Buyer Beware: Firms Look Closely at Legal Liabilities of Merger Partners

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Former Gardner Carton & Douglas partner Steven L. Loren, who pleaded guilty to a criminal felony act over the representation of a firm client, left the firm in advance of its merger with Drinker Biddle & Reath in 2007.

But that didn't stop Drinker Biddle's name from appearing on a lawsuit filed earlier last month against Loren, Gardner Carton and several others who the plaintiffs allege were involved in a kickback scheme to sell property of a Chicago university to members of the scheme despite higher offers coming from the plaintiff.

Rush Oak v. Levine was filed in the Circuit Court of Cook County in Illinois Nov. 2. Drinker Biddle's name can only be found within the first three pages of the 50-page complaint, including in the caption. The firm is listed as the merger partner of Gardner Carton and then not mentioned again.

Legal liability due diligence has become part of the merger process for large firms that have to weigh whether the risk is worth the reward. Most analysts said, however, that there are safeguards that can be put in place to protect the surviving entity. But they agree that the process can add to the cost and overall risk of a combination.

According to the complaint, several of the individual defendants have pleaded guilty in federal court to fraud charges related to the real estate deal. Loren pleaded guilty to a felony criminal act arising out of his work for a client who pleaded guilty to fraud in this alleged conspiracy. Loren was not going to be criminally prosecuted for events relating to the deal but admitted in the plea agreement that he was aware of other criminal acts his client was involved with during the same time, according to the complaint.

Rush Oak and co-plaintiffs Brian, Philip, Pamela and Shawn Farley said in the complaint Gardner Carton is vicariously liable for Loren's actions.

Drinker Biddle spokesman John Byrne said, "We don't see any merit in the suit whatsoever."

He wouldn't comment beyond that.

When Drinker Biddle and Gardner Carton confirmed in late 2006 that they would be merging, Drinker Biddle Chairman Alfred W. Putnam Jr. said Drinker Biddle had some of its litigation partners look into the cases against Loren that were pending at the time.

"We don't think they really pose a substantial risk to Gardner Carton," he told The Legal at the time.

Drinker Biddle certainly isn't alone in facing litigation stemming from acquisitions of firms or lateral groups.

Morgan Lewis & Bockius had to fend off a suit by former Brobeck Phleger & Harrison employees who sued the firm for failure to comply with WARN Act filings. The firm had hired dozens of Brobeck lawyers and staff and took over some of the space of the dissolving firm in 2003. The employees lost because they were laid off the same day an agreement became effective for Morgan Lewis to purchase furniture and other equipment from the firm. The judge ruled Brobeck, not Morgan Lewis, was still responsible for complying with WARN Act notices that day.

Morgan Lewis was again brought into a similar situation this year after former Thelen employees sued a number of law firms who picked up some of the attorneys and staff from the dissolved firm.

A recent report by The Recorder, a Legal Intelligencer affiliate, noted that Morgan Lewis was sued in October along with Orrick Herrington & Sutcliffe, DLA Piper, Nixon Peabody and Howrey over similar WARN Act violations. Staffers were given 30 days' notice, not 60 as required under the act. The employees argue that the acquisition by the defendant firms of Thelen partners equated to a purchase of part of the business. That makes them bound to the same obligations as an employer under WARN, according to the report.

Ward Bower of Altman Weil said firms looking at mergers have to do legal due diligence along with financial and tax due diligence when looking at acquiring another firm. They have to look at current or potential lawsuits and the professional liability history of a firm.

Potential lawsuits can pose a dilemma because firms have to take people at their word that these won't be major issues, he said. The problem in today's market is that with almost any larger firm there is something lurking that could turn into a lawsuit, Bower said. Clients are more eager to sue their law firms and the bigger the firm is, the harder these issues can be to identify. That all makes mergers a bit riskier than they were 10 or 20 years ago, he said.

One litigator familiar with these types of cases said they are similar to most successor liability suits involving other types of corporations and the courts apply various tests to see whether successor liability applies. The only difference, the attorney said, is that law firms don't have assets like the typical corporation does.

The attorney said courts have found successor liability among law firms, but it's more typically when a firm closes down to avoid creditors and opens up under a different name with nearly the same people.

In order to curb potential liability, most firms will include as part of the merger agreement that the acquired firm maintain its own tail, or claims-made insurance, in the event suits are brought from events that occurred before the merger. Other firms may just use their existing professional liability insurance to cover any claims that arise from prior acts of the acquired firm, the attorney said.

This is not to say, however, that the surviving firms don't have to engage in the fight and have an attorney sit at the defense table. That means added time and money even if the risk of a verdict against them is minimal, the attorney said.

Frank D'Amore of Attorney Career Catalysts said many mergers will require an additional insurance policy is purchased.

"In larger-scale mergers, that can become a lot of money," D'Amore said.

And the money is just one factor. If the acquired firm doesn't provide full-disclosure of potential suits or is perceived to have clouded the reality of the risk, that could be a detriment to the culture as the two entities work to integrate. The cultural ramifications for the firm have led firms to dig deeper in their legal due diligence than they have in the past, he said.