California Bar | Winter 2008 Bar Exam Question PT-A

Answers to Winter 2008
California Bar Exam Questions

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Winter 2008 Performance Test

Answer

PT-A ONE-STOP EQUIPMENT LEASING v. FRANK REEVES

To Joan Clay
RE: Draft Brief in Opposition to Demurrer for One Stop Corp.

ARGUMENT
III. Third Cause of Action: Negligent Advice of Counsel
A. Since One Stop did not discover Reeves’ negligent advice concerning tax and corporate filings until October 13, 2007, the Third Cause of Action for Reeves’ negligent advice, filed February 5, 2008, is timely filed.

Sec 340.6 (a) states a negligence action against an attorney (other than for fraud) must be brought within one year of discovery or within one year of the time when, with reasonable diligence, the negligence could have been discovered. Defendant Reeves’s
apparent position is that One Stop discovered on November 20, 2006 that Reeves’ advice that One Stop should not file corporate tax returns was negligent.

However, Plaintiff One Stop Corp., through its CEO David Matchie, severed attorney-client relations with Reeves on November 20, 2006 over dissatisfaction with Reeves’s handling of two suits. Matchie had no suspicion that Reeves had handled corporate reports and tax filings negligently. Reeves had advised Matchie that because the financial records of One Stop were not complete, filing a return based on incomplete information amounted to fraud and could result in penalties and possible imprisonment of Matchie as CEO and sole shareholder. The advice was negligent because failing to file for that year and, to cover that up, the successive years, only created greater legal peril for Matchie and for One Stop itself

Reeves may be relying rather on the second clause of 340.6, that Matchie should have discovered Reeves’ negligent advice with reasonable diligence some time before October 13, 2007, when One Stop’s new counsel advised Matchie that One Stop’s corporate status had been suspended due to tax and corporate filing failures since 2004. Reeves would assert that the file folder of tax and corporations deficiency notices should have put a reasonable person on notice that he had been negligent. But Reeves himself had covered up his initial negligence of failing to keep complete financial records by lying directly to Matchie.

In Krusesky, the court stated that a client has the right to rely on legal advice. The court there stated: “A client damaged in the context of such a relationship is under no duty to investigate her attorney’s actions unless she has actual notice of facts sufficient to arouse suspicions of a reasonable person.” The negligent advice on which this cause of action is based is Reeves’ telling Matchie that the consequence of filing the 2004 tax return with incomplete data was worse than not filing and that avoiding corporate information filings was a mere formality that could be corrected with no adverse consequence at all.

If Reeves was competent to act as corporate counsel, he must have known that avoiding taxes for years leads to greater and greater penalties and that failing to file corporate documents can (and did) result in stripping the corporation of the power to do business. Matchie had no reason to suspect that Reeves had given him deliberately false advice. Until Matchie received the report from One Stop’s new counsel on October 13, 2007, he was still unaware that Reeves’ advice had been grossly negligent.

Since One Stop did not discover Reeves’ negligent advice concerning tax and corporate filings until October 13, 2007, the Third Cause of Action for Reeves’ negligent advice, filed February 5, 2008, is timely filed.

B. Since Defendant actively concealed his omissions, the four-year statute of limitations is tolled under 340.6 (3) and Plaintiff’s suit is timely filed.
Defendant Reeves cites Jordache for the principle that a cause of action accrues when there is a remedy. Mr. Reeves may argue that Matchie had knowledge that tax penalties had been assessed when Reeves received the corporation’s folder from him on November 20, 2006. The Jordache case construes subsection (1) of 340.6. That section tolls the statute of limitations if the plaintiff had not sustained actual injury.

The Jordache court approves four factors to determine actual injury: (1) the issue is predominantly factual; (2) it may occur without prior adjudication, judgment or settlement; (3) it is not met by nominal damages, speculative harm or the mere threat of future harm; and (4) the relevant consideration is the fact of damage, not the amount. The court found that “the loss or diminution of a right or remedy constitutes injury or damage.” Mr. Reeves would argue that when Matchie discovered both that penalties had been levied against One Stop and that its corporate status had been suspended, there was
actual injury. Knowing that tax penalties had been assessed and that the corporation had lost the right to exist meet the Jordache test for “a loss or a diminution of a right.” The inability of One Stop to sue or defend suits against G.M., Goodfelllows and even against Reeves himself are losses of remedies.

However, the Jordache rule does not cover a defendant’s active wrongdoing. In Jordache, the plaintiff sued only for omission by counsel; in the instant case, One Stop is suing for active concealment of wrongdoing. The Jordache rule concerns only the one-year discovery provision of 360.6. But One Stop’s suit is based on the alternative four-year provision in 340.6.

Sec 340.6’s alternative deadline is four years from the date of the Defendant’s wrongful act or omission, if this date is sooner than one year from discovery. Here, Reeves advised Matchie not to file a corporate tax return on February 2004. Four years from that date is February 2008. That date is sooner than October 13, 2008. Therefore, Plaintiff asserts that the four-year provision in Sec 340.6 should apply.

