Will the real intended third-party please stand up?

• Author: Peterson, Paul C.

TRADITIONALLY, absent fraud or collusion, the only parties with standing to sue an attorney for malpractice were those in privity of contract with the attorney, that is, the lawyer's clients. (1) However, over the past several decades, the traditional "privity" doctrine has eroded as courts have begun to allow beneficiaries of an attorney's estate-planning services to bring malpractice claims. (2) The modern trend in the estate-planning context is to recognize the existence of an attorney's duty to those outside the attorney-client relationship. Outside the estate-planning context, the legal landscape is less dear.

This article addresses three legal doctrines that have been found to provide non-clients with standing to sue an attorney: the third-party beneficiary rule (outside the context of wills, estates, and trusts), the implications of opinion letters, and the potential exposures that lawyers face to non-clients for fraud, and aiding and abetting the alleged wrongful conduct of their clients.

1. Attorney Malpractice Liability to Non-Clients

   In certain contexts, courts have found that a non-client has standing to sue an attorney for malpractice. They have done so under a number of different theories. The first approach is a multi-criteria balancing test, which originated in California. (3) A related approach adopts a contractual third-party beneficiary analysis, which requires that the non-client be a "direct and intended beneficiary" of the attorney's services before the courts will impose a duty. (4) Another approach is contained in the Restatement (Third) of the Law Governing Lawyers Section 51(3); (5) however, this approach has been widely criticized as unworkable. (6)

   A more recent trend has been the recognition of an attorney's duty of care to non-clients outside the estate-planning context. With few exceptions, courts recognizing this duty of care have applied some version of the third-party beneficiary theory, requiring that non-clients be "direct and intended beneficiaries" of the transaction for which the client has engaged the attorney's services.

   The cases below are some of the most recent and important decisions regarding this issue. They highlight the factual contexts in which courts have recognized, and have refused to recognize, the standing of a non-client in a legal malpractice action.

   1. McIntosh County Bank v. Dorsey & Whitney, LLP (7)

      McIntosh provides a good starting point from which to survey the contours of this evolving doctrine. The case involved a syndicated lending transaction and asked whether the attorneys for the lead bank in the transaction could be held liable in malpractice to the banks participating in the loan as investing third parties. Plaintiffs, thirty-two banks participating in a syndicated loan transaction originated by lead bank, Miller & Schroeder ("M & S"), collectively sued legal counsel for M & S--Dorsey & Whitney, LLP ("Dorsey")--alleging that it had committed legal malpractice and breached fiduciary duties owed to the participating banks in structuring the loan.

      M & S closed two loans to a company (the "Company") formed to develop and manage a casino on the reservation of the St. Regis Mohawk Tribe (the "Tribe") in the State of New York. During Dorsey's preparation of the loan documents, a question arose as to whether National Indian Gaming Commission ("NIGC") approval of some of the documentation was required. Dorsey knew that failure to obtain NIGC approval might place the participating banks' interest in the collateral at risk, but advised M & S that NIGC approval was not required. Dorsey failed to advise M & S of the risks to closing without NIGC approval. M & S would not have closed the loans if it had known the risk of closing without NIGC approval. The loans closed without approval from the NIGC. M & S then sold most of the participation interests in the loans to plaintiffs. Shortly thereafter, the Tribe defaulted on the loans. Because the NIGC had not approved the changes, plaintiffs lost their interest in the collateral.

      Affirming the trial court's grant of summary judgment in favor of Dorsey, the Minnesota Supreme Court extended the application of the California balancing test and found that non-clients could gain standing to sue an attorney for malpractice outside the estate-planning context. In doing so, it reaffirmed the threshold requirement that to have standing to sue an attorney for malpractice, a non-client "must be a direct and intended beneficiary of the attorney's services." (8) The court defined a "direct beneficiary" to require that the benefit to the non-client be the "end and aim of the transaction" in which the attorney rendered his services. (9) It did so to "prevent nonclients who receive incidental benefits from the representation, or who only receive downstream benefits, from holding the attorney liable." (10)

