The following articles are excerpts from the newsletter:

Law Firms May Be Liable for Deficient "Due Diligence,"
Kim Lesniak and Jim Arnold

Recent Developments Concerning Protection of Historic Properties, Endangered Species and Wetlands,
Brenda Mallory, Beveridge & Diamond, P.C.,

Make Your Law Department into a "Profit Center"?,
Jim Arnold

LAW FIRMS MAY BE LIABLE FOR DEFICIENT "DUE DILIGENCE"

Kim Lesniak
Chair

Jim Arnold
Vice Chair

Everyone knows the importance of adequate due diligence before a commercial transaction. A recent federal court decision from the Western District of New York (Buffalo, N.Y.) suggests that lawyers may be at risk if "due diligence" is inadequate. And, although the case arose from a big Baltimore law firm's handling of a transaction in the mid-1980s, the recent news articles about another big law firm in Los Angeles, and a high school being built on an old oil field reminds us that "many do not learn from other's mistakes, but only perfect them." (Keith Hopson, Austin, Texas, chair of the Superfund & Hazardous Waste Committee.)

In the words of Senior U.S. District Judge Elfvin,

"[the Baltimore law firm] was to assist in [the consultant's] investigation --- and --- using [the consultant's] findings in tandem with its own analysis of facts and applicable laws -- advise [its client, the buyer] and to draft the purchase agreement." Keywell Corp. v. Piper & Marbury, LLP, No. 96-CV-0660E (W.D.N.Y., Feb. 11, 1999), 1999 WL 66700, 1999 U.S.Dist.LEXIS 1445.

In 1986, the 350 attorney Baltimore law firm (with a New York City office), was retained by a company, Keywell, which was buying three properties from a recycling company, Vac Air Alloys Corporation. One of the properties was a steel recycling plant in Frewsburg, New York (western New York State, near Chautauqua). The market for recycled nickel, in which Vac Air specialized, was expected to rise sharply. But, Vac Air had a cash flow problem.

The law firm hired an environmental consulting firm to conduct an environmental audit of the three sites. As the judge said, the law firm was to assist in the audit, and using the consultant's findings-in tandem with its own analysis of the facts and law-advise the buyer and draft the purchase agreement.

One of the consultant's employees visited the Frewsburg metals recycling plant. The Baltimore law firm arranged for him to view certain files of the seller, and to interview one-and only one-of the seller's officers, a Mr. Boscarino. Mr. Boscarino had taken an active role in Vac Air's business since 1971. Mr. Boscarino flatly denied to the consultant that Vac Air had ever disposed of any toxic wastes on the Frewsburg property. He also asserted that there were no documents which would show otherwise.

Unfortunately, as the court noted, Mr. Boscarino was lying on both counts, for it was learned several years later that until the late 1970s Vac Air had dumped spent trichloroethylene ("TCE") on the property. In addition, Mr. Boscarino had written a file memo in 1985 which referred to "potential problems" from the unearthing of decomposed drums which had been filled with hazardous waste and buried.

The consultant noted concerns in its draft report, and the fact that it was only allowed to question one representative of the selling company. Relying on the representation that no on-site disposal had occurred, the consultant did not recommend, nor did it do, more extensive soil and groundwater sampling of the Frewburgs property.

Two of the law firm's attorneys reviewed the consultant's draft report and suggested changes. Their client, Keywell, was not given a draft, nor was Keywell asked for its comments or questions about the consultant's findings. (Keywell also claimed that the law firm failed to give it the consultant's cleanup cost estimates.) The draft report was changed, and a final report was produced to Keywell.

If all of this does not strike an observer as a "pathway to problems," the reported decisions show that the law firm's attorney then had a conference call with the client to discuss the final consultant's report. The attorney said that the report was free of "red flags." (The client and the law firm dispute whether the attorney also said maximum cleanup liabilities were $1 million or $4.8 million. Sad to say, they turned out to be about $6 million.)

After the conference call, the deal closed, with representations and indemnities from Vac Air, Mr. Boscarino, et al., that no hazardous wastes had ever been stored, treated, or disposed on the property. The representations and indemnities had a short life, though, of only a few years.

The next step down this law firm's descent into litigation with a former client was in 1990, several years later. A grand jury and government investigators learned that the Frewsburg property was the source of contamination of city wells. The next year, Keywell sued Mr. Boscarino for contribution under CERCLA, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. §9601 et seq. But, Keywell's lawsuit failed. Keywell Corp. v. Weinstein, 33 F.3d 159 (2d Cir. 1994).

