"UNDERLYING WORK"
PROBLEM
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A partner in a law firm (Partner A)
represents a client in the purchase of heavy equipment. Partner A
drafted the key sales documents. A year later, the client and the
seller have a disagreement over the seller's obligations if the equipment
fails to perform certain tasks. In the meantime, Partner A has
retired. The client comes to another partner in the law firm
(Partner B) to seek assistance in resolving the dispute. If the
parties cannot agree, they must, pursuant to one of the documents, submit to
binding arbitration. Partner B retrieves Partner A's files on the
purchase and reviews the documents. A key provision in one of the
documents that might greatly affect the result seems ambiguous.
Partner B gets several "second opinions" from other lawyers in
the firm. Partner B concludes that the provision is indeed ambiguous
and that other lawyers in the firm have routinely been using another
version of that provision that is much more clear.
Should the firm take the
case? The glib answer is that it depends. On a more serious
note, the issue of whether a law firm can handle a dispute when it might
involve its earlier work has become seriously troubling. Law firms
used to do this all the time. The problem is that conflicts of
interest have become so prominent and dangerous in malpractice
cases. If the law firm were to take the case, and the result is a
bad one, the client will go to another law firm for an evaluation.
That law firm may
very well come up with a three-part analysis that will be very difficult
to counter.
"They
made the wrong arguments." First,
the new law firm may conclude that one of the reasons the original law
firm lost the case is that it made the wrong arguments – that it avoided
arguments that were apt to focus on its conduct in handling the underlying
transaction.
"Did
they discuss the credibility issue with you?" Second,
the new law firm will point out that the original firm surely knew that it
would have to call at least one of the transactional lawyers in the firm
as a witness. Although most
states’ versions of Model Rule 3.7 allow a lawyer to try a case even
though his partner will be a witness, doing so could create credibility
issues with the trier of fact. The
new law firm may not be kind in its analysis of the credibility point.
"You
mean they did not discuss settlement with you at all?" Last,
is the question of settlement. The
new law firm may conclude that the original firm did not press settlement
as it should have. Part of
the reasoning may very well be that the original law firm knew that
because of its handling of the underlying transaction, it would have to be
a third party at the settlement table.
Because it did not want to focus on its own involvement and
potential liability, it avoided settlement.
In effect, it deprived its client of an opportunity to settle the
case on terms much more favorable than the resulting verdict.
We are
aware of several situations where the plaintiff’s lawyer in
the resulting malpractice case made precisely these arguments, and the
original law firm and its carrier(s) settled the case, rather than risk an
adverse verdict or award.
A case
confronting these very principles is Eurocom, S.A. v. Mahoney, Cohen &
Co., 522 F. Supp. 1179 (S.D.N.Y. 1981). Large
Firm attempted to represent a plaintiff in a case arising out
of a transaction it had handled. The defendant moved to add Large
Firm as a third-party defendant or, in the alternative, to disqualify
Large Firm as counsel for plaintiff in the case. The court
granted the motion to disqualify for the reasons discussed above.
The court briefly discussed the lawyer-as-witness rule, but minimized its
effect, because the lawyers who would have been witnesses were either dead
or gone. Taking a broader view, however, the court said:
A potential conflict arises between Cleary, Gottlieb and
its own client. Under Hercules [Chemical Co., Inc. v. North Star
Reinsurance Corp., 72 A.D.2d 538, 421 N.Y.S.2d 67 (1st Dept. 1979)],
plaintiff's recovery is subject to possible diminution by Cleary, Gottlieb
fault (assumed arguendo for the sake of this discussion only).
n1 If the jury reached such a conclusion, Cleary, Gottlieb would
presumably face a malpractice action, brought by its own client. In these
circumstances, Cleary, Gottlieb has its own interest in minimizing its
role during the underlying commercial transaction, and maximizing that of
the plaintiff's own representatives, so that any factors tending to reduce
plaintiff's recovery would not be laid at the door of Cleary, Gottlieb.
