Violating Rule on Business Deals With Clients Justified Unwinding Companies’ Joint Venture

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By Joan C. Rogers  

Aug. 6 — A joint venture between two entities is void and subject to rescission where a lawyer involved in the transaction overlooked the ethics rule on lawyer-client business deals, the Washington Supreme Court held July 31.


Clients' Legal Fees in Action Against Third Party Weren't Recoverable as Malpractice Damages

Attorneys' fees that a lawyer's former client incurs in litigation against another party are not recoverable as damages in the client's malpractice action against the lawyer when the third party was privy to the events which led to that litigation, the Washington Supreme Court declared July 31 ( LK Operating, LLC v. Collection Grp., LLC, 2014 BL 212964, Wash., No. 88846-9, 7/31/14).  

The court held that The Collection Group, LLC (“TCG”) and its founder, Brian Fair, did not have a viable malpractice claim against their former counsel because they asserted no compensable damages. Their only alleged damages were legal fees they incurred in a contract action with a third party, LK Operating LLC (“LKO”), but LKO was closely linked with the lawyer's allegedly wrongful actions toward the clients that gave rise to the contract litigation in the first place, Justice Mary E. Fairhurst explained.

Two Lawsuits. In the contract action decided the same day, the supreme court held that a joint venture agreement between TCG and LKO was unenforceable and subject to rescission on public policy grounds because attorney Leslie Powers was involved in the business transaction in his capacity as an attorney but did not comply with Washington Rule of Professional Conduct 1.8(a).

The court also held in the contract action that Powers violated Rule 1.7 (current-client conflicts) because he simultaneously represented parties with conflicting interests—including Fair and LKO—without getting their informed consent.

In the companion malpractice case against Powers and his law partner Kevin Therrien, Fairhurst pointed out that Washington courts follow the “American Rule” that attorneys' fees are not available as costs or damages absent a contract, statute or recognized ground in equity.

The “ABC Rule” is an equitable doctrine that makes attorneys' fees compensable as consequential damages in certain situations, the court said. It explained that the rule has three elements: “(1) a wrongful act or omission by A … toward B …; (2) such act or omission exposes or involves B … in litigation with C …; and (3) C was not connected with the initial transaction or event…, viz., the wrongful act or omission of A toward B.”

‘Inextricably Linked.' The third element was not satisfied here, the court held, because LKO was “inextricably linked” with all of Powers's allegedly wrongful actions that involved Fair and TCG in the contract litigation with LKO.

That link existed, the court said, whether the wrongful action was that (a) Powers provided concurrent representation to LKO and Fair in violation of Rule 1.7; (b) he entered into the joint venture agreement without complying with Rule 1.8(a); or (c) he passed off a business opportunity to LKO, which he and Therrien had founded as part of their estate plans.

Because LKO was connected with the lawyer's allegedly wrongful acts that embroiled TCG and Fair in the contract action, the ABC Rule did not apply, and the malpractice claim was properly dismissed because Fair and TCG did not assert any recoverable damages, the court concluded.

Full text at http://www.bloomberglaw.com/public/document/LK_OPERATING_LLC_a_Washington_limited_liability_company_Plaintiff.


The court made clear that a business contract is presumptively unenforceable on public policy grounds when the transaction is subject to Washington Rule of Professional Conduct 1.8(a) and the lawyer does not abide by its safeguards.

Compliance with Rule 1.8(a) was mandatory in this instance, Justice Mary E. Fairhurst said, because the lawyer provided legal services to one of the entities as part of the overall transaction, even though he did not acquire an ownership interest in the joint venture.

The court also held that the lawyer's participation in the transaction violated Rule 1.7, which prohibits lawyers from representing clients with conflicting interests. However, the court didn't decide what remedy would be appropriate for breaching that standard, because the transaction was subject to rescission anyway due to the lawyer's Rule 1.8(a) violation.

In a companion case arising from the transaction, the court held that attorneys' fees the lawyer's former client incurred in its litigation against the other company were not recoverable as damages in a malpractice action against the lawyer. (See box.)

Joint Venture

The litigation before the court grew out of a joint venture proposal.

The venture involved The Collection Group LLC (“TCG”), a debt collection company, and LK Operating LLC (“LKO”), which attorney Leslie Powers and his law partner Keith Therrien had formed as part of their estate plans to manage trusts for their adult children.

The joint venture wasn't formalized in writing until disagreements developed about the extent of LKO's ownership interest in TCG. During the joint venture, LKO invested funds in TCG, and Powers and his firm provided legal services to TCG at no cost.

The supreme court held the lawyer's failure to comply with ethics rules made the transaction void and unenforceable.

“Mr. Powers entered the business transaction contemplated by the joint venture proposal in violation of former RPC 1.8(a), and rescission is the appropriate remedy for that violation under the unusual facts presented,” it said.

The joint venture proposal was made before Washington amended its professional conduct rules in 2006, so the court applied the pre-2006 version. The differences between the former and current versions did not figure into the court's decision, however.

