Nelson Brothers Professional R v. Freeborn & Peters, LLP

In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 14-2046
NELSON BROTHERS PROFESSIONAL REAL ESTATE, LLC, et al.,
Plaintiffs-Appellees,
v.
FREEBORN & PETERS, LLP,
Defendant-Appellant.
____________________
Appeal from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 11 C 1277 — Harry D. Leinenweber, Judge.
____________________
ARGUED SEPTEMBER 23, 2014 — DECIDED DECEMBER 5, 2014
____________________
Before POSNER, ROVNER, and WILLIAMS, Circuit Judges.
POSNER, Circuit Judge. The plaintiffs in this diversity suit
for legal malpractice are a limited liability company that
we’ll call for the sake of brevity Nelson Brothers and the two
brothers (Brian and Patrick Nelson) who are the sole mem-
bers (owners) of the company; we’ll call them the Nelsons.
The defendant, Freeborn & Peters, is a well-known Chicago
law firm which the suit accuses of malpractice consisting of
2 No. 14-2046
eight breaches of the duty of loyalty that they owed the
plaintiffs, their clients. More than $1.3 million in damages
was sought. The case was tried to a jury, which returned a
verdict that after being modified by the district judge
awarded $786,880.85 to Nelson Brothers and $249,957.33
jointly to the two Nelsons—a total of slightly more than $1
million. The jury had calculated the total losses of Nelson
Brothers and the Nelsons personally at $1,731,311.00, but
had reduced the amount to $1,508,231.58 on the ground that
the plaintiffs had been negligent and their negligence had
contributed to their losses. The judge thus reduced the
amount of damages further.
The malpractice claim arises from a transaction that the
law firm handled for the plaintiffs involving real estate in
Algonquin, Illinois, a suburb of Chicago. In 2008 Ben Rein-
berg and Burt Follman had hired Freeborn & Peters to han-
dle their acquisition of a shopping center under construction
in Algonquin, to be called the Algonquin Galleria. Edward J.
Hannon was the Freeborn & Peters partner whom they dealt
with. Reinberg’s and Follman’s company, Alliance Equities,
contracted to buy the shopping center, but the deal had not
yet closed. To help finance the acquisition Alliance Equities
planned to sell ownership interests in the property to inves-
tors seeking tax advantages. These investors would be ten-
ants in common of the shopping center. The parties call them
the “TIC” investors.
Needing a partner, Alliance Equities was referred to Nel-
son Brothers and the two firms formed a joint venture, Alli-
ance NW, half owned by each firm, to close the deal for the
shopping center and complete its construction. The price
was $22.5 million, and to help pay it Alliance NW obtained a
No. 14-2046 3
$16 million mortgage loan from a bank, and hired Freeborn
& Peters, in the person of Hannon, to provide the legal ser-
vices needed for the project. Representing as he did a joint
venture of Alliance Equities and Nelson Brothers, Hannon
was obligated to be loyal to both. The plaintiffs argue that he
breached his duty to them in a variety of respects, for exam-
ple by favoring Alliance Equities, his original client, over
Nelson Brothers.
The agreement establishing the joint venture appointed
three persons to manage the venture: Reinberg, Follman, and
one of the Nelsons (Patrick), rather than all four of the prin-
cipals (Reinberg, Follman, and both Nelsons). Expenditures
of up to $50,000 could be authorized by a majority of the
managers, thus giving Alliance Equities control of such ex-
penditures. Larger expenditures required the agreement of
the joint venture’s members, Alliance Equities and Nelson
Brothers. Patrick Nelson testified that Hannon did not in-
form him that the Nelsons could be outvoted with regard to
expenditure decisions by the managers within the $50,000
limit.
The agreement made Nelson Brothers responsible both
for obtaining the money needed to close the deal to buy the
shopping center and for selling ownership interests to TIC
investors. The amount of money needed for the closing was
the difference between the $22.5 million purchase price and
the sum of the $16 million mortgage loan and money re-
ceived from the sale of ownership interests. Nelson Brothers
agreed that it would obtain a loan in the amount required to
close the gap and that the loan would be without recourse to
Alliance Equities, meaning that Alliance Equities would not
4 No. 14-2046
be liable should the joint venture fail to repay the loan—only
Nelson Brothers would be.
Nelson Brothers obtained a gap loan (a “mezzanine”
loan, as it is called in the trade) of $5.175 million, but this
was short by more than a million dollars of closing the gap
between the mortgage loan and the purchase price. So Nel-
son Brothers obtained a second gap loan, again without re-
course to Alliance Equities—so again only Nelson Brothers
would be liable to the lender should there be a default.
