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Grochocinski v. Mayer Brown Rowe & Maw, LLP

United States Court of Appeals, Seventh Circuit

June 21, 2013

David E. Grochocinski, not individually, but solely in his capacity as the Chapter 7 Trustee for the bankruptcy estate of CMGT, Inc., Plaintiff-Appellant/Cross-Appellee,
v.
Mayer Brown Rowe & Maw, LLP, et al., Defendants-Appellees/Cross-Appellants. and Edward T. Joyce and Associates, Cross-Appellee and Appeal of: R. Gerard Spehar, Movant, Appellant,

Argued January 16, 2013

Appeals from the United States District Court for the Northern District of Illinois, Eastern Division. No. 1:06-cv-05486—Virginia M. Kendall, Judge.

Before Bauer and Hamilton, Circuit Judges, and Miller, District Judge. [*]

Hamilton, Circuit Judge.

The story of Rumpelstiltskin is about turning straw into gold. The legal malpractice case at the heart of these appeals presents a modern attempt to turn metaphorical straw into real gold. The district court rejected the effort, as do we.

This case originated in a contract dispute between CMGT, Inc. and Spehar Capital, a company CMGT hired to help it find financing. Spehar Capital sued CMGT over a dispute related to this agreement and eventually procured a $17 million default judgment against CMGT, which had no assets to pay it. Spehar Capital devised a plan to recover on the judgment. Step one: force CMGT into bankruptcy. Step two: convince the bankruptcy trustee to bring a malpractice action against CMGT's law firm based on the theory that but for the law firm's negligence, Spehar Capital would never have obtained the default judgment. Step three: win the malpractice action or force a settlement for the nominal benefit of CMGT's bankruptcy estate. Step four: since Spehar Capital's claim on the bankruptcy estate dwarfs all others, Spehar Capital receives the lion's share of the payment to the bankruptcy estate. Result: Spehar Capital receives payment on the default judgment by convincing another court that the default judgment should never have been entered. A meritless default judgment would be transformed into a significant payout. Straw turns into gold.

We are now at step two. The bankruptcy trustee sued CMGT's law firm, known as Mayer Brown, the defendant here. The trustee claimed that Mayer Brown committed malpractice by failing to advise CMGT on the consequences of not settling its dispute with Spehar Capital and by failing to defend CMGT against Spehar Capital's suit. Mayer Brown moved to dismiss, arguing in part that this suit should be dismissed as a fraud on the court due to the inconsistency between the theory of the malpractice case and a recovery by Spehar Capital. The district court denied the motion to dismiss but granted discovery for the limited purpose of investigating the fraud on the court theory. Mayer Brown then moved for summary judgment, and the district court granted the motion, reasoning that the doctrine of judicial estoppel barred the inconsistencies in this suit, based on undisputed facts. We agree. If the trustee were to prevail in this suit, there would be a clear impression that one court was misled. In the related appeals, we affirm the denial of Gerard Spehar's motion for intervention and the denial of defendant Mayer Brown's motion for sanctions against plaintiff's counsel and the trustee.

I. Factual Background

A. CMGT

CMGT was formed in 1999 to provide management services to the health care industry. CMGT owned software that made it easier for companies to track employee absences. While CMGT appears to have had a promising business idea, it lacked the start-up capital needed to implement its plan on the desired scale.

CMGT agreed to have Ronald Given, a partner with Mayer Brown, guide it through the process of obtaining financing.[1] The engagement letter provided that Mayer Brown would provide services "in connection with [CMGT's] initial capitalization, formative acquisition activities, and other related general corporate activities." In exchange, CMGT agreed to pay Mayer Brown 1.5 times the firm's normal hourly rates, but would owe nothing unless and until CMGT secured over $1 million in financing. Mayer Brown also retained the right to terminate the agreement if unpaid legal fees exceeded $50, 000 or if CMGT did not secure financing by May 2000. May 2000 came and went without financing, but Mayer Brown continued to provide legal services with the hope that financing would materialize.

