Anthony E. Davis
Anthony E. Davis ()

This article explores a subject that is only tangentially related to the Rules of Professional Conduct (unless a conflict of interest is involved), but which is central and critical to lawyers’ and law firms’ professional and business interests: What information about a new client does a lawyer need to obtain in order to make sensible decisions about whether or not to proceed? Two recent cases, one from New York and one from the U.K., have important lessons for lawyers, wherever they practice.

‘P&P Property’

In reviewing the English case, P&P Property v. Owen White & Catlin, 2016 WL 05484797 (UK High Ct. of Justice, Chancery Div. 2016), it is important to note that English lawyers operate within a regulatory framework that requires them to undertake detailed “know your client” investigations about prospective clients, based on U.K. anti-money laundering (AML) laws. In addition, if lawyers find that a prospective client may be seeking assistance to violate the AML laws, they are required to report their suspicions to the authorities—without regard to attorney-client confidentiality.

The Case: The purchaser of a London property sued the seller’s attorneys after a fraudulent real estate transaction fell apart, alleging breach of warranty of authority, negligence and breach of trust and undertaking. The seller’s attorney was contacted by the purported owner of unoccupied real property in London to sell the property. The seller contacted the attorney from Dubai, claiming that he, as seller, needed cash on an urgent basis to purchase a property in Dubai.

The attorney and seller met in person at the law firm’s office in London. The seller presented a passport which the attorney later claimed contained a good likeness of the seller. To comply with the U.K. AML regulations, the law firm arranged for an anti-money laundering search for the seller , which came back marked as “referred”—meaning that further inquiry about the seller was required. The attorney requested and obtained additional information from the seller to confirm his identity and address, including bank statements and the completion of documents by a local Dubai solicitor all of which appeared to confirm the seller’s identity.

The sale closed and the purchase price was sent to the law firm to be held on behalf of the seller. Following the seller’s instruction, the funds were then transferred from the law firm’s account to the seller’s bank account in Dubai. The purchaser then began to repair and renovate property, but the true owner of the property turned up and accused the purchaser of trespass. It was only then recognized that a fraud had occurred, and the purported seller could not be located.

The purchaser claimed that the law firm was liable for breach of warranty of authority, in that through words and conduct, the firm represented that it had authority to act for the true owner of the property. In reliance upon those warranties of authority, the purchaser agreed to purchase the property. The court disagreed, concluding that the law firm could only be held to have acted upon authority conferred by its client—the fraudulent owner—and no warranty was implied that the firm also had the authority of the property’s true owner.

The purchaser further claimed that because it relied upon the representations and actions of the law firm, a duty of care should be imposed even though it had not been a client. The court concluded that absent special circumstances, attorneys in real estate conveyancing transactions are to be understood as acting on the instructions of their client when making representations, and could not be taken to be making a representation of the bona fides of ownership.

Consequently, the court concluded that the law firm had no duty to the purchaser to take reasonable care to ascertain the identity of the seller or to ensure that it was the true owner of the property. That duty fell to the purchaser’s own counsel, who did not independently confirm seller’s identity and instead relied upon his belief that seller’s attorneys would have carried out identity checks.

The purchaser’s final claims—breach of trust and breach of undertaking (a written stipulation between lawyers)—were based upon its allegations that the law firm received the sale proceeds in trust and the proceeds were distributed to the seller in breach of that trust. The law firm contended that the funds were not held in trust for the purchaser, or if they were, the terms of the trust were not breached. The court found that the funds were held by the law firm as agent for the seller, and the firm had been authorized by the purchaser’s attorney to release the funds upon his confirmation of completion of the sale.

Analysis

Several conclusions jump out from this case. First, if the firm had actually violated its “know your client” duties under the AML laws, the outcome might well have been different. Second, a more thorough investigation would have avoided long and costly litigation, and harm to its reputation.

Another all-too-familiar aspect of the matter also stands out: The prospective client was in a hurry. It is critical that firms avoid shortcutting whatever level of due diligence they ordinarily undertake in order to confirm the client’s identity and the facts surrounding the transaction. This is particularly vital where the client is in another jurisdiction or country and the bulk of communications occur via email or telephone with little in-person contact.

‘Exeter Law Group’

In the United States, the absence of “know your clients” rules does not negate the need for lawyers and firms to undertake serious enquiry about the bona fides of prospective clients before beginning to engage in substantive conversations with them.

In Exeter Law Group v. Wong, 2016 NY Slip Op 32425(U), 12/9/ 2016, Supreme Court, New York County, the issue was different: What does a lawyer or law firm need to do to establish who is (and is not) the client in the matter.

The Case: Two individuals engaged a law firm to assist with transactions involving two corporations in which the individuals held shares. The law firm eventually sued both its clients (the individuals) and the corporations to recover fees. The clients and corporations asserted counterclaims in response, including claims for legal malpractice and breach of fiduciary duty. The firm moved to dismiss the counterclaims.

The firm argued the shareholders had no standing to bring a direct action for legal malpractice for injuries allegedly suffered by the corporations. The firm also argued that the corporations lacked standing to bring a legal malpractice claim because neither corporation engaged the firm and no privity existed.

The court permitted the claims of both the shareholders and the corporations to proceed to trial. The court explained that to the extent that the shareholders were bringing claims as individuals who were harmed when they relied on alleged negligent representations in structuring their business ventures, they could state a claim for legal malpractice. With respect to the corporations’ claims, the lack of a retainer agreement was not dispositive on the issue of whether there was an attorney-client relationship. Further, the court found it significant that the firm had asserted claims against the corporations to recover fees.

As to the breach of fiduciary duty claim, the shareholders and corporations argued the firm and one of its attorneys disclosed confidential and privileged information to another attorney outside the firm in order to coerce payment to the firm. The firm and attorney moved to dismiss on the grounds that the engagement letter explicitly authorized the firm to confer with the outside attorney. In addition, they argued the claim should be dismissed because New York Rule of Professional Conduct (NYRPC) 1.6(b)(4) and 1.6(b)(5)(ii) authorized them to reveal client confidences in consulting with other lawyers. Finally, they argued that there is no private right of action for a violation of the NYRPC.

The court permitted the fiduciary breach claim to proceed to trial as well. The court found that, although the engagement letter might have permitted the attorney and firm to consult with the outside lawyer on certain matters, it did not “flatly contradict” the shareholder’s allegations that this lawyer may have disclosed confidential communications without authorization. Further, the court explained that the alleged coercive nature of the communication may rise to the level of a breach of a fiduciary duty. Finally, the court determined that a claim for breach of fiduciary duty can be stated where the defendant lawyer is alleged to have used confidential information to disadvantage a former client.

Analysis

This case underscores the critical importance of specificity in engagement agreements. Had the agreement specified who was and was not the client, the corporations’ claims would likely have been dismissed. The breach of fiduciary duty claim might well also have been disposed of had the agreement detailed what information counsel was authorized to disclose. Finally, the decision highlights the danger of suing non-clients for fees. Doing so may imply that specific tasks were undertaken for the benefit of the non-client and permit the non-client to state claims notwithstanding the fact that it was never a party to the engagement agreement.

Conclusion

The bottom line question for every lawyer and law firm is: Do you have explicit “know your client” policies and procedures in place that are sufficient to protect you from involvement in illegal activities, or from being drawn into reputation-threatening litigation—or from simply not getting paid for your services?