Transactional Legal Malpractice Claims By John M. Palmeri and Franz Hardy Application of the Case within a Case Standard Traditional defenses can still be effective, even in these unique, high value cases, with which courts often struggle. Legal malpractice claims arising from business transactions present a unique set of circumstances. Transactional claims may involve sophisticated, complex, and high risk agreements that are distinct from typical liti- gation malpractice cases. Damages may be substantial as the transacting parties have high expectations of returns under their agreements. Even though traditional legal malpractice theories apply to transactional settings, the typical standards and defenses, such as the proximate cause requirement of case within a case, have special application in transactional settings. This article provides an overview of some of the basic legal concepts that surround transactional legal malpractice claims as well as some practical considerations in defending such claims. Overview of Elements The elements of a professional negligence cause of action are 1) the duty of the professional to use such skill, prudence, and diligence as other members of the profession commonly possess and exercise; 2) a breach of that duty; 3) a proximate causal connection between the negligent conduct and the resulting injury; and 4) actual loss or damage resulting from the professional s negligence. See Kituskie v. Corbman, 714 A.2d 1027, 1030 (Pa. 1998); Mattco Forge, Inc. v. Arthur Young and Company, 52 Cal. Rptr. 2d 780, 788 (Cal. Ct. App. 1997). To establish the proximate cause element in a legal malpractice case, the plaintiff must establish the case within a case, which requires proof that the claim underlying the malpractice action should have been successful if the attorney had acted in accordance with his or her duty. Bebo Construction Company v. Mattox and O Brien, P.C., 990 P.2d 78, 83 (Colo. 2000). Case within a Case Applied to Transactional Claims Courts have been asked whether case within a case applies to claims involving transactional malpractice; that is, whether a plaintiff must prove that an excluded or unfavorable term in the underlying agreement would have been accepted by the other negotiating party if the attorney had acted in accordance with his or her duty. The majority of courts that have addressed this is- n John Palmeri is a partner in the Denver office of Gordon & Rees LLP. He is a member of DRI and FDCC and past president of the Colorado Defense Lawyers Association. Franz Hardy is a partner in the Denver office of Gordon & Rees LLP. He is a member of DRI and the Colorado Defense Lawyers Association. Their practices focus on the representation of lawyers and law firms, as well as complex civil litigation. 48 n For The Defense n March 2008 2008 DRI. All rights reserved.
sue have determined that the case within a case standard does apply to transactional malpractice claims. See, e.g., Viner v. Sweet, 70 P.3d 1046, 135 Cal. Rptr. 2d 629 (Cal. 2003); Hazel and Thomas, P.C. v. Yavari, 465 S.E.2d 812 (Va. 1996); Cannata v. Wiener, 789 A.2d 936 (Vt. 2001); Blackhawk Building Systems, Ltd. v. Aspelmeier, Fisch, Power, Warner and Engberg, 428 N.W.2d 288 (Iowa 1988); Jerry s Enterprises, Inc. v. Larkin, Hoffman, Daly & Lindgren, Ltd., 711 N.W.2d 811 (Minn. 2006); Froom v. Perel, 872 A.2d 1067 (N.J. Super. 2005); Serafin v. Seith, 672 N.E.2d 302 (Ill. App. 1996). The Viner v. Sweet decision, supra, is instructive. The plaintiffs in Viner filed a lawsuit against the attorney who represented them in the sale of their business. The plaintiffs claimed that the defendant attorney had led them to believe that several favorable terms were included in the sales agreement, which were in fact not included. A jury awarded the plaintiffs lost profits of over $13 million. The defendant moved for judgment notwithstanding the verdict and for a new trial, arguing that the trial court erred in failing to instruct the jury that the plaintiffs had to prove they would have obtained those favorable terms in the sales agreement but for the defendant s negligence. The trial court denied the motions. The California Court of Appeals affirmed and distinguished the standard for establishing causation in transactional malpractice claims as opposed to traditional litigation malpractice claims. The California Supreme Court rejected the court of appeals rationale, which it summarized as follows: First, the court [of appeals] asserted that in litigation a gain for one side is always a loss for the other, whereas in transactional work a gain for one side could also be a gain for the other side. Second, the court [of appeals] observed that litigation malpractice involves past historical facts while transactional malpractice involves what parties would have been willing to accept for the