Failed Banks And Attorney Liability: A New Trend

May 10, 2011
Law 360

The recent economic crisis has had a negative impact on many industries, including, notably, the banking industry. In 2010, there were 157 bank failures nationally. More failures are expected in the next two years. This is bad news for banks and for many of the lawyers that represented them.

In just the last few months, the FDIC has filed legal malpractice suits against some of the most respected law firms in the country. Demands have been made against many more with tolling agreements and settlements with others. Indeed, the FDIC’s website reports that as of Feb. 7, 2011, “[t]he FDIC has authorized seven fidelity bond, attorney malpractice, and appraiser malpractice lawsuits. In addition, 218 residential malpractice and mortgage fraud lawsuits are pending.” This is just the beginning of what will likely be a steady stream of claims against lawyers as the FDIC attempts to recover from the deep pockets of lawyers and their legal malpractice insurers.

Under federal law, the FDIC acquires all of the claims of a failed bank including against outside professionals (including lawyers). As part of its investigation in every instance of a bank failure, the FDIC has formed a Professional Liability Operation. In addition, the FDIC has retained national counsel to assist in connection with the assertion and prosecution of claims against lawyers including legal malpractice claims.

The FDIC has many advantages over typical legal malpractice plaintiffs. Most notably, it has a deep pocket to fund litigation. Equally importantly, it enjoys many protections unavailable to most plaintiffs including defenses and accountability for negligence, failure to mitigate and post-takeover conduct.

Contrary to popular belief, FDIC recovery actions are not limited to botched real estate transactions. While certainly real estate transactions are a prime target, the FDIC has also pursued claims arising out of representations in litigation, acquisitions and operations. More recently, the FDIC has become much more aggressive about pursuing litigation to gain access to what documents and information within the possession of lawyers.

There are two relevant time limits that are important. First, the FDIC has reported that once a bank has closed, the FDIC will bring its tort claims within three years and its breach-of-contract claims within six years of the closing (although if a particular state authorizes a longer statute of limitations, the FDIC will follow that state’s rules). Second, the FDIC typically completes its investigations within 18 months of a takeover.

Lawyers and law firms who have represented a failed bank should take affirmative proactive steps to protect themselves. Here are several important things to do once a law firm learns that a client bank has failed and the FDIC has taken over:

1) Notify your legal malpractice insurer of a "circumstance that might give rise to a claim." This is different than giving notice of a legal malpractice claim. Under most malpractice policies, this notice triggers the coverage and protects the law firm in the event that the FDIC decides months (or years) later to pursue a legal malpractice claim.

2) Establish a "control group" or "potential claim" partner to provide advice and monitor the situation. This should not be a lawyer who has worked on matters for the failed bank. Some of the worst admissions (sometimes unfounded) come from unprivileged internal communications from lawyers trying to figure out what happened and who is responsible.

3) Secure and segregate all files for the failed bank. Increasingly, the FDIC has filed litigation against law firms seeking the discovery of files. One of the complicating issues surrounding files involves what is appropriately considered to be part of the file. To address this issue, the most effective strategy is to "lock down" the file as of the date of the takeover so that there is no dispute about the file’s content on that date.

4) Close all existing files (with a termination letter if one does not already exist) and open a new client/matter for any ongoing matters. The lawyer’s and firm’s client has changed. The failed bank as an existing client ended with the takeover. The FDIC is a new client. These are important distinctions for a lot of reasons. For conflict of interest purposes, the failed bank is now a former client and the FDIC is a current client. More importantly, lawyers and law firms should avoid any suggestion that the statute of limitations has not started because the representation is ongoing.

5) If any disputes arise, hire outside counsel for the law firm experienced in matters involving "lawyers’ law" even if the legal malpractice insurer has retained counsel. The interests of the law firm and the legal malpractice insurer differ greatly. For the legal malpractice insurer, it really is about money. For the lawyer and law firm, much more is at stake. Lawyers and law firms need someone who is looking out for their interests only.

So, how much should law firms who have represented failed banks worry? In the failed savings and loan association situation from a few years ago, one in four takeovers resulted in claims against professionals. To date, the FDIC has included in lawsuits, claims against law firms AND individual lawyers; claims for legal malpractice, breach of fiduciary duty AND punitive damages; and claims for attorneys fees.

The risks are high and lawyers should treat them accordingly.

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