The Second Circuit's ruling left only Keywell's (by this time former) law firm facing Keywell's liability "bullet." So, in 1996, Keywell sued the Baltimore law firm in the federal court in Buffalo for malpractice, namely, for failing to "facilitate and provide an adequate environmental audit. ..." In response, the law firm apparently did not challenge Keywell's claims as to what the firm's attorneys did or did not do (after all, the law firm appears to have had significant control over the consultant). Instead, the law firm argued, inter alia,that Keywell's $84 million profit on the purchase of Vac Air should offset the $6 million in cleanup costs paid by Keywell. Sort of a "no harm, no foul" argument.

The federal judge in Buffalo didn't buy this "offsets" argument. Nor did he buy the firm's argument that Keywell could not or would not have renegotiated or backed out of the deal had the contamination been discovered. The judge rejected the law firm's motion for summary judgment in early 1999. Keywell Corp. v. Piper & Marbury, LLP, supra,(W.D.N.Y., Feb. 11, 1999).

As a result, this federal jurist, a senior member of the federal court bench, ruled, as quoted above, that the Baltimore law firm had been working in tandem with the consultant to advise their mutual client, and to enable the law firm to draw up the purchase agreement. The applicable law was that of New York State (not Maryland, where the firm is headquartered). Attorneys practicing in New York have a fiduciary duty to provide all information material to a client's decision as to whether to proceed. In the eyes of this court,

"...[s]hould the attorney negligently or wilfully withhold [information material to a client's decision] - or torture the same - the attorney will be liable for any losses the client suffers by virtue of having been caused to act without the benefit of undisclosed material facts."

To defeat the lawyer's motion for summary judgment, the client need only show that a jury might conclude, [in paraphrase]

"Yes, the client has suffered some harm resulting from the law firm's breach of duty, and such harm could be quantified to a reasonable degree."

If this test is met, the issue will go to the trier of fact, i.e., the jury. The federal judge concluded that "it is clear that Keywell has presented evidence sufficient to create a triable issue of fact as to whether Piper's alleged malpractice proximately caused the damages Keywell claims." Moreover, the court hinted that the damages might best be measured by "comparing the $6 million liability" Keywell acquired in the transaction with the possibility that, armed with accurate information, Keywell could have negotiated for "zero." [The court did dismiss Keywell's claim for punitive damages against Piper & Marbury.]

Of course, the problems faced by the Baltimore law firm arose from a transaction almost a decade and a half ago. But, more recently, the Los Angeles County School Board reportedly voted to sue 700 attorney O'Melveny & Myers LLP for malpractice for problems arising from building the $600 million Belmont High School complex. It seems that the facility is being built on an old oil field. The school board, inter alia, claims the law firm failed to conduct proper due diligence in the investigation of the property and in counseling the Board on its purchase.

Although separated by a continent and a decade, the Keywellcase and the report from Los Angeles should raise caution flags for both inside and outside counsel. A "deal philosophy" based on "ask me no questions, and I will tell you no lies," may result in significant liabilities for the legal professionals involved. Although an expanding and vigorous economy requires business concerns to drive a transaction, due diligence should be as "diligent" as possible. These instances suggest that attorneys working with environmental consultants to conduct compliance audits should be careful to involve their clients in the process. They should not unilaterally discourage or prevent the consultants from the investigation which the lawyer, the consultant, and the client believe to be necessary. After all, it is the client's "nickel."

[Editor's Note: Not all purchases of industrial facilities in the 1980s turned out as badly as this one. In fact, in one of them the buyer's experienced general counsel negotiated the entire purchase agreement himself -- using outside counsel only for documentation and issues of local law. He insisted on a $1 million escrow account for toxic cleanup liabilities. After the close (and after the $1 million was spent on removing lead contamination), several thousand gallons of solvent were discovered floating on the groundwater beneath the plant. Before the representations and warranties expired, the buyer filed a CERCLA contribution lawsuit. At the buyer's summary judgment hearing, the federal judge announced, "Let's get one thing perfectly clear; this property has got to be cleaned up, and the sellers are going to do it." The case settled within the week. Acme Steel Co. v. Cold Metal Products, Inc., N.D. Calif., 1989 (unreported hearing).]

