[Shareholder Oppression] Liability of attorneys for aiding and abetting breac...
Eric Fryar
Span Enterprises v. Wood, No. 01-07-00364-CV (Tex. App.—Houston [1st Dist.] December 4, 2008). [click here to read opinion]
Triumph Healthcare, LLP was a startup venture seeking investors, and was formed as a limited liability partnership. Triumph reached an agreement with Span to invest $500,000, of which $200,000 would be capital and $300,000 would be a loan. Triumph was represented by attorney Ivan Wood. Triumph consulted with Wood prior to reducing the agreement with Span to writing. Woods suggested that Triumph issue span "Series A preferred partnership units" instead of incurring $300,000 in debt. The idea was proposed to Span, which agreed on the understanding that the $300,000 would be paid back, the preferred units would be converted to common units, and Span would end up with a 10% ownership interest in Triumph. Triumph and Span signed a "Preliminary Agreement" which stated that Triumph would incorporate the terms of the preliminary agreement into the partnership documents. Ultimately, when Wood drew up the final documents, however, he changed the terms to provide that Span's ownership would be diminished as the preferred units were paid off. The change was not disclosed to Span, which signed the final documents, apparently without reading or understanding the changes.
When the $300,000 was paid off and the preferred units were redeemed, Span found itself with a much lower ownership interest than it had agreed to. Span sued Wood for "knowing participation/aiding and abetting" in Triumph 's breach of fiduciary duties. The trial court granted a summary judgment on the grounds that Texas does not recognize a cause of action against an attorney for "aiding and abetting" his client's alleged breach of fiduciary duties. The Court of Appeals affirmed.
The Court of Appeals first held that there was no attorney-client relationship, explicit or implied, between Wood and Span. Word was Triumph's attorney, and the only evidence proffered to establish a duty to Span was the subjective belief of Span's general partner that the statement in the Preliminary Agreement requiring Triumph's attorney to incorporate the terms of the preliminary agreement into the partnership documents created a duty to Span. There was no evidence that this subjective belief was ever communicated to Wood; therefore, the court held that the evidence did not raise a fact issue as to the existence of an attorney-client relationship between Wood and Span. The Court does not address the issue of fiduciary duties between Span and Triumph, but without question Triumph did owe its partner fiduciary duties under Texas law, and these duties would be violated by changing the terms of the partnership interests without disclosure and knowingly taking advantage of the partner's ignorance of the change. The question was whether the partnership's attorney could be held liable individually as the person who effected that change.
The Court of Appeals held that the attorney could not be held personally liable because the attorney's conduct constituted nothing more than providing legal advice to his client: "Texas courts have refused 'to expand Texas law to allow a non-client to bring a cause of action for 'aiding and abetting' a breach of fiduciary duty, based upon the rendition of legal advice to an alleged tortfeasor client.' Alpert v. Crain, Caton & James, P.C., 178 S.W.3d 398, 407 (Tex. App.—Houston [1st Dist.] 2005, pet. denied)." Span argue that Wood's conduct establishing liability was (1) coming up with the scheme of issuing preferred partnership units in lieu of common, (2) failing to advise Span that they should have a lawyer review the final documents, and (3) failing to comply with the preliminary agreement in drawing up the final documents. The court of appeals held that this conduct did not constitute conduct "independent of Wood's representation of Triumph."
As related by the court of appeals opinion, the facts of this case were not very compelling in establishing liability on the lawyer. However, imagine a slightly different scenario (and one that happens all the time). What if a majority shareholder, who manages the business and controls the board of directors, requests that his attorney help him devise a scheme to squeeze out a minority shareholder? The majority shareholder consults counsel to find out how he can accomplish his objective with minimum risk of liability. The lawyer proposes a plan to use the powers and prerogatives the law confers on the majority shareholder to squeeze out the minority. However, the lawyer should know that the very objective of the scheme is a breach of the majority shareholder's fiduciary duties. Every action in the scheme devised by the attorney, even if in other circumstances legal and legitimate, would be undertaken in bad faith and to accomplish an illegal objective. Often the attorney will advise the majority shareholder to do things that are actually illegal—frequently because the attorney is himself ignorant of some aspects of the law governing shareholders' rights or because the attorney believes that the majority can "sell" a legitimate pretext for the conduct. Also, frequently, the lawyer becomes an active participant in the scheme to defraud or oppress the minority shareholders. There are additional issues if the lawyer is the attorney for the corporation and thus may be violating duties he owes to his client or allowing the corporation to pay for services that only benefit the majority shareholder personally, or if the facts establish an implied attorney-client relationship with the minority shareholder.
