AmBase v. Davis Polk & Wardwell, ___N.E.2d___, 2007 WL 1213706 (App.Ct. N.Y. 2007)

Brief Summary
The court in this case affirmed the dismissal of a legal malpractice case against the defendant law firm and held that, based on the signed retainer, the engagement was limited to negotiating a settlement with the IRS for a disputed withholding tax and that a money judgment for the defendant’s fees was appropriate.

Complete Summary
The AmBase Corporation (“AmBase”) became an independent entity in 1985 when its parent company, City Investing Company (“City Investing”), liquidated. Subsequently, the IRS determined City Investing was liable for failing to withhold 30 percent of interest payments to a related entity for six years. AmBase was advised that it was liable as City Investing Finance N.V.’s agent for withholding taxes as part of a prior agreement (“Agreement”) with City Investing when substantial assets were transferred to AmBase by City Investing Company Liquidating Trust. In 1995, the IRS determined that there was a deficiency of $20,986,609 for the tax years 1979 through 1985.

When AmBase was unable to successfully resolve the dispute, it retained Davis Polk & Wardwell (“Davis Polk”). The case was successfully litigated in May 2001 and the Tax Court found in favor of AmBase. Id. at *1.

Problems developed, however, when AmBase refused to pay outstanding legal fees of $1,424,104 to Davis Polk and requested a refund of previously paid fees. Under the retainer agreement, if Davis Polk was successful in resolving the tax matter with the IRS, AmBase would pay Davis Polk a “success fee” calculated at 150 percent of Davis Polk’s billed time, subject to a $2 million cap. Id. at *1.

AmBase then filed a suit for legal malpractice against Davis Polk claiming that the firm failed to advise AmBase that it was only secondarily liable for payment of the taxes under the Agreement with City Investing. The lower court rejected AmBase’s arguments; granted the Davis Polk motion to dismiss; and awarded the firm a money judgment of $1,424,104 for outstanding fees and interest. Id. at *2. The appellate court affirmed and this appeal followed.

On this appeal, the court noted that the issue was whether a legal malpractice lies under the circumstances of this case. The court noted “the gravamen of this legal malpractice claim is that defendants failed to advise plaintiff that the Agreement allegedly provided that AmBase was not primarily liable for the subject taxes in the underlying Tax Court proceeding that primarily rested with City Trust. Plaintiff claims that defendants were provided with a copy of the Agreement but never fully reviewed the document to determine what effect, if any, it had on the underlying dispute…” Id. at *2. AmBase claimed that “but for” the negligence, it would not have had to keep a multimillion-dollar loss reserve on its books, which created the appearance of a negative net worth and led to lost business opportunities. Id. at *2.

Davis Polk disputed that AmBase was only secondarily liable and also took the position that, under the retainer, they were only to litigate whether the taxes were due, not who was responsible for them. The retainer agreement stated that AmBase had “engaged [Davis Polk] to represent [it] as agent for City Investing to resolve the tax issues currently before” the IRS. The court concluded that the plain language of the retainer was that Davis Polk was retained to litigate the amount of the tax liability and not whether it should be allocated to some other entity. The malpractice issue must then focus on whether Davis Polk exercised reasonable skill in handling the dispute between AmBase and the IRS, which resulted in “a most favorable outcome that was publicly praised by AmBase principals.” Id. at *3 citing Darby & Darby, P.C. v. VSI Intl., 95 N.Y.2d 308,313 (2000). The court also noted that for seven years before Davis Polk was retained in the case, both AmBase and the IRS took the position that AmBase was responsible for the total tax obligations. Id. at *3. The court found that the assertion by AmBase that it had erroneously interpreted the Agreement was speculative since no such interpretation had been given to any prior court or arbitrator.

Finally, there was nothing in the record to support the “but for” causation argument that Davis Polk’s failure to advise that AmBase may not have been primarily liable for the taxes led to the reserve and loss of business opportunities, especially since the loss reserve had been present for years before Davis Polk was retained. After Davis Polk reviewed the case, it had advised the AmBase accountants that they had a very strong case and most likely no liability for the taxes. Id. at *3.

The court also addressed whether the award of a money judgment to defendants when there was no recovery proceeding for one, violated the procedural due process rights of the plaintiff. The court held that “having failed to challenge the amount of the legal fees in its complaint or at any time throughout the proceedings that followed, and also having failed to challenge the procedure leading to the entry of judgment against it -- including correcting the Supreme Court’s mistaken impression that a counterclaim had been filed -- AmBase is now precluded from doing so.” Id. at *4. The dismissal and award of attorney fees was affirmed.

Significance of Case
The success of the Davis Polk firm in this case hinged upon the carefully worded description of the services to be provided in the retainer agreement. Other firms would be well advised to take similar precautions to avoid the “buyer’s remorse” that AmBase experienced and its attempt to avoid paying a significant fee to its defense lawyers who successfully litigated the case.

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