Precedent and policy prohibit the assignment of debtors’ legal-malpractice claims to a creditor. That’s what Houston’s 14th Court of Appeals held on July 22 in InLiner Americas Inc., et al. v. MaComb Funding Group .

The case involves three companies sued by a creditor for defaulting on a loan. The companies then signed a security agreement in which they granted MaComb, the creditor, a security interest in certain of their assets, identified as “Collateral” in the agreement. The question before the 14th Court was whether unrelated legal-malpractice claims that the companies brought against attorneys and firms who represented them in a separate patent suit were part of the collateral.

The 14th Court panel concluded that the malpractice claims were not assignable and thereby not “collateral,” as the parties had defined the term in the security agreement the debtors had signed. The panel further concluded that funds from the settlement of the malpractice claims are not the proceeds of such collateral.

Reversing the trial court’s judgment in favor of MaComb, the 14th Court rendered a declaratory judgment in favor of the debtors, InLiner Americas and InLiner USA, collectively referred to as InLiner in the opinion, and CAT Contracting Inc. Justice Jeff Brown wrote the panel’s opinion, in which Justices Leslie Brock Yates and Charles Seymore joined.

According to the 14th Court’s opinion, InLiner and CAT had appealed the trial court’s judgment, arguing that their legal-mal claims were not assignable because the claims did not constitute “collateral” as contemplated by the security agreement they signed. As further noted in the opinion, MaComb argued that the debtors assigned to MaComb their rights in “all causes of action” and any resulting “proceeds.” Those assignments were part of a general assignment in a commercial setting and did not violate Texas public policy, MaComb argued.

Houston solo Lance Kassab, one of the attorneys representing InLiner and CAT, says, “I’ve always believed you can’t assign a legal-malpractice claim in Texas.”

Kassab contends MaComb is trying to “carve out” an exception to Texas precedent. In 1994′s Zuniga v. Groce, Locke & Hebdon , San Antonio’s 4th Court of Appeals held that an assignment of a legal-malpractice claim arising from litigation is invalid. In 1997′s Vinson & Elkins v. Moran , the 14th Court held that Zuniga prohibits the assignment of all legal-mal claims, regardless of whether they arise from litigation.

Abrams Scott & Bickley partner Barry Abrams of Houston, MaComb’s attorney, says the type of traditional lending situation seen in InLiner does not give rise to a public policy issue. At issue in InLiner , Abrams says, is whether a debtor should be able to keep the proceeds of a legal-mal claim when the debtor has not repaid the creditor. In that situation, “the lender goes unpaid, and the debtor gets a windfall,” he says.

Abrams says McComb will file a petition for review at the Texas Supreme Court.

The Collateral

The 14th Court’s opinion provides the following background: In 1990, Instituform Technologies Inc. sued InLiner and CAT in federal court, alleging patent infringement. On Sept. 30, 1995, the trial court in the patent infringement suit ruled in Instituform’s favor on liability. In August 1997, InLiner and CAT got a secured loan from MaComb and signed a promissory note, agreeing to pay MaComb $1.5 million by July 1, 1999. They also signed a security agreement on the same day, granting MaComb a security interest in certain of their assets, identified as “Collateral,” defined to include “to the maximum extent same are assignable pursuant to the terms thereof,” all “causes of action” and all “products and process of any and all of the foregoing Collateral.” The debtors defaulted on the loan in July 1999. On Aug. 30, 1999, a federal court awarded Instituform $9.5 million in damages in the patent infringement suit.

The background on the case continues as follows: MaComb filed suit on the loan in December 1999. The following month, the parties entered into an agreed interlocutory judgment in which the debtors acknowledged joint and several liability for sums due under the promissory note. To prevent MaComb from executing on the judgment, the parties entered into a Possession, Management and Assignment Agreement (PMA) in June 2000, assigning to MaComb all of the collateral. In 2003, InLiner and CAT sued the attorneys who represented them in the federal patent litigation.

According to a footnote in the 14th Court’s opinion, the defendants in the legal-malpractice suit included “Edward W. Goldstein, Susan K. Knoll, and the firms with which they each have been affiliated: Arnold, White & Durkee, L.L.P.; Arnold, White & Durkee Corp.; Howrey, Simon, Arnold & White, L.L.P.; and Goldstein & Polasek.

Goldstein and Knoll each did not return two telephone calls seeking comment.

Arnold, White & Durkee merged with Howrey & Simon in 2000 to form Howrey Simon Arnold & White. The firm now is known as Howrey. Stephen Cagle, managing partner of the Houston office of Howrey, says, based on the legal-mal settlement, the firm is not permitted to say anything regarding the case.

In 2005, InLiner and CAT filed a declaratory judgment action against MaComb in the legal-malpractice suit, seeking a declaration that MaComb did not acquire their legal-mal claims through the PMA agreement. MaComb filed a counterclaim seeking a declaration that it had acquired the debtors’ legal-mal claims. MaComb and the debtors filed cross-motions for traditional summary judgment. The trial court granted MaComb’s summary judgment motion and denied the debtors’ motion.

In a May 18, 2006, order, the 127th District Court found that the debtors’ assignment to MaComb of their rights in all causes of action and any resulting proceeds “was part of a general assignment in a commercial setting and transaction.” The district court further found that the assignment to MaComb “does not violate Texas public policy and is enforceable.”

According to the 14th Court’s opinion, InLiner and CAT subsequently settled their claims against the legal-mal defendants. Kassab says the settlement is confidential.

The 127th District Court signed the final judgment in the underlying suit on March 26, 2008. InLiner and CAT then appealed.

In the 14th Court’s opinion, Brown wrote that “under the unambiguous terms of the parties’ agreements, the debtors’ legal-malpractice claims are among the causes of action conveyed to MaComb ‘to the maximum extent same are assignable.’ ” However, citing Zuniga , Brown also wrote, “In Texas, assignments of legal-malpractice claims arising from litigation generally are invalid.”

As noted in the 14th Court’s opinion, MaComb argued that the assignment of a legal-mal claim is unenforceable only if it violates public policy by requiring “a duplicitous change in the positions taken by the parties” in the underlying litigation. [See the court's opinion.]

That is just one of several public policy concerns about allowing the assignment of legal-mal claims, according to the opinion. Brown wrote that such assignments could lead to commercial marketing of claims, substitution of a malpractice claim for a claim against an insolvent defendant, discouragement of voluntary settlement agreements, compromise of client confidentiality and weakening of the attorney’s duty of loyalty.

Ann Graham, a Texas Tech University School of Law professor who teaches banking and commercial law but who is not involved in InLiner , says she is persuaded by the 14th Court’s analysis of the public policy reasons for not allowing assignment of legal-mal claims.

“A legal-malpractice claim does involve attorney-client privilege issues, confidentiality of a client. . . . It’s just a very special area,” Graham says.

Graham also agrees with the 14th Court that allowing the assignment of legal-mal claims could lead to commercial marketing of such claims.

“You don’t want unrelated parties purchasing claims against lawyers,” she says. “It would undermine the sanctity of the attorney-client relationship.”

Graham says the opinion in InLiner reinforces public policy about the attorney-client relationship. “The attorney-client relationship is between the attorney and the client, not some third party,” she says.

Mary Alice Robbins is on Twitter at www.twitter.com/maryarobbins.