Paul Porvaznik – Business Litigator

This is a guest post from Chad Main of Percipient, an e-discovery and legal technology company focused on managed document review.

A recent opinion from the Illinois First District of Court of Appeal, Cronin & Company, LTD. v. Richie Capital Management, LLC, 2014 IL App. 131892-U (unreported), raises interesting questions about attorney liens, client files, e-discovery and the Rules of Professional Conduct. In Cronin, the court held that an attorney’s retaining lien (a lien used to secure payment of unpaid legal fees), attached to electronically stored information (ESI) hosted by an e-discovery vendor in Relativity, an e-discovery software platform. The court noted that although retaining liens attach only to documents actually possessed by the attorney asserting the lien, it encompassed ESI hosted by the vendor because the vendor acted at the direction of the attorney and therefore, the vendor’s possession of the electronic data was imputed to the attorney. As discussed below, in states that permit them, retaining liens are a helpful tool for attorneys to secure outstanding fees, but attorneys must also be mindful of the tension between the right to recover fees and the Rules of Professional Conduct.

Types of Attorneys Liens Available to Recover Fees

In Illinois, attorneys may assert two types of liens against former clients to ensure payment of outstanding fees. The first is a charging or, special lien governed by the Illinois Attorney’s Lien Act, 770 ILCS 5/1, which attaches to the recovery in the case for which the attorney is retained. The second type of lien, and the kind asserted in Cronin, is a retaining lien. A retaining lien enables an attorney to retain a client’s files, money and property possessed by the attorney until outstanding fees are paid. Upgrade Corp. v. Michigan Carton, Co., 87 Ill. App. 3d 662 (1st Dist. 1980).

Retaining liens are generally passive liens and enforceable only to defend against an action by the client seeking return of the property. Retaining liens continue until: 1) payment of outstanding legal fees; 2) the client posts adequate security for payment of unpaid fees; or 3) the attorney surrenders possession of the withheld property. Twin Sewer & Water, Inc. v. Midwest Bank & Trust, Co., 308 Ill. App. 3d 662, 644 (1st Dist. 1999). However, an attorney’s right to a retaining lien is not absolute and courts may order the release of client property if equity or fairness warrants. Upgrade, 87 Ill. App. 3d at 664.

Tension Between Attorney Liens and The Rules of Professional Conduct

Although attorneys may be permitted to assert liens over client property, they must be aware of ethical obligations relating to client files. As noted by Seventh Circuit in Johnson v. Cherry, 422 F.3d 540, 555 (7th Cir. 2005):

As a general matter, a lawyer’s ethical duties to her client do not preclude an attorney from invoking her retaining lien in furtherance of her right to compensation. See Ill. Rule of Professional Conduct 1.8(i)(1); see also American Bar Association’s Model Rules of Professional Conduct 1.8(i)(1), 1.16(d) (2000). This is not to say that retaining liens are beyond criticism. See John Leubsdorf, Against Lawyer Retaining Liens, 72 Fordham L.Rev. 849 (2004) (urging abolition of retaining lien). But the lien has been recognized and enforced in Illinois for more than 100 years. See Sanders v. Seelye, 128 Ill. 631, 21 N.E. 601, 603 (1889).

One of the main tensions between attorney liens and the Rules of Professional Conduct is found in Rule 1.16 which governs the termination of client relationships. Jim Doppke, former senior litigation counsel for the Illinois Attorney Registration and Disciplinary Commission, and now with Chicago’s Robinson Law Group cautions that “Rule 1.16 requires attorneys to take all steps ‘reasonably practicable’ to protect a client’s interest” and in some circumstances holding back client files, such as e-discovery materials, could prejudice a client.

So, what should an attorney do who wants to assert a retaining lien against the client’s file? Doppke says the first step should be negotiation of the outstanding fees and to make sure negotiations are in writing. “[Attorneys] definitely want to communicate ‘on the record’ with the client or new counsel because if the dispute is brought to the attention of the ARDC, often one of the allegations against the attorney is inadequate communication with the client.” Doppke says that attorneys should “surrender all paper and files to which the client is entitled,” but notes that lawyers may retain any documents as permitted by law. However, Doppke notes that “what the client is entitled to” is admittedly vague and absent a court order, is often determined by subjective factors.

Attorneys may not be completely without guidance. The federal court for the Northern District of Illinois addressed the issue of attorney liens and a client’s right to property in Lucky-Goldstar Intl. (America), Inc. v. International Mfg. Sales Co., Inc., 636 F. Supp. 1059 (N.D. Ill. 1986). What a client is entitled to, observed the court, “begs the question. If the attorney is properly asserting the retaining lien, the client is not entitled to the property” and therefore, rules of attorney discipline are inapplicable. However, the court acknowledged the tension between an attorney’s right to assert retaining liens and a client’s right to property, but noted that neither was absolute. A court faced with a dispute over an attorney’s retaining lien “should be to provide access to the documents necessary without prejudicing the rights of either party to a controversy [over attorneys fees].” The court counseled attorneys to consider:

• the client’s financial situation;
• the sophistication of the client in dealing with lawyers;
• the reasonableness of the fee;
• whether the client clearly understood and agreed to pay;
• whether imposition of the retaining lien would prejudice the important rights or interests of the client or others;
• whether failure to impose the lien would result in fraud or gross imposition by the client, and
• whether there are less stringent means to resolve the dispute.

