Claims of damages in the form of "deepening insolvency" of a corporation, where such a corporation is already insolvent at the time of the alleged attorney malpractice, is not sufficient to constitute actual harm or loss.

This case arose out of a CEO's looting of a corporation, resulting in the involuntary bankruptcy of the corporation and the liquidation of its assets. The corporation was owned by two groups of equity holders, the first being the CEO, who was looting the company, and the second being holders of preferred stock. Upon learning of certain financial discrepancies, the board of directors created a special committee on behalf of the holders of preferred stock to conduct an investigation. The committee then engaged the defendant law firm for that purpose. The defendant law firm subsequently issued a report finding no evidence of fraud or malfeasance. The plaintiff alleged that the defendant law firm negligently failed to discover massive fraud, thereby allowing the CEO to continue to loot the company and increase its debt for another three years prior to the fraud being discovered. As an initial matter, the court held that the plaintiff, as liquidating trustee, could not bring claims of professional negligence on behalf of creditors of the insolvent corporation, who had no attorney-client relationship with the defendant law firm and who never knew about or relied upon the subject report. On the other hand, the court rejected the defendant law firm's attempt to limit its representation to the "special committee," despite language in the retention agreement expressly limiting the representation in that manner. The court noted that to hold otherwise would effectively immunize a lawyer from liability by limiting the scope of the attorney-client relationship to an entity incapable of suffering actual loss. Rather, the purpose of the law firm's representation was to protect the interests of the holders of the preferred stock, non-parties to the lawsuit. Nonetheless, the court held that no actual loss or harm was suffered by virtue of the subject report as the corporation was already insolvent at the time of the alleged malpractice with no hope of survival. In so holding, the court rejected the plaintiff's claims that the "deepening insolvency" of the corporation was sufficient to constitute actual loss which, in reality, only injures new creditors left holding the bag. At the time of the malpractice, the shareholders, the clients and the beneficiaries of the law firm's services had no equity and, therefore, could not be harmed by any further acts of fraud.

Case Law Alert - 2nd Qtr 2011