Should a majority shareholder's attorney be personally liable for devising and implementing a scheme to force a minority shareholder to sell for an unfair price? The majority shareholder's lawyer owes no duty directly to the minority shareholder; however under Texas law, "where a third party knowingly participates in the breach of duty of a fiduciary, such third party becomes a joint tortfeasor with the fiduciary and is liable as such." Kinzbach Tool Co. v. Corbett-Wallace Corp., 160 S.W.2d 509, 514 (Tex. 1942); see also Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d 687, 701 (Tex. App.—Fort Worth 2006, pet. denied); Baty v. ProTech Ins. Agency, 63 S.W.3d 841, 863 (Tex. App.—Houston [14th Dist.] 2001, pet. denied); Cox Tex. Newspapers, L.P., v. Wootten, 59 S.W.3d 717, 721 (Tex. App.—Austin 2001, pet. denied); S.W. Tex. Pathology Assoc., L.L.P., v. Roosth, 27 S.W.3d 204, 208 (Tex. App.—San Antonio 2000, pet. dism'd w.o.j.); Thompson v. Vinson & Elkins, 859 S.W.2d 617, 624 n. 5 (Tex. App.—Houston [1st Dist.] 1993, writ denied); Kirby v. Cruce, 688 S.W.2d 161, 166 (Tex. App.—Dallas 1985, writ ref'd n.r.e.). Furthermore, instigating, aiding, or abetting the wrongdoing constitutes participation. Cotten v. Weatherford Bancshares, Inc., 187 S.W.3d at 701; Pabich v. Kellar, 71 S.W.3d 500, 508 (Tex. App.—Fort Worth 2002, pet. denied); Portlock v. Perry, 852 S.W.2d 578, 582 (Tex. App.—Dallas 1993, writ denied).
On the other hand, there are equally strong public policies in Texas to limit an attorney's liability to third parties for zealously advocating his client's interest. At common law, the rule of privity limits an attorney's liability to those in privity with the attorney. McCamish, Martin, Brown & Loeffler v. Appling Interests, 991 S.W.2d 787, 792 (Tex. 1999). A lawyer is authorized to practice his profession, to advise his clients, and to interpose any defense or supposed defense, without making himself liable for damages. Morris v. Bailey, 398 S.W.2d 946 (Tex. Civ. App.—Austin 1966, writ ref'd n.r.e.); Kruegel v. Murphy, 126 S.W. 343, 345 (Tex. Civ. App. 1910, writ ref'd). Therefore, an attorney in Texas cannot be liable to non-client third parties for legal malpractice. McCamish, Martin, Brown & Loeffler v. Appling Interests, 991 S.W.2d at 792; see also Barcelo v. Elliott, 923 S.W.2d 575, 577 (Tex. 1996). Moreover, Texas courts recognize a "qualified immunity" that protects attorneys from liability to third parties who are injured as a result of the attorney's performance of his professional duties, particularly in the course of litigation. See Alpert v. Crain, Caton & James, P.C., 178 S.W.3d 398, 405-06 (Tex. App.—Houston (1st Dist.) 2005, pet. denied); Butler v. Lilly, 533 S.W.2d 130, 131-34 (Tex. App.—Houston [1st Dist.] 1976, writ dism'd). This qualified immunity generally applies even if conduct is wrongful in the context of the underlying lawsuit. Renfroe v. Jones & Assocs., 947 S.W.2d 285, 288 (Tex. App.—Fort Worth 1997, writ denied) ("Under Texas law, attorneys cannot be held liable for wrongful litigation conduct."). Thus, an attorney's conduct, even if frivolous or without merit, is not independently actionable if the conduct is part of the discharge of the lawyer's duties in representing his or her client. Alpert v. Crain, Caton & James P.C., 178 S.W.3d at 406; Chapman Children's Trust v. Porter & Hedges, L.L.P., 32 S.W.3d 429, 441 (Tex. App.—Houston [14th Dist.] 2000, pet. denied).
