Academic journal article Defense Counsel Journal

Lawyers' Potential Exposure to Liability in Fraudulent Business Transactions

Academic journal article Defense Counsel Journal

Lawyers' Potential Exposure to Liability in Fraudulent Business Transactions

Article excerpt

CAN attorneys in representing clients, requests become personally liable for their client's fraudulent actions? Yes, in limited, although expanding, situations.

Is this a concern? Absolutely.

Does it make sense? Yes, under a proper analysis, but not otherwise.

What are the primary causes of this expansion of attorneys, personal liability? As is common, bad fact cases with inadequate remedies.

Are there adequate defenses to potential personal liability when representing clients engaged in fraudulent actions? Yes, the best being strict compliance with the applicable rules of professional responsibility and conduct, with a sound understanding of the various issues at play.

What are those issues? Read on.



When it comes to fraudulent transactions, the traditional liability protection for attorneys inherent in the attorney-client relationship is eroding in the business litigation context and, in fact, in most legal representations. This results from business clients trying to avoid the actions of their fraudulent managers or directors, or both, and the attendant liability, as well as the search by damaged third parties for additional sources of recovery when business clients have inadequate financial resources.(1) While most of the cases cited in this article deal with corporate relationships, the principles are applicable to most forms of business entities, although with limited application to sole proprietorship relations.

Traditionally, if clients engaged in wrongdoing, their attorneys had only to be silent to avoid liability, but this is not necessarily the case now. Several commentators have observed there is a growing concern about attorneys, duties of confidentiality and loyalty to clients, as contrasted to an emerging view in some courts that attorneys owe a duty to the public to prevent vent their clients from committing fraudulent acts. In the face of these potentially conflicting duties, it is more and more important for attorneys to determine what action or inaction to take when clients commit or may commit an illegal or fraudulent acts.

The courts have recognized the duty to the public most significantly in the savings and loan association cases arising from the collapse of many financial institutions in the late 1980s and early 1990s. In those instances, federal agencies, in an effort to recoup some of the cost of bailing out the failed institutions, turned to the only deep pockets" available - the attorneys, and accountants, malpractice insurers.(2) In many of those cases, the courts found that the attorneys had an affirmative duty to seek out their clients, wrongdoing and prevent the fraudulent transactions.


Courts are holding attorneys to a higher standard than ever before in regard to the fraudulent actions of their clients. This is especially true in the corporate arena and specifically as a result of the savings and loan association crisis. The Federal Deposit Insurance Corp. and counsel for corporations in general are developing creative ways to shift or extend the liability for the fraudulent actions of directors and managers to their attorneys or accountants, or both.

A. Emerging Duty to Public

The Ninth Circuit in FDIC v. O'Melveny & Meyers,(3) delivered one of the strongest messages as to lawyers, duties to prevent their clients' fraud. O'Melveny & Meyers was retained by American Diversified Savings Bank to prepare "Private Placement Memoranda," called PPMs, for two real estate limited partnership offerings. It was not the first law firm hired by ADSB to perform tasks related to real estate limited partnership offerings. In fact, prior to hiring O'Melveny, ADSB had retained and fired an accounting firm and a law firm.

The second accounting firm was replaced with a third shortly after O'Melveny was hired. …

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