 

RECENT DEVELOPMENTS CONCERNING PROTECTION OF HISTORIC PROPERTIES, ENDANGERED SPECIES AND WETLANDS

Brenda Mallory
Beveridge & Diamond, P.C.
Chair, Endangered Species Committee

People undertaking construction projects increasingly have become aware that numerous federal approvals may be required before the groundbreaking ceremony. This past summer, there was considerable administrative activity affecting several of the major federal land use statutes. This activity was a reminder of the challenge associated with staying up to date on the various requirements affecting development and of the need for project proponents and practitioners to be prepared to participate in rulemakings at the administrative level in order to influence the type of requirements with which they must contend.

New Regulations Governing Protection of Historic Properties
First, effective June 17, 1999, the Advisory Council on Historic Preservation ("Advisory Council") significantly modified the principal federal regulations governing the protection of historic properties. See 64 Fed. Reg. 27,044 (May 18, 1999). Section 106 of the National Historic Preservation Act ("NHPA"), 16 U.S.C. §1536, requires federal agencies to consider the impacts that their grants, projects, approvals or permits will have on historic resources and to allow the Advisory Council an opportunity to review and provide comments on the proposed impacts.

Some of the major changes included in the new Section 106 regulations are as follows:

1. The Advisory Council will no longer participate in the consultation process on individual projects, unless certain specified criteria are met, and it elects to do so. Those criteria are that the undertaking (i) will have substantial impacts on historic resources; (ii) raises important questions of policy or interpretation; or (iii) raises issues of concern to Indian tribes or Native Hawaiian organizations.
2. The Advisory Council will no longer review routine decisions made by the federal agency and the State Historic Preservation Officer ("SHPO"). It will not review most Memoranda of Agreement entered by the agencies or the SHPOs.

[The impact of these two changes will vary. On the one hand, there will be one less entity to deal with-an appealing change to most developers. On the other hand, the Advisory Council sometimes offers a less parochial view of issues and can help move negotiations forward.]

1. Greater effort is made in the new regulations to define the roles of the various participants in the Section 106 process and their relationships to one another. For example, the lead authority of the federal agency is emphasized; applicants for federal assistance or approval may be allowed to initiate consultation with the other parties; and both the applicant and local governments must be invited to participate in the process.
2. The new regulations include a number of mechanisms to encourage better coordination between the regulatory review process under Section 106 and other federal requirements, such as the National Environmental Policy Act ("NEPA"). In addition, the agency may use its NEPA process and documents to substitute for the Section 106 requirements, if certain conditions are met.
3. The agencies are authorized to create certain exemptions from the 106 requirements for marginal or routine cases.

In general, the Advisory Council was attempting in its new regulations to facilitate a more effective, efficient, and streamlined process. While a number of provisions reflect that underlying purpose, whether the Council was successful will be determined by how these provisions work in practice. One thing for certain, the implementation during the first year or so is likely to be confusing and uncertain at times. If you are involved in a development or project that requires a federal agency to comply with Section 106, you should plan your schedule to allow extra time to resolve interpretation issues under the new regulations and plan to have early and detailed coordination with the key historic entities that will be involved, to explicitly map out an approach for the process.

Proposed Guidance Covering the Role of Critical Habitat
The second development of interest to corporate counsel is the U.S. Fish & Wildlife Service's ("F&WS's") announcement that it will be preparing "guidance" on the role of "critical habitat" in protecting endangered species. Once critical habitat is designated, Section 7 of the Endangered Species Act ("ESA") requires an agency to ensure that its activities will not result in the destruction or adverse modification of the an endangered species "critical habitat." 16 U.S.C. § 1536(a)(2).

On June 14, 1999, F&WS announced its intent to develop policy or guidance and/or revise existing regulations to clarify the role of habitat in endangered species conservation. F&WS indicated that it would examine all the tools available to identify and conserve the habitat of listed and threatened species, including critical habitat determinations ("prudency" and "determinability") and designations under Section 4 of the ESA. The F&WS intends to streamline the processes for making critical habitat determinations and designations. As this issue of the Newsletter was being prepared, the F&WS announced that the public comment period would be open until October 29, 1999. The comments will be used in developing the ultimate guidance document or revised regulations.

This is an example of where involvement in the rulemaking process could help to influence what areas become entitled to protection under Section 7 of the ESA. The agency was seeking comments on issues such as:

1. When will the designation of critical habitat provide additional benefit beyond that afforded by listing and what considerations should be included in the prudency determinations?

1. Are there better ways to identify critical habitat than pinpointing small areas of species occurrence on a map and drawing precise circles around those areas? Would more general habitat delineations and broad descriptions of habitat types be more useful? How might a more descriptive approach be employed?

1. How could the agency, at the stage of developing a recovery plan, be more specific about the extent of habitat protection necessary for recovery?
2. How can economic analyses evolve into a streamlined and cost-effective process?