Exception exists to the rules protecting attorneys. If an independent duty to the non-client exists, "based on the professional [attorney's] manifest awareness of the non-client's reliance on the misrepresentation and the professional's intention that the non-client so rely," then an attorney may be liable for negligent or fraudulent misrepresentation. See McCamish, 991 S.W.2d at 792 (allowing a cause of action for negligent misrepresentation by a non-client under the Restatement (Second) of Torts § 552). A lawyer may also be held liable for conspiring with his client to commit fraud on a third party. The leading case on this exception is Likover v. Sunflower Terrace II, Ltd., 696 S.W.2d 468 (Tex. App.—Houston [1st Dist. 1985, no writ), which held that an attorney could be held personally liable for conspiracy to defraud where the attorney had actively participated in a fraudulent scheme to get plaintiff to execute a deed. The Likover court noted: "However, an attorney is liable if he knowingly commits a fraudulent act that injures a third person, or if he knowingly enters into a conspiracy to defraud a third person. Hennigan v. Harris County, 593 S.W.2d 380 (Tex. Civ. App.—Waco 1979, no writ). Over 100 years ago, the Supreme Court of Texas held that where a lawyer acting for his client participates in fraudulent activities, his action in so doing is 'foreign to the duties of an attorney.' Poole v. Houston & T.C. Ry, 58 Tex. 134, 137 (1882). The Court held that a lawyer could not shield himself from liability on the ground that he was an agent, because no one is justified on that ground in knowingly committing a willful and premeditated fraud for another. Id. at 137-38." Id. at 472. The court held that in order to find an attorney engaged in a conspiracy with his client to defraud a third party, the evidence must show that the attorney had knowledge of the object and purpose of the conspiracy; that there was an understanding or agreement to inflict a wrong against, or injury on, the third party; that there was a meeting of minds on the object or cause of action; and that there was some mutual mental action coupled with an intent to commit the act that resulted in the injury. Id., relying on Great National Life Insurance Co. v. Chapa, 377 S.W.2d 632, 635 (Tex.1964); Schlumberger Well Surveying Corp. v. Nortex Oil & Gas Corp., 435 S.W.2d 854 (Tex.1968); see also Querner v. Rindfuss, 966 S.W.2d 661, 666 (Tex. App.—San Antonio 1998, pet. denied); Mendoza v. Fleming, 41 S.W.3d 781, 787 (Tex. App.—Corpus Christi 2001, no pet.); McKnight v. Riddle & Brown, P.C., 877 S.W.2d 59, 61 (Tex. App.—Tyler 1994, writ denied). Kirby v. Cruce, 688 S.W.2d 161, 164 (Tex. App.—Dallas 1985, writ ref'd n.r.e.), held that the attorney and client are liable to injured parties as co-conspirators where it can be inferred that (1) an attorney has knowledge of deception being practiced by a client, and (2) the lawyer participated in the scheme and intended to participate in sharing any ill-gotten gains. See also Dallas Ind. Sch. Dist. v. Finlan, 27 S.W.3d 220, 234 (Tex. App.—Dallas 2000, pet. denied), cert. denied 534 U.S. 949 (2001).
Greenberg Traurig of New York, P.C. v. Moody, 161 S.W.3d 56, 89 (Tex. App.—Houston (14th Dist.) 2004, no pet.), held evidence sufficient to affirm jury verdict on attorney's role in scheme to defraud investors where stock was sold on the promise of a forthcoming IPO and the law firm took an active and visible role in preparing for the IPO, thus creating the illusion that the IPO was real, even though the law firm knew that an IPO could not take place. The court held that the evidence must establish that the attorney specifically intended to agree to accomplish an unlawful purpose or lawful purpose by unlawful means, that there must be "indications" that the attorney knowingly agreed to defraud a third party. Id. at 88-89.
Nevertheless, courts have sought to limit the scope of the exception. Bernstein v. Portland Sav. and Loan Ass'n, 850 S.W.2d 694 (Tex. App.—Corpus Christi 1993, writ denied), overruled on other grounds in Crown Life Ins. Co. v. Casteel, 22 S.W.3d 378, 43 Tex. Sup. Ct. J. 348 (Tex. Jan 27, 2000), held that Likover would not govern when the basis of the attorney's liability was his failure to disclose confidential information about his client to a third party. The court held that no such duty could be imposed on a lawyer. Id. at 701-02.
