CLM 2015 Professional Liability Conference Chicago, IL / June 4-5, 2015

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1 CLM 2015 Professional Liability Conference Chicago, IL / June 4-5, 2015 Don t Be the One Left Holding the Bag How to Avoid Being the Fall Guy When Business Relationships Go Sour Given the fall out from failed Big Business deals, Big Commercial Property Developments and following the recent 2007 Home Lending and Mortgage fiasco, potential investors and lenders are much more wary in making their investment decisions. Because of their concerns regarding the viability of these financial investments or projects, Professionals are being contacted to provide advice or render some professional assistance in the course of the investment process. Architects and Engineers are asked to consult over an existing or new project. Lawyers and Accountants are contacted for their guidance or opinions regarding a joint venture, business development or deal. Professionals in general might be called upon or enlisted to provide support or advise on financial investment opportunities that might have little relation to their actual expertise. Suddenly the deal goes south, the project is in Bankruptcy, the investment fails and the only one left holding any deep pocket is the professional s Error & Omission policy. Guess who is sued? Here is How the Trap Works Here is a list of Type of Scenarios that a Professional can find themselves caught in the litigation trap: A longtime, loyal client asks the Professional as a favor to look over a proposal or send a comfort letter to a lender vouching for the client s financial stability. The Professional writes the letter based on the client s say so and after the venture fails the lender sues the Professional. A Professional helps two buddies to resolve a business dispute informally and suddenly becomes the target of one or both of the (former) buddies. An existing client needs a loan from the Professional and either the Professional lends the client money by taking a higher cut of the potential pending case or takes as collateral some asset or stock options of the client s business raising ethical issues. A Professional provides non-professional services to clients either a business the Professional owns and refers the client to it or other recommended vendors. Does the Professional become a guarantor of those non-legal services?

2 Claims that might be raised in litigation: a. Negligent referral b. Lack of due diligence c. Negligent supervision d. Misrepresentation e. Breach of fiduciary duty Threshold Question: Is there Privity? Is There an Attorney-Client Relationship? A Professional often learns of a business opportunity from a former or current client? Common business transactions include loans to or from clients; a lawyer taking a financial interest in a client business venture in lieu of the lawyer s fee or a lawyer simply investing in a client s business project. The Professional-Client business transaction presents a myriad of troublesome issues. As attorneys and law firms struggle to survive in today's economy and face an ever-increasing encroachment on legal services from third parties, potentially their biggest challenge is just over the horizon--the growth of legal malpractice claims from third parties who are not clients. The traditional rule that an attorney owes a duty of care only to his or her client was once the bedrock defense available to attorneys in suits brought by third parties in both contract and tort actions. As courts look to provide recovery for the uncompensated third party, an erosion of the privity defense continues to gain ground. For franchise attorneys, the potential of lawsuits from disgruntled parties they do not represent is of growing concern. Richard C. Duell III, Erosion of Privity: The Extension of Legal Malpractice Claims to Nonclients, 31 Franchise L.J. 21 (2011) Jurisdictions Permitting Non-Client Legal Malpractice Claims There are many jurisdictions that allow third parties to bring legal malpractice claims where no attorney-[client relationship is formed. In these jurisdictions, the attorney may be liable to a third party where the third party was an intended beneficiary of the attorneys' services or where it was reasonably foreseeable that negligent service or advice to or on behalf of the client could cause harm to others. Waggoner v. Snow, Becker, Kroll, Klaris & Krauss, 991 F.2d 1501 (9th Cir. 1993). There are six considerations courts analyze to determine whether a duty arises absent privity of contract and not based upon the attorney-[client relationship. These considerations are (1) the extent to which the transaction was intended to affect the plaintiff; (2) the foreseeability of harm to the plaintiff; (3) the degree of certainty that the plaintiff suffered injury; (4) the closeness of the connection between the defendant's conduct and the injury; (5) the policy of preventing future harm; and (6) whether recognition of liability under the circumstances would impose an undue burden on the profession. Goldberg v.

3 Frye, 217 Cal. App. 3d 1258, 1268 (1990); France v. Podleski, 303 S.W.3d 615 (Mo. App. 2010); Grimes v. Saikley, 904 N.E.2d 183 (Ill. App. 2009); Chang v. Lederman, 172 Cal. App.4th 67 (2009); Donahue v. Shughart, Thomson & Kilroy, P.C., 900 S.W.2d 624 (Mo. 1995). An attorney's knowledge that third parties will be affected by the representation of the client is not in and of itself sufficient to create a duty of care to the third party. B.L.M. v. Sabo & Deitsch, 55 Cal. App. 4th 823 (1997). An essential predicate for establishing an attorney's duty of care under an intended beneficiary theory is that both the attorney and the client must intend for the third party to be a beneficiary of legal services that the attorney was to render. Id. The clear absence of mutual intent on the part of the lawyer and the client is critical to whether the third party can maintain a viable legal malpractice claim. An attorney's undertaking of a duty to the third party must be the result of a conscious decision. Zenith Ins. Co. v. O'Connor, 148 Cal. App. 4th 998 (2007); Donahue, 900 S.W.2d at 629 (the first factor a non-client must demonstrate includes a showing that it cannot be characterized as an incidental or indirect beneficiary). Jurisdictions Not Permitting Non-Client Legal Malpractice Claims Currently, only nine states continue to require contractual privity for plaintiffs alleging legal malpractice claims arising from wills and estates transactions.52 The modern state law trend is to recognize the existence of a duty beyond the confines of those in privity to the attorney-client contract. 53 Among states that have abrogated strict privity, two of the most commonly-invoked alternatives to strict privity are the California balancing approach54 and the Florida-Iowa rule.55 The California balancing test was first set out in 1958 in Biakanja v. Irving,56 a case that signaled the beginning of the end of the strict privity requirement. Three years after its decision in Biakanja, the California Supreme Court affirmed the balancing test in Lucas v. Hamm.62 The holding in Lucas has since been utilized by courts in other states, including Wisconsin, Hawaii, Minnesota, and Connecticut.63 Because it allows a plaintiff to make out a legal malpractice claim without demonstrating strict privity, states that have adopted this approach emphasize the attorney's action and the plaintiff's harm, rather than whether the plaintiff has pleaded facts suggesting the existence of a formal attorney-client relationship. Under the Florida-Iowa rule, the third-party plaintiff must show that their (1) interest in the estate is either lost, diminished, or unrealized and that (2) the testator's intent as expressed in the testamentary instruments is frustrated in whole or in part as (3) a direct result of the lawyer's professional negligence. 69 Thus, the relationship between the beneficiary and decedent, rather than the relationship between the beneficiary and the attorney, is key under this test. Again, courts using this approach neither preclude nor allow all third-party plaintiffs to state a claim, but conduct a fact-dependent inquiry. In addition to its use in Florida and Iowa, this intent-based approach has been adopted in other states, including New Hampshire, Illinois, and Oregon.70