1. How can NEPA compliance (when required) be conducted in a simple and efficient manner?
2. How can the designation process be streamlined? Should existing regulations be modified to accomplish this goal? If so, how?

F&WS will be trying to address some important issues in a systematic way. If your company potentially would be affected by a policy on critical habitat, you should consider monitoring future developments in this administrative process.

Final Policy on Safe Harbor and Candidate Conservation Agreements with Assurances
The third development also concerns endangered species protection. On June 17, 1999, the F&WS and the National Marine Fisheries Service ("the Services") issued their long awaited final policy on Safe Harbor and Candidate Conservation Agreements, as well as the related regulatory changes necessitated by the final policies. Safe Harbor Agreements and Candidate Conservation Agreements with Assurances Final Rule, 64 Fed. Reg. 32,706; Announcement of Final Safe Harbor Policy, 64 Fed. Reg. 32,717; Announcement of Final Policy for Candidate Conservation Agreements with Assurances, 64 Fed. Reg. 32,726. Both policies provide incentives for private and other non-federal property owners to take actions to benefit imperiled species. Specifically, the Safe Harbor Policy provides incentives for these private property owners to restore, enhance, or maintain the habitats for listed species. In exchange for undertaking protective management activities on their land, the Services provide assurances that additional land, water, and/or natural resource use restrictions will not be imposed as a result of their voluntary conservation activities to benefit covered species. When the property owner meets all the terms of the Agreement, the Services will authorize incidental taking of the covered species at a level that enables the property owner ultimately to return the enrolled property back to agreed upon baseline conditions.

Similarly, the Candidate Conservation Agreement provides incentives for non-federal property owners to implement conservation measures for species that are proposed for listing under the Act as threatened or endangered, species that are candidates for listing, and species that are likely to become candidates or proposed in the near future. In exchange for implementing conservation measures, the landowners receive assurances from the Services that additional conservation measures will not be imposed if the species become listed in the future. They also receive an associated enhancement of survival permit under Section 10(a)(i)(A) of the ESA.

Both policies are a recognition of the public-private partnership that is necessary to improve the status of imperiled species. Project proponents should consider whether use of these tools would help address some of the regulatory stumbling blocks they face, by addressing potential impacts to species and their habitat.

Wetlands Update
Finally, Nationwide Permit replacements, administrative appeals process and "Tulloch" rulemaking continue to dominate the wetlands debate.

• Replacement Permits: The Corps has been in the process of developing Replacement Permits which will substitute for Nationwide Permit 26-the controversial general permit which had been slated to expire in September. On July 21, 1999, the Corps published its proposal to issue five new NWPs and modify six existing NWPs to replace NWP 26 when it expires. The Corps also proposed to modify nine NWP general conditions and add three new general conditions. The proposed new permits would cover activities such as commercial and residential development, reshaping drainage ditches, hard rock mining, and storm water management. The modified permits would cover activities such as utility line work, transportation crossings, restoration of non-tidal streams, and agriculture. District and division engineers also have published regional conditions that would be used to ensure that only minimal adverse effects on the environment occurred as a result of these Replacement Permits. The comment period has been extended until October 7. The district and division engineers are to decide individually whether to extend their comment periods. The Corps extended NWP 26 to January 5, 2000, or the effective date of the Replacement Permits, whichever comes first.

1. Administrative Appeals Process: On March 9, 1999, the Corps issued final regulations establishing an administrative appeals process for permit denials and unacceptable permit conditions. At the Annual ALI-ABA Wetlands Conference in June, Michael Davis, deputy assistant secretary for Civil Works, Policy and Legislation, announced that the Corps would convene a task force in July to review proposals for a one-step appeals process for jurisdictional determinations as well.

• Follow-up Tulloch Rulemaking: At the ALI-ABA conference, both Corps and US EPA officials indicated that a high priority is closing the "loophole" in their regulations created by the D.C. Circuit's 1998 decision in National Mining Association v. United States Corps of Engineers ("NMA"), 145 F.3d 1399 (D.C. Cir. 1998). The court in that case held that the Corps exceeded its Clean Water Act authority when it promulgated 1993 regulations expanding the scope of activities encompassed within the definition of "discharge of dredged material" to include any redeposit of dredged material, including incidental fallback, into waters of the United States. On May 10, 1999, the Corps and US EPA issued a final rule to reconcile its existing regulations with the D.C. Circuit case. That rule provided that the agencies would conduct a subsequent rulemaking to further define what constitutes "incidental fallback" that is not regulated as well as delineate what redeposits of dredged material are regulated. The agencies apparently are working on that proposal now and plan to issue a draft in the fall.

