It is no secret that law firms with a concentration in real estate law, real estate closings or title work are higher risk. Many of these firms have seen price increases and even non-renewals for their insurance in the last number of years. While the actions by underwriters may be frustrating for policy holders, according to research done by the ABA a claim leader in recent years have been real estate suits. Real estate claims tend to be severe – frequently leading to high damages – and many stemmed from the real estate boom and bust we experiences 10 years ago.
A recent claim made against a national firm shows yet another reason for firms to be wary of real estate work. In this matter, the law firm of Dentons is in the news for receiving a lawsuit claiming they are partially responsible for a default in a real estate loan costing $41M. The allegations are being brought by the lender in this case. The plaintiff claims that the firm failed to properly assist in the due diligence of the transaction. Specifically, that the missed the fact that the borrower misrepresented their financial situation – an act that later led to the default on the loan.
The real lesson, however, is not that a real estate firm should do better due diligence. It is that Dentons never represented the lender. A predecessor firm did.
Sonnenschein, Nath & Rosenthal (SNR) was merged in to Dentons and prior acts picked up under the definition of “predecessor firm” in Denton’s lawyer’s malpractice insurance policy. It was SNR that performed the real estate work in 2007 and since Dentons were now responsible for the past work of SNR, Denton’s was named in the lawsuit.
Firms engaging in mergers and acquisitions need to carefully consider this point. Buying a practice may seem like a good way to grow, but it is not without its risks. When merging in another entity, the new firm could be picking up exposures to past acts and engagements that was not contemplated in the initial due diligence.
For firms who do not want to be responsible for the past work product of a merged in firm, there are ways to sever the liability. The merged in firm would need to purchase a “tail” on their expiring policy. However, this route is more expensive initially and many firms try to avoid doing this. While less expensive in the short term to pick up the prior acts of the acquired firm, it could potentially lead to future lawsuits such as the one Dentons is experiencing.
Contact us to discuss ways to further protect your law firm when performing real estate work or when acquiring other practices.