Lessons from Fortress v. Dechert

By Edward J. Levin The Daily Record Newswire In Summer 2010, the legal opinion world was rocked by news that the claim of affiliates of Fortress Investment Group against the law firm Dechert LLP, for $50 million in damages arising from a legal opinion letter given by Dechert, had survived a motion to dismiss. That world settled down somewhat on the news that on Nov. 29, a New York intermediate appellate court dismissed Fortress's claims against Dechert. Fortress Credit Corp. v. Dechert LLP, 2011 WL 5922969. This column looks at the November decision by the New York Supreme Court, Appellate Division, First Department. Background Dechert issued a legal opinion letter to Fortress, the lender, in a fraudulent financing that was arranged by Marc S. Dreier. Dreier, who was then an attorney and had represented the purported borrowers (Solow Realty & Development Company, LLC and affiliates) on litigation matters for a number of years, forged the signatures of the borrowers on the loan documents and other documents, and misappropriated the loan proceeds after they were wired to his trust account. In May 2009, Dreier pleaded guilty in federal court to orchestrating a massive Ponzi scheme and to conspiracy to commit securities fraud and wire fraud, money laundering, securities fraud, and wire fraud. He was sentenced to 20 years in prison and disbarred. According to court pleadings, starting in 2005, ostensibly on behalf of the borrowers, Dreier arranged with the lender to borrow money to finance the purchase of foreign real estate assets. Dreier acted as a limited guarantor and manager of the loans. The initial loan of $25 million closed in January 2006, and it was extended and increased in 2007 to approximately $50 million. In 2008, the lender agreed to loan the borrowers an additional $50 million, but the lender insisted that the borrowers hire an independent law firm to issue an opinion letter to the lender. Dreier engaged Dechert to serve in that role and paid it $100,000. The lender made the additional loan of $50 million to the borrowers, but the borrowers had no knowledge of it, did not authorize it, did not sign the loan documents, and never received the loan proceeds. Dechert, the law firm that was supposedly representing the borrowers, had no direct contact with the borrowers or any of their officers or employees. Dechert's only contact regarding the borrowers was with Dreier. Dechert undertook no due diligence to determine the involvement, or lack of involvement, of the borrowers in the loan transaction. In connection with the additional $50 million loan, on June 25, 2008, Dechert, as "special corporate counsel" to the borrowers and Dreier (collectively, the "Loan Parties"), rendered an enforceability opinion in favor of the lender. That opinion provided "each of the Transaction Documents constitutes the valid and binding obligation of each of the Loan Parties ... enforceable against such Loan Party in accordance with its terms." Dechert's letter also included the opinion that "each of the Loan Parties has duly executed and delivered each of the Transaction Documents to which it is a party." With those opinions in hand, the lender funded the $50 million loan. Causes of action If a lender wants to collect damages for harm caused by a third-party opinion letter written in connection with a loan, it must first find one or more viable causes of action to pursue against the law firm that gave the opinion. Because the opinion issuer represents the borrower (and perhaps other loan parties, such as guarantors) and delivers the opinion letter on their behalf to the lender, the lender is not the client of the law firm that renders the opinion. In other words, the lender is a "nonclient" as to the law firm. The Fortress court found the lender could not sue Dechert for legal malpractice because they did not have an attorney-client relationship. Also, as a general matter, the opinion giver does not have a contract with the lender, and so there is no legal "privity" (the nexus that is often required to bring a successful lawsuit) between them. However, New York courts have fashioned an exception to this rule. The Fortress court cited Prudential Insurance Company of America v. Dewey, Ballantine, Bushby, Palmer & Wood, 80 N.Y.S.2d 377, 605 N.E.2d 318, 590 N.Y.S.2d 831 (1992), for the proposition that in New York, to permit recovery for pecuniary loss sustained as a result of another's negligent misrepresentations, there must be a showing that there was either actual privity of contract between the parties or a relationship "so close as to approach that of privity," sometimes referred to as "near privity." In satisfaction of this requirement, the Fortress court found the lender's complaint alleged a "near privity" relationship because it averred that the purpose of the opinion letter was to aid the lender in deciding whether to enter into the loan, Dechert was aware that the lender was relying on the opinion in determining whether to make the loan, and Dechert showed its understanding of this reliance by addressing the opinion letter to the lender. Stated differently, under New York law, a law firm that represents a borrower may have liability to a lender in connection with an opinion letter issued in a loan transaction. Law firm not liable Although it held that the lender could sue Dechert because it found "near privity," the Fortress court ultimately declined to hold Dechert liable for damages to the lender. The court noted that because the complaint did not allege that the lender advised Dechert that its obligations were not limited to the review of only specified documents and the complaint did not allege that the lender advised Dechert that it needed to investigate, verify, and report on the legitimacy of the loan transaction, the lender could not establish that Dechert breached a duty of care. The court also found that Dechert had no reason to suspect that the borrowers were not actually participants in the loan transaction or that their signatures had been forged. The court found that Dechert's statements in the opinion letter were not misrepresentations, as would be required to find liability under Prudential, because the opinion letter stated that Dechert had not made an independent inquiry into the accuracy of the factual representations or certificates. The court also rejected the claim that Dechert was liable for fraud. The complaint alleged that Dechert acted recklessly in failing to confirm that the borrowers were actually involved in the loan, but the court held that this was not a sufficient allegation of scienter (guilty knowledge), a necessary element in an action for fraud. The court based this holding on its findings that there were no allegations that Dechert made a knowingly false statement or that it knowingly participated in the fraud. Explicit assumptions Significantly, Dechert included in its opinion letter an assumption that the signatures on all of the documents were genuine and an assumption that all of the documents it had seen were authentic. The court said that the opinion letter "was clearly and unequivocally circumscribed by the[se] qualifications." Essentially, these assumptions had the effect of enabling Dechert to issue the opinion letter as if the certificates of the borrowers, the resolutions of the borrowers, and the loan documents were authorized by the borrowers and that they were properly signed and delivered by them. As it turned out, all of these documents were forged by Dreier, but the court allowed the opinion to be read as if all of the documents were approved and signed by the borrowers. Therefore, the court held that the lender's complaint failed to state a cause of action against Dechert for breach of fiduciary duty. Accordingly, the court reversed the decision of the trial court and ordered that the case against Dechert be dismissed. Notwithstanding the law firm's role in the fraud perpetrated by Marc Dreier, Dechert has avoided liability to the lender for now. Dechert allegedly did no due diligence before issuing its letter, did not even meet with, correspond with, or otherwise communicate with its "clients," and rendered its opinion letter based on forged entity certificates, entity resolutions, and loan documents. It can be inferred from the fact that that Dechert received a fee of $100,000 for only a few days' work that it should have known that something was amiss. Despite this, the court read the assumptions that Dechert included in its opinion letter literally and interpreted the letter in the fictional world that the opinion letter described. ---------- Edward J. Levin, a member of Gordon Feinblatt LLC, chairs the Legal Opinions in Real Estate Transactions Committee of the ABA's Section of Real Property, Trust and Estate Law as well as the Special Joint Committee on Lawyers' Opinions in Business Transactions of the MSBA's Sections of Business Law and of Real Property, Planning and Zoning. The opinions expressed in this article are his own. The author thanks Cheri Wyron Levin for her advice on this article. Published: Thu, Jan 19, 2012