RONALD R. PETERSON, as Trustee for the estate of Lancelot Investors Fund, Ltd., Plaintiff-Appellant,
KATTEN MUCHIN ROSENMAN LLP, Defendant-Appellee
Argued April 16, 2015
Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 12 C 3393 -- Harry D. Leinenweber, Judge.
For RONALD R. PETERSON, as Chapter 7 Trustee for Lancelot Investors Fund, Ltd., Plaintiff - Appellant: Edward T. Joyce, Attorney, Edward T. Joyce & Associates, P.C., Chicago, IL.
For Katten Muchin Rosenman Llp, Defendant - Appellee: Peter C. John, Attorney, Christina D. Harrison, Attorney, Williams Montgomery & John Ltd, Chicago, IL.
Before BAUER, EASTERBROOK, and SYKES, Circuit Judges.
Easterbrook, Circuit Judge.
As we discuss in Peterson v. McGladrey LLP, No. 14-1986 (7th Cir.) ( McGladrey II), also issued today, the Trustee appointed to marshal the assets of Lancelot Investors Fund and other entities in bankruptcy (collectively " the Funds" ) has filed multiple suits against solvent entities that, the Trustee maintains, failed to detect the peril the Funds were in and help curtail their risks. See also Peterson v. McGladrey & Pullen, LLP, 676 F.3d 594 (7th Cir. 2012) ( McGladrey I ); Peterson v. Somers Dublin Ltd., 729 F.3d 741 (7th Cir. 2013); Peterson v. Winston & Strawn LLP, 729 F.3d 750 (7th Cir. 2013).
This appeal concerns the Trustee's contention that Katten Muchin Rosenman LLP committed legal malpractice during the six years it advised the Funds how to structure their transactions with entitles controlled by Thomas Petters. As we recount in the other opinions we have cited, the Funds loaned money to the Petters vehicles, which in turn supposedly financed some of Costco's inventory. Petters insisted that the Funds not contact Costco; doing that, he said, would upset his favorable business relations with it.
Security for the Funds' advances was supposed to come in two forms: paperwork showing the inventory Petters furnished and Costco's undertaking to pay, and a " lockbox" bank account into which Costco would deposit its payments for the Funds to draw on, eliminating any risk that Petters would put his hand into the till. That is how the Funds described the arrangement to their own investors. Yet Costco never put a penny into the account; all of the money came from a Petters entity. Gregory Bell, who established and managed the Funds, asserts that Petters told him that Costco had insisted on paying one of Petters's vehicles. As we observe in McGladrey II, however, Bell (and the Funds) lied to investors about the arrangements and asserted that the money came directly from Costco. The actual setup left the Funds at Petters's mercy--and he had no mercy, just as he never had any dealings with Costco. When Petters's Ponzi scheme collapsed, so did the Funds.
The Trustee's complaint contends that Katten violated its duty to its clients by not telling Bell that the actual arrangement (no checks with Costco, no money directly from Cost-co) posed a risk that Petters was not running a real business. Katten had been engaged to structure transactions, the Trustee asserts, and part of that duty entails telling the client what contractual devices are appropriate to the situation. The complaint focuses on two periods: first, a time during 2003 when principal contracts were being negotiated and signed; second, a time during 2007 when Petters fell behind in payments to the lockbox (he asserted that Costco was late paying him) and the Funds consulted Katten about what to do. According to the complaint, in 2003 Katten did not advise the Funds to ask for additional protections--the Trustee believes that Katten's lawyers did not recognize the risk from the combination of no contacts and no direct payments, plus the potential that the paperwork purporting transactions with Costco had been forged. The complaint also alleges that in 2007 Katten advised the Funds to defer the due dates on the payments, and that no other change was necessary, even though the delay coupled with the other indicators should have alerted any competent transactions lawyer to the possibility of fraud, and the lawyer should have counseled the client to obtain better security.
The district court dismissed the complaint under Fed.R.Civ.P. 12(b)(6) for failure to state a claim on which relief may be granted. Instead of taking the complaint on its own terms, the district court's opinion narrates the events from the law firm's perspective. Katten maintains, and the opinion states, that Bell knowingly bypassed verification with Costco in order to obtain a higher interest rate from Petters. Thus the Funds knowingly took a risk and cannot blame a law firm for failing to give business advice.
There are three problems with this decision. First, it rests on a factual view extrinsic to the complaint and therefore is not an appropriate use of Rule 12(b)(6). The complaint alleges that Bell attributed the Funds' high return at least in part to the lack of direct verification with Costco and that he told some would-be investors about this tradeoff, but it does not allege that Bell was indifferent to legal advice concerning how to curtail risks given the no-contact constraint.
Second, the decision does not engage the complaint's main contention--not that Katten was supposed to do something about Petters's no-direct-contact edict, but that Katten had to alert its client to the risk of allowing repayments to be routed through Petters, drafting and negotiating any additional contracts necessary to contain that risk. As the complaint depicts matters, Bell did not appreciate the difference between funds from Costco and funds from Petters. A competent transactions lawyer should have appreciated that the former arrangement offers much better security than the latter and alerted its client. If a client rejects that advice, the lawyer does not need to badger the client; but the complaint alleges that the advice was not offered, leaving the client in the dark about the degree of the risk it was taking.
The third problem is that the decision does not identify any principle of Illinois law that sharply distinguishes between business advice and legal advice. It is hard to see how any such bright line could exist, since one function of a transactions lawyer is to counsel the client how different legal structures carry different levels of risk, and then to draft and negotiate contracts that protect the client's interests. A client can make a business decision about how much risk to take; the lawyer must accept and implement that decision. But it is in the realm of legal advice to tell a client that the best security in a transaction such as this one is direct verification with Costco plus direct deposits to a lockbox; the second-best is direct deposits to a lockbox; and worst is relying wholly on papers over which Petters had complete control, for they may be shams with forged signatures by Costco managers who have never heard of Petters. Knowing degrees of risk presented by different legal structures, a client then can make a business decision; but it takes a ...