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November 26, 2013

White Mountains Reinsurance Company of America v. Borton Petrini, LLP (2013) 221 Cal.App.4th 890, (rev. denied 2/11/14)

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The Third District holds an assignment of a legal malpractice claim is permissible where incidental to a  commercial transfer of assets and liabilities between insurance companies.   

Modern Service Insurance Company insured Flora Cuison, who was responsible for a serious car accident.  Modern Service retained Borton, Petrini, LLP, which failed to respond to a policy limits demand.  Through a series of transactions, Modern Service was eventually acquired by White Mountains Reinsurance Company, which assumed responsibility for the Cuison matter.  After Borton was terminated, the case settled for a significant amount over the policy limits. 

White Mountains sued Borton as the successor-in-interest to Modern Service.  The trial court determined the cause of action accrued at the time Modern Service began incurring legal expenses after the policy limits demand expired.  Thus, White Mountains could only have acquired the cause of action by assignment. The court ruled White Mountains lacked standing since a legal malpractice cause of action may not be lawfully assigned in California. 

On appeal, the Court observed California’s longstanding rule against assignment of legal malpractice claims originated from a legal malpractice action filed by an assignee of a client in an underlying divorce action.  That Court observed that while assignments are generally valid, there is an exception for claims based on wrongs of a purely personal nature, such as legal services.  Although legal malpractice claims are based on contract, they involve a highly personal and confidential attorney-client relationship.  A legal malpractice action should not become a commodity to be exploited and transferred to economic bidders with no professional relationship with the attorney, to whom the attorney never owed a legal duty, and who never had any prior connection with the assignor or his rights

Assignments would also encourage unjustified lawsuits, increase legal malpractice litigation, and force attorneys to defend themselves against strangers.  This would place an undue burden on the legal profession and the overburdened judicial system, restrict the availability of competent legal services, embarrass the attorney-client relationship, and imperil the sanctity of the highly confidential and fiduciary relationship between attorney and client.

The White Mountains Court addressed a number of decisions in which California courts have addressed assignments of legal malpractice claims.  In one case, a court would not allow assignment of fraud and intentional breach of contract claims assigned to a client’s former adversary, because they were based on attorney services.  Regardless of the characterization, resolving the case would require a trial court to second-guess the attorney’s professional evaluations and strategic choices made in a confidential relationship in which the assignee had no part, and was in fact adverse to the attorney-client partnership.

That White Mountains Court in noted trust between attorney and client could be impaired by the future threat of an assignment of a legal malpractice claim to a stranger or adversary.  This could compromise vigorous advocacy, as attorneys would be reluctant to alienate an adversary who might someday sue the attorney on an assigned legal malpractice claim. An attorney might also favor an insurer at the expense of an insured if the attorney fears the insurer might someday turn over its malpractice cause of action to a third party. Assignment of malpractice claims would inevitably result in higher malpractice insurance premiums.

A malpractice suit filed by a former adversary is also fraught with illogic and unseemly arguments.  For instance, in the underlying lawsuit the adversary may claim she is entitled to recovery; in the assigned legal malpractice case she must make the claim she was not entitled to that recovery.

In another case a plaintiff secured an order directing the defendant assign his legal malpractice claims to the plaintiff.  On appeal the Court observed where an assignment is involuntary, a lawsuit may be filed even when the client is satisfied with the services.  The attorney must preserve the attorney-client privilege while trying to show that the representation was not negligent. 

In another case, an insurer alleged it paid millions to settle a lawsuit against its developer insureds because of misrepresentations based on advice of counsel.  The insurer asserted a right of subrogation in the developer’s legal malpractice lawsuit.  The Court of Appeal affirmed the trial court’s dismissal.  Absent express statutory authorization, non-assignable claims are not subject to subrogation.

A similar result was reached in a case in which  a creditor of two corporations involved in financial restructuring and bankruptcy proceedings alleged the corporations’ attorneys breached their fiduciary duties and committed legal malpractice by allowing the fraudulent transfer of corporate assets to a corporate principal.  The creditor claimed to be an assignee of the corporations’ claims by order of the bankruptcy court.  The Court held the public policy concerns against assignment exist equally in the bankruptcy context, and upheld the trial court’s dismissal. 

The White Mountains Court then surveyed out-of-state cases, where courts have determined the rule should not apply where the assignment is incidental to a larger commercial transaction involving the transfer of other business assets and liabilities.  The public policy concerns that weigh against the assignment of legal malpractice claims do not arise in that context.

For instance, in Washington D.C., a corporation’s attorney arranged for consulting agreements and large bonus payments to two former officers.  These expenses were passed on to a government agency.  Ultimately, the corporation faced criminal and civil liabilities as a result.  Another corporation acquired the original corporation’s assets and responsibility for the fines imposed.  When the attorney sued for fees, the acquiring corporation countersued for breach of contract. 

