Attorney Representing Closely Held Entity Owed Duty to Protect Company's Two Owners

By Lance J. Rogers  

Owners of a closely held corporation may assert personal claims of malpractice against the company's attorneys where the principals' financial interests were so integrated into the entity's that the owners may be deemed intended third-party beneficiaries of the representation, the Nebraska Court of Appeals ruled Nov. 8 (Sickler v. Kirby, Neb. Ct. App., No. A-10-965, 11/8/11).

The ruling permits two owners of a business to pursue their individual malpractice claims against lawyers who, they allege, gave them such bad advice that it subjected their company to ruinous litigation and costly government enforcement actions.

Franchising Snafu

Steve Sickler and Cathy Mettenbrink hired attorney Jeffrey Orr to advise them on franchising laws and to help them prepare the necessary documents to sell franchises of their specialty retail coffee business. With Orr's assistance, Sickler and Mettenbrink formed Baristas & Friends Inc. to be the franchisor corporation, and they collected over $800,000 from the sale of 22 franchises.

The trouble began when franchisees started complaining that B&F's franchising disclosure document did not meet the requirements of federal or state law. The document is a federally mandated certificate that reveals to potential buyers extensive information about the franchisor and the franchise organization.

Orr turned to Robert Kirby of Croker, Huck, Kasher, DeWitt, Anderson & Gonderinger for assistance and advice about the documents, and apparently used Kirby's guidance to twice amend the disclosure document while B&F continued to sell franchises. According to the plaintiffs, Kirby did not communicate these deficiencies directly to them.

Civil Liability

The revisions didn't solve the problems, however, and Sickler, Mettenbrink, and B&F were sued by a franchisee named Nesler. Bradley Holbrook of Orr's firm represented the owners personally and Kirby represented B&F. Nesler was awarded $132,422.95 plus $49,000 in attorneys' fees. A franchisee named Turnbull later obtained a judgment against B&F in excess of $130,000.

The plaintiffs' troubles did not end there. The Federal Trade Commission won injunctive relief against Sickler, Mettenbrink, and B&F, and also was awarded a suspended civil penalty judgment of $242,000.

Orr and his firm later withdrew due to the conflict of interest. In 2009 Orr was publicly reprimanded for accepting the franchising matter that was beyond his legal experience and ability. See State ex rel. Counsel for Discipline v. Orr, 759 N.W.2d 702, 25 Law. Man. Prof. Conduct 85 (Neb. 2009).

Sickler and Mettenbrink sued Kirby and Croker Huck for malpractice. The defendants moved for summary judgment, asserting that they were retained solely to represent B&F, not Sickler or Mettenbrink. The trial court agreed with the defendants, finding no triable issues of duty or proximate cause.

In an opinion by Judge Richard D. Sievers, the court of appeals reversed, concluding that both B&F and Sickler and Mettenbrink individually have standing to sue Kirby and Croker Huck.

‘Inseparable' Interests

There is “ample evidence in the record of the defendants' negligence in their representation of B&F” and that the company suffered damages, Sievers said.

On the more complicated question of whether Sickler and Mettenbrink could maintain a malpractice action in their own right, the court found that although the Croker defendants had not been retained by B&F's owners personally, under the circumstances they owed a duty to the owners as individuals. There are triable issues of fact as to whether Kirby and his firm breached that duty and proximately caused the damages alleged by the individual plaintiffs, Sievers said.

Although Croker Huck was hired to represent B&F, the court said, Nebraska allows a nonclient to sue a lawyer when the client's representation was designed to benefit the nonclient under Perez v. Stern, 777 N.W.2d 545, 26 Law. Man. Prof. Conduct 64 (Neb. 2010). In that decision, the supreme court declared that a lawyer alleged to have mishandled a wrongful death case could be held liable to the decedent's children.

Perez announced a multifactor balancing test for deciding when an attorney's obligations run beyond the actual client, which includes looking at:

  •  the extent to which the transaction was intended to affect the third party;
  •  the foreseeability of harm;
  •  the degree of certainty that the third party suffered injury;
  • the closeness of the connection between the attorney's conduct and the injury suffered;
  •  the policy of preventing future harm; and
  •  whether recognition of liability under the circumstances would impose an undue burden on the legal profession.

Applying these factors, the court concluded that the Croker defendants owed a duty of reasonable care to Sickler and Mettenbrink.

“Here, there is substantial evidence that the interests and fates of Steve [Sickler] and Cathy [Mettenbrink] are indistinguishable from those of B&F,” the court said. Because the interests of the entity and its owners were practically indistinguishable, the court continued, the owners clearly were intended beneficiaries of Kirby's representation of B&F.

The court found analytical support in Detter v. Schreiber, 610 N.W.2d 13, 16 Law. Man. Prof. Conduct 228 (Neb. 2000), which held that an attorney who did legal work for a small, closely held corporation had a conflict of interest that prevented him from representing one shareholder in a lawsuit against the other regarding corporate management and financial issues.

“In the instance of closely held corporations, it seems clear that the financial well-being of the directors, officers, and owners of the corporation is usually inseparable from the interests and fate of the corporation,” the court observed.

Economic Terminus

The franchising snafu “effectively meant the death of B&F,” the court said. If proven, the plaintiffs' evidence indicates that “a cascading series of events, all related to the defective franchising documents, combined to ruin what had started as a successful franchising business,” Sievers stated.

Sickler and Mettenbrink were exposed to a variety of adverse legal actions, the court said, which included repayment to complaining franchisees of franchise fees, attorneys' fees, and damages. Even the damages assessed exclusively against B&F also harmed the owners, it added, in that they jeopardized the company's future prospects.

It may be that some of the damages Sickler and Mettenbrink experienced are solely attributable to Orr and his firm, the court said. But there is evidence, it added, that some of those damages could have been avoided or mitigated had Kirby advised the owners to stop all franchising activity once the document problems were identified, to seek the advice of an experienced malpractice attorney, or to join Orr in the lawsuit as a responsible third-party defendant.

Richard J. Rensch and Sean P. Rensch of Rensch & Rensch Law, Omaha, Neb., represented Sickler and Mettenbrink. Kirby and Croker Huck were represented by William R. Johnson of Lamson, Dugan & Murray, Omaha, and Raymond E. Walden of Walden Law Office, Omaha.

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