Leonard v. Dorsey & Whitney LLP, 2009 WL 88855, __F.3d__(8th Cir. 2009)
Brief Summary
The Bank that purchased a participation interest in a loan from an investment bank lacked standing to sue the investment bank’s law firm as either a direct client or a third party beneficiary.
The law firm also did not have a duty to disclose to its investment bank client: (1) that it had a conflict of interest in representing the investment bank in a lawsuit brought by a bank participant against the investment bank; and (2) its potential legal malpractice to the investment bank in subsequent litigation on behalf of the investment bank because this potential could not reasonably have been expected to prejudice the law firm’s continued representation of the investment bank.
Complete Summary
In 1999, law firm Dorsey & Whitney, LLP (“Dorsey”) represented investment bank Miller & Schroeder, Inc. (“M&S”) in connection with two loans to a casino development company intended to partially finance the development of a Native American casino. M&S participated out 100 percent of the two loans to a number of banks under the terms of a participation agreement. One of the banks, Bremer Business Finance Corporation (“Bremer”), purchased a 57 percent participation interest in one of the two loans, and more than 30 other banks purchased the remaining participation interests. Prior to the closing of the two loans, Dorsey advised M&S that approval from the National Indian Gaming Commission (“NIGC”) was not required for the two loans.
In 2000, the borrower defaulted on the two loans. Dorsey filed a lawsuit on behalf of M&S against the borrower and obtained a judgment in M&S's favor for the full amount of the two loans, plus interest. Shortly after Dorsey filed suit against the borrower, Bremer sued M&S in Minnesota state court, alleging that M&S had fraudulent induced Bremer into purchasing its participation interest by representing that NIGC approval had been obtained prior to loan closing. Dorsey represented M&S in the lawsuit brought by Bremer. Bremer's lawsuit was stayed when M&S filed for Chapter 7 bankruptcy protection.
As part of M&S's bankruptcy, the bankruptcy trustee brought two breach of fiduciary duty claims against Dorsey: one for failing to disclose to M&S a conflict of interest in the litigation between M&S and Bremer, on the grounds that Dorsey was simultaneously M&S's lawyer and Bremer's lawyer in the lawsuit against the borrower; and another for failing to disclose to M&S the possible commission of malpractice by Dorsey in advising that NIGC approval was not required for the two loans. Bremer then filed an adversary complaint against Dorsey in bankruptcy, asserting a direct legal malpractice claim against Dorsey.
With respect to Bremer's claims, the bankruptcy court issued a report and recommendation containing proposed findings of fact and conclusions of law in which it concluded that Bremer had standing to sue Dorsey as a direct client or, alternatively, as a third party beneficiary. The bankruptcy court held that Dorsey had committed malpractice by not advising M&S to delay closing of the two loans without NIGC approval. With respect to the bankruptcy trustee's breach of fiduciary duty claims, the bankruptcy court issued a final order and judgment, holding that Dorsey had breached its fiduciary duties to M&S by failing to advise M&S of the potential conflict and of the potential malpractice claim.
The district court presided over the bankruptcy court's report and recommendation regarding Bremer's claims, and held that Bremer did not become Dorsey’s client until Dorsey initiated litigation against the borrower. As a result, the district court determined that Bremer could not recover its participation interest from Dorsey. Nevertheless, the court still found that because Dorsey represented Bremer in the lawsuit against the borrower, Dorsey was required to disclose its potential malpractice to Bremer. The district court reasoned that, had Bremer known of this possibility, it would have sued Dorsey instead of suing the essentially “judgment proof” borrower. Id. at *7. The district court entered judgment for Bremer and reduced its damage award to $409,000, which represented the amount of legal fees Bremer incurred in pursuing its fraud claims against M&S.
The district court presided over Dorsey's appeal of the bankruptcy court's judgment for the trustee. The district court affirmed the bankruptcy court's judgment that Dorsey had breached its fiduciary duties to M&S.
Dorsey then appealed the district court’s judgment to the Eighth Circuit. Between the time of the district court’s decision and oral arguments in the Eighth Circuit, the Minnesota Supreme Court ruled on a case involving substantially the same facts and legal issues pertaining to the participant banks' standing to assert a legal malpractice claim against Dorsey. See Hinshaw & Culbertson, Lawyers for the Profession Alert, Minnesota Supreme Court Clarifies Standards for Potential Lawyer Liability to Non-Clients, (Apr. 8, 2008). The state court case was a parallel proceeding based on the same loan transaction; but involving claims against Dorsey by the other bank participants other than Bremer. In the Minnesota Supreme Court decision, Dorsey was absolved of any liability with respect to claims asserted against it by the bank participants on the grounds that the bank participants lacked standing to sue Dorsey for legal malpractice because they were neither direct clients of Dorsey nor direct and intended third-party beneficiaries of Dorsey's representation of M&S in the loan transaction.
With respect to the district court's decision on Bremer's claim against Dorsey, the Eighth Circuit reversed the district court because it felt bound to apply the Minnesota Supreme Court’s rule of decision. The latter court was faced not with the issue of a direct attorney-client relationship, but with the issue of whether the bank participants had standing to sue Dorsey as third party beneficiaries. The state supreme court noted that a lawyer can only be liable to a third party that is a “direct and intended beneficiary of the lawyer’s services.” Id. at *13. That court held the lenders were not direct and intended beneficiaries because the standard form participation agreement between M&S and the bank participants evidenced an arms-length transaction. Specifically, the participation agreement called for the bank participants to independently evaluate the loans and it defined the relationship between M&S and the bank participants as that of “a seller and purchaser of a property interest.” Id. at *16.
The Eighth Circuit also found the district court’s theory of causation regarding the $409,000 in damages awarded to Bremer was illogical because the misconduct upon which the district court based its malpractice finding occurred before the date—according to the district court—that Bremer had standing to sue for malpractice.
The Eighth Circuit reversed the district court's decision on the trustee’s breach of fiduciary duty claims. First, the Eighth Circuit held that there was no conflict in Dorsey's representation of M&S in the lawsuit against the borrower because Bremer was never Dorsey’s client or a third party beneficiary of Dorsey's representation of M&S. As such, Dorsey did not breach any fiduciary duty to M&S because no conflict existed.
Second, the Eighth Circuit held that Dorsey had no obligation to disclose to M&S its potential malpractice. The Eighth Circuit looked primarily to the treatise “Legal Malpractice” by Ronald E. Mallen & Jeffrey M. Smith (2008 ed.), and the Restatement (Third), of “The Law Governing Lawyers” (2000). The court noted the bankruptcy court relied too heavily on the Minnesota Rules of Professional Conduct and that a violation of an ethical rule “does not give rise to a cause of action against the lawyer and does not give rise to a presumption that a legal duty has been breached.” Leonard at *18. The court also held that“[d]isclosure must be made if the failure to do so could reasonably be expected to prejudice the client’s continued representation.”
The court further held that a claim for legal malpractice based on negligent legal advice does not arise until the client suffers damages as a result. Because “Dorsey’s work on the [casino development company] litigation was part of its legitimate efforts to prevent its possible error in judgment from harming M&S[,] there was not a substantial risk that Dorsey’s interests were adverse to those of M&S.” Leonard at *19.
Significance of Opinion
This opinion joins a long line of cases involving law firm liability to third parties. Also of note is the line the court draws between ethical violations and breaches of fiduciary duty.
This alert has been prepared by Hinshaw & Culbertson LLP to provide information on recent legal developments of interest to our readers. It is not intended to provide legal advice for a specific situation or to create an attorney-client relationship.
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