Degiacomo v. Holland & Knight, LLP

Citations: 219 F. Supp. 3d 265; 2016 U.S. Dist. LEXIS 163619; 63 Bankr. Ct. Dec. (CRR) 105Docket: Case No. 11-11010-JNF; Civil Action Nos. 16-10528-NMG, 14-10483-NMG

Court: District Court, D. Massachusetts; November 27, 2016; Federal District Court

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Defendants Holland & Knight, LLP, H&K, and Richard J. Hindlian filed a motion for summary judgment against the plaintiff's legal malpractice claim, which arises from the plaintiff's role as Bankruptcy Trustee for the Estate of Inofin, Incorporated. They also sought to strike deposition testimony from Michael Cuomo. The court granted the defendants' motions.

Inofin, founded in 1994, specialized in acquiring and servicing subprime auto loans and was controlled by Michael Cuomo and Kevin Mann. The company raised capital through unsecured investor loans. Inofin engaged in dubious lending practices by using investor funds to finance affiliated startups without informing investors, contributing significantly to its insolvency.

Despite legal advice from Sullivan & Worcester that startup loans should not be considered assets for regulatory purposes, Inofin inaccurately reported these loans as assets from 2005 to 2009. This misrepresentation concealed a negative net worth, which, had it been reported accurately, could have led to regulatory action against Inofin.

Inofin's financial reporting was managed by Sharkansky, whose advice was disregarded when Inofin sought to separate its financial statements from those of the startups. Following Sharkansky’s warnings about negative net worth implications, Inofin terminated their services and hired Richard Tobin, who continued to misclassify the startup loans as assets. Simultaneously, Inofin also began factoring auto loan receivables to alleviate cash flow issues, compromising the value of the loans by 8%.

Inofin improperly recorded factored loans as assets, inflating its income and assets while understating expenses. Despite legal counsel from Robert Allison in 1994 and Ed Woll in 2003, advising that promissory notes were securities requiring SEC registration, Inofin failed to comply. In 2009, the SEC initiated an investigation, revealing Inofin had factored approximately $26 million in loans. By December 2010, Inofin's financials showed a negative net worth of $29 million, leading to a cease and desist order and an involuntary Chapter 7 bankruptcy petition filed by creditors in February 2011. The Bankruptcy Court appointed a trustee, Mark D. DeGiacomo. The SEC's investigation resulted in a civil complaint against Inofin and its executives for securities fraud, and criminal charges for wire fraud and conspiracy are pending.

In September 2013, the Trustee initiated a legal malpractice claim against Inofin's primary outside counsel, H&K and partner Hindlian, alleging inadequate legal advice regarding securities laws from 2006 to 2011. The Trustee asserts that Hindlian had a comprehensive understanding of Inofin’s operations and prepared preferred stock offerings in 2007 and 2008. In November 2008, after receiving an inquiry about selling notes to investors with 401k plans, Hindlian advised that the notes were unregistered securities, but Inofin did not pursue the investment. Hindlian subsequently prepared a private placement memorandum (PPM), referring to the notes as securities, but was instructed by Inofin's principal, Mr. Cuomo, to cease work on the PPM. Following this, H&K and Hindlian continued to provide legal advice but did not advise Inofin on compliance with securities laws, leading to claims of negligence for failing to inform Inofin of the legal implications of their actions regarding their notes.

The Trustee alleges that the defendants' negligence allowed Inofin to continue its business operations improperly from January 2009 to February 2011, leading to increased promissory note debt and expenses, resulting in millions of dollars in damages for which the defendants are liable. Following a motion in March 2016 to withdraw the reference of the adversary proceeding, the defendants sought summary judgment and moved to strike Mr. Cuomo's deposition testimony. 

Regarding the legal standards for the motions, the Court can only consider evidence admissible at trial, with impermissible hearsay excluded under Federal Rules of Evidence. Testimony from an unavailable witness may be admissible if the opposing party had a chance to cross-examine it. A witness is deemed unavailable if they invoke the Fifth Amendment. 

