm concedes in its motion for reconsideration that if CMBG3 had characterized the money it paid to the Individual Defendants as distributions of profit, rather than treated as salaries and thus expenses on the law firm’s books, then CMBG3 would have reported total net profits over the same period.

          Given the total amount of salaries CMBG3 paid out, and assuming that most of those amounts were distributed to the Individual Defendants rather than paid to employees, it appears that Defendants’ new firm has been quite profitable to date. That reality does not change merely because CMBG3 paid out its positive earnings to its members as salaries rather than as distributions of profit. Indeed, Plaintiff characterizes this as "an accounting issue."

          The Governo Firm has not shown that it makes any sense to consider the bottom lines of CMBG3’s income statements in isolation, and to ignore the salaries earned by the Individual Defendants, in calculating whether Defendants earned a profit since leaving the Governo Firm.

         The economic reality is that CMBG3, LLC cannot earn profits or suffer losses that are not shared with its members, i.e., the Individual Defendants. Under Massachusetts tax law, an LLC with two or more members is treated as a partnership unless the LLC elects to be taxed as a corporation. See 830 C.M.R. § 63.30.3, ¶3; G.L.c. 63, § 30, ¶16; G.L.c. 62, § 1(p); Pogorelc v. Commissioner of Revenue, Docket No C 328710, 2018 WL 5098822, at *3-*4 (Mass.App. Tax Bd. Oct. 4, 2018). This means that such an LLC is treated as a pass-through entity, no income is taxed at the corporate level, and all income, losses, deductions, and credits must be allocated to and treated as if realized directly by the LLC’s members. Id., ¶3(e); 830 C.M.R. § 62.5A.1, ¶(3)(b).1; G.L.c. 62, § § 1(p) & 17. Consistent with these tax rules, the new information submitted by Plaintiff shows that CMBG3 allocated and paid out its positive earnings to the Individual Defendants in the form of salaries.

          In sum, the Governo Firm has not shown that there is any reason for the Court to reconsider its prior ruling ...

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