If you were looking for something else to worry about at night, ponder the following scenario that forms the basis for the putative class-action complaint brought by the lender group-plaintiffs (the “Plaintiffs”) that was dismissed by the United States District Court for the Northern District of Illinois and affirmed on appeal in Oakland Police & Fire Retirement System et.al. v. Mayer Brown. [1]
Prior to its 2009 bankruptcy filing, General Motors (“GM”) entered into a secured transaction with JP Morgan (as agent for a lender group) that was structured as a sale and lease back of real property (the “2001 Synthetic Lease.”) In 2006, JP Morgan also served as the agent for a separate lender group in a loan transaction whereby GM borrowed $1.5 billion which was secured by different real property (the “2006 Term Loan.”) UCC-1 financing statements were filed for both transactions.
In 2008 GM was gearing up to pay off the $150 million remaining balance on the 2001 Synthetic Lease. Towards that end, it instructed its counsel, Mayer Brown, LLP, to prepare the appropriate documents to release the security interest in the real estate. According to the Plaintiffs, Mayer Brown included the 2006 Term Loan UCC-1 in the documents to be terminated upon the payment of the balance on the 2001 Synthetic Lease. Thus, a UCC-3 terminating the 2006 Term Loan UCC-1 was prepared and erroneously included in the closing documents. The Plaintiffs assert the mistake was not noticed by anyone at Mayer Brown (other than a sharp-eyed paralegal, whose observation was ignored.) The closing documents were then sent to Simpson Thacher & Bartlett as counsel for JP Morgan who also did not notice the erroneous termination of the 2006 Term Loan UCC-1. Thus, in 2008 the closing on the 2001 Synthetic Lease went forward, and with it, the termination of the UCC-1 for the entirely separate 1.5 billion 2006 Term Loan. The question addressed by the Seventh Circuit is whether Mayer Brown, counsel to GM, owed a duty to the lenders (the principals of JP Morgan) on the 2006 Term Loan such that Mayer Brown would be liable to such lenders for the mistaken UCC-1 termination.
In 2009, GM filed for bankruptcy protection. Although the erroneous termination was discovered at that point, the bankruptcy court ordered GM to repay the 2006 Term Loan with interest - which it did. However, this direction was subject to the creditors’ committee’s right to challenge the perfection of the security interest - which it did. An adversary proceeding ensued and the bankruptcy court found the security interest was still in tact. But the matter was taken up on appeal and the Second Circuit Court of Appeals reversed the bankruptcy court in a 2015 decision. The Second Circuit ruled that based on Delaware law, JP Morgan had approved the termination, even though it was a mistake, and the UCC-1 termination was enforceable.[2] Thus, the GM creditors commenced actions to claw back the funds repaid by GM to the lenders on the 2006 Term Loan. Litigation stemming from the termination of the security interest appears to be ongoing. Prior to the litigation by the creditors’ committee, Plaintiffs were apparently blissfully unaware of the mistake.
Plaintiffs’ reaction when they learned of it, however, added a twist. Rather than bringing an action against JP Morgan and/or its counsel, Plaintiffs chose to sue Mayer Brown -the law firm representing GM - for legal malpractice and negligent misrepresentation. Unfortunately for the Plaintiffs, the Court of Appeals agreed with the district court and found that Plaintiffs failed to state a claim as Plaintiffs were third-party non-clients and Mayer Brown owed them no duty under Illinois law.
The Plaintiffs put forth three theories, each of which was rejected by the Seventh Circuit: first, JP Morgan was actually a client of Mayer Brown in unrelated matters and therefore was owed a duty as a direct client rather than a third-party non-client; second, by drafting the closing documents, Mayer Brown owed a duty to JP Morgan (and its principals) even if they were third-party non-clients; and third, GM’s retention of Mayer Brown as counsel had as its primary purpose the influencing of JP Morgan in approving and signing the closing documents.
The Seventh Circuit found that under Illinois law and the Illinois Supreme Court’s decision in Pelham v. Griesheimer (“Pelham”)[3] most legal malpractice cases involve a direct attorney-client relationship; however, a small subsection of the law extends the lawyer’s duty to non-clients when the attorney-client relationship has as its “primary purpose and intent” the “benefit or influence” of a third party. An example of such a circumstance would be when an attorney prepares an opinion letter.
Under the Plaintiffs’ first theory, since JP Morgan (which served as agent for the lender group which included Plaintiffs) was represented by Mayer Brown in unrelated matters, Mayer Brown had a direct attorney-client relationship with JP Morgan and thus owed a duty of care to JP Morgan and then, indirectly, to Plaintiffs. If this theory was countenanced by the Seventh Circuit, the current practice of law, in particular in large firms where conflict waivers are routine, would have been turned on its head. Conflict waivers would be a nullity as the attorney would still owe a duty of care to the client signing the waiver – thus making the conflict un-waivable. The Seventh Circuit referred to the Plaintiff’s theory as “astonishing” and found it posed a direct conflict with the rules of professional responsibility which permit conflict waivers.
The Court next analyzed the circumstances when an attorney owes a duty to a non-client. The Plaintiffs asserted that Pelham actually supports an exception to the “primary purpose” rule that occurs when the attorney voluntarily agrees to perform a task (here, the preparation of closing documents) that will be foreseeably relied on by the third-party non-client. The Seventh Circuit rejected this theory finding no exception to the “primary purpose” rule and further recognizing that in complex transactions there are always first drafts of documents and attorneys creating such first drafts do not then owe a duty of care to all the other parties to the transaction.
Lastly, the Plaintiffs argued that the “primary purpose” rule was actually satisfied as GM’s primary purpose in retaining Mayer Brown was to influence JP Morgan to approve the closing documents on the Synthetic Lease. The Seventh Circuit disagreed and distinguished the facts from a case that did satisfy the “primary purpose” rule wherein an attorney who served as counsel for a title company and conducted defective title searches and prepared defective closing documents was found to owe a duty to the third party lender. In that case the work was considered “non-adversarial” because as closing agent, the attorney’s work was to be relied on by all the parties to the transaction. In contrast, the parties to the Synthetic Lease deal each had their own counsel in the transaction to represent their respective needs and despite the parties having a common purpose the Court rejected the assertion that the transaction was without adversity.
This case is a bitter pill for the Plaintiffs and it remains troubling that a simple mistake in a complex transaction can result in the termination of the security interest on a $1.5 billion dollar loan. But had the Seventh Circuit ruled differently in this matter and shifted the duty of care to GM’s attorneys under any of the theories proposed by Plaintiffs, the effects on the practice of law could have been substantially more troubling.
[1] Oakland Police & Fire Retirement System v. Mayer Brown, LLP, --- F.3d ---- (2017), 2017 WL 2791101 (7th Cir. 2017).
[2] See Official Comm. of Unsecured Creditors v. JP Morgan Chase Bank, N.A. (In re Motors Liquidation Co. II ), 777 F.3d 100 (2d Cir. 2015).
[3] Pelham v. Griesheimer, 92 Ill.2d 13, 64 Ill.Dec. 544, 440 N.E.2d 96, 99 (1982).