In the meantime, US EPA has adopted a specific strategy for dealing with Tulloch type activities, which includes aggressive enforcement of illegal activities that go beyond the incidental fallback allowed under the D.C. Circuit decision; encouraging states to use their authorities to regulate some of these activities; and ultimately, working toward legislative modifications to address the issue.

The fervor with which the Corps, US EPA and the environmental community are approaching this issue necessitates that the regulated community be on its guard for agency overreaching. If you are planning a project that includes activities that should not be regulated because of the Tulloch decision, you need to allow sufficient time in your schedule to resolve any disagreements. The National Association of Home Builders recently filed a lawsuit in Virginia because of what the association views as illegal enforcement actions by the government. The lawsuit concerns a 500-acre parcel in Virginia Beach, Virginia owned by False Cape Enterprises. The regulated community should watch the case with interest.

Conclusion
As indicated by these developments, navigating through the federal regulatory review process, with its ever evolving requirements, is a challenge that each project proponent must face. Successful completion of a development project, on schedule, is always the goal, but only achievable when a developer is armed with the latest nuances of the federal programs and a plan for effectively completing each phase of the regulatory review process.

 

MAKE YOUR LAW DEPARTMENT INTO A "PROFIT CENTER"?

Corporations in California may now recover fees for the legal services of their in house counsel - if their "internal contract" has a "recovery of attorneys fee" clause, and if their in house counsel "charge" them for legal fees.

Jim Arnold
Vice Chair

A California court of appeals recently ruled that the litigation expenses of salaried attorneys charged by a parent corporation to its subsidiaries could be recovered in litigation. PLCM Group, Inc. v. Drexler, 72 Cal.App.4^th 693 (1999), Calif. Supreme Court rev. granted, Aug. 11, 1999. The issue is one of first impression in California. The case was a lawsuit arising out of a malpractice insurance contract. The eventual decision has some likelihood of being applied to all corporate counsel who represent their companies in litigation in California. (Ed. note: The facts of the case are a variation of the insurance company/"captive" law firm arrangement, where although the law firm maintains its "letterhead," all of its work is for the company's policyholders and all of the attorneys and staff are paid salaries by the insurance company.)

PLCM Group and Deerborn Insurance Co. were subsidiaries of Aon Corp. Deerborn sold malpractice insurance to Drexler, an attorney in private practice. The insurance contract provided that the prevailing party in any dispute would recover attorneys fees and costs. The contract included a $20,000 deductible. A third party sued Drexler for malpractice. PLCM and Deerborn hired a law firm, HBB, to defend the malpractice lawsuit.

Drexler, however, refused to pay HBB all of the $20,000 deductible included in his policy. Drexler disputed HBB's representation and the fees charged by HBB. PLCM and Deerborn sued Drexler, and he countersued. In this lawsuit, PLCM and Deerborn used salaried attorneys employed by Aon Corp.

The jury awarded PLCM and Deerborn $10,300 against Drexler. The court then awarded $61,000 in attorneys fees to PLCM and Deerborn. Drexler appealed. He argued that because PLCM and Deerborn "represented themselves" they were "in pro per" and did not "incur" attorneys fees to enforce the malpractice insurance contract.

The California Second District Court of Appeals ruled that PLCM and Deerborn could recover the $61,000 in fees and expenses of the salaried attorneys employed by Aon Corporation. The appeals court noted that Aon charged the costs of its legal division annually to Aon's subsidiaries. PLCM and Deerborn incurred liabilities to Aon's "Corporate Law Division" in exchange for legal representation. Thus, the subsidiaries could recover reasonable attorneys fees.

The appeals court also provided guidance in how such fees should be calculated. The trial courts should not use a "salary plus cost" approach. Instead, the trial courts should use the "prevailing market rate." The appeals court reasoned that litigation expenses should be based on the market value of the services received -- not on the corporation's costs. It specifically found that a reasonable "market rate" for hourly fees of a seven-year attorney in San Francisco was $185 per hour and in Los Angeles was more than $215 per hour. [Ed. note: There is other authority that rates for experienced environmental counsel in San Francisco is between $250 and $300 per hour.]

The opinion, at least until the California Supreme Court rules, has at least persuasive effect in determining the rates at which independent "Cumis" counsel should be paid in California. [Calif. Civil Code § 2860 allows companies to pick independent counsel, at the cost of the company's insurance carrier, at the standard market rate.]