In re Src Holding Corp.

352 B.R. 103

In re SRC HOLDING CORPORATION, a/k/a, Miller & Schroeder, Inc. and its subsidiaries, Debtor.

Bremer Business Finance Corporation and Brian F. Leonard, Trustee, Plaintiffs, v. Dorsey & Whitney LLP, a Minnesota Limited Liability Partnership, Defendant. and McIntosh County Bank, et al., Plaintiffs, v. Dorsey & Whitney LLP, a Minnesota Limited Liability Partnership, Defendant.

Bankruptcy No. 02-40284.

Bankruptcy No. 02-40285.

Bankruptcy No. 02-40286.

Adversary No. 05-4051.

Adversary No. 03-4291.

United States Bankruptcy Court, D. Minnesota.

August 28, 2006.

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Paul L. Ratelle, Fabyanske, Westra, Hart & Thomson, P.A., Minneapolis, MN, for Bremer and Leonard in the Bremer case.

Richard G. Mark, Mark G. Schroeder, Jason R. Asmus, Briggs and Morgan, P.A., Minneapolis, MN, for Dorsey & Whitney.

Edward W. Gale, Thomas C. Atmore, Leonard, O'Brien, Spencer, Gale & Sayre, Ltd., Minneapolis, MN, for Leonard in the Leonard v. Dorsey case.

FINDINGS OF FACT, CONCLUSIONS OF LAW AND ORDER FOR JUDGMENT WITH RESPECT TO NONCORE PROCEEDINGS AS TO WHICH THE PARTIES HAVE CONSENTED TO THE ENTRY OF JUDGMENT AND REPORT AND RECOMMENDATION WITH RESPECT TO NON-CORE PROCEEDINGS AS TO WHICH THE PARTIES HAVE NOT CONSENTED TO ENTRY OF JUDGMENT

NANCY C. DREHER, Bankruptcy Judge.

INTRODUCTION....................................................................114
FINDINGS OF FACT................................................................115
   I.  THE PARTIES..............................................................115
       A.  Miller & Schroeder and Marshall..................................115
       B.  Dorsey & Whitney.................................................116
       C.  Bremer...............................................................117
       D.  President R.C.-St. Regis Management Company..........................117
       E.  The St. Regis Mohawk Tribe...........................................118
  II.  THE STATE OF NEW YORK COMPACT............................................118
 III.  THE MANAGEMENT AGREEMENT.................................................118
  IV.  THE ENGAGEMENT LETTER....................................................119
   V.  THE NOTICE AND ACKNOWLEDGEMENT OF PLEDGE.................................120
  VI.  THE REQUEST FOR NIGC APPROVAL............................................122
 VII.  THE AMENDMENT TO THE MANAGEMENT AGREEMENT AND THE TRIBAL
       RESOLUTION ..............................................................125
VIII.  NIGC DELAY...............................................................126
  IX.  ST. REGIS II.............................................................127
   X.  THE RUN-UP TO CLOSING....................................................128
  XI.  MILLER & SCHROEDER'S MARKETING AND BREMER'S PURCHASE OF A
      PARTICIPATION INTEREST....................................................133
 XII.  THE PARTICIPATION AGREEMENT..............................................136
XIII.  POST-CLOSING EVENTS......................................................140
 XIV.  THE PRESIDENT LITIGATION.................................................142
  XV.  THE BREMER/MILLER & SCHROEDER LITIGATION.............................154
 XVI.  THE EFFORTS TO COLLECT AGAINST THE TRIBE.................................161
CONCLUSIONS OF LAW .............................................................164
  I.  JURISDICTION/CORE-NON CORE ...............................................164
      A.  Jurisdiction of Counts I, II and III in the Bremer Case: Core —
           Non-Core ............................................................164
      B.  Jurisdiction of Count IV in the Bremer Case and Count IV in the
           Miller & Schroeder Case; Core — Non-Core...................165
 II.  BREMER'S MALPRACTICE CLAIMS IN THE BREMER CASE............................166
      A.  Res Judicata and Collateral Estoppel...................................166
      B.  Standing...............................................................168
          1.  Direct Attorney-Client Relationship................................168
          2.  Third-Party Beneficiary...........................................170
      C.  Negligence.............................................................173

