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Ronald R. Peterson, As Chapter 7 Trustee For Lancelot Investors Fund, Ltd. v. Winston & Strawn

October 10, 2012

RONALD R. PETERSON, AS CHAPTER 7 TRUSTEE FOR LANCELOT INVESTORS FUND, LTD.
AND COLOSSUS CAPITAL FUND, LTD., PLAINTIFF,
v.
WINSTON & STRAWN, LLP, DEFENDANT.



The opinion of the court was delivered by: Matthew F. Kennelly, District Judge:

MEMORANDUM OPINION AND ORDER

Ronald R. Peterson, the Chapter 7 Trustee for the bankruptcy estates of Lancelot Investors Fund, Ltd., and Colossus Capital Fund, Ltd., brings this action against the law firm Winston & Strawn, LLP, alleging legal malpractice based on the firm's representation of the two funds. Winston & Strawn has moved to dismiss all of Peterson's claims. For the reasons stated below, the Court grants the motion.

Background

The Court draws the following facts from Peterson's second amended complaint and accepts them as true for purposes of the motion to dismiss. Hallinan v. Fraternal Order of Police of Chicago Lodge No. 7, 570 F.3d 811, 820 (7th Cir. 2009).

Lancelot and Colossus (the Funds) are two hedge funds. Greg Bell managed their investments through two investment management companies. Bell owned and operated the management companies. He decided where to invest the Funds' assets and worked to attract new investors for the Funds.

Bell invested most heavily in purchase-order finance notes issued by entities controlled by Thomas Petters. These entities ostensibly sold their goods to wholesale retailers like Sam's Club and Costco. The Funds' loans were secured by the accounts receivable and physical inventories of the entities. In reality, however, there were no physical inventories-all the purchase orders were fakes. Petters had in fact been operating a massive Ponzi scheme, using the Funds' assets to pay off other debts while keeping a portion for himself. Like most Ponzi-scheme investors, the Funds initially received returns on their investments, taken mostly from later investors. In September 2008, however, Petters's scheme unraveled, and the Funds crumbled.

Peterson contends that both Bell and the Funds were ignorant of Petters's fraudulent operation until at least October 2007. Between October and December 2007, however, Bell grew suspicious when Petters failed to make timely payments to the Funds. Eventually Bell discovered the scheme. In April 2008, Bell joined in the fraud, working with Petters to conduct a series of transactions that made the Funds appear to investors to be operating legitimately.

In December 2003, the Funds put out a Confidential Information Memorandum (CIM), detailing the nature of their investments. The CIM described various restrictions on Bell (through the investment management companies). These restrictions allowed him to invest only in entities that had a pre-existing binding agreement with a retailer to sell inventory and required him to make investment decisions based on the character of the inventory and the entity's ability to provide sufficient collateral. In addition, the CIM required "an affiliate of the Fund or Investment Manager . . . [to confirm] the delivery of the Underlying Goods and the payment of the Retailer" to the entity. 2d Am. Compl. ¶ 29(f). Finally, the CIM required the Fund to "have a 'lock-box' arrangement with the [entity,] pursuant to which the Fund will have control over [its] bank account in which the Retailer will pay the purchase price for the Underlying Goods." Id. ¶ 29(g). Bell failed to follow these restrictions. Peterson does not allege in his complaint that any other employee of the Funds attempted to procure any such lock-box arrangements.

In August 2005, Bell retained Winston & Strawn to represent the Funds and Bell's investment management companies. Specifically, as alleged in the complaint, Winston & Strawn agreed to represent Bell's investment management companies "and all privately offered investment funds whose investments were managed by [them]." Id.

¶ 10. Peterson alleges that immediately after retaining Winston & Strawn, Bell told the firm that the Funds were not satisfying the criteria laid out in the 2003 CIM. He stated that Petters would not allow him to verify the inventory and that the Funds did not have any lock-box arrangements with any of Petters's businesses. Bell told Winston & Strawn, however, that he trusted Petters, and he continued to invest the Funds' assets in his businesses.

In March 2006, the Funds issued an amended CIM, which Winston & Strawn drafted. It contained the same investment restrictions as the prior versions and additionally created a new position of "Loan Acquisition Officer," whose job was to review and evaluate proposed loan investments recommended by Bell. Peterson's complaint does not disclose the identity of the officer or what, if any, role he or she played in assessing Bell's investment recommendations. See id. ¶ 16. Bell continued to invest the Funds' assets in Petters's businesses without complying with the restrictions. The Funds continued to operate without any lock-box operation in place until the FBI exposed Petters's Ponzi scheme in September 2008 and the Funds collapsed.

Peterson contends that as Bell became increasingly suspicious of Petters in late 2007, he approached Winston & Strawn with questions regarding his deferred compensation from the Funds (earned through the investment management companies), and how he could protect his personal assets off-shore. In January 2008, Bell retained Winston & Strawn to represent him in a personal capacity, in addition to the firm's engagements as counsel for the Funds and the investment management companies.

Peterson has sued Winston & Strawn for legal malpractice. Illinois law governs. See Raleigh v. Ill. Dep't of Revenue, 530 U.S. 15, 15 (2000) ("The basic federal rule in bankruptcy is that state law governs the substance of claims."). The complaint includes two claims, in each of which Peterson alleges that the firm breached its duties of disclosure and due care throughout its representation of the Funds from August 2005 through September 2008. 2d Am. Compl. ¶ 13 (dividing the claim into two counts based on the timing of Bell's actions). Peterson contends that when Bell told Winston & Strawn he was not complying with the investment restrictions in the 2003 CIM, the firm failed to meet its legal obligation to disclose those facts to an "unconflicted representative" of the Funds and to exercise due care in addressing the investment management companies' "legal obligation to comply with the Funds' investment restrictions." Id. ¶ 32--33. Peterson also alleges that the law firm was negligent in drafting the 2006 CIM, which he contends created the "false impression" for its readers that Bell was complying with the investment restrictions. Id. ¶ 35. Finally, Peterson alleges that in early 2008, when Bell expressed concern about Petters and sought individual representation, the law firm again failed to meet its legal obligations to disclose and to address potential harm to the Funds.

Winston & Strawn has moved to dismiss Peterson's complaint on three grounds: (1) the defense of in pari delicto bars Peterson's claims; (2) his complaint fails to state a claim upon which relief can be granted; and (3) Peterson's first claim is barred by the ...


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