future. Third, the court [of appeals] stated that business transactions generally involve a much larger universe of variables than litigation matters. According to the Court of Appeals, in contract negotiations the number of possible terms and outcomes is virtually unlimited, and therefore the jury would have to evaluate a nearly infinite array of what-ifs, to say nothing of if that, then whats, in order to determine whether the plaintiff would have ended up with a better outcome but for the malpractice. Id. at 1050 (citations omitted). The California Supreme Court reversed and rejected the court of appeals rationale in failing to apply the case within a case standard. The Court of Appeals here attempted to distinguish litigation malpractice from transactional malpractice in order to justify a relaxation of the but for test of causation in transactional malpractice cases. One of the distinguishing features, according to the court, was that in litigation a gain for one side necessarily entails a corresponding loss for the other. We question both the accuracy and the relevance of this generalization. In litigation, as in transactional work, a gain for one side does not necessarily result in a loss for the other side. Litigation may involve multiple claims and issues arising from complaints and cross-complaints, and parties in such litigation may prevail on some issues and not others, so that in the end there is no clear winner or loser and no exact correlation between one side s gains and the other side s losses. In addition, an attorney s representation of a client often combines litigation and transactional work, as when the attorney effects a settlement of pending litigation. The but for test of causation applies to a claim of legal malpractice in the settlement of litigation, even though the settlement is itself a form of business transaction. Nor do we agree with the Court of Appeals that litigation is inherently or necessarily less complex than transactional work. Some litigation, such as many lawsuits involving car accidents, is relatively uncomplicated, but so too is much transactional work, such as the negotiation of a simple lease or a purchase and sale agreement. But some litigation, such as a beneficiary s action against a trustee challenging the trustee s management of trust property over a period of decades, is as complex as most transactional work. Id. at 1052 (citations omitted). The California Supreme Court concluded that, just as in litigation malpractice actions, a plaintiff in a transactional malpractice action must show that but for the alleged malpractice, it is more likely than not that the plaintiff would have obtained a more favorable result. Id. at 1054. Most commentators agree with the holding and rationale of the Viner decision, supra. Proof of causation requires analysis of the consequences of proper advice. Thus, the client needs to prove what should have been achieved had the proper advice been given. If the alleged error is the failure to obtain or advise of a provision, concession or benefit, the client must prove that the other party would have agreed. It is not sufficient to show that the other party might have agreed. R. Mallen and J. Smith, Legal Malpractice 23.5, at 469 (2006 ed.). In the transactional setting, a plaintiff should therefore have to demonstrate that an underlying position (be it a set of proffered business terms or otherwise) was compromised or negatively impacted due to the purported negligence of the defendant-attorney. While I (and many others) use the term casewithin-a-case in the context of legal malpractice matters generally, the plaintiff in a transactional legal malpractice case will generally not be complaining of negligence in some underlying litigation. The use of the term case-within-acase should not distract from the valid argument, however, that the plaintiff in the transactional legal malpractice matter should still have the same burden as the plaintiff in the litigation legal malpractice matter to demonstrate that a meritorious underlying position was compromised by the negligence of the defendant-attorney. This means that the plaintiff must show that he or she would have been ultimately better off in the underlying transaction in a world where the defendant-attorney s purported negligence had never occurred. George S. Mahaffey, Jr., Cause-In-Fact and the Plaintiff s Burden of Proof with Regard to Causation and Damages in Transactional Legal Malpractice Matters: The Necessity of Demonstrating the Better Deal, 37 Suffolk U. L. Rev. 393, 436 7 (2004). For The Defense n March 2008 n 49
