In Tough Times, Look Out for Legal Malpractice Claims

Jett Hanna

03-13-2009

Economic downturns often increase the risk that lawyers will face unhappy clients complaining of legal malpractice. While some lawyers may think they have nothing to fear since their practices do not involve areas of law many blame for the economic collapse, such a belief is unfounded. Some legal malpractice risks are not tied to any one specialized practice area but simply become more common when the economy goes bad.

Trouble sometimes arises because scenarios lawyers did not consider occur, or difficult economic circumstances test tough-to-draft language. Similarly, insignificant conflicts of interest -- either between the lawyer and the client or between clients in multiple representation situations -- take on heightened importance as clients face difficult financial circumstances.

Clients, desperate to stay afloat, may be more inclined to sue their lawyers, taking a chance that malpractice litigation will solve their financial problems. Lawyers, too, are more likely to sue clients for fees in a recession. Since legal malpractice is a mandatory counterclaim to a suit for fees, clients often elect to pursue a legal malpractice counterclaim rather than lose their opportunity to do so.

Some legal malpractice issues are simply an inevitable outcome of activity occurring more frequently in a bad economy. A spike in the number of foreclosures often means more people are unhappy with related legal services. People often sue lawyers who act as trustees in foreclosures, alleging failure to conduct the sale in a proper manner, though the more likely scenario is a suit to enjoin foreclosure.

As collection activities rise, more people will seek relief under the Fair Debt Collection Practices Act. Various state and federal fair debt collection practices laws may apply to lawyers involved in collection activities, including foreclosures and collection litigation, so all such lawyers should understand and abide by these laws' requirements if there is any doubt as to their application.

Lawyers, regardless of specialty, are more likely to have to consider the application of bankruptcy law and related issues applicable to insolvent adversaries in a tough economy. Failure to warn a client of the potential application of voidable preferences easily can trip up attorneys. Lawyers are sometimes sued for failing to make sure that a bankruptcy trustee completes the actions necessary for clients not in bankruptcy to consummate deals with debtors. Any time a lawyer is dealing with an adversary in bankruptcy, understanding the bankruptcy angles is critical.

Fraudulent transfers are another source of problems for lawyers. When a party or a client enters into a transaction with the intent to delay or hinder creditors, a lawyer may be liable directly to creditors. For example, if a lawyer holds funds for a client to avoid a creditor's finding them, the lawyer may have to surrender the funds held for the client together with any legal fees paid by the client from escrowed funds. Clients sometimes sue lawyers when the lawyer fails to recognize a fraudulent transfer that was not intentional. For example, cancellation of a lease might be considered a fraudulent transfer if the residual leasehold interest was valuable. Knowledge of fraudulent transfer law is critical during bad economic times.

RISKY INSOLVENCY

Insolvent clients often pose malpractice risks for lawyers. When a client becomes insolvent, it is common for management, shareholders, partners and bankruptcy trustees to scrutinize transactions affecting the financial condition. The client itself or its bankruptcy trustee may consider litigation if the lawyer had a conflict or if the advice given appears, in retrospect, to have been in error. Significant decisions about representation made without consulting upper management or the board of directors also can spell trouble for attorneys.

Insolvent clients may have fiduciary duties to creditors and shareholders, and lawyers can be subject to suits for aiding and abetting breach of such fiduciary duties. The 5th Court of Appeals in Dallas, Texas, held in 2007's Kastner v. Jenkens & Gilchrist that, generally, only knowing aiding and abetting of breach of fiduciary duty by a lawyer will result in liability. In a securities fraud context, the U.S. Supreme Court held in 2008's Stoneridge v. Scientific Atlanta that lawyers may face liability for directly making false statements to others but generally are not liable for innocent participation in what proves to be a fraudulent scheme.

Angry clients and creditors can do tremendous damage to lawyers in the aftermath of spectacular business failures. As a result, lawyers should carefully consider whether to continue to deal with clients who may be facing insolvency. Lawyers should evaluate whether a significant transaction for a shaky client stands a good chance of actually saving the company. If not, the deal papered by the lawyer may be seen as a cause of the client's collapse.

Litigators are not immune from these worries during hard times. Litigation usually increases in a bad economy. A lawyer may do his or her best work in getting a result where the client loses less than it would have lost otherwise. Unfortunately, it is often difficult to convince a jury that the lawyer did a good job when the client loses.

To avoid fallout from bad results in litigation, lawyers should follow several steps. If a client is not doing what it needs to do, such as responding to discovery in a timely manner, or is not following the lawyer's advice, the lawyer should consider withdrawing if he or she can do so without prejudicing the client's case. Give the client an assessment of the case that includes the risks and potential rewards, preferably in writing. Documenting case evaluation can help protect lawyers when a client interprets a better-than-expected result as a loss.

Jett Hanna is a senior vice president at Texas Lawyers' Insurance Exchange. His duties have included supervision of lawyers' and judges' professional liability claims, underwriting, loss prevention and computer operations. He is a member of the State Bar of Texas, a registered professional liability underwriter and an adjunct professor at the University of Texas School of Law.