In a case of first impression, a New Jersey appeals court has cleared the way for punitive damages to be based on fees awarded in a legal malpractice case.

The Appellate Division, in an Aug. 16 published ruling, called "meritless" the defense argument that counsel fees in a legal malpractice action are not compensatory damages on which punitive damages can be predicated.

Nevertheless, the panel in Kaye v. Rosefielde struck down a $250,000 punitive damages award because it had vacated the underlying $717,000 fee award.

The case was brought against Alan Rosefielde, a New York attorney who was paid $500,000 per year as chief operating officer and general counsel of Flagship Resort Condominiums, a time-share company.

Bruce Kaye, the company's chief executive officer, asserted that Rosefielde — who had set up three entities that gave him partial ownership in two of Kaye's businesses — engaged in unethical machinations and fraudulent transactions to enrich himself at Kaye's expense. He sought rescission of Rosefielde's interests.

Rosefielde counterclaimed for breach of contract and violation of the whistleblower statute.

After an Atlantic County bench trial in 2007, Superior Court Judge William Nugent ruled almost entirely in Kaye's favor, finding malpractice, fraud and breach of fiduciary duty by Rosefielde and granting the requested rescissions.

Nugent also found that Rosefielde violated conflict of interest rules in arranging to buy out the interest of one of Kaye's business partners, also one of his clients, then transferring that interest to one of his own entities.

Nugent rejected contentions that Rule of Professional Conduct 1.8 does not apply to in-house counsel and that Rosefielde was acting as a businessman rather than a lawyer and was thus covered by the business judgment rule.

The only compensatory damages awarded, however, were $4,000 that Rosefielde had charged to the company for a junket to Las Vegas, plus legal fees on the malpractice claim under Saffer v. Willoughby, 143 N.J. 256 (1996).

Jacobs & Barbone of Atlantic City, which represented Kaye, was awarded 75 percent of the $1.03 million it requested, or $803,190.

From that amount, Nugent deducted 10 percent because Rosefielde successfully defended part of the malpractice claim alleging that the company was fined $500,000 by the Federal Trade Commission for violating the "Do Not Call" law, and incurred $200,000 in legal fees due to his dereliction, leaving a net fee award of almost $717,000.

The punitive damages were predicated on compensatory damages of $4,000 and $717,000, but the appeals court reversed the fee award because of concern about the relationship between the fees and the actual damage caused by Rosefielde's malpractice.

The panel noted that the claimed value of more than $1 million for Rosefielde's share of the three entities as to which rescission was granted was based on speculation about future sales and any potential economic injury to Kaye was cured by the rescission.

It vacated the fee award and remanded for a recalculation of the fees, leaving only the $4,000 in compensatory damages. But it reversed and remanded on the punitive damages, too, for the trial court to re-examine whether they are warranted.

"In performing this analysis, the court may consider an award of counsel fees based on legal malpractice as compensatory damages," Appellate Division Judges Jose Fuentes, Ronald Graves and Jonathan Harris wrote.

It must also "identify with particularity the conduct that warrants punitive damages," which must not exceed the statutory cap of $350,000 or five times compensatory damages, whichever is greater.

Bennett Wasserman of Davis Saperstein & Salomon in Teaneck, an author and lecturer on legal malpractice, says the court recognized that the award of legal fees is "really not fee shifting at all, but actually an award of compensatory damages incurred by the plaintiff to fix the attorney's damage caused by his malpractice."

He calls the ruling as "a reasonable approach, perhaps even a sensible compromise between an 'all or nothing' approach on the award of counsel fees under Saffer v. Willoughby."

The panel further held the case was not tainted by the conduct of a trial judge, Stephen Perskie, which drew him a censure.

Perskie was censured for not taking himself off the case in light of his ties to a key witness and for visiting the courtroom during trial and speaking with Kaye's lawyer.

Rosefielde had argued that Perskie ruled for Kaye on important motions and that his visits conveyed to Nugent that he had on ongoing interest in the matter.

The appeals court said there was nothing to indicate Perskie's actions affected the outcome, and any possible taint was purged by Nugent's impartiality.

Kaye's lawyer, Edwin Jacobs Jr., says he is pleased that the court upheld Nugent, except for wanting more particularity on how counsel fees were calculated, thus triggering "a do over on punitive damages.

"Math aside, it's a complete affirmance," he says, adding he will go back and re-present his $1 million plus fee claim.

The telephone number listed for Rosefielde's law office with the New York State court system was not working Tuesday and a lawyer listed at the same address said he did not have a number where Rosefielde could be reached.

Rosefielde's attorney, John Connell of Archer & Greiner in Haddonfield, did not return a call. Neither did Perskie, now with Perskie Mairone Brog & Baylinson in Linwood.