September 11, 2013

Malpractice suits against in-house counsel

Posted in Corporate Litigation, Employment Law by Gene Killian |

The law can be a miserable business. Deadlines lurk around every corner, and it sometimes seems as though judges, adversaries and clients are simply waiting for unwitting lawyers to trip up – in the clients’ case, so that malpractice insurance can be tapped. For some lawyers, the role of in-house counsel seems superficially appealing. After all, won’t a lot of these problems go away if you’re comfortably working in-house for one business? And, no timesheets!

As the old saying goes, be careful what you wish for. The role of General Counsel brings with it a whole host of new difficulties, among them the problem of blurred distinctions between the role as lawyer and the role as businessperson. A recent case in the New Jersey Appellate Division shows what can happen when distinctions are disregarded. Let’s briefly review the case, and spot the red flags.

Kaye is a self-made businessman with a ninth grade education who owns a number of companies based in Atlantic City, in the resorts and entertainment industry. In 1997, he met Rosefielde, a New York-licensed attorney who began giving Kaye tax and management advice. Faced with declining revenues in his Atlantic City businesses, Kaye asked Rosefielde to come work for him full time as Chief Operating Officer.

Kaye gave Rosefielde a “sweetheart” deal, apparently without the approval of his Board of Directors. This included free travel from Rosefielde’s home in Florida to and from Kaye’s offices in Atlantic City; an annual “fee” of half a million dollars; a wine cellar stocked with fine wines; and absolute authority over corporate decisionmaking. Red flag: lack of oversight. I can’t tell you how many times over the years I’ve seen corporate officers and attorneys take advantage of “too much leash,” or, better put, no leash at all.  As Reagan famously said: “Trust but verify.”  (Not only should a corporate officer or attorney not be given absolute freedom, the corporate officer or attorney shouldn’t want it!)

Upon accepting his position as Chief Operating Officer, Rosefielde sent a memo to all company employees forbidding them from asking to meet with Kaye on any issue, on pain of termination. Kaye, for his part, advised all company employees that they were expected to obey Rosefielde without question.  This is another red flag: creation of an internal corporate fiefdom, responsible to no one.

In addition to his position as Chief Operating Officer, Rosefielde functioned as General Counsel, overseeing litigation and negotiating various deals and settlements.  He did well for the companies on some of them, including favorably resolving an FTC investigation. 

But, having assumed absolute power within the companies, Rosefielde began looking for ways - to put it delicately - to increase his compensation package.  La Sammana was a hotel and condominium in Brigantine, for example, which Kaye planned to convert into timeshare units. Kaye created the legal entity "La Sammana Ventures" to own the property. 10% of La Sammana was owned by the company’s sales director, Lattuga.  Rosefielde told Kaye that Lattuga was doing a terrible job and should be fired.  Kaye did not want to fire Lattuga, with whom he had a long-term friendly relationship, but Rosefielde did so anyway.

Rosefielde had acted as Lattuga’s personal attorney on several matters, and, as part of the firing, Rosefielde prepared documents that Lattuga signed, transferring Lattuga’s 10% interest in La Sammana to Rosefielde (without telling Kaye).  Lattuga apparently was unaware of the import of the documents. And Rosefielde also had Kaye sign documents, that Kaye apparently did not carefully read, assigning ownership interests in Kaye’s companies to Rosefielde.  Another red flag: signing documents without taking the time to read them, because you “trust” the person putting them under your nose.

As with many sordid stories, sex plays a role here.  Rosefielde arranged trips to Las Vegas, paid for from corporate accounts, apparently involving hookers. And several women at the company accused Rose of unwanted sexual advances, although none of them actually filed suit.  Red flag: no reasonable way for aggrieved employees to make complaints about the behavior of a person in power. 

Kaye eventually woke up and fired Rosefielde. He then filed a lawsuit against Rosefielde, including a claim for legal malpractice. Rosefielde argued that he had never acted as an attorney with respect to Kaye – only as a businessman. Therefore, the argument went, the Rules of Professional Conduct relating to conflicts of interest did not apply.

Not surprisingly, the Court would have none of it, writing in part:

 “Rosefielde acted as general counsel, Kaye's personal attorney, and COO. Rosefielde committed malpractice by violating RPC 1.8(a) and by fraudulently obtaining his interest in BA Management. In [the Trial Court’s] words: ‘RPC 1.8 exists to guard against precisely the harm occasioned by Rosefielde's conduct and self-dealing with his clients.’ [The Trial Court] found plaintiffs' legal malpractice expert's testimony credible and persuasive on the question of whether Rosefielde committed malpractice. He concluded that Rosefielde's fraudulent conduct creating BA Management and obtaining an interest therein constituted malpractice per se. On these bases, [the Trial Court] found that plaintiffs were entitled to compensatory damages that included counsel fees and the cost for prosecuting the malpractice action.”

This case obviously presents an extreme example of wrongful conduct in which very few in-house lawyers would ever think of engaging. But it also contains a very important lesson. In the current litigation environment, all in-house counsel must scrupulously avoid the appearance of impropriety, and must be aware that, even when acting as businesspeople, the prohibitions contained in the Rules of Professional Conduct constrain their behavior.  That can create some difficult issues, given, for example, RPC 4.1 (a)’s prohibition against making a “false statement of material fact or law to a third person.” Negotiations often involve “strategic misrepresentation,” after all. I have no general answer to this conundrum, other than to quote Mark Twain:  “If you tell the truth, you don’t have to remember anything.”

The financial cost of failing to abide by the ethical rules can be astronomical.  Note the Court’s description of the record in Kaye v. Rosefielde:  “The record includes: sixty-five volumes of transcripts, covering approximately 7000 pages of witness testimony and arguments of counsel at various hearings; eight volumes of appellants' appendices, consisting of 2939 documents and exhibits; and two volumes of respondents' appendices, consisting of 383 pages of additional documents.”  That’s a lot of legal fees.

If you’d like to read the entire lengthy decision in Kaye v. Rosefielde, click here.

- Gene Killian