When a business transaction goes awry, a natural target of the disappointed principals is the attorney who arranged or advised the deal. Clients predictably attempt to shift some part of the loss and disappointment of a deal that goes sour onto the shoulders of persons who were responsible for the underlying legal work. Before the loss can be shifted, The case within a case concept is a standard of proof designed to limit damages to those actually caused by a professional s malfeasance. 50 n For The Defense n March 2008 however, the client has an initial hurdle to clear. It must be shown that the loss suffered was in fact caused by the alleged attorney malpractice. It is far too easy to make the legal advisor a scapegoat for a variety of business misjudgments unless the courts pay close attention to the cause in fact element, and deny recovery where the unfavorable outcome was likely to occur anyway, the client already knew the problems with the deal, or where the client s own misconduct or misjudgment caused the problems. It is the failure of the client to establish the causal link that explains decisions where the loss is termed remote or speculative. Courts are properly cautious about making attorneys guarantors of their clients faulty business judgment. John H. Bauman, Damages for Legal Malpractice: An Appraisal of the Crumbling Dike and Threatening Flood, 61 Temp. L. Rev. 1127, 1154 55 (1988). Although courts and commentators focus on the legal concept of establishing proximate cause in addressing transactional legal malpractice cases, there is also a practical acknowledgement that such claims often involve highly speculative agreements where parties expect high returns that make proof of damages a concern. The case within a case concept is a standard of proof designed to limit damages to those actually caused by a professional s malfeasance. Mattco Forge, Inc. v. Arthur Young and Company, 60 Cal. Rptr. 2d 780, 789 (Cal. Ct. App. 1997). For example, in Viner, supra, the jury returned the $13 million verdict based upon the plaintiffs claims of lost future profits. Indeed, transactional claims often involve purported future profits. It is well recognized that a plaintiff in a legal malpractice action should only be compensated for his or her actual losses. Kituskie v. Corbman, 714 A.2d 1027, 1030 (Pa. 1998). Actual damages cannot be based on mere speculation or conjecture. Western Cities Broadcasting, Inc. v. Schueller, 849 P.2d 44, 48 (Colo. 1993). Case within a Case Is Not Universally Applied Application of the case within a case standard, although well recognized, is far from uniform. Judge Richard Posner of the U.S. Court of Appeals for the Seventh Circuit has held that proving the case within a case is unnecessary in transactional claims. Nicolet Instrument Corporation v. Lindquist & Vennum, 34 F.3d 453, 456 (7th Cir. 1994). The plaintiff in Nicolet was represented by the defendant law firm in the sale of a wholly owned subsidiary. After the sale was complete, the plaintiff remained liable under the sales agreement for a building lease between the sold subsidiary and the lessor. Years after the sale, the former subsidiary defaulted on the lease and the plaintiff was required to pay $2.6 million to the lessor. The plaintiff alleged that the defendant law firm was negligent in failing to eliminate the plaintiff s contingent liability under the lease. The district court granted the defendant s motion for summary judgment, concluding that the plaintiff had failed to prove that the purchaser would have agreed to accept the liability but for the defendant s failure to include it in the sales agreement. The court of appeals reversed based upon its rationale that traditional but-for causation analysis did not apply in transactional legal malpractice settings. Proof of causation is even more difficult in a negotiating situation, because while there is (at least we judges like to think there is) a correct outcome to most lawsuits, there is no correct outcome to a negotiation. Not only does much depend on the relative bargaining skills of the negotiators, on the likely consequences to each party if the negotiations fall through, and on luck, so that the element of the intangible and the unpredictable looms large; but there is no single right outcome in a bargaining situation even in principle. Every point within the range bounded by the lowest offer that one party will accept and the highest offer that the other party will make is a possible transaction or settlement point, and none of these points is correct or incorrect. Id. at 455. The court of appeals continued: But to withstand summary judgment [plaintiff] was not required to prove that but for the law firm s negligence it would have avoided the $2.6 million rental expense that it incurred. All it had to show was that a rational trier of fact, confronted with the evidence produced in the summary judgment phase of the litigation, could conclude that, yes, [plaintiff] had suffered some harm as a consequence of the law firm s negligence and could quantify that harm to a reasonable, which