Lawyers Who Helped Set Up Investment LLPs Owed No Duty to Investors Under Any Theory

The ABA/BNA Lawyers’ Manual on Professional Conduct™ is a trusted resource that helps attorneys understand cases and decisions that directly impacts their work, practice ethically, and...

By Joan C. Rogers  

 

Statements made by a speaker at an investment seminar that lawyers retained to create the business entities “represent you [investors] as well” did not create any duty of care that would make the lawyers liable for the investors' losses when the venture ultimately went broke, the U.S. Court of Appeals for the Seventh Circuit held Aug. 16 (Rosenbaum v. White, 7th Cir., No. 11-3224, 8/16/12).

Speaking through Judge Daniel A. Manion, the court held that the lawyers did not have even an implied attorney-client relationship with the investors--as needed to prove malpractice or constructive fraud--merely because one of the lawyers attended the seminar and briefly described their prospective role in setting up two companies for the potential venture, or because the architect of the investment plan told attendees that the attorneys “are working for you just like they are working for me.”

Nor did the lawyers owe the investors any legal duty under the Indiana Rules of Professional Conduct, the court stated. The court also held that:

• the attorneys were not liable for securities fraud on the theory that the lawyer who attended the seminar failed to speak up to dispel any misimpressions;

• they were not liable for actual fraud where the lawyer's comments at the seminar related solely to future events; and

• the lawyers were not liable for civil conspiracy where they used nothing but proper means to accomplish the lawful purpose of forming entities for the investment plan.

 

Have Losses, Will Sue.

Chad Seybold, a securities broker who had become a real estate investor, created a plan to enlist other individuals in a venture that would buy, rehabilitate, and then sell or refinance and rent residential and commercial properties in Marion, Ind. The plan involved the creation of two limited liability companies, one of which would be partially owned by a group of private investors.

Seybold contacted attorney Beau Jack White to form the entities, and White brought in a senior partner in his law firm, James Beaman, who was more versed in that area of law.

Seybold held an investment seminar to pitch the idea to a group of potential investors. At the meeting, which White attended, Seybold discussed the plan at length and asked White whether he would like “to add anything on the creation of the company.”

In a presentation that lasted about seven minutes, White explained that, by structuring the investors' company as an LLC, the investors would be insulated from personal liability in the event of a lawsuit against the company.

White also said that he and his firm were looking into how to avoid certain securities law issues that might arise from the creation of the LLCs. In addition, he noted that concerns about preventing conflicts of interest with Seybold's other companies could be addressed in the LLC's operating agreement.

Following White's remarks, Seybold told the potential investors that the attorneys represented the investment entity rather than Seybold personally, and “[t]hat means they represent you as well.” Seybold also said he too would be a part owner of the company, so that the attorneys “are working for you just like they are working for me.” White stood next to Seybold during these comments and did not attempt to clarify or correct them, Manion said.

Beaman drafted articles of organization and operating agreements for the two entities, along with a loan agreement and a promissory note for one of the LLCs to borrow funds. Investors put more than $1 million into Seybold's venture. Not much more than a year later, Seybold informed the investors that due to the downturn in the real estate market their investments were gone and that he was filing for bankruptcy.


“Although the Rules may form a standard of conduct by which a lawyer's duty can be measured, such a duty must arise from common law and may not be predicated on the Rules themselves.”
Judge Daniel A. Manion

Believing that Seybold had bilked them out of their money, the investors filed suit in federal court for the Northern District of Indiana against him and others, including the attorneys. Eventually the complaint was whittled down, leaving White, Beaman, and the law firm as the remaining defendants. After the trial court granted the defendants' motion for summary judgment, the plaintiffs appealed.

The court of appeals agreed with the district court that the plaintiffs had not established a cause of action against the attorneys on any of the theories they asserted: malpractice, fraud, securities law violations, or conspiracy.

No Attorney-Client Relationship.

The lawyers could not be liable to the investors for malpractice or constructive fraud, the court held, because they did not have an attorney-client relationship with the investors, and therefore did not owe them any duty.

Although the plaintiffs claimed that they relied on the fact that the attorneys were representing each of them individually when they decided to invest in Seybold's plan, Manion pointed out that most of the plaintiffs never met the lawyers; those that did, he said, had only limited interaction with them.

The testimony of those who met the attorneys “reflects a common understanding that the attorneys were hired to represent the investors collectively and for the purpose of forming the companies involved in the investment plan,” he said.