      D.  Causation.............................................................178
      E.  Damages...............................................................180
III.  THE TRUSTEE'S CLAIM IN CASE NUMBER 05-4015 — INDEMNITY AND
       CONTRIBUTION.............................................................182
 IV.  THE TRUSTEE'S AND MARSHALL'S CLAIMS IN CASE NUMBER 03-4291................182
      A.  MRPC 1.7(a)...........................................................183
      B.  MRPC 1.7(b) and 1.4...................................................185
      C.  Waiver................................................................188
      D.  Dorsey Breached its Fiduciary Duties of Loyalty and Full Disclosure...189
      E.  Disgorgement..........................................................189
      F.  Marshall Investments' Claim — Breach of Fiduciary Duty..........191
      G.  Judicial Estoppel.....................................................191
      H.  Prejudgment Interest..................................................192
ORDER FOR JUDGMENT..............................................................193

The above-entitled matter came on for trial before the undersigned for seven days in February 2006, during which twenty witnesses (including seven experts) testified and hundreds of pages of documents were received in evidence. Appearances were as noted on the record.

INTRODUCTION

In a nutshell, this is a story about what happens when a lawyer makes a mistake, learns he has done so, and then, without disclosing the problem to the client, tries to repair the problem on his own. It is also a story about how lawyers get into trouble when they fail to squarely address the issue of conflicted representation. In 1999, attorneys at the defendant law firm made a $12 million mistake in connection with documenting a major business transaction. The mistake _first surfaced over a year later, at which time, instead of disclosing to the clients that there was a good possibility that the firm had committed malpractice, the firm urged that it be retained by the clients in major litigation arising out of that very business transaction. In the end, the law firm's attempted malpractice claims repair in that litigation only patched part of the problem and the clients were still out approximately $8 million.

This case is about one of the clients who wants approximately $1.5 million in damages for the money it invested in the transaction and has not yet retrieved, along with 8400,000 that it incurred in another piece of litigation arising out of the transaction. Further, it is about the bankruptcy trustee who wants the law firm to disgorge the nearly $1 million in attorney's fees one of the clients (now the bankrupt debtor) paid to the law firm to pursue and defend litigation that, by reason of the law firm's failure to disclose its error, should never have happened.

The facts in this case are; complex, but the lesson is simple. Know your client and if you make a mistake, and you know or should know that you have done so, be honest with that client. Otherwise you may find yourself in court in the embarrassing position of trying to explain to a judge why your clients were not really your clients and why you should be allowed to shed fiduciary duties attendant in all attorney-client relationships.

These are two consolidated adversary proceedings commenced in the chapter 7 bankruptcy case of SRC Holding Corporation a/k/a Miller & Schroeder, Inc., and its subsidiaries ("Miller & Schroeder").

In Case No. 05-4051. ("the Bremer case"), Bremer Business Finance Corporation ("Bremer") has sued Dorsey & Whitney, LLP ("Dorsey") for damages incurred by Bremer when it purchased a participation interest in a loan ("St. Regis II"). The St. Regis II loan was made to President R.C.-St. Regis Management Company ("President"), a developer and manager of the St. Regis Mohawk Tribe's ("Tribe") Indian gaming facilities. Bremer alleges that Dorsey was retained as legal counsel to the lender to prepare the loan documentation and to close the transaction. Bremer alleges that Dorsey negligently prepared the loan documents and failed to secure proper regulatory approval before closing the loan as a consequence of which Bremer has a legal malpractice claim. Bremer seeks return of its investment in the loan participation and associated damages. Brian F. Leonard, the Chapter 7 trustee in Miller & Schroeder's bankruptcy case ("trustee"), also sues Dorsey for contribution and indemnity for any sums the estate has to pay on the claims Bremer has filed in the bankruptcy case.

In Case No. 03-4291 ("the Miller & Schroeder case"),¹ the trustee asserts that Dorsey is liable to it for breach of fiduciary duties of loyalty and full disclosure, which occurred when Dorsey undertook to represent Miller & Schroeder and the loan participants in a collection action against President ("the President litigation") and then accepted representation of Miller & Schroeder when Bremer sued Miller & Schroeder in a second piece of litigation ("the Bremer/Miller & Schroeder litigation"). The trustee, and the estate's successor Marshall Investments Corporation ("Marshall"), seek to have Dorsey disgorge all attorney's fees and costs they paid to Dorsey to pursue the President litigation and to defend the Bremer/Miller & Schroeder litigation.

FINDINGS OF FACT

I. THE PARTIES

A. Miller & Schroeder and...