In June 2001, CMGT also hired Spehar Capital to assist in the search for investors. Spehar Capital pairs com- panies seeking investors with venture capitalists seeking investments. For this service, Spehar Capital receives a finder's fee. Its founder is Gerard Spehar. The agreement between CMGT and Spehar Capital, as amended on September 30, 2002, provided that Spehar Capital would receive a success fee "immediately at the successful closing of a funding" with a firm introduced to CMGT by Spehar Capital or with whom CMGT approved Spehar Capital to hold discussions. The firms that met these conditions were identified in an Exhibit A that was attached to the contract and could be "amended only by written addendum." Upon the closing of such a deal, CMGT was to pay Spehar Capital six percent of the capital raised. Spehar Capital was also to receive six percent of CMGT's common stock "[a]t such time as CMGT receives and accepts a Term Sheet or other commitment from an investor(s) for a minimum of $1, 000, 000, " and Spehar Capital was to have exclusive investment banking rights. In addition, after the closing of a successful financing transaction, Spehar Capital was to receive a total of $100, 000 in consulting fees spread over twelve consecutive months.

B. The Trautner Deal

In 2003, CMGT still needed an investor. In July 2003, a CMGT shareholder named Charles Trautner proposed solving CMGT's financial woes with what we will call the "Trautner deal." He proposed a spinoff transaction in which his investment group would form a new corporation that would purchase CMGT's assets for either $500, 000 or 20 percent of the new corporation's stock. To make the two options equivalent from the perspective of CMGT's shareholders, the new corporation would receive an initial capitalization of at least $2.5 million. CMGT's president, Lou Franco, signed a non-binding letter of intent with Trautner on August 1, 2003, and CMGT's shareholders then approved the deal on August 22, 2003. The Trautner deal was scheduled to close by September 30, 2003.

But a dispute with Spehar Capital derailed the Trautner deal, and that dispute spawned the malpractice action now before us. The Trautner deal did not provide for any payment to Spehar Capital. CMGT, with the advice of Mayer Brown, had concluded that the deal was outside the scope of its contract with Spehar Capital. According to CMGT, because the deal was arranged through channels independent of Spehar Capital and because Trautner was not included in Exhibit A, Spehar Capital was not entitled to any payment. Spehar Capital, however, maintained that it was entitled to payment. Spehar Capital alleged that CMGT asked Spehar to participate in conversations about the deal with Trautner and that CMGT unreasonably refused to add Trautner to the list on Exhibit A after Spehar Capital found out about the proposed Trautner deal on August 8, 2003.

Over the next month, Spehar Capital and CMGT were unable to reach any resolution, though the extent to which they engaged in settlement negotiations is disputed. Mayer Brown contends it is absurd to suggest CMGT could settle because CMGT had no money with which to settle or even to defend the litigation. The trustee contends that Spehar Capital wanted to settle and that CMGT could have offered to settle with a percentage of future financing proceeds.

The trustee also contends that Mayer Brown negligently failed to advise CMGT about the risk of not settling for the future of CMGT. As an example of this failure, the trustee points to an August 26, 2003 email in which the president of CMGT, based on advice from Mayer Brown, sent a letter to the shareholders conveying confidence that "any claims against the transaction will not succeed and, as a practical matter, the only substantive effect we will be facing is additional documentation complexity and a delay in the winding up of CMGT . . . ."

According to the trustee, Mayer Brown failed to provide adequate advice to CMGT because the law firm had negotiated a "functionally equivalent" deal with Trautner that would have allowed Trautner essentially to assume CMGT's business without formally purchasing CMGT's assets from its shareholders. This alternative deal envisioned assigning CMGT's existing contracts to the new company formed by Trautner. CMGT would pay the new company for servicing CMGT's contracts, including its accrued legal fees owed to Mayer Brown, which would be paid on CMGT's behalf. In effect the deal would have given Trautner the benefit of the Trautner deal and Mayer Brown would have received payment of its fees without having to worry about Spehar Capital's claim. According to the trustee, however, ...


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