There were mechanics’ liens on the shopping center as a
result of costs incurred during its construction. At least some
of those liens, however, were insured against by title insur-
ance policies. The bank that had made the $16 million mort-
gage loan was comfortable with the mechanics’ liens; alt-
hough they were prior debts, the bank considered its loan
protected by its title insurance; should enforcement of the
mechanics’ liens result in losses of property that was collat-
eral for the loan, the title insurer would cover the loss. See
Noel C. Paul & Andrea Yassemedis, “Title Insurance Cover-
age for Mechanics Liens: A Lender’s Guide,” Oct. 31, 2012,
http://apps.americanbar.org/litigation/committees/insurance
/articles/septoct2012-mechanics-liens.html (visited Dec. 2,
2014). The gap lender was similarly protected. But some of
the potential TIC investors became spooked when they
learned there were mechanics’ liens on the property, fearing
that as part owners they might have to repay part of the
liens or lose their ownership interests to foreclosure. As a
result there was a delay in closing some $3 to $4 million in
TIC sales, and some of the sales were cancelled altogether.
The Nelsons were alarmed. They needed the money from
those sales to close the deal to buy the shopping center. They
No. 14-2046 5
decided to retain new lawyers rather than rely on Freeborn
& Peters, which they were beginning to distrust, to help
them solve the problem. The fees they paid their new law-
yers are part of the damages they seek to recover in this law-
suit. The Nelsons contend that Hannon had failed to advise
them that there were mechanics’ liens on the property, or to
create an escrow fund to enable the liens to be removed so
that they wouldn’t prevent sales to the TIC investors from
closing.
Freeborn & Peters ripostes that the sale of the shopping
center to the joint venture closed only two weeks before the
financial collapse of September 2008, which drove down real
estate values, and that as a result it became difficult to attract
TIC investors. But apportioning the losses to the plaintiffs
between inadequate representation by Freeborn & Peters
and a sudden scarcity of potential TIC investors attributable
to the financial collapse was a task for the jury. The law firm
also argues that the plaintiffs’ claim of damages caused by
Hannon’s failure to advise them of the mechanics’ liens is
barred by the statute of limitations, but they waived this ar-
gument in the district court by not making it until after the
jury’s verdict, which was too late. See Fed. R. Civ. P. 50,
Committee Notes on Rules—2006 Amendment; United States
EEOC v. AIC Security Investigations, Ltd., 55 F.3d 1276, 1286–
87 (7th Cir. 1995); United States for Use of Wallace v. Flintco
Inc., 143 F.3d 955, 960–61 (5th Cir. 1998).
The plaintiffs’ loss was the difference between their ex-
penditures in trying to obtain a substantial interest in the
shopping center and what they obtained for those expendi-
tures—namely, that interest. If that interest were worth any-
thing, awarding the plaintiffs as damages all their expendi-
6 No. 14-2046
tures would overcompensate them. But their contention,
which the jury appears to have accepted, is that the interest
they acquired was worthless because without the money of
the potential TIC investors who were scared off by the me-
chanics’ liens Nelson Brothers could not repay the loans that
had been used to buy the property, which it alone was obli-
gated to repay. An alternative possibility is that the project
failed simply because of the financial crisis, which as we said
hit real estate hard. But the jury didn’t buy that theory.
A dispute arose between Alliance Equities and Nelson
Brothers over fees owed Freeborn & Peters. (No surprise
there.) Alliance Equities wanted to use proceeds from a sale
of TIC interests to pay down those fees. Nelson Brothers dis-
agreed. But exercising their right to authorize expenditures
by the joint venture of less than $50,000, Reinberg and
Follman, over the opposition of the third manager, Patrick
Nelson, voted to pay $49,999 of the TIC proceeds to Freeborn
& Peters. This transaction infuriated the gap lender, who,
according to Patrick, threatened to declare Alliance NW in
default for failing to remit the TIC proceeds to it. This con-
tretemps occurred on the eve of the expiration of the six-
month term of the gap loan. The joint venture wanted an ex-
tension; the lender granted a three-month extension but at a
price twice as high as contemplated in the loan agreement.
The plaintiffs blame Hannon for failing to prevent the
$49,999 expenditure that by violating the terms of the gap
loan agreement precipitated the imposition of stiff terms for
the extension.
Still another concern of the Nelsons about the gap loan
was that the loan agreement imposed what are called “bad
boy” guarantees on them. As a result, not only was the loan
No. 14-2046 7
nonrecourse against Alliance Equities but the Nelsons indi-
vidually were guarantors. They contend that they had to
hire another law firm to advise them of the breadth of the
guarantees, which they say Hannon hadn’t explained to
them.
