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August 4, 2004

Vega v. Jones, Day, Reavis & Pogue (2004) 121 Cal.App.4th 282 (rev. den. 10/27/04)

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The Second District holds that there are no barriers to a non-client’s claim of fraud against transactional counsel who actively conceal facts material to the transaction.

Frank T. Vega was a large shareholder in Monsterbook.com, which was acquired by Transmedia Asia Pacific, Inc. (“Transmedia”).  During the weeks between Vega’s acceptance of the merger offer and the closing, Transmedia sought and secured ten million dollars in investment financing from a third party which included “toxic” stock provisions that seriously diluted the shares of all other Transmedia stockholders.  Transmedia and its counsel Jones Day knew that ninety-five percent of companies who engage in such financing end up in bankruptcy.  Jones Day withheld a two-page disclosure that clearly described the provisions of the ten million dollar investment.  Jones Day knew that a full disclosure would have caused the collapse of the acquisition and the financing, forcing Transmedia to go out of business.  Vega, Monsterbook, and their counsel Heller Ehrman were told the financing was standard and that Jones Day would supply additional documents to support this characterization.  Jones Day then supplied Heller Ehrman with a different, sanitized version of the disclosure that did not include the “toxic” stock provisions.  Jones Day also prepared a consent form concerning the investment that misrepresented the financing, which Vega signed.

Two weeks before the closing Jones Day filed a “Certificate of Designation” with the Delaware Secretary of State, certifying the creation of the “toxic” stock.  This document, available to the public, contained all the terms of the financing.  Eight months after the closing Vega learned for the first time, through a press release issued by Transmedia, about the “toxic” stock provisions of the financing.

Jones Day’s demurer to Vega’s cause of action for fraud was sustained without leave to amend.  The court held that the claim did not allege an actionable, affirmative misstatement by Jones Day; that Vega could not justifiably have relied on the statements made by Jones Day; that Vega could not state a claim based on omission or nondisclosure because Jones Day owed Vega no duty to disclose; that Vega did not allege damages proximately caused by Jones Day; that Vega had no standing to bring the claim because it was derivative in nature; that the claim was barred by the statute of limitations; and that the claim was barred by res judicata.  Jones Day’s demurrer to the negligent misrepresentation claim was sustained on the same grounds and because a negligent misrepresentation claim cannot be based on an omission or nondisclosure.  The court also concluded Vega failed to plead both causes of action with the requisite specificity.

The Court of Appeal reversed.  The court began by discussing a cause of action for fraud against an attorney.  The elements of fraud are: (1) representation; (2) falsity; (3) knowledge of falsity; (4) intent to deceive; (5) reliance and resulting damage.  Active concealment or suppression of facts by a non-fiduciary is the equivalent of a false representation, which is actual fraud.  A fraud claim against a lawyer is no different from a fraud claim against anyone else.  Limitations on an attorney’s professional duty of care to non-clients do not apply to liability for fraud.

A statement that the financing was “standard” and “nothing unusual” is not an actionable misrepresentation.  While expressions of professional opinion are sometimes treated as representations of fact, a casual expression of belief is not similarly treated.  No party to a major transaction could reasonably rely on a casual statement by counsel for another party to the transaction.

However, the allegation that Jones Day provided a sanitized version of the disclosure to conceal the “toxic” stock provisions are sufficient to state a claim for fraud based on active concealment or suppression of facts.  The court disagreed with the argument that Jones Day’s provision of the sanitized disclosure was irrelevant because it had no duty to disclose the suppressed fact.  Having provided the disclosure Jones Day was not entitled to conceal a material term.

The court distinguished claims by non-clients against attorneys based on a theory of professional negligence.  In such a case there is no liability because no duty exists.  However, in cases involving misrepresentations of fact rather than legal opinions a non-client may recover against an attorney under a negligent misrepresentation theory.  Vega’s allegation involved concealment of a material fact, not the expression of an inaccurate legal opinion.  Jones Day had a duty not to defraud even when negotiating at arm’s length with counsel.  The court saw no distinction between an affirmative false statement and the concealment or suppression of material facts.

The court rejected Jones Day’s argument there can be no concealment claim when information is publicly available.  The mere fact that information exists somewhere in the public domain is not conclusive.  In a nondisclosure case there is a question of whether the defendant knows of material facts, and knows those facts are neither known nor readily accessible to the plaintiff.  Jones Day knew about the “toxic” provisions of the financing, and knew it had not disclosed the terms to Vega.  The sanitized disclosure raised questions about whether Jones Day intentionally concealed information to induce Vega to believe the transaction was standard.  It was a question of fact whether the reference to the Delaware filing in the consent form was sufficient to apprise Vega of the true terms of the financing.

Vega adequately alleged reliance and causation by claiming that he would not have exchanged his valuable Monsterbook stock for the Transmedia stock had full disclosure been made.

The complaint alleged that Jones Day intentionally concealed the “toxic” financing terms from Vega and Monsterbook so that Plaintiff would proceed with the transaction.  Thus, the complaint sufficiently apprised Jones Day of the facts of the claim to allow Jones Day to prepare its defense.

Vega’s claim is not derivative because he does not seek to recover on behalf of the corporation for injury done to the corporation; the gravamen of his cause of action is injury to himself.

Jones Day argued that the three-year statute of limitations should be measured from the Delaware public filing since this document put Vega on inquiry notice.  The court disagreed because inquiry notice is triggered only where there is a duty to inquire.  It is a question of fact whether plaintiff was aware of facts that would make a reasonably prudent person suspicious.

concept of privity has been expanded to include a relationship between the party to be estopped and the unsuccessful party in the prior litigation that is sufficiently close to justify application of the doctrine of collateral estoppel, due process limits the application of this principle.  In addition to an identity of interest and adequate representation the circumstances must be that the party to be estopped should reasonably have expected to be bound by the prior adjudication.  There was no basis to conclude that Vega should reasonably have expected to be bound by lawsuits in which he did not participate in any way, in which he had no proprietary or financial interest, and over which he had no control of any sort.

Comment: Vega is another case that allows non-clients to pursue claims of fraud against attorneys rendering professional services.  See, e.g., Shafer v. Berger, Kahn, Shafton, Moss, Figler, Simon & Gladston (2003) 107 Cal.App.4th 54 [PL Update No.  151].  While this is understandable in clear cases of fraudulent conduct, often there is no bright line between expressions of opinion versus expressions of fact.  Allegations of fraud, which are not typically covered by errors and omissions coverage, are a way to overcome limitations on an attorney’s obligation to non-clients.  The court also rejected the defense of res judicata based on Jones Day’s victory in earlier lawsuits brought by other shareholders.  Jones Day claimed Vega was in privity with the other shareholders since they were all former shareholders in Monsterbook, Vega knew about their lawsuits, and Vega used the same attorney.  While the

 

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