The Risk Manager, Spring 2017
What is a Lawyer’s Obligation to Provide Business Advice?
A panel at the 2016 Legal Malpractice Risk Management (LMRM) Conference discussed the increasing risk of transaction malpractice claims. The panelists pointed out that transactional practice generates the highest percentage of incurred losses compared to reported claims (4% of claims, 8-9% of losses). Additionally, transactional claims typically result in double the payments of other practice areas. Cost of defense is more than double other practice areas (complexity, documentation, multiple parties, multiple experts). Failure to provide appropriate advice constitutes almost 25% of claims and 30% of losses.
The panel used the case of Peterson v. Katten Muchin Rosenman LLP, (792 F.3d 789 (2015)) to develop the emerging law on the malpractice standard of care for advising on business transactions. Katten was sued for malpractice for its advice on how to structure the Trustee client’s loan transactions with entities controlled by an individual who turned out to be running a Ponzi scheme. The client alleged that Katten owed them a duty to tell them that the arrangement posed a risk that the other party was not running a real business. The client claimed that part of this duty requires advising what contractual devices are appropriate to the situation. Katten was, therefore, negligent in not recognizing the fraud risk the arrangements entailed and should have advised the client to take additional protections. The district court dismissed the case ruling that the client “knowingly took a risk and cannot blame a law firm for failing to give business advice.” The 7th Circuit reversed and remanded the case for further proceedings.
The 7th Circuit opinion began by observing that the district court “does not identify any principle of Illinois law that sharply distinguishes between business advice and legal advice. It is hard to see how any such bright line could exist, since one function of a transaction lawyer is to counsel the client how different legal structures carry different levels of risk, and then to draft and negotiate contracts that protect the client’s interests.” The Court then ruled:
- Advising clients how best to maintain security for their loans using legal devices is a vital part of a transactions lawyer’s job.
- An attorney in a counseling situation must advise a client of the risks of the transaction in terms sufficiently clear to enable the client to assess the client’s risks. The care must be commensurate with the risks of the undertaking and tailored to the needs and sophistication of the client.
- We take the point that a transactions lawyer’s task is to propose, draft, and negotiate contractual arrangements that carry out a client’s business objective, not to tell the client to have a different objective or to do business with a different counterparty.
- A lawyer is not a business consultant. But within the scope of the engagement a lawyer must tell the client which different legal forms are available to carry out the client’s business, and how (if at all) the risks of that business differ with the different legal forms.
- The Trustee alleges that Katten did not offer any advice about how relative risks correspond to different legal devices, and its complaint states a legally recognized claim for relief. Whether the law firm has a defense and whether any neglect on its part caused injury – are subjects for the district court in the first instance. (citations omitted)
The LMRM panelists advised:
- A letter of engagement (LOE) is the first opportunity for a lawyer to carefully delineate the nature of the advice to be provided – what is the scope of the legal advice covered by the retention.
- Update the LOE as circumstances change to assure that the distinction between business advice and legal advice is not compromised.
- Document the file to indicate whether legal advice or business advice was given in a given meeting.
- Remember that a lawyer is often responsible for putting the transaction together and the last stopgap before execution. If the deal goes bad, the lawyer is a lucrative target to blame. Tight LOEs and careful documentation of the nature of advice given is the best defense.
In a prior newsletter we offered this risk management advice on transaction matters contained in a New Jersey Superior Court unpublished opinion.* It is well worth repeating.
“When a malpractice claim is brought against an attorney retained to represent a client in the drafting and review of written agreements, with respect to complex transactional matters, involving, as here, significant financial issues, depending upon the particular facts and the expert testimony presented, we perceive several actions which may be considered by a jury in determining whether the attorney breached the standard of care.
- First, did the attorney ascertain the client’s business objectives through appropriate consultation?
- Was reasonable advice provided to the client on the various legal and strategic issues bearing on those identified business objectives? (An attorney in a counseling situation must advise a client of the risks of the transaction in terms sufficiently clear to enable the client to assess the client’s risk.)
- During the drafting process, did the attorney scrutinize the proposed agreement to ensure that the writing effectuates the business objectives defined by the client?
- Did the attorney review the written agreement with the client, to determine that the client understood the material terms that might reasonably affect the client’s decision to execute it (attorney is obligated to inform the client promptly of any known information important to him [or her]); (attorney should review all important provisions with the client before proceeding to an agreement)?
- Were the various provisions to accomplish each of the client’s stated objectives pointed out or, if they were not, did the attorney ensure that the client assents to the omission of any such objective?
We do not suggest that all of these actions are always required. However, if the scope of representation includes one or more of these activities, failure to perform an included act in a reasonably competent manner may indicate a breach of the standard of care.” (citations omitted)
* Cottone v. Fox Rothschild LLP**2014 BL 240874, N. J. Super. Ct. App. Div., No. A-0420-12T4, 9/2/14, (unpublished).