Freeborn & Peters denied in the district court that they
had been retained to represent either Nelson Brothers or the
Nelsons with regard to the terms of the gap loan. But on ap-
peal they have switched grounds and contend that because
the Nelsons were never required to make good on the guar-
antees, they incurred no loss that can be attributed to the law
firm. The contention overlooks the fact that the fees the Nel-
sons paid their new lawyers were a reasonable measure to
head off the harm that could have resulted from Freeborn &
Peters’s failure to advise the plaintiffs of the risks associated
with the guarantees. The fees mitigated the consequences of
that failure—a failure the plaintiffs deem negligent.
Eventually, with the gap loan partially repaid yet more
than $4.3 million of principal still owing on it, the joint ven-
ture sought and was refused a further extension of the loan.
Shortly afterward the lender declared a default, requiring
Nelson Brothers to repay the loan.
Hannon admits that he never discussed with the Nelsons
the potential conflicts of interest between them and Alliance
Equities or the possibility that the Nelsons should retain
separate counsel to advise them.
Of the $1,731,311 in damages sought by the plaintiffs,
$259,069 were for the lawyers’ fees they incurred (other than
to Freeborn & Peters) to resolve the mechanics’ liens prob-
lem and to assess the risks associated with the Nelsons’ per-
8 No. 14-2046
sonal guarantees of the extended gap loan. The balance of
the damages sought consisted of money that the Nelsons
had had to repay to another gap lender and to relatives from
whom they had borrowed and of earnest money to secure
membership in the joint venture. They claim that they would
not have borrowed any of this money or entered into the
joint venture in the first place had Hannon advised them of
the risks they were taking—the risks created for example by
the bad-boy guarantees, Alliance Equities’ control of ex-
penditures under $50,000 (which led to the expenditure that
caused such trouble with the original gap lender), and the
absence of an escrow fund to pay off mechanics’ liens. Im-
plicit in treating the repayments of loans as losses is that the
money borrowed produced no profits for Nelson Brothers or
net income for the Nelsons personally. For the acquisition of
the shopping center turned out to be a flop, causing substan-
tial losses to both the Nelsons and their company as a result
of their having to repay substantial loans from which they
derived no benefit.
Freeborn & Peters argued at trial that it didn’t represent
the plaintiffs at all, but that is wrong. It represented both
parties to the joint venture, Alliance Equities and Nelson
Brothers, and Nelson Brothers and the Nelsons are inter-
changeable. A reasonable jury could find that the law firm
violated its ethical obligations to the plaintiffs by not warn-
ing them of the firm’s conflicts of interest, by drafting
agreements that reflected favoritism toward Alliance Equi-
ties and concealing the favoritism from the plaintiffs (as by
not revealing that Alliance Equities would be controlling the
below-$50,000 expenditures—which later resulted in the de-
cision to pay the law firm $49,999 owed to the gap lender),
and by failing to advise the plaintiffs of the risks to them
No. 14-2046 9
created by the bad-boy guarantees and the mechanics’ liens
on the shopping center, and finally by closing the deal for
the shopping center without providing for an escrow to cov-
er the liens.
Freeborn & Peters argues that it isn’t liable for any prob-
lems with the mechanics’ liens because it was unforeseeable
that the mortgage lender would be worried by them. The ar-
gument ignores the fact that the TIC investors may have
been scared off investing by fear that they might have to pay
off the liens as part owners of the shopping center. An expert
witness for the plaintiffs testified that title insurance would
not have assuaged the investors’ fears as well as an escrow
fund would have done because the title insurer might find
reasons not to indemnify the insureds.
The law firm argues that at least it has no liability to the
Nelsons as distinct from their company because they were
not a client but merely the client’s owners. Corporate share-
holders (or their equivalent, members of an LLC) can’t seek
personal damages for an injury to their corporation, since if
the corporation obtains damages the shareholders will be
compensated indirectly—their shares will be worth more.
But the law firm created individual liabilities for the Nel-
sons—their personal guarantees of the gap loan and their
obligations to repay the relatives from whom they borrowed
money to enable repayment of that loan.
10 No. 14-2046
The jury’s determination of liability is thus unassailable.
But its damages award, even as corrected by the district
judge, was irregular and presents the most difficult issue in
this appeal.