Secondly, the theory defendant asserts against Cleary, Gottlieb constitutes an inevitable complicating factor in settlement discussions.
The possibility of settlement is always encouraged by the Court; but the
parties are entitled to advice on that subject from counsel who are
entirely uninhibited by any personal involvement of their own in the
merits.
Eurocom
was a disqualification case. Yet, it would not take much effort for
a plaintiff's lawyer, in the appropriate case, to transform the same
reasoning into a breach of fiduciary duty claim for damages.
Another
Disqualification Case. Jamieson v. Slater, 2006 U.S. Dist. LEXIS 86712 (D. Ariz. Nov. 27,
2006). Lawyer represented
Husband No. 2 in dissolution action against Wife.
During the dissolution proceeding Lawyer filed lis
pendens against Wife’s real estate.
The dissolution court, finding that Husband No. 2 had no claim to
Wife’s real estate, ordered the lis
pendens released. Lawyer
also filed a quiet title action against Wife’s real estate on behalf of
Husband No. 1. As a result of
this meddling with Wife’s title, Wife filed this action against Husbands
1 and 2 and against Lawyer. Lawyer
appeared for himself and Husbands 1 and 2.
Wife, claiming Lawyer had a conflict, moved to disqualify Lawyer.
In this opinion the court granted the motion. As to Wife’s standing, the court held that given the
seriousness of the conflict, Wife did not need standing (analysis of
standing not that clear). As
to the conflict, the court identified various ways Lawyer’s conflicts
could adversely impact not only Wife but also Husbands 1 and 2.
In discussing Lawyer’s underlying work problem, the court said:
In the present case, the interests of [Husband No.
1] and [Husband No. 2] conflict with the interests
of [Lawyer] because the actions of [Lawyer] while he represented
[Husband No. 2] and [Husband No. 1] in lawsuits against [Wife] is the primary
wrongdoing for which [Wife] seeks to recover damages.
Because [Lawyer] is a named co-defendant in the present case,
there is a significant risk that his ability to consider, recommend, and
carry out an appropriate course of action on behalf of [Husband No. 2]
and [Husband No. 1] will be materially limited as a result of his
exposure to personal liability (bold and italics, the court’s).
Crews v. County of Nassau, 2007 U.S. Dist. LEXIS 6572 (E.D.N.Y. Jan.
30, 2007). This is a civil
rights case arising out of the criminal prosecution of one of the
plaintiffs (“Plaintiff”). Lawyer,
who is representing Plaintiff in this case, also defended Plaintiff in the
criminal case. The defendants
moved to disqualify Lawyer because he would be a witness in this case, but
also because he would have a conflict of interest arising out of his work
on the criminal case. In this
opinion the court granted the motion on both grounds.
As to the latter ground, the court said in part:
If, as defendants
argue, [Lawyer] erred in his representation of [Plaintiff] in state
court, [Lawyer] would have a significant incentive to tailor his
representation of plaintiffs in this case so as to avoid revealing or
belaboring his alleged errors.
Liability
Cases. In Veras Investment
Partners, LLC v. Akin Gump Strauss Hauer & Feld LLP, 2007 N.Y.
Misc. LEXIS 6543 (N.Y. Misc. Sept. 27, 2007), the law firm had advised a
client on securities trading strategies. It later represented the
client in investigations by the SEC and others into those very trading
strategies. In this opinion the court denied a motion to dismiss
parts of a complaint dealing with this alleged conflict. Brodie
v. U.S. Dep’t of Justice, 2007 U.S. Dist. LEXIS 75191 (E.D. Pa. Oct.
4, 2007), appears to be another case where a law firm got sued after
attempting to represent in a criminal proceeding, which involved advice
the firm had given to the client before the criminal proceeding.
Given the nature of the proceeding, the malpractice claim was not clearly
described.
