PA: Conflicts and Malpractice in Commercial Transactions
Fiorentino v. Rapoport, 693 A.2d 208 (Pa. Super. 1997).
PA underlying sale of business interest : conflict of interest
Student contributor: Cheryl Neuman
Facts: Plaintiff and his business partner had established a restaurant servicing business. Ten years later, plaintiff and his partner decided to end their business relationship. They hired defendant lawyer to draft the terms of their mutual agreement. The defendant, however, failed to discuss the possibility of a default by one of the partners, conflict of interest, or the possibility of hiring independent counsel by each of the business partners. Subsequent to signing the termination agreement, one business partner could not pay plaintiff the money that he owed the other under the agreement. Furthermore, the business partner transferred the business’s assets to other companies—owned by his family, that competed in the restaurant servicing business. The defaulting partner filed for bankruptcy. Plaintiff then sued defendant for 1) breach of contract, 2) legal malpractice, and 3) breach of fiduciary duty.
Issue: Was it the inadequate quality of defendant’s legal services that allowed the defaulting partner to strip the business of all assets, rendering it judgment proof, so that he could not pay what was owed to plaintiff?
Ruling: Yes, it was the negligence of defendant’s legal services that allowed the defaulting partner to liquidate his business so that he could declare bankruptcy and subsequently fail to pay the money owed to plaintiff. Plaintiff’s expert (the Editor here) testified that it is a universal practice for lawyers to consult form books when drafting agreements for the sale of a business. Common protection used in these agreements include clauses that require corporate stock to be transferred through third-party escrow accounts, prohibit the transfer of corporate assets to other entities for less than the full market value, and prevent the buyer from setting up businesses that compete with the business providing the payment source for the seller, which is what happened in this case. None of those common safety clauses were used in the termination agreement and that benefitted one partner over the other. The conflict of interest should have been obvious to the defendant lawyer.
Lesson: The crux of the matter is that the default could have been avoided if the agreement had been properly drafted to prevent the transfer of assets away from the servicing business into other businesses that actively competed with the original business. That happened becuase, the defendant lawyer had a conflict of interest, since he could not concurrently represent both the separating partners whose interests were adverse to one another. It was therefore inevitable that one side of the transaction was going to benefit at the cost of the other. The Court relied heavily on the plaintiff's expert and permitted the suit to proceed under both tort and contract theories.
This case points out why it is important to make sure each partner has independent counsel. It is too difficult for an attorney, as in this situation, to adequately represent both parties, especially because both parties interests are very different. Also, even if the attorney had only represented one of the partners he still did not represent them competently. If he was upholding the duty of competence, he would have made sure he was well aware of common practices mentioned and he would provided safeguards or avenues to complete the transaction while avoiding such a situation as this. Since he clearly wasn't fully aware of how to complete the transaction, he did in fact breach the duty of competence owed to his clients.
I agree with the holding in this case. Within a business transaction, especially a business venture that ends badly, it just seems like a no brainer that the same lawyer should not represent both sides. Lawyers are humans and no matter what a lawyer says or what his intentions may be, he will lean to one side or another especially when the sides are bitter rivals. Thus, it seems obvious that the two sides in a case like this should not be represented by the same lawyer.
This case stands as a a reminder, that when dealing with partners, should one of them become adverse to the other, the attorney's work product will most most likely be reviewed for any possible flaw that could be used as a release valve for the injured partner. It is plain error to be the only attorney drafting documents between business partners without properly insulating your self from the eventual adversarial dissolution.
I agree with the court’s holding. Here there was not only a conflict of interest but also the attorney deviated from the ordinary skill and knowledge expected of a lawyer who is engaged to prepare a contract for the sale of a business. I agree with Ms. Deaner that if the attorney was upholding the duty of competence he would have made sure to follow common practice of including safety clauses, such as requiring corporate stock to be transferred through third-party escrow accounts, and preventing the buyer from setting up businesses that compete with the business providing the payment source for the seller. This in addition to only representing one side of the transaction may have prevented this malpractice suit.
This case is a perfect of example of what not to do. First, don't overlook an obvious conflict of interest when representing two parties. Separating business partners will almost invariably have competing interest because each one wants the best deal for themselves. This is not like a married couple who only have children together who come in and ask you to do joint wills for them. This is a commercial transaction where each party wants what's best for them.
Secondly, after proceeding to not recognize or ignore the obvious conflict of interest, don't fail to competently represent your client.
It is hard to disagree with anything the court held in this case. Not only do I agree with everything Mr. Anzalone stated, but this case is a great mirror of a situation where an attorney could have done "good," but went "bad" in the representation of multiple parties. A discussion of this issue was undertaken previously on this blog ( click here for the posting ) in regards to real estate transactions. Baldasarre v. Butler, 132 N.J. 278 (N.J. 1993). Here, as is arguable in Baldasarre, an attorney can represent both parties as a neutral legal counsel, but if the attorney is negligent, the harm caused can be significant.
There is no Brightline rule for dual representation by an attorney, and for good reason. However, as all the commentary has stated thus far, if an attorney is going to represent multiple parties who could become adversarial in the future, strive for perfection (or pay the price).
I also agree with the court's holding in this case and with the lesson that this case teaches us. This case involved an obvious conflict of interest and I am surprised that the attorney did not advise the clients to obtain independent legal advice. This case reminds us all, especially in a commercial transaction, that an attorney must do a conflicts check and even if they subjectively believe that they can legitimately represent both parties the attorney must advise both parties to seek the advise of independent legal counsel.