October 14th, 2008
Do your business contracts have an attorneys’ fee provision awarding reasonable fees and costs to the prevailing party? Many do. The common view on these provisions is that they promote fair outcomes (loser pays) and may deter lengthy ltigitation, since each side wants to avoid having to pay the other side’s attorneys. I haven’t seen any empirical evidence to back this up. I recently obtained $3.4 million in attorneys’ fees for a client, pursuant to a contract, and the case highlights some of the risks involved in attorney fee provisions. (For details of the case, read The Recorder article about the Duane Morris case posted on this website.)
Consider at least two situations in which the fee provision may drive unnecessary litigation: consumer contracts and complex transactions. Most consumers, including those who enter into residential leases, obtain legal representation on a contingency basis. The economics of paying hourly attorneys fees doesn’t work for most consumers involved in contract disputes.
The existence of an attorney’s fee provision in a consumer contract/lease does two things. First, it makes it easier for the consumer to retain counsel on a contingency basis, even for a small case, since counsel will be paid a reasonable hourly rate if the consumer plaintiff prevails. Second, it encourages many counsel to over-lawyer a case. That is because a “reasonable fee” is based on a loadstar calculation: the number of hours worked times the market hourly rate. The loadstar in many cases will turn out to be more than the amount at issue in the lawsuit. For example, it’s not unusual to see a $10,000 fee award (or more) in a case resulting in a $1,000 judgment for the prevailing party.
The same thing can occur in complex commercial cases. Though business entities involved in large scale litigtation can ususally afford to hire hourly counsel, where there is a fee provision, hourly counsel may agree to work on a contingency basis. In these cases, multiple the numbers above by one thousand and you can predict the result: the law firm will very soon have a larger stake in the litigation than the client. Cases that might otherwise have settled or resolved between entities may be driven to trial by lawyers chasing a fee.
Attorneys and their clients should evaluate their contracts and experience with past disputes and decide whether the client may be better served by the default American rule: each side pays its own attorneys.
September 11th, 2008
Chart Explaining The Parole Evidence Rule
Most lawyers don’t think about graphics until they’re preparing for mediation, arbitration or trial. But many pre-trial motions and issues involve ideas that are hard to explain with text but easy to show graphically: organization charts, process flow charts, and time lines (especially for statute of limitations motions). Even complex legal analysis can in some cases be reduced to an easy-to-use decision tree. Still, most judges and lawyers cling to the outdated notion that only juries benefit from graphics.
Here’s an example of how I used graphics in the law-and-motion department. All lawyers remember the phrase “Parole Evidence Rule” from law school. But like the “Rule Against Perpetuities” (which I forgot shortly after taking the bar exam) or the “Battle of the Forms” from the Uniform Commercial Code, you could read cases applying the Parole Evidence Rule all day long without attaining a state of clarity.
The seemingly simple rule (”You cannot use extrinsic evidence to change the meaning of a contract”) has so many exceptions that it sometimes seems turned on its head (closer to “You can always use extrinsic evidence to explain or interpret the meaning of a contract”).
While noodling over the meaning of the rule as applied to an “exclusive negotiations” contract between a developer and a public entity, a colleague and I grabbed a butcher-paper flip chart and Magic Marker and started scribbling boxes, arrows and case names like mad. After balling up and discarding several sheets, we finally distilled the holdings of nearly a dozen cases into a single, unified chart. Eureka!
We sent the chart off to a graphic artist who “prettified” it, adding cool colors, subtle shading and shadow effects and selecting an easy-to-read type face. This is the chart we all wish we’d had in law school. (Students, see below on how you can get yours.)
Using text narrative, you can state the rule and list the exceptions. But you’d need dozens of pages to describe all the possible combinations that could apply to a given case. As the saying goes, a picture’s worth a thousand words. We attached the finished product to our brief. I can’t say it made the difference, but the judge adopted our view of the law over the opponent’s.
What does the future hold? Trial graphics have gone beyond static images on a board to video animation projected on a screen. In patent cases, lawyers routinely prepare animations to explain and simplify technology. It won’t be long before video makes its way into routine motion practice.
With the spread of electronic filing, some courts (such as the Ninth Circuit U.S. Court of Appeals) are experimenting with e-briefs that allow lawyers to hyperlink to cases and record pages. Though I haven’t heard of it, no doubt some trial courts already accepted video deposition clips into a motion record.
Imagine this in your brief: Instead of the ho-hum response “I followed routine company policy,” the court can watch the deponent mopping his sweaty brow, whispering into his lawyer’s ear, the lawyer whispering back, and the nervous witness stuttering as he utters this testimony. Now that’s a picture worth a million words!
The thumbnail image with this article is a low-resolution version of my Parole Evidence Rule chart (a.k.a., The Parole Evidence Rule Made Easy). I’m happy to send law students, lawyers and others a free full-size Adobe Acrobat PDF file of the chart. Use it to get ideas for your own case.
For details on this free offer, click here to visit the “Think Visual” page.
Credits: Co-author of the chart: San Francisco Deputy City Attorney Warren Metlitzky (a guy who can’t do anything without a chart); Graphic Artist: David Rosenthal of LegalVision (a guy who can make a chart for anything).