What should a firm
being asked to handle the "underlying matter" do? Where no
reasonable person could argue that the firm's underlying transactional
work had anything at all to do with the dispute or how it is
resolved, perhaps the firm simply proceeds. Where there is
some doubt, perhaps the firm explains the situation to the client and asks
for the client's consent to proceed. The next level of protection is
to require the client to seek other counsel on the issue of whether the
firm should stay in the matter. Some situations could be so serious
that the firm should not proceed under any circumstances.
Special Note on Bond Practice
The Internal
Revenue Service has been aggressively auditing tax-exempt transactions.
Typically the IRS goes to the issuer for information. If the IRS
believes the bond issue in question should be taxable, it will first
negotiate with the issuer to see if the issuer will pay the resulting tax,
rather than the bondholders. Such a resolution is called a "closing
agreement." This process usually results in the issuer
bringing pressure on other participants in the transaction to contribute
to the settlement. Frequently, the issuer or other participant will
seek help from the law firm that represented it in the original
transaction. As often as not, this will be "bond counsel;" that is
the law firm that issued the opinion on state law and federal income tax
issues.
Should that law
firm get involved in the audit? Again, it depends. Certainly,
if the IRS is going after the structure of the transaction, and the law
firm in question was largely responsible for that structure, the law firm
may simply decline. At the other end of the spectrum, the IRS
concerns may involve the conduct of one or more participants long after
the law firm concluded its work. There, the law firm's prior work
may simply not be an issue. In between those two situations, the law
firm will have to do a careful analysis.
The law firm
may recommend that the client get independent advice on the conflict
issues. Or, the law firm may recommend that the client hire another
law firm to be co-counsel and protect the client on conflict issues.
A very important part of any analysis is the issue of whether the law firm
should contribute to the settlement. One could argue that the law
firm is in no position to provide the required objectivity on that issue.
The good news
is that bond lawyers are becoming increasingly sensitive to these issues.
The bad news is that IRS officials continue to observe law firms that are
up to their necks in exposure continue to represent their clients in
audits with no apparent independent supervision. It is now at the
point that the IRS requires law firms in this position to obtain conflict
waivers from their clients before the IRS will deal with the firm.
For an example
of how not to handle an "underlying work" situation, read on.
Brown & Sturm's Sturm und Drang
This is a chilling reminder of what can happen to a lawyer who uses poor
judgment in handling a dispute that arises out of that lawyer's earlier
work. A lawyer ("Brown") and his firm ("Brown &
Sturm") represented an elderly couple ("the Kings") who
owned farmland. The Kings' accountant flagged the fact that if they
died owning the property, the estate taxes could be substantial.
Brown advised that if the Kings would sell the property to their children,
much of the tax could be avoided. Brown further advised that the
selling price should be based on an appraisal of the land as "farm
use only." The ultimate price, $600,000, was based upon such an
appraisal.
The Kings also sought the
advice of a partner at Piper & Marbury ("Wolf"). But,
Wolf told the Kings that the plan to sell the property was badly
flawed. He did not mince words. He said in a letter:
[T]he federal gift and estate taxes . . . insist not only upon
"fair market value" at the very highest and best use, but also
require full disclosure with regard to any transfer either by gift or
death, with very substantial monetary penalties for not making full
disclosure, including the possibility of fraud penalties and possibly
even criminal prosecution in what the Internal Revenue Service might
consider an extreme case.
Brown told the Kings that he
disagreed with Wolf, the Kings discharged Wolf, and in 1982 they sold the
property to their children for $600,000. The Kings passed away a few
years later. The IRS looked into the sale and ultimately presented
the children with a tax bill of $60 million (not a misprint), half of that
being penalties.
The Kings' children,
represented by Brown, appealed to the Tax Court. Brown predicted
that the assessment would not stand up. But, while that case was
pending, Brown learned that the IRS had a copy of Wolf's letter.
Brown then told the children that they had better settle with the IRS,
which they did for $20,000,000. They did not have that much money,
property values went down, and the family entity holding the property went
into Chapter 11.
This situation has spawned
at least three lawsuits, in addition to the Chapter 11 proceeding. Brown
& Sturm v. Frederick Rd., 768 A.2d 62 (Md. App. March 5, 2001) concerns Brown's attempt to
collect a $4.8 million fee from the children. The court affirmed a
trial court finding that Brown should not get the fee.