4 There are several jurisdictions that require the existence of an attorney-[client relationship in order for an attorney to be liable for legal malpractice. In order to establish liability for professional negligence or legal malpractice, the plaintiff must show the existence of a duty owed to them by the attorney, a breach of that duty, and damages arising from the breach. Banc One Capital Partners Corporation v. Kneipper, 67 F.3d 1187 (5th Cir. 1995). Allen v. Steele 252 P.3d 476 (Colo. 2011). Under Texas law, there is no attorney-[client relationship absent a showing of privity of contract, and an attorney owes no professional duty to a third party or non-client. First National Bank of Durant v. Trans Terra Corporation International, 142 F.3d 802 (1998); Ryddle v. Morris, 675 S.E.2d 431 (S.C. 2009) (finding before a claim for malpractice may be asserted, there must exist an attorney-[client relationship.). Nonetheless, most of these jurisdictions find a narrow set of circumstances in which an attorney can be liable to a third party. These circumstances arise when the attorney has committed fraud or a malicious or tortious act, including negligent misrepresentation. Allen v. Steele 252 P.3d 476 (Colo. 2011); Scholler v. Scholler, 462 N.E.2d 158 (Oh. 1984) (a cause of action for legal malpractice exists only if the evidence shows either: (1) that the plaintiff is in privity with the client of the defendant attorney, or (2) that the defendant attorney acted maliciously). Absent these limitations, lawyers would be potentially liable to an unforeseeable and unlimited number of third parties. Id. Attorneys' liability is also limited due to the adversarial nature of litigation in which injury to a third person often is the direct, intended objective of the attorney's representation. Allen, at 482. Hess v. Fox Rothchild, LLP, 925 A.2d 798, 806 (Pa. Super. 2007) ( to maintain a claim of legal malpractice based on negligence, a plaintiff must show an attorney-[client or analogous professional relationship with the defendant- [attorney. ). LEGAL MALPRACTICE Can Lawyers Be Sued by Non-Clients? Daniel S. Strick and Jordan S. TafflinFor A legal malpractice action brought by a realtor against an attorney who unsuccessfully sought to enforce an option to purchase property is barred by collateral estoppel based on the prospective purchaser's prior unsuccessful legal malpractice suit. The developer then pursued a legal malpractice action against the first attorney, alleging mishandling of the action between the developer and the property owner. The suit sought damages for lost profits resulting from loss of the right to enforce the partnership's option to purchase and develop the property. The second attorney pursued this action but decided not to file a separate legal malpractice claim on behalf of the realtor because he believed a conflict of interest existed between the developer and the realtor, due to the limited assets available to redress the property owner's alleged misconduct. However, the attorney allegedly failed to promptly advise the realtor of this situation and failed to respond to the realtor's inquiries. The statute of limitations governing a legal malpractice action on behalf of the realtor expired. The developer's legal malpractice action against the second attorney eventually resulted in an appellate decision against the developer.

5 The realtor filed the instant action for legal malpractice against the second attorney, asserting that he lost his commission because of that attorney's negligence in failing to file a timely legal malpractice action against the first attorney. The case went to trial and resulted in a jury verdict and judgment against the second attorney. The second attorney appealed the legal malpractice judgment in favor of the realtor. The attorney argued that the realtor's suit was barred by the collateral estoppel doctrine because the same issues had been resolved in the attorney's favor in the legal malpractice action brought by the developer. The Court of Appeal reversed, holding that collateral estoppel barred the realtor's legal malpractice suit. In so ruling, the court observed that the two legal malpractice claims raised identical issues, and that the applicability of the collateral estoppel doctrine therefore depended upon whether the developer and the realtor were in privity. The court observed that the realtor's right to a commission was derivative of the developer's right to purchase the property, and that the developer and realtor shared a united interest in vigorously pursuing their claims. In addition, the realtor actively participated in the developer's pursuit of its claim. In the court's view, these considerations supported a finding that the two parties were in privity. Mooney v. Caspari, 138 Cal. App.4th 704, 41 Cal.Rptr.3d 728 (2006) Discuss types of issues that may be raised when a professional gets involved in business or investment transactions which ultimately break down, for example: a. Coverage issues: i. Is there a retainer agreement? ii. Is the involvement outside the scope of professional services? b. Ethical issues: i. Rules of professional conduct for professionals relating to entering business transaction with clients c. Conflict issues: i. Does the investment or business transaction engaged in by the professional raise a conflict with the professional s work? Is the professional personally investing in an entity which is an adverse party in a client s litigation?