Sometimes a Good Offense is the Best Defense: How to Manage Expansion of Attorney Liability to Non-Clients
by David Evans, Jennifer Saunders, and Holly Teel
(County Bar Update, March 2005, Vol. 25, No. 3)

 

Sometimes a Good Offense is the Best Defense: How to Manage Expansion of Attorney Liability to Non-Clients

 

By David Evans, Jennifer Saunders, and Holly Teel of Haight Brown & Bonesteel LLP. Evans is the managing partner of the firm's San Francisco office. Saunders and Teel are partners in the Los Angeles office. All three have extensive experience defending professional liability actions against attorneys and other professionals.

 

It's a given that an attorney can be held liable to a client for negligently breaching the duty arising from the attorney-client relationship. Commentators suggest that the courts have effectively expanded this duty and extended attorney liability to non-clients. Although it's troubling that an attorney could be held liable to the client's adversary in any "non-fraud" situation, a recent case suggests that such expanded notions of duty and liability have been applied only in very limited situations.

 

When Can an Attorney be Held Liable to a Non-Client?

 

Where an attorney volunteers or "undertakes" to provide information to a non-client (or knows that the non-client is going to use information that the attorney provides) but fails to make a full disclosure or conceals material information, the courts likely will impose liability. In fact, some courts have imposed such liability even when the non-clients are represented by their own counsel. This liability is not predicated upon a general duty of care owed from the attorney to the non-client.1 Instead, courts relied upon the basic elements of fraud/misrepresentation claims to find liability -- intent (or negligent disregard for consequences), justifiable reliance, and damage. However, all courts that considered the issue declined to impose liability based on a non-client's reliance on the assertion of an opinion, as distinguished from a statement of fact.2 The extension of such liability is not a new trend; in fact, there have been numerous case decisions since the 1970s holding that an attorney may be held liable to a non-client for such a misrepresentation or concealment.3

 

The Vega v. Jones Day Decision

 

Frank Vega v. Jones, Day, Reavis & Pogue (2004) 121 Cal.App.4th 282 is one of the most recent cases addressing the issue. Vega, a shareholder in Monsterbook.com and represented by his own attorneys, filed an action for fraud and negligent misrepresentation against Jones, Day, Reavis & Pogue, the law firm that represented Transmedia, the prospective purchaser of Monsterbook. Transmedia had secured financing for the acquisition that included "toxic" stock provisions, under which investors would receive convertible preferred stock that seriously diluted the shares of all other Transmedia stock-holders. The court found both Transmedia and Jones Day knew that toxic stock financing was a "desperate and last resort of financing for a struggling company," and that 95 percent of companies that engaged in such financing ended up in bankruptcy.

 

Although Jones Day prepared and filed with the Delaware Secretary of State a document that revealed these toxic stock provisions, the firm provided plaintiff and his lawyers with a "sanitized" version of the schedule that made no mention of such provisions.

 

The firm also informed Vega's attorneys that the financing arrangement was standard despite knowing that this was a desperation measure and that disclosure of the toxic provisions likely would have killed the deal.

 

Months later, when plaintiff first learned of the dilution provisions, he filed suit against Jones Day. Vega alleged Jones Day concealed the dilution provisions with the intent to induce him to give up his valuable stock in Monsterbook in exchange for Transmedia's toxic and worthless stock. Vega claimed Jones Day misled his counsel that the transaction was "standard" and "nothing unusual," and by failing to provide a copy of the actual disclosure form it had prepared (instead providing a sanitized version without the toxic provisions). Vega did not know, and had no reason to suspect, that the financing contained stock dilution provisions. As a result of Jones Day's concealment of the toxic financing terms, Vega alleged that he lost his $3.45 million interest in Monsterbook.

 

Jones Day demurred to Vega's complaint and was sustained by the trial court on several grounds, including the following:

-- the claim did not allege an actionable, affirmative misstatement by Jones Day;

-- Vega could not have relied justifiably on the statements allegedly made by Jones Day; and

-- because Jones Day owed Vega no duty to disclose, Vega could not state a claim based on omission or nondisclosure.

 

Plaintiff appealed. The appellate court upheld Vega's fraud claim against Jones Day, stating that "a fraud claim against a lawyer is no different from a fraud claim against anyone else." The court also noted that while an attorney's professional duty of care extends only to the attorney's own client and intended beneficiaries of the legal work, the limitations on liability for negligence are inapplicable to liability for fraud. Jones Day's liability to Vega was based upon its "active concealment or suppression of facts" arising from the failure to provide plaintiff with its initial disclosure schedule instead of the sanitized version. The court recognized Jones Day owed no professional duty of care to Vega as an adverse party in the stock transaction but reasoned the firm had "specifically [undertaken] to disclose the transaction" and, having done so, could not conceal a material term.4

 

Avoiding Liability to Non-Clients

 

The courts will continue to expand attorneys' liabilities to non-clients, particularly where an attorney volunteers to provide information to a non-client. With this in mind, attorneys should focus on steps to minimize or avoid such exposures:

-- Use caution when volunteering information to a non-client.

-- Clarify, in writing, limitations or disclaimers on the scope and substance of any communications to a non-client.

-- If the non-client has counsel, material communications should be in writing.

-- Avoid having statements construed as representations of fact, as opposed to expressions of opinion.

-- Finally, recognize that such expanded liability exposure creates a tension between the obligation to zealously represent the client and the need to make accurate and complete disclosures to non-clients once having volunteered to provide such information. Discretion may be the better part of valor in such circumstances.

 

1 See Goodman v. Kennedy (1976) 18 Cal.3d 335, 339; B.L.M. v. Sabo v. Deitsch (1997) 55 Cal.App.4th 823, 838. An attorney may be held liable to a third-party beneficiary of the attorney-client relationship, i.e., someone the actual client intended to benefit by the attorney's services. Goodman v. Kennedy, 18 Cal.3d at 339; see also Norton v. Hines (1975) 49 Cal.App.3d 917, 921.

 

2 B.L.M. v. Sabo v. Deitsch (1997) 55 Cal.App.4th 823, 839.

 

3 See, for example, Home Budget Loans, Inc. v. Jacoby & Myers (1989) 207 Cal.App.3d 1277; Cicone v. URS Corp. (1986) 183 Cal.App.3d 194; and Roberts v. Ball, Hunt, Hart, Brown & Baerwitz (1976) 57 Cal.App.3d 104.

 

4 The court held that Jones Day's representation that the financing was "standard" and "nothing unusual" was not an actionable misrepresentation, as it was only a "casual statement" of belief.

 

This article is intended to inform the reader of potential liability exposures for attorneys. This article reflects general principles only and does not render legal advice. Readers should consult legal, financial, insurance and other advisors if they have specific concerns. Neither the Los Angeles County Bar Association, Aon and its affiliates, nor the authors assume any responsibility for how the information in this article is applied in practice or for the accuracy and completeness of the information. Reproduction without written permission is prohibited. This article is made available by Aon Direct Insurance Administrators, administrators of the LACBA Sponsored Aon Insurance Solutions Program, to the LACBA members.

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