      The court also required that the attorney "must be aware of the client's intent to benefit the third party," before a non-diem could gain standing to sue. (11) Even if the client intended the attorney's work to benefit a third-party, unless the attorney acted knowing of that intent, the attorney owes no duty of care to the third-party. "Such a requirement is in keeping with the fiduciary and ethical duties attorneys owe their clients. Imposing on attorneys a duty toward beneficiaries of whom they are unaware would risk dampening their zealous advocacy on behalf of clients, for fear of harming a third party to whom a duty might later be found." (12)

      Applying these principles to the facts of the case, the Minnesota Supreme Court found that the participating banks "were not direct and intended beneficiaries of the attorney-client relationship between M & S and Dorsey." (13) The court emphasized that this situation was "far from the will-drafting context in which the third-party beneficiary theory was first developed." (14) Because plaintiffs' position relative to the transaction "was that of parties with whom defendant's clients might negotiate a bargain at arm's length," they could not have been direct and intended beneficiaries of the attorney-client relationship. (15)

   2. State of California Public Employees Retirement System v. Shearman & Sterling (16)

      In Shearman & Sterling, the New York Court of Appeals decided a closer question. Addressing whether California Public Employees' Retirement System ("CalPERS") was an intended third-party beneficiary of the relationship between one of its business partners and their counsel, the court applied a form of the "direct and intended beneficiary" test later articulated in McIntosh.

      CalPERS sued Shearman & Sterling for professional negligence following the default of a loan it had acquired from Shearman & Sterling's client, Equitable Real Estate Investment Management, Inc. ("Equitable"). The New York Supreme Court dismissed CalPERS' direct causes of action because CalPERS failed to demonstrate that it was an intended third-party beneficiary of the work Shearman & Sterling performed on behalf of Equitable. CalPERS appealed.

      Pursuant to an agreement between CalPERS and Equitable (the "Agreement"), Equitable originated and dosed commercial property loans for sale and assignment to CalPERS. Sherman & Stearling represented Equitable in connection with the loans. In the course of their relationship, CalPERS and Equitable developed standard form loan documents, including a promissory note that contained a prepayment and

      acceleration penalty, which they used in their loan transactions. CalPERS asked Shearman & Sterling to incorporate the standard promissory note into the loan documents.

      However, during negotiation of a commercial loan between Equitable and the borrower, the terms of the standard form loan documents were modified; the acceleration clause in the promissory note had been changed. Shearman & Sterling provided a draft note to CalPERS, which had been black-lined to reflect changes in the loan documents. CalPERS made no objection to the loan documents. Following the dosing, Equitable assigned the loan to CalPERS. The borrower later defaulted and, when CalPERS accelerated the loan, discovered that the acceleration fee had been reduced, which harmed CalPERS.

      The Court of Appeals found the allegations in the complaint insufficient to establish that CalPERS was an intended third-party beneficiary of the work Shearman & Sterling performed on behalf of Equitable. In addressing CalPERS' argument it was an intended third-party beneficiary of the legal services Shearman & Sterling provided to Equitable, the court stated:

      A party asserting rights as a third-party beneficiary must establish (1) the existence of a valid and binding contract between other parties, (2) that the contract was intended for his benefit and (3) that the benefit to him is sufficiently immediate, rather than incidental, to indicate the assumption by the contracting parties of a duty to compensate him if the benefit is lost. (17) The court found a valid and binding contract between Equitable and Shearman & Sterling for the law firm's services in the loan transaction. However, contrary to CalPERS' assertion, the court held that Equitable did not retain Shearman & Sterling for CalPERS' benefit. Although the sole purpose of the business relationship between CalPERS and Equitable was to allow CalPERS to invest in long-term commercial real estate loans obtained by Equitable, the court determined that CalPERS and Equitable did not at all times share the same interests. The court noted the Agreement declared the agents of Equitable acted independently, and were not the agents of CalPERS. The Agreement also required CalPERS' counsel (and not Shearman & Sterling) to approve all dosing documents on CalPERS' behalf. Relying on the language of the Agreement and the scope of Shearman & Sterling's representation, the court held that CalPERS was not an intended third-party beneficiary Shearman & Sterling's relationship...