is not to say a high, degree of precision. Id. In conclusion, the court seemed to realize, but accept, that this standard allowed speculation to what the purchaser may or may not have agreed. Had [plaintiff] through the law firm made clear at the outset that it didn t want to remain stuck with potential liability on the lease, [the purchaser] might have raised its estimate of [the plaintiff s] reservation price and have decided to accept the contingent liability on top of paying [the purchase price]. For all we know, it thought [the purchase price] a good price and was willing to pay more, whether in cash or in the assumption of a contingent liability. Id. at 456; see also Keywell Corporation v. Piper and Marbury, LLP, 1999 U.S. Dist. LEXIS 1445 (W.D.N.Y. 1999). Without the case within a case standard, courts seem to invite speculation as to both the possible terms of an agreement as well as subsequent damages. Unless a trier
of fact is required to apply the case within a case standard, it is permitted simply to speculate as to what the other negotiating party would have accepted as a proffered contract term. An Iowa decision demonstrates why this is problematic. In Benton v. Nelsen, 502 N.W.2d 288 (Iowa App. 1993), the client claimed that the attorney was negligent by not providing him a memorandum from a creditor that recommended how the client could reduce his debt. Although the court noted that disputed facts existed as to whether the attorney provided the client with the memorandum, the court determined that the terms of the memorandum were very complicated, it contained substantial requirements from the client, and there was no evidence that the creditor would have signed a contract based only on the memorandum. Id. at 292. The appellate court affirmed summary judgment in favor of the attorney and concluded that the plaintiff failed to show that he could have complied with the extensive provisions of the memorandum or that the creditor would have signed an agreement. Id. Although a review of the actual or missing terms of the agreement seems logical, under the Nicolet opinion, evidence as to whether the plaintiff could have met or the third party would have agreed to the terms is not essential. Under this rationale, a jury need only conclude that, yes, [plaintiff] had suffered some harm as a consequence of the law firm s negligence and could quantify that harm to a reasonable, which is not to say a high, degree of precision. Nicolet, 34 F.3d at 455. This standard presumes that the other party would have agreed no matter how burdensome the terms. It focuses on the attorney s alleged negligence, that is, whether the attorney should have attempted to negotiate the missing terms. As recognized by the court in Benton, supra, this permits a jury to award damages based merely on a breach of duty. Without the case within a case concept, transactional attorneys would become the guarantor of any contract, where in hindsight, a term, could have reduced or eliminated the client s liability or loss. See Simko v. Blake, 506 N.W.2d 258, 259 60 (Mich. App. 1993) (because no amount of work can guarantee a favorable result, attorneys would never know when the work they do is sufficiently adequate to protect not only their clients from error, but themselves from liability), aff d, 532 N.W.2d 842 (Mich. 1995). Requiring a plaintiff to establish the case within a case in transactional malpractice lawsuits reduces the filing of frivolous or unsubstantiated claims where a plaintiff could assert that any number of provisions should have been included in a contract. Considerations Interestingly, the California Court of Appeals in Viner and the U.S. Seventh Circuit Court of Appeals in Nicolet determined that it is often difficult for a plaintiff to present evidence and for a jury to decide whether a term may have been adopted in a contract between negotiating parties. The jury would have to evaluate a nearly infinite array of what-ifs, to say nothing of if that, then whats, in order to determine whether the plaintiff would have ended up with a better outcome but for the malpractice. Viner v. Sweet, 70 P.3d at 1050 (quoting the California Court of Appeals decision). The court of appeals in Viner reasoned that having a jury decide whether a contract term would have been agreed to is highly speculative. However, on the other hand, ignoring whether or not a term would have been accepted seems to invite more speculation. Although it may be more difficult to show the adoption or rejection of a term during contract negotiations than a result in litigation, evidence of the underlying negotiation is available. This evidence includes testimony of the individuals who negotiated the underlying contract, prior negotiations, previous drafts of the contract, the significance or effect of the term at issue, the relative bargaining