1st Circuit nixes suits against lawyers and auditors of defendants in prior case

By Sheri Qualters
Law.com National Law Journal

Plaintiffs may not proceed with class actions against lawyers and auditors who worked for the defendants in an earlier class action, the U.S. Court of Appeals for the 1st Circuit has ruled.

On Sept. 22, a unanimous panel held that a constructive trust established by the judge in the first action could not reach payments made by the defendants to lawyers and accountants in exchange for services. It also ruled the new class actions were entirely new lawsuits, not enforcement actions for the prior case, and they could not proceed unless the class was certified anew.

The ruling in the consolidated appeals of the two cases, Zimmerman v. Epstein Becker & Green and Zimmerman v. BDO Seidman LLP, affirmed a July 2010 dismissal of the two cases by Senior Judge Michael Ponsor of the District of Massachusetts.

In the original action, Zimmermann v. Cambridge Credit Counseling Corp., named plaintiffs Andrew and Kelly Zimmermann brought a suit under the Credit Repair Organization Act (CROA) against Richard and John Puccio and credit repair companies they controlled. Ponsor entered judgment in December 2008 in favor of the certified class for $259 million. He also established a constructive trust over “all fees that consumers paid to the current or former defendant entities.”

As the 1st Circuit put it, “the plaintiffs found that the judgment was ‘largely uncollectible’ against the class action defendants, and so the Zimmermanns sought new targets.” They filed one against the defendants’ auditors and another against the defendants’ law firms and attorneys in November 2009.

The lawyer case was against the following defendants: Epstein Becker, Sheppard, Mullin, Richter & Hampton of Los Angeles; Paul Kaplan, a lawyer who previously worked at both Epstein Becker and Sheppard Mullin, according to court papers;New York lawyer Brian Davis, his prior New York practice and his Garden City, N.Y., successor firm, Spence & Davis; and New York attorney Douglas Viviani and his firm.The auditor case named BDO Seidman, Chipetine Neu & Silverman of New York and Massachusetts-based Kostin, Ruffkes & Co. as defendants.

The Zimmermanns stated two causes of action in the attorney and auditor cases. The first was enforcement of “a constructive trust seeking the return of [the plaintiffs’] own money” that was allegedly fraudulently taken by the individual and corporate defendants in the Cambridge Credit case and transferred to the auditor and attorney defendants.

The second was that the defendants, except Sheppard Mullin, provided material assistance to the Cambridge Credit defendants, which violated the CROA.

The plaintiffs’ brief before the 1st Circuit claimed that some fees the Zimmermann class paid the defendants in the underlying case can be linked to fees later paid to the attorney and auditor defendants. These include the following: more than $6.9 million to Epstein Becker, nearly $1.2 million to Paul Kaplan, about $249,000 to Sheppard Mullin and roughly $330,000 to the Davis defendants. The 1st Circuit heard oral arguments on July 25.Judge Michael Boudin authored the opinion, joined by Judge Juan Torruella and Federal Circuit Judge Timothy Dyk, who sat on the panel by designation.

Boudin wrote that “the narrowest and clearest basis for rejecting” the plaintiffs’ constructive trust claim is that such a “trust cannot be read as intended to claw back monies expended, prior to the imposition of the trust, by the [individual defendants] or their companies in the ordinary course of business and in exchange for fair value.”

Boudin explained that a constructive trust is a court-imposed device set up to prevent unjust enrichment. Boudin also noted that the lower court imposed a constructive trust because the individual defendants commingled the finances of the various companies they controlled or managed and used the companies’ money for personal use.

Boudin acknowledged that the language of the particular constructive trust established by the court “might in some circumstances” reach transfers that happened before the constructive trust was established and paid to innocent persons or entities. He also wrote that the constructive trust’s language “is not as clear cut as it might be.” “But very little suggests that the order was intended to reach payments, made before the constructive trust was even imposed, to lawyers, accountants or the butcher, baker or candlestick maker,” Boudin wrote. “It is even less credible that it was intended to reach payments made in exchange for the fair value of such services. Very serious questions, of retroactivity, fair notice, and equity would be raised by such a reading.” He noted that “it can hardly be ‘unjust enrichment’ for lawyers and accountants hired by companies to be paid for their services.”

Boudin then tackled the plaintiffs’ CROA claims against the defendants. In order to have a case, Boudin wrote, the plaintiffs must proceed under Federal Rule of Civil Procedure Rule 23, which governs class actions. “But a certified class in one action is not a free floating entity entitled to conduct new and separate lawsuits against new defendants; unless and until it is certified in the new action.”

He concluded by stating that “new CROA claims against a new set of defendants cannot ride on the coat-tails of the earlier action under the guise of an enforcement proceeding.” The plaintiffs’ lawyer, Joseph Tusa, a New York-based solo practitioner, did not respond to requests for comment. Several defense lawyers split the oral argument time on July 25. These included Neil Dilloff, a Baltimore DLA Piper partner who represented Epstein Becker; Maura Barry Grinalds, a New York partner at Skadden, Arps, Slate, Meagher & Flom who represented Paul Kaplan; Lisa Wood, a partner at Boston’s Foley Hoag who represented BDO Seidman; Anthony Scibelli, a Boston Hiscock & Barclay partner who represented Chipetine Neu & Silverman; and Mark Goidell, a partner at Amityville, N.Y.-based Ansanelli Law Group who represented Davis, Spence & Davis and Viviani. Dilloff said Epstein Becker “is gratified that the appellate panel so quickly affirmed the decision of the district court in its favor.”

“The fact that the decision came less than two months after oral argument fully validates [Epstein Becker’s] position,” Dilloff said. “It is hoped that this favorable decision will put this matter to rest once and for all.” Goidell said his clients are gratified by the ruling and pleased the court used such strong language in admonishing plaintiffs’ counsel about the frivolity of their claims. “We’re also pleased the court recognized the chilling effect that this claim and these kinds of claims, if permitted, would have for all attorneys who would otherwise defend statutory fraud claims.”

Wood said that the court’s holding that BDO Seidman was not liable on either theory “extended the long line of cases holding that an auditor is not secondarily liable for the misconduct of an audit or tax client.” “The 1st Circuit also made clear that a plaintiff cannot make an end run around this well established precedent by trying to enforce a previously obtained judgment against an auditor or indeed other third parties who provided professional services to the judgment debtor,” Wood said. “The First Circuit’s decision will prevent other parties from trying to pursue the constructive trust theory in other cases.”

The ruling is significant because if the 1st Circuit had allowed the plaintiffs’ “unprecedented attempt to recycle a previously certified class into a roving class, it would have radically transformed class action litigation, jettisoning fundamental notions of due process along the way,” added Grinalds.

Scibelli did not respond to requests for comment.

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