Bottom line, Doppke says, is that the attorney must “keep an eye on the ball of what the client needs to go forward with the case” and not withhold those documents. This could be especially true in matters with significant e-discovery because a bulk of the case material could be electronic documents. As noted, one solution is requiring the client to post security for the unpaid fees as suggested by the court in Upgrade. This protects both the client’s ability to prosecute or defend a case and the attorney’s interest in unpaid fees.

 

An ill-fated wind turbine project in Southeast Wyoming sets the unlikely stage for a court’s encyclopedic corporate liability history lesson.  In Greenhunter Energy, Inc. v. Western Ecosystems Technology, Inc., 2014 WY 144, 337 P.3d 454 (Wyo. 2014), the Wyoming Supreme Court traces the evolution of the corporate form (and later, the equitable piercing the corporate veil remedy), from its pre-Biblical origins through the modern day where the limited liability company is the business vehicle of choice for start-ups and entrepreneurs across the country.

The plaintiff got about a $44K judgment against an LLC defendant  for consulting work the plaintiff did as part of a wind turbine development.  In post-judgment discovery, the plaintiff learned that the LLC was controlled in every way by its parent company – a publicly-traded entity – who decided what LLC creditors would and wouldn’t be paid.

The plaintiff then added the corporate parent as a defendant and the lower court pierced the LLC’s veil of protection and found the parent company responsible for the judgment.  Affirming the piercing judgment, the Wyoming Supreme Court held:

– the cardinal features of an LLC are limited liability and flexibility.  LLC’s have the personal liability protections of a corporation with the taxation benefits of a partnership (no “double taxation” at entity and personal levels, e.g.);

– Wyoming’s LLC Act provides that a failure of an LLC to observe corporate formalities isn’t enough to impose liability on LLC members or managers for LLC obligations (Wyo. Stat. Ann. s. 17-29-304).

– although Wyoming’s LLC Act provides that LLC members aren’t responsible for an LLC’s debts, an LLC’s veil of limited liability can be pierced where there is a unity of interest between the LLC and a dominating person or entity, and where recognizing corporate existence will lead to injustice or sanction a fraud;

– A Wyoming LLC can be pierced not only where there is actual fraud (misrepresentation of fact, scienter, reliance, damages, e.g.) but also where there is constructive fraud – conduct that doesn’t rise to the level of (intentional) fraud but is treated the same because of its similar harmful consequences;

– Two key factors involved in the piercing equation include undercapitalization and commingling: the degree to which a business is intermixed with the affairs of its member;

– No single factor is determinative on its own and the court’s piercing calculus is fact-driven.

(¶¶ 12-33)

The defendant and the LLC were separate entities and had separate bank accounts. Still the court upheld the lower court’s piercing of the LLC’s corporate veil to bind the defendant.

The undercapitalization factor weighed heaviest in the court’s analysis.  There is no magic capital infusion number that equals adequate capitalization.  The court noted that over a several-month period during the time plaintiff was submitting bills to the LLC, that it (the LLC) had a zero bank balance and that the defendant dictated what bills the LLC would and wouldn’t pay.

Since the LLC was continually unfunded by choice instead of by external market forces, the LLC was inadequately capitalized.  (¶¶ 40-43).

The court also found that the LLC and its corporate parent intermingled their business and finances.  Key facts cited by the court included: (i) the same accountants managed both the LLC’s and the defendant’s finances; (ii) the LLC didn’t have any employees.  Instead, defendant’s employees negotiated and inked contracts for the LLC; (iii) the LLC had no revenue separate from the defendant and the defendant used the LLC to “pass through” funds for bill payment; and (iv) the defendant claimed tax deductions for the LLC’s business without assuming responsibility for any of the LLC’s debts.  

In short, the defendant enjoyed all the benefits of an LLC without also shouldering the responsibility for its operation.  (¶¶ 44-45).

Q: But Shouldn’t the Plaintiff Have Gotten A Guaranty?

The defendant’s last argument was that the plaintiff should have protected itself by insisting on a guaranty from the corporate defendant.  The court rejected this, noting that the “reality of the marketplace” is that companies like the plaintiff are often in a competitively vulnerable position compared to large corporations like the defendant and lack the leverage to require a guaranty from the corporation.

Taken together, these factors led the to find the conditions ripe for piercing and held the defendant responsible for the judgment.

Afterwords:

A significant opinion for its exhaustive analysis of piercing litigation with a special focus on piercing an LLC.;

Piercing was allowed here even though there was no finding of actual or constructive fraud and where Wyoming’s LLC Act specifically provides that LLC members are not liable for LLC debts;

Time will tell whether this case and others like it will embody a major change in corporate liability law making it easier to pierce the veil of limited liability where a dominant entity controls a weaker, affiliated one.

A special thanks to Robert Ansell of Silverman Acampora (Jericho, NY) for alerting me to this
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