As for White's comments at the seminar, the court said he merely described the exact purpose for which he and the law firm had been hired--to structure the LLCs in the most economically fair and efficient way possible. “No investor could have reasonably believed that the defendants would be professionally involved with the plan past the point of the LLCs' formation,” Manion said.

The court also found Seybold's remarks at the meeting insufficient to imply an attorney-client relationship between the attorneys and the investors. It was clear in context, Manion said, that Seybold's statements were intended to provide assurance that the attorneys were hired to represent the two new LLCs during their formation. “None of the potential investors could have reasonably believed that Seybold's monologue provided each of them with a personal attorney-client relationship for the indefinite future,” he declared.

The court also emphasized that the operating agreement for the investors' LLC contained a disclaimer that should have alerted a reasonable investor to the fact that the lawyers were not representing them personally.

Rules Don't Create Legal Duty.

The plaintiffs also asserted that even if no attorney-client relationship existed, the defendants still owed them a duty under Indiana's Rules of Professional Conduct. In particular, they cited Rule 4.3, which specifies a lawyer's responsibilities in dealing with unrepresented persons on a client's behalf. It provides that when a lawyer realizes or should realize that the unrepresented person misunderstands the lawyer's role, the lawyer must make reasonable efforts to correct the misunderstanding.

The court found it unnecessary to delve into this theory, however, after finding it “quite clear that the Indiana Rules do not create a legal duty.” The Preamble to the ethics rules makes clear, Manion explained, that the professional conduct standards do not purport to create or describe any civil liability.

“Although the Rules may form a standard of conduct by which a lawyer's duty can be measured, such a duty must arise from common law and may not be predicated on the Rules themselves,” the court stated. Absent any such duty to the plaintiffs, it concluded, the plaintiffs' malpractice and constructive law claims failed.

No Fraud.

The attorneys' lack of duty to the plaintiffs was also fatal to their claims for securities fraud, the court decided.

The investors premised their securities fraud claims on White's silence during Seybold's remarks at the seminar in which he assured the potential investors that the attorneys “are working for you just like they are working for me.” They also argued that White should have disclosed his inexperience with business and securities law during his own comments at the seminar. White's silence led them to forgo obtaining independent legal counsel before deciding to invest, the plaintiffs claimed.

The court observed that in the context of securities law, an alleged omission cannot be fraudulent absent a duty to speak, and that such a duty comes from a fiduciary relationship established by state law. Because no such relationship existed between the attorneys and the investors, White had no duty to respond to Seybold's statements and any omission on his part was not fraudulent, Manion said.

Nor did the unhappy investors have any success on their claim for actual fraud based on the statements made at the investment seminar about future events. Under Indiana case law, Manion explained, actual fraud may not be grounded upon representations about future conduct, broken promises, or statements of existing intent that are not fulfilled.

The court said that the main topic of conversation at the seminar--the formation and structure of the LLCs--was hypothetical because none of the investors had yet decided whether to invest in Seybold's plan. His statements about the attorneys' role and White's comments at the meeting necessarily concerned future conduct or were representations of intent that were not yet executed, Manion said.

No Conspiracy.

The court also held that the lawyers could not be held liable for civil conspiracy, as the plaintiffs did not provide any evidence that the lawyers acted in concert with Seybold to commit an unlawful act or to accomplish a lawful purpose through unlawful means. The lawyers merely performed lawful work for the lawful purpose of forming limited liability companies for Seybold's investment plan, the court said.

The court emphasized that the attorneys' work was completed two months before the plaintiffs made their investments. As the lawyers performed no further services for Seybold or the LLCs, the plaintiffs cannot succeed on their conspiracy cause of action, it declared.

P. Adam Davis of Davis & Sarbinoff, Indianapolis, argued for the plaintiffs. Philip E. Kalamaros of Hunt Suedhoff Kalamaros, of St. Joseph, Mich., and South Bend, Ind., argued for the lawyers.


Full text at http://op.bna.com/mopc.nsf/r?Open=kswn-8x8qjz.

The ABA/BNA Lawyers’ Manual on Professional Conduct is a joint publication of the American Bar Association Center for Professional Responsibility and Bloomberg BNA.

Copyright 2012, the American Bar Association and The Bureau of National Affairs, Inc. All Rights Reserved.