The second lawsuit: after
the $20 million settlement with the IRS, Brown encouraged the children to
sue Wolf and Piper & Marbury, which they did in Montgomery County,
Maryland. In October 1992 that court entered summary judgment
against the children. In the course of its ruling, the court
suggested that the real problem was Brown's bad advice regarding the sale
of the property. The appellate court affirmed in an unreported
opinion.
The third lawsuit is the
children's suit against Brown and Brown & Sturm. They filed the
suit after learning of the judge's remarks about Brown's work in granting
Piper & Marbury's summary judgment. This being long after the
sale of the property and the adverse developments in the Tax Court, Brown
claimed that the suit should be barred by the Statute of Limitations and
laches. The trial court and appellate court agreed. The
Maryland Supreme Court reversed, Frederick Road Ltd. Partnership v.
Brown & Sturm, 756 A.2d 963 (Md. 2000) . According to the
opinion in the fee case, the malpractice case against Brown, as of March
5, 2001, was pending in Montgomery County Circuit Court,
Both reported opinions are
riddled with suggestions that the law firm should not have handled the Tax
Court proceeding. For example, in the fee case, the court said in a
footnote:
n14 Appellees point out that Brown & Strum never considered
employing what might have been its strongest defense against the fraud
claim before the Tax Court: that the Kings had relied upon erroneous
professional advice by Bonsall (Kings' accountant). Such a defense might
have required appellants (Brown & Sturm) to testify before the Tax
Court, which would have created a conflict in their representation under
the Maryland Lawyers' Rules of Professional Conduct and forced them to
withdraw. See Md. R. Prof. Conduct 3.7 (precluding a lawyer
from acting as an advocate in a trial during which he is likely to be a
witness).
Both opinions also contain
suggestions that the law firm should have advised the family to consider
whether they should make a claim against the firm for its questionable
advice about the sale of the property.
Another Prominent Lawyer Badly Burned
NC Illinois
Trust Co. v. First Illini Bancorp, 752 N.E.2d 1167 (Ill. App.
2001). Bank A was trustee of a trust that owned a half interest in a
company. Rudman owned the other half of the company. Bank A and Rudman
sought to sell the
company to Sexton. Rudman was designated "point man" to handle the sale.
As part of the deal Rudman made representations about the financial
condition of the company. A beneficiary of the trust warned Bank A that
Rudman's financial representations were false and objected to Bank A's
proceeding with the sale. Bank A was also aware that more than ten
years prior to the sale Rudman had been convicted of a fraud involving
tobacco taxes.
Bank A sought the advice of a
prominent Galesburg, Illinois lawyer, Burrell Barash. Barash advised Bank
A to proceed with the sale. After the sale Sexton claimed he had been
defrauded because the financial representations were false. Sexton sued
Bank A and Rudman in federal court. Notwithstanding that he had advised
Bank A on the sale, Barash undertook to defend both Bank A and Rudman in
the federal court case, which arose out of the sale! One of the
beneficiaries objected to Barash representing both Bank A and Rudman,
claiming that Bank A should be seeking indemnification from Rudman. Barash
responded that the parties should present a united front in the trial. As
an alternative, Barash suggested that Rudman agree that Bank A could
proceed against him later. Rudman did so, agreeing in part that the
statute of limitations on Bank A's indemnification would be tolled. Barash
proceeded to represent both Bank A and Rudman in the federal case, and the
jury returned a verdict against them on liability. The parties then settled
with the defendants paying Sexton $375,000 in damages. Bank A paid its
part out of the trust estate. Bank A also paid Barash's fees out of the
estate.
Bank B became successor trustee of
the estate and sued Bank A for damages arising out of the all the above.
The jury returned a verdict against Bank A for the estate's loss as well as
punitive damages exceeding $1,000,000. This opinion affirms most of
what the jury did including the punitive damages award. In the opinion the
court notes that Bank B has also sued the decedent's estate of Burrell
Barash.