strength of the participants, the experience of the negotiators, the relationship of the participants, and the importance to the other contracting party of completing the transaction. Similarly, in litigation malpractice lawsuits, the parties may look to the opposing party and other witnesses in the underlying lawsuit, as well as other direct and circumstantial evidence to show what the outcome of the underlying case would have been but for the alleged breach of duty by the attorney. Courts adopting the case within a case standard in transactional settings differ on whether expert witness testimony alone is sufficient for a plaintiff to meet this burden. Compare Hazel and Thomas, P.C. v. Yavari, 465 S.E.2d 812 (Va. 1996) (it is insufficient for a plaintiff to prove causation with only expert testimony; the plaintiff must produce evidence from the underlying transaction to sustain this burden) with Froom v. Perel, 872 A.2d 1067 (N.J. Super. 2005) (proper expert testimony would have been sufficient). During a subsequent legal malpractice case, participants in the underlying transaction should be willing to reveal their true positions as to the adoption or rejection of any disputed contract term since the transaction is now closed, they have no interest in the current dispute, and they are obligated to provide such testimony under oath. Courts should promote a search for the truth in all cases where evidence is available. See Tartaglia v. Paine Webber, Inc., 794 A.2d 816, 820 (N.J. Super. 2002). The mere possibility that it may be more difficult to determine the result of an underlying transaction than an underlying trial does not mean that it becomes appropriate to take the issue away from the jury. Juries are often asked to weigh extrinsic evidence to determine the intent of contracting parties. See Johnston v. Ivac Corporation, 885 F.2d 1574 (Fed. Cir. 1989) (jury to determine interpretation of patent claim where genuine evidentiary conflict existed); In re Texas General Petroleum Corporation, 52 F.3d 1330 (5th Cir. 1995) (the determination of the parties intent in an ambiguous bankruptcy reorganization contract was a question of fact for the jury); Bidlack v. Wheelabrator Corporation, 993 F.2d 603 (7th Cir. 1992) (jury to determine intent of parties where four corners of contract were ambiguous). This undermines the rationale that the jury would have to evaluate a nearly infinite array of what-ifs, to say nothing of if that, then whats, in order to determine whether the plaintiff would have ended up with a better outcome but for the malpractice. Viner v. Sweet, 70 P.3d at 1050 (quoting the California Court of Appeals decision). Simply because the issue is difficult or evidence complex should not permit a court to relax the causation standard for the jury. The problem is that courts and attorneys are not always willing to do what is within their For The Defense n March 2008 n 51
power to help juries understand cases and perform their function. Lisa Meyer, Note: Taking the Complexity Out of Complex Litigation: Preserving the Constitutional Right to a Civil Jury Trial, 28 Val. U.L. Rev. 337, 340 41 (1993). Courts seem to have little problem applying the case within a case standard to transactional aspects of underlying litigation lawsuits. Legal malpractice divorce cases often involve settlement where the spouse claims he or she would have received more marital property but for his or her attorney s negligence. Also, disgruntled parties frequently claim that they would have received a higher monetary settlement but for the attorney s unpreparedness for an upcoming trial. In these cases that involve aspects of both litigation and transaction malpractice, practitioners should consider focusing the causation element on the plaintiff having to prove that the other side would have agreed to pay more or to more favorable terms, rather than the outcome of the underlying lawsuit if it had proceeded to trial. As a practical matter, it seems easier to elicit from the underlying opposing parties that they would not have paid more or that the claims lacked merit, than demonstrating what another trier of fact would have decided after weighing all of the evidence. Conclusion Under the broad umbrella of legal malpractice, transactional claims are unique. Defense counsel and insurers should recognize that such claims often do not fit the traditional litigation legal malpractice model. Courts struggle to apply traditional legal malpractice concepts, such as case within a case, to transactional based lawsuits. Evolving standards, the highly speculative nature of these deals, and the high value of the underlying cases can add to the challenge of defending such cases. Nevertheless, the case within a case standard can be an effective defense in these often high value claims. 52 n For The Defense n March 2008