One would think that an attorney who devised and actively implemented an oppression scheme would be personally liable under the Likover line of cases, given the well-established doctrine that a breach of a fiduciary relationship can constitute fraud because the fiduciary relationship imputes higher duties, such as duties of good faith, candor, and "full disclosure respecting matters affecting the principal's interests and a general prohibition against the fiduciary's using the relationship to benefit his personal interest, except with the full knowledge and consent of the principal." Chien v. Chen, 759 S.W.2d 484, 495 (Tex. App.—Austin 1988, no pet.). At common law, the term "fraud" means an act, omission, or concealment in breach of a legal duty, trust, or confidence justly imposed, when the breach causes injury to another or the taking of an undue and unconscientious advantage. Id.; Russell v. Industrial Transp. Co., 258 S.W. 462 (Tex. 1924); Kellum v. Smith, 18 Tex. 835 (1857). Common-law fraud includes both actual and constructive fraud. "Actual fraud" usually involves dishonesty of purpose or intent to deceive. Archer v. Griffith, 390 S.W.2d 735, 740 (Tex. 1964). "Constructive fraud" encompasses those breaches that the law condemns as "fraudulent" merely because they tend to deceive others, violate confidences, or cause injury to public interests, regardless of the actor's mental state. Id. When one has a duty to speak the truth, a false representation of a past or present material fact is fraudulent when another relies thereon to his detriment. Many Texas courts have held that breach of fiduciary duties is a species of fraud when the breach involves any misrepresentation, nondisclosure, or deception. See, e.g., In re Estate of Kuykendall, 206 S.W.3d 766, 770 (Tex. App.—Texarkana 2006, Flanary v. Mills, 150 S.W.3d 785, 795 (Tex. App.—Austin 2004, pet. denied); Jones v. Tex. Dept. of Protective and Reg. Serv., 85 S.W.3d 483, 491 (Tex. App.—Austin 2002, pet. denied); Connell v. Connell, 889 S.W.2d 534, 542-43 (Tex. App.—San Antonio 1994, writ denied).
However, as in the First Court of Appeals decision today in Span Enterprises v. Span, courts have been reluctant to extend attorney liability to knowing participation/aiding and abetting of breach of fiduciary duties. See also Thompson v. Vinson & Elkins, 859 S.W.2d 617, 624 n. 5 (Tex. App.—Houston [1st Dist.] 1993, writ denied) (noting that, "while an attorney could be individually liable for conspiracy to defraud, the same would not be true of a knowing participation in a breach of fiduciary duties, as this application would violate the privity rule"); Kastner v. Jenkens & Gilchrist, P.C., 231 S.W.3d 571, 580-81 (Tex. App.—Dallas 2007, no pet.) ("The supreme court has not extended the reach of McCamish to include an aiding and abetting breach of fiduciary duty claim asserted by a non-client based upon the rendition of legal advice to a tortfeasor client."); McConnell v. Ford & Ferraro, LLP, 2001 WL 755640 (Tex. App.—Dallas 2001, pet. denied) (declining to extend the exceptions to the privity rule to create individual liability on an attorney who knowingly participated in the breach of fiduciary duties by the directors of a corporation in a "freeze out" merger).
All of these cases follow Alpert v. Crain, Caton & James, P.C., 178 S.W.3d 398 (Tex. App.—Houston (1st Dist.) 2005, pet. denied). In this case, the plaintiff was a businessman who managed several businesses and several trusts set up for his children. For a period of four years, the plaintiff was represented and assisted by an attorney named Riley. After the professional relationship between the plaintiff and attorney Riley terminated, the attorney sued the plaintiff in probate court (presumably for nonpayment of fees), and the plaintiff counterclaimed against the attorney. The attorney had retained the law firm of Crain, Caton & James, P.C. to represent him in the litigation in probate court. Thereafter, the plaintiff brought this action in District Court solely against the law firm alleging that the law firm's conduct in the course of the probate court litigation aided and abetted Riley's breach of fiduciary duties. Of course, a law firm only began to represent Riley after the date that he no longer owed fiduciary duties to the plaintiff. Not to be deterred, the plaintiff contended that the law firm had concealed Riley's past malpractice and breach of fiduciary duties, had filed a frivolous lawsuit against Alpert the plaintiff in probate court, and had disparaged the plaintiff's reputation in the business community. Id. at 402-03. The law firm specially excepted and argued that there was no Texas cause of action for an attorney's aiding and abetting a client's breach of fiduciary duties based solely on a lawyer's performance of his professional duties. The trial court sustained the special exceptions and dismissed the lawsuit when the plaintiff refused to amend. While the appellate court affirmed the trial court's dismissal, it is apparent that the decision was influenced by the monumental stupidity of the plaintiff's legal theory. The Court held: "Absent any allegation that Crain Caton committed an independent tortious act or misrepresentation, we decline Alpert's invitation to expand Texas law to allow a non-client to bring a cause of action for 'aiding and abetting' a breach of fiduciary duty, based upon the rendition of legal advice to an alleged tortfeasor client." Id. at 407.