The significance of this case is that
Barash first advised Bank A to proceed with the sale of the business in
the face of claims that Rudman was committing fraud. Then Barash attempted
to represent Bank A and Rudman in the federal court case. To make
matters worse, this opinion notes that because of the way the
settlement of the federal court case was structured, Bank A lost its right
to sue Rudman for indemnity. The opinion is bereft of details as to
why Barash did what he did, but one must wonder how objective he could
have been agreeing to defend the case - and defend two parties with
divergent interests, at that.
Other Cases
We are
not aware
of any other opinions that address this issue directly as those above. However,
Streber
v. Hunter, 221 F.3d 701 (5th Cir. 2000) is very
close to being such a case and also involves tax advice and an IRS
proceeding. The lawyer had given tax advice to two
sisters. The IRS assessed the sisters back taxes and
penalties. The sisters challenged the assessment in court, and the same lawyer
represented them in that proceeding.
It turned out badly for the sisters. They
sued the lawyer, his firm, and others in the firm, for malpractice.
The claim included the allegedly bad advice the firm gave the sisters
initially and the allegedly bad advice the firm gave the sisters about the
litigation. The court did not state specifically that handling both
matters created a conflict of interest; however the court could not have
been impressed favorably by that conduct, either. One of the sisters
settled before the appeal. The Fifth Circuit affirmed the verdict
for the other sister and against the lawyer, the firm, and others, for
$839,000.
A case that
contains an element of the underlying work problem is Chang v. Chang,
597 N.Y.S.2d 692 (N.Y. App.
1993). The court was concerned about the fact that the lawyer was
handling a case in which he would have to testify about his underlying
work. The case was also complicated by the fact that the lawyer was
a defendant in the case along with his clients. Nevertheless, the
court's concern about the lawyer's underlying work is apparent from the
following:
As a defendant himself, Mr. Cartelli (the lawyer) was in a
hopelessly compromised position. He had represented the corporation in all
the complained-of transactions. He was exposed to the possibility of a
finding of professional malpractice or being part of a scheme to defraud.
A finding against his own clients, the Changs, even as to the fifth cause
of action, might well exonerate him of all liability.
Sammis v. Brobeck, Phleger & Harrison, 2002 Cal. App. Unpub.
LEXIS 1896 (Cal. App. June 4, 2002).
This appeal is from a summary judgment for Brobeck in a malpractice
suit brought by its former client, Sammis.
The case is in its early stages, so not much significance can be
assigned to the opinion, which, among other things, was ordered not to be
published. However, the
following language did appear:
Additionally, Sammis alleged that Brobeck urged him to settle
with Lorenz to hide Brobeck's own conflict of interest, arising from its
malpractice in the Saiga transaction.
Main Events Productions, LLC v. Lacy, 220 F. Supp. 2d 353 (D.N.J. 2002). Patrick English represented Main Events in negotiating and
drafting a promotion agreement with Jeff Lacy, a boxer.
This case concerns the agreement drafted by English.
For that reason, Lacy has moved to disqualify English as Main
Events’ lawyer. One of the bases for the motion was that English might be a
witness. The court brushed
that aside, noting that another lawyer would try the case.
Lacy also contended that English’s role in drafting the
agreement in question creates a “personal interest” and would cause
him to justify his conduct in ways not necessarily in the interests of
his client. The court
simply disagreed saying, in effect, that the concern was speculative.
The court did not say as much, but it could not have hurt that
English had brought in another lawyer to try the case.
Further, while the court did not discuss Lacy’s standing the
make the motion, one wonders whether Lacy's not being the
"victim" of the alleged conflict might have influenced the
court.
Dahlin v. Jenner & Block, L.L.C., 2002 U.S. Dist. LEXIS 23973 (N.D. Ill. December 12, 2002).
Malpractice case against Jenner & Block.
Because it is only the denial of Jenner’s motion for summary
judgment, it would not be useful to present the facts in detail.