The District Court noted the policies against assignment were not present.  There was no chance the claim could be sold to an opponent or an unrelated third party.  The predecessor corporation’s liabilities became the burden of the acquiring corporation.  The interests involved were purely pecuniary, and did not implicate the kinds of concerns raised by the sale or assignment of a personal injury claim. Thus, a limited exception to the non-enforceability of assignments would not establish a general market for such claims.  Finally, the acquiring corporation assignee had an intimate connection with the underlying lawsuit.

In a Rhode Island case, financial institutions purchased loans extended by a group of lenders to a corporation.  The lenders’ attorneys had failed to perfect the lenders’ security interest in the corporation’s assets, and the financial institutions were unable to collect the full value of the loans.  The Rhode Island Supreme Court allowed the assignment, reasoning the claim arose out of a larger commercial loan transaction, and not a mere purchase of a legal malpractice claim.  The financial institutions acquired all of the attendant obligations and rights connected to the loans, including the lenders’ legal malpractice action against the defendants.

The Court rejected a general rule prohibiting  assignments in all cases.  It distinguished between market assignments involving purely economic transactions, and freestanding malpractice claim assignments.  Only the latter invoke the public policy rationale against assignment.  The Court reasoned the attorney-client privilege was not a bar, because in a market assignment the client impliedly waives the attorney-client privilege.

In Illinois, a law firm represented a corporation against allegations of trade secret misappropriation.  The corporation’s adversary obtained a multi-million dollar verdict after the law firm advised the corporation not to settle for a comparatively modest sum.  The trial court granted a judgment notwithstanding the verdict which the adversary appealed.  During the appeal, the corporation became a wholly owned subsidiary of an acquiring corporation, and the merged corporation’s shareholders agreed to hold the acquiring corporation’s shareholders harmless from any liability in connection with the trade secret case.  The appellate court reinstated the verdict, and the acquiring corporation settled the case for millions of dollars.  The corporation’s former shareholders suggested suing the law firm for malpractice, and both corporations modified an escrow agreement to give the former shareholders the right to assume control of the malpractice suit if the corporations were not pursuing it to their satisfaction, and the right to receive ninety percent of the proceeds.  

The Illinois Court held legal malpractice claims could be transferred under certain circumstances.  For example, if a client dies after filing a claim for legal malpractice, the claim passes to the client’s estate.  If a bankruptcy estate owns a bankrupt debtor’s claim for legal malpractice, the estate has the power to assign the claim to the debtor.  The Court held there is no prohibition on the transfer of a legal malpractice claim as part of a transfer of assets in a merger, and the claim is not assigned to an unrelated third party, but to the party who actually suffered the loss. 

The White Mountains Court then addressed an Idaho case in which a public medical center retained counsel to defend claims brought by former hospital employees.  After the attorneys were terminated, the medical center’s assets were transferred to a private company, and the medical center ceased to exist.  The private company carried the burden of the employee’s claims, and settled them for millions of dollars after considerable legal expenses.  The private company filed a legal malpractice action against the law firm. 

 The Idaho Supreme Court allowed the assignment, because it did not implicate the policy rationales that disfavor malpractice claim assignments.  The private corporation was not a stranger to the litigation; it had assumed the defense and settled the claims after the medical center ceased to exist.  The purchase was not an isolated one  made in a marketplace for legal malpractice claims; it was one component of a sale that transferred the medical center’s assets and liabilities, its operations, and its management team.  The private corporation was intimately connected to the litigation leading to the claim.  Because the private corporation assumed the obligations of the employee’s claims, it should also have the rights attendant to that assumption, including the right to collect for malpractice losses.

The White Mountains Court was persuaded by the out-of -state authority that a narrow exception to the non-assignability of legal malpractice claims is appropriate.  An assignment that is only a small, incidental part of a larger commercial transaction between insurance companies involving the transfer of assets, rights, obligations, and liabilities, and that does not treat the legal malpractice claim as a distinct commodity, does not create a market for such claims.  White Mountains did not simply buy a malpractice claim, it acquired Modern Service’s entire book of insurance business in California. A small part was the Cuison policy and Modern Service’s right to sue Borton for legal malpractice.  Nothing about the transaction amounted to a naked right of action for fraud and deceit as a marketable commodity.

Further, White Mountains was not a former adversary of Modern Service. When White Mountains succeeded to all of Modern Service’s rights and obligations, it became the insurer in the tripartite relationship with Cuison and Borton, and was liable to the same extent Modern Service would have been had the acquisition never occurred.  Since White Mountains assumed the obligations of the litigation, it should have the rights attendant to that assumption, including the right to recoup losses due to Borton’s malpractice.  

Another significant fact is all communications were through a third party claims administrator; there was no intimate, personal, attorney-client relationship. 

Comment:  This case carves out an exception to long standing non-assignment rules designed to protect the sanctity of the attorney-client relationship.  It remains to be seen if the exception truly remains narrow as the Court suggests, or if parties will seek to contrive transactions to get around the rule of non-assignment.

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