To what extent is a lawyer guilty of malpractice for material misrepresentations to a client, and the client's counterparties?

Question

An investor agreed to invest an amount of money, 2X, in a startup through a convertible note. At the end of two years, the investor had the option of receiving back the monetary amount of his note with accrued interest, or converting his note into equity at a pre determined rate. The terms of the deal were that the investor would invest X up front, to allow the company to acquire a particular asset, and the remaining X upon the company's successful acquisition of this asset, which everyone involved agreed was key to the deal.

The company failed to acquire the key asset, and in this contingency, the terms of the contract called for the company to return X to the investor. The company notified the investor's lawyer of this fact, but the lawyer falsely told the client that the asset had been acquired, and asked the client to forward the remaining X. The client failed to do so, which would have been a "default" had the asset, in fact, been acquired.

The lawyer also represented to the company that he had reviewed the finances of the investor (he had not), and that the investor was an "accredited investor" as defined by the SEC, who could invest in unregistered securities, even though this was not the case.

After two years, the client sued for the return of X, which the company had spent. The company counterclaimed for the remaining X by saying that it would have survived if the investor had invested the whole amount. Because of certain jurisdictional and procedural issues, this set of lawsuits will take years to resolve.

Did the lawyer violate a fiduciary duty by telling the client that the asset had been acquired when, in fact it had not been, and if so, what are the consequences to the lawyer?

What responsibilities did the lawyer have under "know your customer" or similar legislation to verify the client's ability to invest as an accredited investor? And to what extent is the lawyer liable for the relevant mispresentations?

Normally, malpractice is not held against the lawyer unless the client wins the underlying case against the company. Is this true here, or are the lawyer's lapses so egregious and so material to the issues involved that the lawyer can be found liable regardless of the outcome of the investor-company litigation?

Answer 1

Did the lawyer violate a fiduciary duty by telling the client that the asset had been acquired when, in fact it had not been, and if so, what are the consequences to the lawyer?

Yes. A lawyer has the obligation that his representations to his client be diligent and materially truthful. Lawyer's violation of that duty prevents his client from making informed decisions.

At the outset, the lawyer's malpractice would warrant sanctions by the disciplinary board where he incurred legal malpractice. A possible suspension, public reprimand, and/or the amount of a monetary sanctions depend on several variables such as lawyer's intent, board's rules & discretion, and lawyer's severity & history of malpractice.

Quantification of the lawyer's liability to his client depends on the losses the client incurred as a result of the lawyer's misrepresentations. This largely depends on the terms of the contract between the investor and the company.

The intentionality (as opposed to negligence) of lawyer's misrepresentations are likely to support a claim of fraud, for which many jurisdictions entitle the injured party to treble damages.

What responsibilities did the lawyer have under "know your customer" or similar legislation to verify the client's ability to invest as an accredited investor?

Know Your Customer mostly relates to prevention and detection of money-laundering (and, to a lesser extent, of tax evasion), not to provider's awareness of his client's financial sophistication. KYC entails a duty the service provider has --if at all-- toward the authorities, not toward the client and typically not either toward the company in which the client intends to invest. Therefore KYC seems inapplicable in the scenario you describe.

It is unclear from your post why the status of accredited investor would be any relevant in this scenario. A startup in need for a particular asset seems unlikely to have a duty to ensure that its investors are classified as accredited for SEC purposes.

Normally, malpractice is not held against the lawyer unless the client wins the underlying case against the company. Is this true here

That seems unlikely. Despite the several gaps in your description, it certainly reflects separate causes of action involving different parties, different types of relation between them, unrelated states of mind, simultaneous fictions devised by the lawyer, and so forth. Accordingly, the outcomes of investor's ensuing claims against his lawyer are independent of investor's suit against the company.

For instance, the extent to which the contract between the investor and the company remained is inconclusive because crucial details of the investor-company contract are missing. Nor is it clear whether the company incurred what is known as invited error by not pressing the investor on the second installment of X the company was expecting. But, regardless of the legal position of the investor and the company with respect to each other, both entities [detrimentally] acted in reasonable reliance on the misrepresentations a third-party made to each of them.

Answer 2

The circumstances described would constitute a breach of fiduciary duty, but probably not professional negligence (which is the usual cause of action called "professional malpractice." There is no allegation that the lawyer acted incompetently, just disloyaly.

A true breach of fiduciary duty (other than a breach of fiduciary duty of care which is duplicative of professional negligence) has different potential remedies.

There may also be an action for common law fraud against the lawyer.