Essentially, Jenner is accused of botching a commercial lease for
a landlord/client. After
allegedly misdrafting the lease, Jenner continued to advise the
landlord. One of the
allegations is that this subsequent advice was not in the landlord’s
best interests because Jenner was driven by it concern over the lease
allegation.
Hetos
Investments, Ltd. v. Kurtin,
1 Cal. Rptr. 3d 472 (Cal. App. 2003).
Gray Cary prepared a promissory note on behalf of the borrower. Later, the firm filed an action for the borrower against the
lender, alleging, among other things, that the note was usurious.
The lender moved to disqualify Gray Cary because the firm was
attacking the validity of the note that it prepared.
The trial court denied the motion, and the appellate court
affirmed. The court
considered the applicability of California Rule 3-210 (not applicable
because only clients are protected by it), ABA Model Rule 1.16(a) (ABA
Model Rules have no force in California), and the “appearance of
impropriety” test under old ABA Canon 9 (recognized by some California
courts, but not applicable here). The
court noted that if anyone were to be harmed by the alleged conflict it
would be Gray Carey’s client, the borrower, not the movant, the
lender. At bottom, the
court felt that no harm would come to anyone by Gray Carey’s remaining
in the case.
Firm Avoided Problem Where "Sophisticated Client" Made the
Questionable Decision in the Subsequent Litigation. Town
of North Hempstead v. Winston & Strawn, LLP, 814 N.Y.S.2d 237 (N.Y. App.
2006).
Winston & Strawn (“W&S”) represented North Hempstead
in entering into a waste disposal agreement.
When the waste disposal project did not go well, one of the
parties sued North Hempstead. W&S
handled the defense, but the plaintiff recovered a jury verdict of some
$32 million. North
Hempstead then sued W&S for malpractice in its handling of the
litigation. One of the
grounds was that W&S did not assert an available affirmative
defense. North Hempstead
claimed that W&S did not assert the defense because it had a
conflict arising out of the way it handled the underlying transaction.
The trial court denied W&S’ motion for summary judgment.
In this opinion the Appellate Division reversed.
As to W&S’ failure to assert the affirmative defense, the
court emphasized that it was the decision of the Town Attorney (“a
sophisticated client”) not to assert the affirmative defense.
Moreover, the court said, the defense was not a sure thing, and
W&S could not be held liable for exercising “professional judgment
on a question that was not elementary or conclusively settled by
authority.” [Note:
several of the facts recited above were not in the opinion, but surfaced
in press reports regarding the unpublished trial court’s opinion.]
Patent Litigation. Breckenridge
Pharm., Inc. v. Metabolite Labs., Inc., 2007 U.S. Dist. LEXIS 7775
(S.D. Fla. Feb. 2, 2007); and
Landmark
Graphics Corp. v. Seismic Micro Tech., Inc., 2007 U.S. Dist. LEXIS
6897 (S.D. Tex. Jan. 31, 2007). In
both cases law firms litigating over patents they had prosecuted. The courts did
not treat them as "underlying work" problems, but rather as lawyer-as-witness
problems.
Duty
of
Disclosure to Client where Lawyer Aware of Mistake.
In re Hoffman,
700 N.E.2d 1138 (Ind. 1998); Circle
Chevrolet Co. v. Giordano, Halleran & Ciesla, 662 A.2d 509 (N.J.
1995); Olds v. Donnelly, 696 A.2d 633 (N.J. 1997);
Shumsky v. Eisenstein, 726
N.Y.S.2d 365 (N.Y. 2001);
In re
Tallon, 447
N.Y.S.2d 50 (N.Y. App. Div. 1982); ABA Informal Op. 1010 (1967); Col. Op. 113 (Nov.
2005) (excellent research tool);
N.J.
Op. 684 (1998); N.Y. Op. 734 (2000); N.Y. City Op. 1995-2 (1995); Restatement § 20, cmt. c; and 2 Mallen & Smith,
Legal Malpractice §14.22 (2007).
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