Judge Pauley NYLJ/Rick Kopstein

A Manhattan federal judge has refused to dismiss a $10 million legal malpractice suit against Seward & Kissel, finding that under the firm’s broad terms in an engagement letter, its lawyers might have been expected to conduct due diligence on a party in a deal.

Seward had represented Mitchell Barack in selling his lighting business to ForceField Energy Inc., shortly before ForceField’s chairman was arrested and the company delisted from public trading.

Ruling on a motion to dismiss in a 2016 legal malpractice case brought by Barack, U.S. District Judge William Pauley III of the Southern District of New York said on Tuesday that Seward “may have had a duty to conduct due diligence on ForceField.”

Pauley said that Barack’s complaint “plausibly alleges” that Seward & Kissel’s conduct fell below the ordinary and reasonable skill possessed by a member of the legal profession “by neglecting to perform any due diligence on ForceField or even communicate with Barack about the amount of due diligence it could or should perform.”

The case, like several other recent disputes between firms and ex-clients, focuses on engagement letter terms, highlighting the importance of including precise language in the letters.

Barack was the founder and sole owner of ESCO Energy Services Company Inc., in the business of energy efficiency upgrades and lighting retrofit projects. Barack sought a buyer for his business and eventually signed in July 2014 a letter of intent to sell ESCO to ForceField. Under the terms, Barack would receive a total minimum purchase consideration of $7.5 million, including $2.5 million in cash, $2.5 million in a deferred payment note collateralized by ForceField’s restricted common stock, and $2.5 million in ForceField’s restricted common stock.

The letter of intent’s terms included a provision permitting—but not requiring—each party to “conduct a thorough due diligence examination” of the other party.

On the same day, Barack, ESCO and Seward & Kissel signed an engagement letter that described the scope of Seward’s work as representation of the client as “lead transaction counsel” in the proposed sale of the client’s stock to ForceField and related agreements and documents.

While Seward & Kissel conducted due diligence on ESCO, it did none for ForceField, nor did it discuss with Barack what due diligence it could, would or should do on ForceField, according to Pauley’s decision.

Less than a week before the transaction closed, ForceField informed Seward that it did not have enough cash to pay Barack the $2.5 million in cash at closing, and instead sought to defer $1.5 million until a later date.

Seward & Kissel advised Barack to proceed with the closing and rely on ForceField’s promise that the remaining $1.5 million would come later, reassuring him that the lack of cash was “routine” and “not unusual,” according to Barack’s complaint.

Roughly six months after the closing, the executive chairman of ForceField’s board of directors, Richard St. Julien, was arrested and charged with securities fraud and conspiracy, and the same day, a securities fraud class action lawsuit was filed against ForceField and senior management.

ForceField’s stock price plummeted, and the SEC suspended the public trading of ForceField’s shares. Ultimately, ForceField delisted itself from public trading.

These events rendered Barack’s restricted stock and deferred payment notes worthless.

As a result, Barack, represented by Seward, bought back ESCO at a “fire sale” price of $900,000 on July 1, 2015, and resold it to another buyer for $1 million—a fraction of the $7.5 million originally negotiated.

In all, Seward charged Barack $150,000 for its services.

In his complaint, Barack alleges that if Seward had performed due diligence, it would have discovered several publicly available “red flags” related to fraud and financial misconduct by ForceField executives.

Seward argued it cannot be held responsible for advising on the prudence of a business decision, and that because it was retained only to close the sale of ESCO to ForceField, the scope of its representation did not include due diligence on ForceField.

Pauley noted that the scope of Seward’s representation in the engagement letter is “facially broad” and nowhere does the letter explicitly carve out specific due diligence responsibilities, nor define “lead transaction counsel.”

Further, while the letter of intent does not require due diligence to be conducted on ForceField, “it certainly contemplates that ESCO’s attorneys may do so,” and the law firm even reviewed and discussed a draft of the letter of intent, the judge said.

Pauley also found that Barack adequately pleaded causation of his malpractice claim.

Seward argued that its inaction cannot constitute the “but for” cause of Barack’s damages, partly because of Barack’s own knowledge of the red flags about ForceField. But Pauley rejected this argument.

“To the extent that Seward & Kissel suggests that Barack should have investigated publicly available red flags himself, this court rejects any such contention,” Pauley said.

Barack’s attorney, Erwin Shustak of Shustak Reynolds & Partners, did not immediately return an email seeking comment, and neither did Seward & Kissel’s attorney, Jacqueline Rubin of Paul, Weiss, Rifkind, Wharton & Garrison.