Based on these authorities, a plaintiff should be able to allege a cause of action against the majority shareholder's attorney for knowing participation in the scheme of oppression, but only in narrow circumstances. First, the plaintiff should plead the claim as civil conspiracy, rather than mere aiding and abetting or knowing participation. The elements of the claims are not the same; civil conspiracy has a higher burden of proof. See Floyd v. Hefner, 556 F.Supp. 617, 659-60 (S.D. Tex. March 31, 2008): ("Aiding and abetting a breach of fiduciary duty and conspiracy are two separate claims with different elements of proof.); Days Inn Worldwide, Inc. v. Sonia Investments, No 3:04-CV-2278-D, 2006 WL 3103912, at *19 n. 20 (N.D.Tex. 2006) ("Civil conspiracy is a separate cause of action that requires, interalia, an underlying tort and a 'meeting of the minds' among the coconspirator 'on the object or course of action' to be taken. By contrast, a cause of action under Cox and Kinzbach requires only the knowing participation of a party in a breach of a fiduciary duty and does not require a conspiratorial agreement."). Second, the breach of fiduciary duties or scheme of oppression must involve misrepresentations, failure to disclose, or deceptive conduct so that breach of fiduciary duties constitutes fraudulent conduct. See Flanary v. Mills, 150 S.W.3d 785, 795 (Tex. App.—Austin 2004, pet. denied); Chien v. Chen, 759 S.W.2d 484, 495 (Tex. App.—Austin 1988, no pet.); cf. Hoggett v. Brown, 971 S.W.2d 472, 487 (Tex. App.—Houston [14th Dist.] 1997, pet. denied) (holding that fraud claim could only be supported by finding of fiduciary duty to shareholder). Third, the plaintiff must plead and prove that the attorney had knowledge of the object and purpose of the conspiracy; that there was an understanding or agreement to inflict a wrong against, or injury on, the third party; that there was a meeting of minds on the object or cause of action; and that there was some mutual mental action coupled with an intent to commit the act that resulted in the injury. Likover v. Sunflower Terrace II, Ltd., 696 S.W.2d 468, 472 (Tex. App.—Houston [1st Dist. 1985, no writ). Additionally, the plaintiff must plead and prove objective "indications" of this agreement. Greenberg Traurig of New York, P.C. v. Moody, 161 S.W.3d 56, 89 (Tex. App.—Houston (14th Dist.) 2004, no pet.). Finally, the plaintiff must plead and prove that the attorney's conduct went beyond mere fulfillment of his professional duties to the majority shareholder. Span Enterprises v. Wood, No. 01-07-00364-CV (Tex. App.—Houston [1st Dist.] December 4, 2008); Alpert v. Crain, Caton & James, P.C., 178 S.W.3d 398, 407 (Tex. App.—Houston (1st Dist.) 2005, pet. denied). Certainly, personal benefit from the proceeds of the fraud would certainly satisfy this burden. Kirby v. Cruce, 688 S.W.2d 161, 164 (Tex. App.—Dallas 1985, writ ref'd n.r.e.). The plaintiff could also plead and prove conduct by the attorney necessary to the accomplishment of the fraudulent scheme, such as meaningless work designed to convey a false impression. Greenberg Traurig of New York, P.C. v. Moody, 161 S.W.3d 56, 89 (Tex. App.—Houston (14th Dist.) 2004, no pet.). In the hypothetical situation described above, where the attorney is central in devising and implementing a scheme to squeeze out a minority shareholder and obtain his stock at an unfair price, the attorney's activities (assuming the intent elements described above are met) should satisfy this final element. The attorney will argue that everything done in devising and implementing a scheme to oppress a minority shareholder is merely the rendering of legal services; however the plaintiff should counter that these particular services are "foreign to the duties of an attorney." Poole v. Houston & T.C. Ry, 58 Tex. 134, 137 (1882).
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Posted By Eric Fryar to Shareholder Oppression at 12/04/2008 08:54:00 PM