Legal Counsel Fails To Disclose Loan Modification Before Transaction

John Lomicky

Written by
— Updated on January 6, 2022

Legal Malpractice Expert

This case involves a legal malpractice claim alleging that the defendant in question engaged in professional negligence when he handed a large transaction dealt with the plaintiff, a principal of the company being sold. The plaintiff was 50% owner of 3 companies being sold at $120 million. In the sale, the buyer proposed a $5 million loan be included as part of the sale for a subsidiary of their company. The defendants advised $2.5 million would be more reasonable and noted in the paperwork that this would be withheld from the payment to the plaintiff. The transaction ended up being held in a remote location and only the signature pages were exchanged. While this is a common practice in the industry, the plaintiff was not given access to the full agreement or promissory note during this time. The plaintiff was not made aware of the $2.5 million loan until the first payment was received. Shortly after the first payment was received, the subsidiary defaulted. While the defendants were handling the transaction on behalf of the plaintiff’s companies and not the plaintiff individually, it was alleged that there was a duty to the plaintiff to disclose this agreement and that the was a breach in the standard of care in how the agreement was managed. An expert in transactional law was sought to give an opinion on the whether or not the defendants engaged in legal malpractice.

Question(s) For Expert Witness

  • 1. Based on your transactional law experience, please describe your initial thoughts regarding the fact pattern above.
  • 2. Did the defendants in question engage in legal malpractice? Please explain.

Expert Witness Response E-157366

It seems unbelievable that the 50% owner of the 3 entities being sold was not made aware of the evolution of the pending transaction, but frankly, that is most likely the fault of the officers and directors of the 3 entities, and not the engaged law firm. There appear to be some substantial factual holes in the summary narrative of the pending malpractice action. Here are my assumptions and questions:

While the plaintiff is a 50% shareholder of each of the 3 entities to be sold, my assumption is that he was neither an executive officer nor a director of any one or more of the 3 entities. If, however, he was, then most likely in his capacity as an executive officer, and clearly in his capacity as a director, he should have been provided with complete and up-to-date drafts of the purchase and sale agreement, and should have been well aware of the 11th hour $2.5 million modification prior to being provided with just the signature pages of the Seller to execute and return. But the question is who should have provided him with such documents?

The sale of the 3 businesses to a new buyer, clearly outside the ordinary course business of such entities, would (in every jurisdiction of which I am aware) require shareholder approval of such sale transaction, which would require that the officers and directors of the three companies provide all shareholders including the Plaintiff with all of the relevant documentation detailing the proposed sale. And that would include this apparent 11th hour negotiated change to reduce the net proceeds by $2.5 million to fund the loan from the Seller(s) to a subsidiary of the Buyer. So clearly the board of directors would need to take all steps necessary to ensure that all shareholders had all of the current information on the sale before asking them to ink the purchase and sale contract.

The defendant law firm was presumably engaged by the officers of the 3 companies perhaps by their in-house counsel if they had a chief legal officer, which engagement would likely have been ratified by such entities’ board of directors. The plaintiff clearly had no direct contractual relationship with the engaged law firm. But what was the communication dynamic from day 1 between the officer(s) or otherwise-designated point persons of the 3 companies to be sold, and the law firm engaged to complete the negotiations and documents required to evidence such sale?

Usually, the very first thing covered in a formal engagement agreement between counsel and the client is the identification of the client, which can oftentimes be the entity(s) and the principals of the entity(s), jointly and severally. In the engagement agreement, who was reflected as the client, whether singularly or collectively? What did the formal engagement provide, if anything, with respect to communications between the firm and the client(s)? If no point person or persons were identified in the engagement agreement, then what was the course of dealing between the law firm and the three company clients? Was there ever a written or verifiable oral directive from the client companies to the law firm to include the plaintiff in its updates and communications regarding the negotiations and status of the pending transactions? Essentially, was the plaintiff involved or at least included in the communication trail from the engaged law firm to the three companies that apparently collectively constituted the clients?

Your summary indicated that the defendants advised $2.5 million would be more reasonable and noted in the paperwork that this would be withheld from the payment to the plaintiff. This statement implies multiple defendants. Were these individual attorneys who worked the deal as well as the firm itself? Who specifically did the defendants advise? My assumption is that the defendant law firm certainly did not make the decision to turn $2.5 million in sale proceeds into a loan given from one or more of the three companies to a subsidiary of the Buyer. Who made that decision?

Did the plaintiff ever receive a complete copy of the purchase and sale agreement, either before or after the 11th-hour modification which effectively reduced the purchase price by $2.5 million? The plaintiff was certainly on inquiry notice of the pending sale. Did he ever make specific inquiries regarding the form and content of the purchase and sale agreement or take reasonable steps to ensure that he had been provided up to date information about the pending transaction?

Assuming that the plaintiff was not kept up to date by the officers and directors of the 3 entities, then my guess is that the plaintiff has a valid claim against one or more of the officers or directors who were involved with authorizing the 11th hour modification which effectively reduced the price by $2.5 million, at least upon the default by the Buyer’s subsidiary. My guess is that the plaintiff figures the law firm’s professional liability policy may be the only deep pocket from which to recover his effective loss of $1.25 million. Absent additional facts which would create the obligation on the part of the law firm to specifically keep the plaintiff directly apprised of the evolving negotiations in this sale transaction, I believe the plaintiff will have an extremely difficult time in showing that the law firm owed a specific duty to the individual shareholder of the 3 entity clients to ensure that such individual had knowledge and approval of the final terms of the purchase and sale transaction.

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