August 26th, 2008
What follows is the introduction from my law review comment written in the aftermath of the Savings and Loan crisis. The title is: “Inside Fraud, Outside Negligence and the Savings & Loan Crisis: When Does Management Wrongdoing Excuse Professional Malpractice?” (26 Loy. L.A. L.Rev. 1165 [June 1993].) With a steady stream of corporate scandal, from Enron to the mortgage meltdown, the subject remains timely. Regulators and class action lawyers still go after the lawyers and accountants. But can they be held to account to investors and creditors for concealed management fraud? Read on.
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The Federal Deposit Insurance Corporation (FDIC), seeking to make attorneys and accountants liable for losses at corrupt savings and loan associations (S & Ls or thrifts), has filed an unprecedented number of malpractice suits against these professionals. Many of these suits resemble the following hypothetical case of Charley K., a successful real-estate-developer-turned-savings-and-loan-kingpin.
In the early 1980s, Charley bought Jefferson Savings & Loan, a small thrift that until then had only made single-family home loans. Charley believed he could make more money by directly investing depositors’ funds in riskier ventures. Under Charley’s management, Jefferson S & L bought 100 acres of undeveloped land on the outskirts of a large city for $50 million. Unfortunately for Charley, the real estate market crashed, and the land value declined to $40 million. Because Jefferson S & L’s capital was only $10 million to start with, the $10 million loss wiped out all of Jefferson’s capital. The institution was–on paper, at least–worth nothing.
Charley should have reported Jefferson’s insolvency to the Federal Savings and Loan Insurance Corporation (FSLIC), which would have closed the thrift. Instead, Charley made a secret deal with speculator X, who owned land near Jefferson’s holdings. Charley, as an individual, would buy Ms. X’s land for $50 million (which was $10 million more than market value) if Ms. X would buy Jefferson’s land for $60 million (which was $20 million more than market value). Charley agreed that his S & L would make a $10 million nonrecourse loan to Ms. X to buy the land without putting any cash into the deal. Besides being an unsound business deal, the transaction violated federal law, and Charley knew it. First, Ms. X could not legally borrow $10 million from Jefferson S & L because that exceeded the maximum amount the thrift was allowed to lend to one person. Second, Charley intended to borrow money from Jefferson to buy Ms. X’s land. This not only exceeded the maximum that the S & L could lend to one borrower, but also would raise regulatory concerns about preferential insider lending. Charley covered up these problems by making the loans to Ms. X and himself through a handful of “dummy” corporations controlled by “straw” parties. The loan applications named neither Charley nor Ms. X.
Charley hired two prestigious law firms to handle the loan documentation. He paid more in fees to split the work, when one firm could have done the job more efficiently, so that neither firm would suspect the true nature of the overall transaction. If lawyers at either firm had scratched below the surface, they would have discovered the connections between the dummy corporations, Charley and Ms. X, but neither firm did. The land deals closed, resulting in a $10 million “profit” to Jefferson. Because the sale on paper appeared to be an arms-length transaction, Jefferson’s Big Six accounting firm approved the entire $10 million as profit–an overnight doubling of the thrift’s capital.
Charley’s scheme, however, could not last indefinitely. The slump in the real estate market worsened, forcing Charley and Ms. X to default on $60 million in loans from Jefferson S & L. By then, the two tracts of land were worth only $40 million together. The two bad loans wiped out Jefferson’s capital and left a $10 million negative net worth. The FSLIC paid off depositors and covered the deficit out of the S & L insurance fund.
Shortly after closing Jefferson S & L, FSLIC lawyers sued the two law firms and the accounting firm to recover $20 million in losses allegedly caused by the firms’ negligence. According to the FSLIC, the land deals were so obviously fraudulent that the professionals must have “looked the other way” to protect a client and their large fees. Because Charley was bankrupt, the well-insured professionals were the “deep pockets” to which the FSLIC looked for recovery. The accounting and law firms were shocked to discover their unwitting role in Charley’s and Ms. X’s fraud and embarrassed that they had not uncovered it. The firms, however, adamantly denied liability, even if they were negligent. The firms moved for summary judgment on the grounds that Charley’s insider fraud and concealment cut off any liability for mere negligence.
The alleged negligent omission of Jefferson’s attorneys and accountants was the failure to uncover the fraud and concealment by their client’s top management. Professionals in this situation have raised what this Comment refers to as the “insider fraud defense.” Part II of this Comment examines the role of attorneys and accountants in the S & L crisis and defines the “insider fraud defense.” Part III compares the facts, procedural background and reasoning of the two leading cases on the insider fraud defense: FDIC v. O’Melveny & Meyers [sic], which rejected the defense, and FDIC v. Ernst & Young, which allowed it. Part IV explores the bases in case law for the defense and applies the precedents to S & L fraud and professional malpractice. Finally, this Comment concludes that courts should allow the insider fraud defense when top management dominated the thrift and successfully concealed its wrongdoing from outside professionals.
You can find the entire article posted at www.bizlitigator.com/insider-fraud-defense
