California law firm Morrison & Foerster might have temporarily thought that it had escaped liability in a legal malpractice case filed against it in 2015 by an investment bank client. Firm principals were undoubtedly buoyed by a 2016 ruling issued by a New York trial court that dismissed the bank's lawsuit against it.
Any resulting euphoria was short-lived, though. An appellate court revived the case last week, announcing that the plaintiff's allegations of negligent client representation were sufficient to send the case back to trial.
The material facts in the matter can be quickly sketched. Back in 2010, a Chinese mining company conducted public offerings on the New York Stock Exchange. Pursuant to doing so, it informed investors that it owned a 90% stake in a coal company.
It didn’t. In fact, the mining entity was essentially a shell.
The investment bank, which was retained as an underwriter, never discovered that. Neither did Morrison Foerster, which the bank hired to do transactional due diligence.
Both entities did receive a report from another company hired by the hank to investigate the Chinese firm. Although the report duly noted that the 90% claim was fraudulent, neither the bank nor Morrison Foerster picked up on that.
As a result, the bank underwrote the offering, relying on language in the law firm's opinion letter stating that attorneys had found nothing indicating that the offering documents were misleading.
The fraud was discovered in 2011, and the bank ultimately paid out $15 million to the SEC to settle allegations that it had repeated false statements.
Although the bank stated that it would never have participated in the offering "but for the defendant's negligence," the trial court ruled against it based on its view that the bank had knowledge of the fraud once it received the third-party report noting it.
The appeals tribunal clearly disagreed with that assessment, stating that mere possession of the report did not put the bank on notice of wrongdoing. The bank had a right to rely on accurate information from Morrison & Foerster, which it never received. The law firm "cannot shift to the client the legal responsibility it was specifically hired to undertake," the appellate panel wrote.
A media report on the case states that it is "likely [the bank] will seek tens of millions of dollars" in damages against Morrison & Foerster.