This position would make Plaintiff’s suit untimely, were it not for the application of subsection (3) of the 340.6, tolling the statute if the attorney willfully conceals the facts constituting the wrongful act or omission when known to the attorney. Here, the reason Reeves advised Matchie not to file a 2003 tax return was to cover up Reeves’ negligence in failing to keep complete financial records of the corporation. He advised Matchie not to file the return, as if the fines and penalties could be avoided. But Reeves knew that the penalties would be greater the longer One Stop delayed. The initial penalties for an incomplete or late return would compound, interest would be added and the criminal penalties—not a danger if the problem were handled expeditiously—would become a reality. Furthermore, Reeves knew that keeping corporate records and filing required reports was not a “mere formality,” which could be later cured without consequence. Because Defendant Reeves intentionally concealed his negligence in failing to keep proper corporate records and covered that up by advising Matchie that his best course of action was to fail to file a tax return, the four-year statute of limitations of 340.6 is tolled.

Therefore, the statute of limitations in 340.6 has not tolled due to Defendant’s active concealment of his omissions, and Plaintiff’s suit is timely filed.

IV. Fourth Cause of Action: Fraud by Counsel
Since One Stop did not discovery Defendant Reeves’ fraud until October 13, 2007, the Fourth Cause of Action, filed February 5, 2008, is filed timely within the applicable three-year statute of limitations.

Section 338 sets a three-year statute of limitations for fraud, which begins to run upon the date of discovery of the facts constituting the fraud. Here, Defendant Reeves knew that he had been negligent in failing to keep complete corporate financial records and falsely advised Matchie that the most prudent course of action was to fail to file corporate tax returns. He did so in order to protect his own source of income from One Stop and to protect himself against malpractice actions for his negligence. Further, he knew that the advice would harm One Stop by exposing it to greater financial loss in tax penalties and the inability to conduct business as a corporation. This constitutes fraud. Matchie was unaware that this advice was fraudulent until One Stop’s new counsel informed it on October 13, 2007. Therefore, the Fourth Cause of Action is filed timely.

V. First, Second, Third, and Fourth Causes of Action: Equitable Estoppel
Even if the statute of limitations bars any of Plaintiff’s causes of action, Defendant should be barred from asserting it because Defendant’s conduct induced Plaintiff into forbearing from suing in a timely manner.

In Battuello, the court held that the defendant should be equitably estopped from asserting the statute of limitations as a defense in circumstances where:

-- Defendant is apprised of the true state of facts. Here Defendant Reeves knew in February 2004 that One Stop’s failure to file tax and corporate documents would
result in decertifying the corporation. Defendant Reeves advised One Stop repeatedly that such filings were a mere formality and that the deficiencies could be remedied as soon as the filings were updated and that One Stop would not suffer any ill effects from the delay.

-- Plaintiff is ignorant of the true facts. Here, Plaintiff relied on its counsel’s advice and was not aware that failing to file corporate reports could result in decertifying the corporation.

-- Defendant intended One Stop to rely on his actions. Here, Defendant Reeves gave Matchie erroneous advice in order to cover up Reeves’ own negligence in failing to keep complete financial books. In order to cover that up, he told Matchie not to file tax returns. In order to cover up the missing tax returns, he told Matchie not to file any corporate reports. He intended that Matchie and One Step rely on his advice to prevent Matchie from discovering the long thread of gross negligence he had engaged in.

-- Plaintiff relied on Defendant’s conduct to its prejudice. As stated in the Third Cause of Action, One Stop severed its attorney-client relationship with Reeves because of Reeves’ inaction in litigation with Goodfellows and G.M. Plaintiff had no idea that Reeves had lied about corporate matters. Matchie continued to believe and rely on Reeves’s advice about these matters.

Plaintiff lost the right to recovery from Goodfellows, the subject of the First Cause of Action, because of Reeves’ cover-up of his negligence in failing to maintain the corporation’s records.

One Stop lost the right to defend itself in a suit by A.B. Construction, the subject of the Second Cause of Action, because Reeves could not defend the suit against the corporation he had allowed to lose its status.

Plaintiff, Reeves would argue, has even lost the ability to recover from Reeves himself for the losses described above, as well as tax fines, penalties, and legal costs in remedying Reeves’ negligent advice, the subject of the Third Cause of Action.

In Battuello, the court applied the doctrine of equitable estoppel because the defendant convinced the plaintiff not to file a timely suit. In our case, Defendant Reeves convinced Matchie not to file corporate tax returns or corporate reports. He convinced Matchie that he would file an action against Goodfellows and would defend the suit against A.B. Construction. It was Reeves’ fraud that lulled Matchie into inaction on all of the claims in this complaint. To permit Reeves to escape liability by hiding behind a technicality would be an egregious inequity.

As to the punitive damages sought in the Fourth Cause of Action, One Stop was unable to sue Reeves within the statute of limitations even after it had discovered his fraud because it took One Stop four months to reinstate the corporation before it could sue. Were it not for this delay, Plaintiff’s suit against Reeves would be indisputably timely. This delay, directly caused by Reeves’s fraud is what Reeves now asserts deprives One Stop of a remedy against him. This surely is the ultimate prejudice to One Stop.

Plaintiff therefore respectfully prays that the court will apply the doctrine of equitable estoppel to deny the Defendant to assert a statute of limitations defense to any of its claims.

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