The plaintiffs made the following expenditures that they
claim they would not have made had it not been for Free-
born & Peters’ malpractice: Expenditures by Nelson Brothers:
$1,283,373.11 as an equity contribution to Alliance NW;
$141,000 in earnest money to secure membership in Alliance
NW; $120,000 paid in attorneys’ fees for legal defense costs
necessitated by the default on one of the gap loans;
$55,714.82 in attorneys’ fees for advice on clarifying the
scope of the guarantees; $83,354 in attorneys’ fees for clarify-
ing potential obligations stemming from the mechanics’
liens. Expenditures by the brothers rather than by their company:
$47,869 repaid by the Nelsons to relatives from whom they’d
borrowed $161,000.
The plaintiffs’ total losses were thus $1,283,373.11 +
$141,000 + $120,000 + $55,714.82 + $83,354 + $47,869 =
$1,731,310.93. The jury assessed Nelson Brothers’ damages at
$865,655.50 and the brothers’ damages at $865,655.50. (The
sum of the two amounts is 7 cents more than the above total,
a difference that can be disregarded.) But the jury also found
contributory negligence by Nelson Brothers and the two
brothers and reduced the award to Nelson Brothers to
$865,655.50 x (1 – 9.1%) = $786,880.85 and the award to the
two brothers to $865,655.50 x (1 – 16.67%) = $721,350.73.
The district judge further reduced the brothers’ award—
to $249,957.33. He got there by finding, first, that the Nel-
sons, not their company, had paid the $55,714.82 in attor-
neys’ fees incurred to clarify the guarantees and the $83,354
No. 14-2046 11
in fees to try to resolve the effect of the mechanics’ liens. To
these amounts he added $161,000—the principal of the loan
the Nelsons had obtained from their relatives, rather than
$47,869, the amount they had repaid. These additions
brought the total up to $300,068.82, which the judge then re-
duced by the percentage the jury had attributed to the
brothers’ contributory negligence. The result, after the judge
rounded the jury’s 16.67% calculation to 16.7% and applied
the deduction to his gross estimate of $300,068.62, was
$249,957.33, and the Nelsons accepted that amount.
Both jury and judge made mistakes. The jury split the
damages 50-50 between Nelson Brothers the company and
the brothers themselves, even though the Nelsons’ only loss
to date is the $47,869 they repaid for the loan they received
from their relatives. The losses could be greater should the
Nelson brothers ever have to pay back the balance of the
$161,000 loan from their relatives, but the parties have not
addressed that question.
The judge incorrectly found that the Nelsons had paid
the $55,714.82 in attorneys’ fees incurred to clarify the guar-
antees and the $83,354 in attorneys’ fees incurred to clarify
the mechanics’ liens. In fact, Patrick Nelson testified that
Nelson Brothers LLC had paid both of those sums, and
Freeborn & Peters doesn’t contest that. And remember that
the judge deemed $161,000 (the principal of the loan from
the relatives), rather than $47,869 (what the brothers repaid)
as the brothers’ loss from having to obtain the loan—without
determining whether they would ever be asked to repay it.
Nelson Brothers was entitled by way of damages to all of
its expenditures, after the discount for its contributory negli-
gence: $1,530,248.71 [($1,283,373.11 + $141,000 + $120,000 +
12 No. 14-2046
$55,714.82 + $83,354) x (1 – .091)]. The Nelsons were entitled
to their expenditures (net of their contributory-negligence
offset), but their only expenditure was the partial repayment
of the loan to them by their relatives, $47,869, which after the
jury’s adjustment for their contributory negligence adjust-
ment was only $39,889.24. Yet the judge decided that Nelson
Brothers should be awarded $786,880.85 and the brothers
$249,957.33. This overcompensates the brothers—awarded
$249,957.33 though entitled to only $39,889.24—and under-
compensates Nelson Brothers, awarded only $786,880.85 but
entitled to $1,530,248.71. Nevertheless, because the plaintiffs
as a whole were awarded only $1,036,838.18, which is much
less than the $1,530,248.71 to which they’re entitled, yet they
aren’t asking for more, and because, the brothers and their
company appear to be interchangeable, the errors made by
jury and judge seem harmless. Cf. Fisher v. Agios Nicolaos V,
628 F.2d 308, 318–21 (5th Cir. 1980); International Paper Co. v.
Busby, 182 F.2d 790, 792–93 (5th Cir. 1950). In any case, the
errors don’t harm the defendant, which can’t (so far as we
know) care whether it writes a check to the Nelsons or to
their LLC. Nor is there any evidence that any creditors of
Nelson Brothers will be harmed by this division of damages
between the company and its owners. Nor are the plaintiffs
complaining about the damages they’ve been awarded.
AFFIRMED.