Business Deal Involved Lawyer

The court rejected Powers's argument that for purposes of Rule 1.8(a) there was no business transaction involving him. His position was that the joint venture was solely between TCG and LKO.

The term “transaction” in Rule 1.8(a) is broader than the word “contract,” the court said.

Here, Fairhurst said, the business transaction stated that TCG would receive financial investments and professional legal services. LKO provided the financial investments, and Powers and his law firm provided the legal services.

“As a matter of law, TCG, LKO, and Mr. Powers were all parties to the business transaction at issue,” the court said.

Fairhurst said that in providing legal services to TCG as part of the transaction, Powers necessarily acted in his capacity as an attorney. Therefore, as a matter of law, the deal was not solely between nonlawyers even though Powers did not personally acquire an ownership interest in TCG, the court said.

Powers violated Rule 1.8(a) as a matter of law, the court decided, because he never provided TCG with any written communication specifying the final parties to the joint venture and the parties' respective roles.

“Surely the parties to a transaction are essential terms of that transaction” under the rule, the court said. Even if TCG did not care who made the financial investment, compliance with the rule is entirely the attorney's responsibility, and “the rule contains no exceptions for apathetic clients,” Fairhurst said.

Impact of Rules on Public Policy

In approving the remedy of rescission, the court held as a matter of law that the business transaction contemplated by the joint venture proposal was unenforceable on public policy grounds.

However, Fairhurst said, “a contract is not automatically unenforceable based solely on the fact that it has some connection to some RPC violation.”

Rather, she said, the guiding inquiry in determining whether a contract is unenforceable as contrary to public policy is whether the contract is injurious to the public.

“We do not purport to set out any all-encompassing rule for how violation of any RPC in connection with a contract might affect that contract's enforceability,” the court said.

Probably Unenforceable

The public policy underlying Rule 1.8(a), the court said, is to guard against overreaching when a lawyer participates in a business transaction with a client.

Therefore, it said, a contract made in violation of the rule is “presumptively, but not necessarily, unenforceable” and “may not be enforced unless it can be shown that notwithstanding the violation, the resulting contract does not violate the underlying public policy of the rule.”

An attorney's noncompliance with the ethics rule on lawyer-client business deals makes the transaction presumptively void.

The court said its holding didn't depart from Hizey v. Carpenter, 830 P.2d 646 (Wash. 1992), which held that professional conduct rules do not set a standard for civil liability. “We do not depart from or disapprove of this long-standing rule in our decision today because it does not apply directly and its reasoning is inapposite in this context,” the court stated.

Rule 1.7 Too

Powers also violated Rule 1.7 by engaging in simultaneous representation of multiple clients with adverse interests without making the necessary disclosures or receiving the clients' informed consent, Fairhurst said.

On this issue, Fairhurst embraced the analysis of the trial court, which said that:

  •  Powers represented LKO and TCG's founder, Brian Fair, in separate, unrelated matters and then represented LKO in the business transaction with Fair by relaying the investment proposal and forwarding funds from LKO to TCG;
  •  Powers had a duty to disclose his personal interest in LKO, his legal duties as manager of LKO and his professional duties as an attorney for LKO; and
  •  his representation of Fair was directly adverse to his representation of LKO in the transaction, and neither client gave informed consent in writing.
  • Other Views

    In a concurring opinion joined by Justice Debra L. Stephens, Justice Gordon McCloud agreed that the lawyer's violation of Rule 1.8(a) supported the remedy of rescission.

    But McCloud disagreed with the majority's views about when courts will enforce a contract entangled in an ethics rule violation. That part of the majority opinion will produce unnecessary uncertainty on the issue, he contended.

    Chief Justice Barbara A. Madsen dissented. She argued that contract rescission is not a proper remedy for an attorney's violation of professional conduct rules.

    Using the rules in this way, she said, contravenes both Hizey and the Scope section of the rules, which states that they are not intended to be a basis for civil liability.

    In the contract action, James A. Perkins of Larson Berg & Perkins, Yakima, Wash., represented LKO. TCG and Fair were represented by Catherine W. Smith of Smith Goodfriend P.S., Seattle; Ronald J. Trompeter of Hacket, Beecher & Hart, Seattle; and Steven C. Lacy of Lacy Kane P.S., East Wenatchee, Wash. Philip A. Talmadge of Talmadge/Fitzpatrick, Tukwila, Wash., represented Powers and Therrien.

    In the companion malpractice case, TCG and Fair were represented by Steven Lacy and Stewart Smith of Lacy Kane P.S., East Wenatchee, and by Catherine Smith and Howard Goodfriend of Smith Goodfriend P.S. Powers and Therrien were represented by Bradley S. Keller and Joshua B. Selig of Byrnes Keller Cromwell LLP, Seattle, and Philip Talmadge.

    To contact the reporter on this story: Joan C. Rogers in Washington at jrogers@bna.com

    To contact the editor responsible for this story: Kirk Swanson at kswanson@bna.com

    Full text of at http://www.bloomberglaw.com/public/document/LK_OPERATING_LLC_a_Washington_limited_liability_company_Petitione.

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