Wednesday, March 15, 2017

No "Friends" Exception To Business Transaction Rule

A censure was imposed by the New Jersey Supreme Court for ethical violations in the course of an attorney's dealings with a lifelong friend (Harvey) and his various business ventures.

The story is told in the report of the Disciplinary Review Board.

The attorney made two loans to Harvey but failed to disclose the transactions (and, significantly, the repayment out of proceeds in which another client had an interest) to that client Young.

The attorney represented an entity client Optimal (co-owned equally by Harvey and Young) that was the plaintiff in a lawsuit. He had brought another law firm in to handle the litigation.

The loans were made in the course of the litigation and secured in part by litigation proceeds.

When the litigation settled (for considerably less than expected), the attorney was repaid out of the proceeds. Unbeknownst to the attorney, Harvey sent Young a falsified settlement sheet that concealed purpose of the repayment.

After years of effort to unravel the situation, Young retained a Tennessee lawyer (Canas) who provided the attorney with the false document. 

The loans and fraud by Harvey were thus revealed to Young.

Young filed a civil suit and a bar complaint.

The attorney  denied that the two loans were prohibited business transactions because it was a friendly arrangement with Harvey

At the [District Ethics Committee] hearing, respondent’s counsel argued that the law does not require people to engage in acts that are futile and that, presumably, compliance with the requirements of RPC 1.8 would have been futile because Harvey needed funds to complete his business transactions within three days and would have lost the deal if he sought out another lawyer. Counsel argued further that RPC 1.8 did not specifically refer to loans and that the loans respondent made, therefore, were not prohibited transactions. There was no conflict of interest, no exploitation, and no adversity.


Counsel denied that respondent had made misrepresentations to Canas. He contended that respondent’s good character, as reported by his character witnesses, should be considered and should exonerate respondent of any wrongdoing. Counsel further argued that the law permitted an adverse interest to be drawn from Canas’ failure to appear at the DEC hearing.

The DEC found a prohibited business transaction but no violation of Rule 4.1 in the dealings with Canas.

Before the Board

In his brief to us, respondent’s counsel argued that the loans respondent made to Harvey were not within the purview of RPC 1.8 because: (i) the loans were made to a high school friend for whom he performed only isolated and occasional legal services; (2) respondent was not acting as an attorney in matters that related to the loans; (3) there was no real or actual conflict between respondent and Harvey/OI; (4) Harvey solicited the loans and was the borrower, not the lender; (5) the loans were of significant benefit to Harvey/OI and their creditors; (6) there was no adverse or potentially adverse consequence or impact to any client or anyone else; (7) Harvey was a sophisticated businessman; (8) Harvey understood and was familiar with loan transactions; (9) the loans were exigent and, if not consummated, could have resulted in the collapse of OI; (10) Harvey was not the grievant; (Ii) respondent would presumptively have had a greater understanding of the loans and the terms of the notes than a newly engaged attorney; (12) Harvey would not have had sufficient time to seek and consult with a new attorney; and (13) the cost, fees, and expenditures of time for retaining new counsel would have presented an undue burden for Harvey and his business...

In sum, counsel argued that the complaint should be dismissed in its entirety because there are no known cases prohibiting a loan from an attorney to a client; at the time of the loans, respondent was not acting as the attorney for Harvey, who was a personal friend; the borrower was not the grievant; and the loans were beneficial, not adverse.

The arguments were rejected

At the time the loans were made, and as the promissory notes memorialize, the HON litigation was still ongoing. Respondent’s own testimony and the documentation in this case support a finding that he was actively involved in his clients’ representation in that litigation. Not only did he represent Harvey, but he also represented Optimal, in which Harvey and Young were equal partners. Clearly, respondent used his knowledge about the litigation to the disadvantage of his clients when he drafted the promissory notes. He knew that a recovery was anticipated from the litigation and gave himself priority over the distribution of the proceeds...

The note made Young and Optimal, who were not parties to the loans, obligors by requiring that respondent be paid first once the HON litigation was resolved. Respondent, therefore, engaged in multiple conflicts of interest with Harvey, Young, and Optimal.

Agreed. Not sure why there was no Rule 1.7 charge here.

As to the second loan

The second promissory note might be viewed as paving the way for the fraud Harvey perpetrated on Young. Because of Harvey’s obligation under the note, he altered the settlement distribution sheet to give the appearance that the loan he repaid to respondent represented litigation expenses relative to the HON lawsuit. He then reduced the net distribution sum by the amount of that phony litigation expense, which actually represented the amount he had taken to repay the loan. Harvey then convinced Young to allow him to keep the remainder of the settlement proceeds. Young, ignorant of the fact that Harvey had already used $107,000 for his own purposes, acquiesced to Harvey’s entreaties. There is no evidence, however, that respondent was an accomplice to this fraud.

The board found the Rule 4.1 violation as well

Respondent did, however, perpetuate his client’s fraud by his subsequent failure to disclose the actual amount of the HON settlement and by confirming to Canas the accuracy of the description of the line item Harvey inserted as advanced litigation expenses. Respondent’s testimony at the DEC hearing, that Young was "fully aware" of the amount of the actual settlement and that Harvey’s alteration of the document "was the commencement of a negotiation between the two of them [Harvey and Young]," is nothing less than disingenuous. Rather, the statement appears to be either an attempt to mask his client’s fraudulent conduct, or to hide respondent’s own cover-up of that conduct. By his conduct in this respect, respondent clearly violated RPC 4.1(a).


Young was the real loser in all of this.

Bottom line

We consider the mitigating factors in this case: respondent’s unblemished ethics history in his twenty years of practicing law and the glowing character testimony and letters from his friends, colleagues, and wife. We also consider the aggravating factors: respondent’s lack of remorse, contrition, or understanding of his violation of the RPCs, and his less than forthright testimony relating to his client’s alteration of the settlement distribution sheet in the HON litigation. Thus, under the totality of the circumstances, we determine that a censure is warranted.

(Mike Frisch)

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