PA underlying sale of business interest : conflict of interest
Student contributor: Cheryl Neuman
Facts: Plaintiff and his business partner had established a restaurant servicing business. Ten years later, plaintiff and his partner decided to end their business relationship. They hired defendant lawyer to draft the terms of their mutual agreement. The defendant, however, failed to discuss the possibility of a default by one of the partners, conflict of interest, or the possibility of hiring independent counsel by each of the business partners. Subsequent to signing the termination agreement, one business partner could not pay plaintiff the money that he owed the other under the agreement. Furthermore, the business partner transferred the business’s assets to other companies—owned by his family, that competed in the restaurant servicing business. The defaulting partner filed for bankruptcy. Plaintiff then sued defendant for 1) breach of contract, 2) legal malpractice, and 3) breach of fiduciary duty.
Issue: Was it the inadequate quality of defendant’s legal services that allowed the defaulting partner to strip the business of all assets, rendering it judgment proof, so that he could not pay what was owed to plaintiff?
Ruling: Yes, it was the negligence of defendant’s legal services that allowed the defaulting partner to liquidate his business so that he could declare bankruptcy and subsequently fail to pay the money owed to plaintiff. Plaintiff’s expert (the Editor here) testified that it is a universal practice for lawyers to consult form books when drafting agreements for the sale of a business. Common protection used in these agreements include clauses that require corporate stock to be transferred through third-party escrow accounts, prohibit the transfer of corporate assets to other entities for less than the full market value, and prevent the buyer from setting up businesses that compete with the business providing the payment source for the seller, which is what happened in this case. None of those common safety clauses were used in the termination agreement and that benefitted one partner over the other. The conflict of interest should have been obvious to the defendant lawyer.
Lesson: The crux of the matter is that the default could have been avoided if the agreement had been properly drafted to prevent the transfer of assets away from the servicing business into other businesses that actively competed with the original business. That happened becuase, the defendant lawyer had a conflict of interest, since he could not concurrently represent both the separating partners whose interests were adverse to one another. It was therefore inevitable that one side of the transaction was going to benefit at the cost of the other. The Court relied heavily on the plaintiff’s expert and permitted the suit to proceed under both tort and contract theories.