In the analysis, Mr. Cuomo's deposition included one hour of cross-examination before he invoked his Fifth Amendment right during continued questioning due to his criminal charges. The defendants argue this limited cross-examination renders his testimony inadmissible, while the Trustee argues it should remain admissible for topics covered. The Court finds that the defendants did not have an adequate opportunity for cross-examination, as Mr. Cuomo's refusal to answer was not merely a tactical decision but completely obstructed further questioning. Consequently, Mr. Cuomo's testimony will be struck from the summary judgment record.

A request for a stay of the civil action by the Trustee is at the Court’s discretion, guided by whether the interests of justice support such action. The Court finds that the interests of justice do not favor a stay, as the defendants are not involved in the related criminal proceedings and would face undue inconvenience and potential prejudice if the civil case is delayed. Additionally, the current stage of litigation and public interests further oppose a stay. The plaintiffs’ request for a stay is therefore denied.

Regarding the motion for summary judgment, the standard requires examining the evidence to determine if there is a genuine need for trial. The moving party must demonstrate no material fact disputes exist, shifting the burden to the non-moving party to present specific facts showing a triable issue. The Court will view the record favorably for the non-moving party and grant summary judgment if no genuine issue materializes.

Defendants argue for summary judgment based on the in pari delicto doctrine and lack of proximate cause. In this case, Massachusetts law governs the malpractice claim since it is pursued under the Court's bankruptcy jurisdiction. The Trustee, standing in the shoes of Inofin, faces the same defenses applicable to Inofin. The in pari delicto defense, rooted in public policy, prevents plaintiffs from recovering damages for their own wrongdoing and applies to torts, including legal malpractice. The Supreme Court has outlined that this defense is appropriate when the plaintiff and defendant share equal responsibility for the wrongdoing, and barring the claim does not contravene public interest. Massachusetts courts have adopted these criteria.

Defendants argue for summary judgment based on the doctrine of in pari delicto, asserting that the fraudulent actions of the bankrupt corporation, rather than any shortcomings in their legal advice, were responsible for Inofin’s extended existence and significant losses from 2009 to 2011. The Trustee counters that this defense is invalid because it requires the plaintiff's involvement in the advice formulation, which is not the case here. Inofin's questionable accounting practices and its failure to classify notes as securities, despite repeated legal advice, are acknowledged. The key issue is whether, when considering the evidence favorably for the plaintiff, defendants are entitled to summary judgment.

The court agrees with the defendants that the overall wrongful conduct must be evaluated for the in pari delicto defense, as established in prior rulings. The First Circuit has ruled that if a plaintiff is the primary wrongdoer, claims against a secondary party for aiding in the wrongdoing are barred under in pari delicto. Inofin is identified as the primary wrongdoer for its deceptive bookkeeping and failure to treat notes as securities despite legal counsel's advice.

The First Circuit's precedent indicates that sophisticated professionals can successfully invoke this defense even when the plaintiff shares responsibility for the wrongdoing. In a cited case, KPMG was not liable for aiding a company in its fraudulent practices due to the company's senior managers' primary culpability. Similarly, while defendants advised Inofin properly, their continuation as counsel without objection to Inofin’s decisions does not render them primary wrongdoers. The primary responsibility for Inofin's fraudulent actions lies with its officers, Cuomo and Mann, confirming that Inofin itself is principally liable for the misconduct leading to its losses.

Defendants are granted summary judgment based on the doctrine of in pari delicto, meaning that the plaintiff's own misconduct negates their claims. Under Massachusetts law, attorneys must exercise reasonable care when advising clients, and to succeed in a legal malpractice claim, the plaintiff must demonstrate that the attorney's breach of duty directly caused damages. Causation must be established beyond mere speculation, requiring evidence that a more favorable outcome would have likely resulted had the attorney acted with adequate skill. 

In this case, the facts reveal that Inofin's counsel consistently advised them that their promissory notes were securities, which Inofin disregarded. Specific instances include advice from Attorney Robert Allison in 1994, Attorney Ed Woll in 2003, and Attorney Hindlian in 2009, all indicating compliance with securities laws was necessary. Despite these repeated warnings, Inofin chose to ignore the advice and failed to comply with SEC regulations. The plaintiff's sole evidence to suggest a different outcome relies on inadmissible testimony from Mr. Cuomo, which does not undermine the documented warnings from counsel. Consequently, even without the in pari delicto defense, the lack of proximate cause further justifies the defendants' entitlement to summary judgment. Defendants' motions for summary judgment and to strike are granted.