Professional Liability Client Alert: Court Gymnastics Needed to Justify Novel Use of Probate Limitations Period to Save Fifteen-Year Old Class Settlement Claims Against Attorneys

In Prakashpalan v. Engstrom, Lipscomb & Lack (2/27/2014 – order modifying opinion and denying petition for rehearing – No. B244236), the Court of Appeal for the Second District reversed the trial court’s order sustaining a demurrer based on the statute of limitations, Code of Civil Procedure § 340.6 for attorneys. The court applied the concept of “late discovery” to permit a disgruntled class plaintiff’s claims against prior counsel arising from a settlement which had occurred fifteen years earlier in a class action against class plaintiffs’ insurer, State Farm, in connection with the 1994 Northridge earthquake. Plaintiffs alleged that in 2012 they discovered that 17 of the 93 settling class members had obtained on average $500,000 from a settlement fund of $100 million; they then assumed that the same average recovery applied to the other 74 plaintiffs and extrapolated a fraud claim against their counsel to allege a $22 million “shortfall.” Other claims were included in plaintiffs’ complaint against their former attorneys but, for purposes of the legal gymnastics of the Second District concerning the fraud-based claims, it is this aspect of the case which is noteworthy.

Finding at the pleading stage that plaintiffs had alleged sufficient facts to support an argument for “delayed discovery” of their claims some fifteen years after-the-fact, the court held that Section 340.6 did not bar all of their claims, even under the maximum four-year limitations period of that statute. (Section 340.6 contains two distinct, alternative limitations periods: one year after actual or constructive discovery of the facts constituting malpractice, or four years after occurrence of the wrongful act or omission, whichever occurs first. Claims for ‘actual fraud’ are excluded from the statute.) The court did, however, affirm the dismissal of plaintiffs’ professional negligence and breach of fiduciary duty claims based on Section 340.6. As to the remaining claims asserted, the court decided that because such claims were predicated upon or arose from the attorneys’ alleged fraud in the distribution and accounting of the proceeds of the $100 million settlement, such claims would more appropriately be analyzed under the limitations provisions of California Probate Code § 16460, which governs trust accounts, rather than Code of Civil Procedure § 338(d), which many earlier California decisions had applied to fraud claims against attorneys.

Although it disagreed with plaintiffs’ assertion that the holding of settlement funds by their attorneys did not constitute “professional services,” the court concluded that such claims sounded in fraud and were thus expressly exempted from Section 340.6. However, the court then performed a perfect back-flip and decided that such fraud-based claims were all subject to the “delayed discovery” principles found in case law interpreting the “general” fraud statute of limitations, Code of Civil Procedure § 338(d) but determined to apply the limitations period specified in Probate Code § 16460, the first time any California appellate court has applied this provision to claims against an attorney concerning disbursements and accountings to clients from an attorney’s client trust account.

Section 16460 applies to a fiduciary’s duty to provide an accounting to a trust beneficiary and sets forth a three-year limitations period, triggered by the trustee’s accounting duty; significantly, if no accounting is given, the three-year limitations period is tolled pending a beneficiary’s discovery of the claim based upon the existence of sufficient information to be put on inquiry notice. The court drew upon California Rule of Professional Conduct 4-100(B) as support for its application of Section 16460 to claims relating to attorney trust accounts as the more specific statute (compared to Section 338(d)) to govern attorney duties and issues. Rule 4-100(B) requires an attorney in an “aggregate settlement” situation to provide sufficient information to enable the client to evaluate whether the settlement proceeds have been properly distributed.

Even though such a discovery standard generally applies in California per Jolly v. Eli Lilly & Co. (1988) 44 Cal.3d 1103, the appellate court’s justification for choosing Section 16460 was that discovery is triggered by the receipt of an accounting, or if no accounting is supplied, by facts sufficient to put the plaintiff on notice of “any wrongdoing.” The court thus permitted claims to proceed against the defendant attorneys based upon plaintiffs’ sheer speculation that because 18% of the class ostensibly received a relatively small portion of the $100 million settlement, the remaining 82% must have received similar amounts, thus leaving the unexplained (but presumptively fraudulent) “shortfall.”

Interestingly, in its order on denial of defendants’ petition for rehearing, the court substantively modified footnote 8 of the original opinion, which had originally read: “Although Rules of Professional Conduct, rule 4-100(B)(3) specifies that such accountings shall be kept for a minimum of ‘five years,’ we do not read that rule to impose an outside limit on the amount of time an attorney must keep accounting records.” The court’s modification struck the underscored language and replaced it with: “. . . the rule does not obviate a fiduciary’s duty to provide an accounting.” This seems to have addressed the subsequent criticisms of the original opinion from both the defendants (in their petition for rehearing) and outside commentators that the court had essentially re-written the Rules of Professional Conduct to require maintenance of trust account records indefinitely; this change should avoid that implication. One wonders whether the defendants in this matter will seek review by the California Supreme Court.

In any event, the decision remains flawed in its contortions to achieve a reversal of the trial court’s order and in its apparent effort to create a new form of action against attorneys not subject to the maximum four-year limitations period of Section 340.6. Seemingly in order to borrow the general duty on fiduciaries to provide accountings to beneficiaries, the court unnecessarily applied Probate Code § 16460 to attorneys when Code of Civil Procedure § 338(d) would have produced the same result. In effect, this opinion invites an argument that the three-year limitations period in Section 16460 should apply to any negligence claim arising from a fiduciary’s duty to account, which would conflict with the Second District’s holding in Vafi v. McCloskey (2011) 193 Cal.App.4th 874 that Section 340.6 applies to all non-fraud claims against an attorney (including, in that case, malicious prosecution claims). Here, the court merits no more than a score of 2.9 for the fall on its dismount. Nonetheless, the fact remains that courts faced with fraud-based allegations against attorneys arising from the distribution of settlement funds may always seek to err on the side of caution when considering such claims at the pleading stage. Attorneys handling aggregate settlements are well advised to provide the form of accountings specified in Rule 4-100(B) in order to ”start the clock” on whichever limitations period is determined to apply.

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March 10, 2014