ITT SMALL BUSINESS FINANCE CORPORATION v. NILES

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Court of Appeal, Second District, Division 7, California.

ITT SMALL BUSINESS FINANCE CORPORATION, Plaintiff and Appellant, v. Edward I. NILES, Defendant and Respondent.

No. B070563.

Decided: October 21, 1993

Carrick & Dale, George D. Dale and Donald J. Aberbook, Los Angeles, for plaintiff and appellant. Brandon & Rihn and Dennis W. Rihn, Los Angeles, for defendant and respondent.

This appeal is from a summary judgment in favor of respondent, an attorney, Edward I. Niles (Niles).   Appellant plaintiff, ITT Small Business Finance Corporation (ITT), brought a professional negligence action against Niles based upon Niles' alleged failure to exercise reasonable care and skill in preparation of loan documents for ITT.   ITT appeals from the entry of summary judgment against it based upon a defense the statute of limitations has time-barred ITT's complaint.

The central issue on appeal is whether appellant sustained “actual injury” over a year before the action was filed.   Under the circumstances of this case, we hold ITT did not sustain such “actual” injury until two months before it filed the malpractice action and remand the proceedings to the superior court.

FACT AND PROCEEDINGS BELOW

On or about December 1984, ITT retained Niles to act as its attorney in connection with preparation of certain loan documents and closing of a $200,000 loan to California Solution, Inc. (not a party to this action).   Contained in the loan was a security agreement granting ITT a first security interest in machinery, equipment, furniture, fixtures, inventory, accounts receivable and leasehold improvements.   In addition, the agreement granted ITT as security second liens on three pieces of real property and a pledge of certain stock as collateral securing the guaranty.

California Solution, Inc. filed for bankruptcy on February 16, 1988.   On February 14, 1990, California Solution filed an adversary proceeding in United States Bankruptcy Court.   One basis for the adversary proceeding was claimed inadequacies in the loan documentation Niles had drafted on ITT's behalf.

On July 11, 1990, ITT sent a letter to Niles informing him ITT expected Niles to indemnify them for any loss suffered in the adversary proceedings and to advise Niles to contact his malpractice insurer.

On January 28, 1992, after nearly two years of litigation in which it claimed the loan documentation was sufficient ITT was compelled to enter into a settlement agreement with California Solution, Inc. for an amount less than the full value of its security.

On March 16, 1992, over two years after the commencement of the adversary proceedings, but only two months after the settlement agreement, ITT filed its claim of professional negligence against Niles.

On May 5, 1992, Niles filed a demurrer to ITT's complaint on the grounds the malpractice action was time-barred by the applicable statute of limitations.   The demurrer was overruled.

On July 8, 1992, Niles filed a motion for summary judgment on the basis of the statute of limitations.   The trial court granted Niles' motion and this appeal followed.

DISCUSSION

I. APPELLANT WAS NOT ACTUALLY INJURED UNTIL AFTER THE SETTLEMENT AGREEMENT RESULTED IN A LOSS.

 The statutory law governing the statute of limitations on cases involving attorney negligence is set forth in Code of Civil Procedure section 340.6, “An action against an attorney for a wrongful act or omission, other than for actual fraud, arising in the performance of professional services shall be commenced within one year after the plaintiff discovers or ․ should have discovered, the facts constituting the wrongful act or omission, or four years from the date of the wrongful act or omission, whichever occurs first.”  (Code Civ.Proc., § 340.6(a).)

The code also lists exceptions that, when occurring, toll the statute of limitation period.   One such exception is Code of Civil Procedure section 340.6(a)(1) which tolls the period while “the plaintiff has not sustained actual injury.”

ITT argues it did not sustain actual injury until the January 28, 1992, settlement conference when it was finally determined it would not receive full security because of insufficiencies in the loan documentation attributable to Niles' performance.   ITT contends until then it was not known whether Niles' performance was deficient enough to cause it any injury.   Niles argues, on the other hand, the actual injury occurred well over a year before the complaint was filed at the time ITT was forced to litigate in the adversary proceedings.

Both parties argue the controlling decisional law in their favor.   However, there appears to be no case directly on point.   The parties have not cited and we have not found any California appellate decision where an attorney has committed alleged negligent behavior, the client vigorously defends the lawyer's actions in the trial court for years, and only after it has been determined in the trial proceeding the attorney's work did cause damage to the client does the client file a malpractice claim against the attorney.

ITT relies heavily on this court's decision in Robinson v. McGinn (1987) 195 Cal.App.3d 66, 240 Cal.Rptr. 423 in which the court held the trial court erred in granting a motion for summary judgment, as the harm plaintiff suffered did not become “irremediable” until he had exhausted his administrative remedies including an administrative appeal.   Niles responds, however, with the recent case of Laird v. Blacker (1992) 2 Cal.4th 606, 7 Cal.Rptr.2d 550, 828 P.2d 691 (Laird) in which the Supreme Court affirmed the limitations period of Code of Civil Procedure section 340.6 commences when a client suffers an adverse judgment or order of dismissal in the underlying action on which the malpractice action is based.   Respondent correctly argues Laird implicitly rejected the irremediable damage notion espoused in Robinson v. McGinn, supra, 195 Cal.App.3d 66, 240 Cal.Rptr. 423 and the line of similar cases.  (This rejection of the notion the commencement of the statute of limitations was tolled until the attorney's error could no longer be remedied through appeal was also supported by the recent decision in Schrader v. Scott (1992) 8 Cal.App.4th 1679, 11 Cal.Rptr.2d 433.)

The instant case is distinguishable from Laird, however.   In Laird, the Supreme Court held the plaintiff sustained actual injury when the trial court dismissed her underlying action and the limitations period is not tolled pending an appeal of that adverse judgment.   The Supreme Court decided irremediable injury, an appellate decision, was not a prerequisite to commencing the statute of limitations on the attorney negligence cause of action.

In the case at hand, however, ITT is not seeking to toll the statute of limitations while it pursues an appeal in the underlying action.   ITT only asks to toll the statute of limitations until it receives confirmation it had indeed been harmed by respondent's alleged negligent behavior because it loses in the trial court proceeding.   The settlement at the trial court level in this case is the functional equivalent of the trial court dismissal in Laird.

ITT's position is supported by language in the Laird opinion.   The Supreme Court holds in that case at page 609 “[W]e conclude the limitations period of section 340.6 commences when a client suffers an adverse judgment or order of dismissal in the underlying action on which the malpractice action is based.”   ITT did not suffer actual injury until January 28, 1992, when it was forced to accept an adverse settlement with California Solution Inc. at the trial court level in the adversary proceedings.   Until that moment it was entirely possible ITT could have prevailed in those proceedings by establishing the loan documentation was sufficient and then suffered no actual injury just as the plaintiff in Laird suffered no actual injury until the moment the trial court dismissed her complaint.

Niles cites other cases he claims support his argument the statute of limitations had run on ITT's claim.   These cases, however, can be distinguished.   For example, in Sirott v. Latts (1992) 6 Cal.App.4th 923, 8 Cal.Rptr.2d 206, (Sirott) the majority of this court held a physician plaintiff sustained actual damage as a result of defendant lawyer's alleged negligence at the time the trial court confirmed an arbitration award denying the doctor malpractice coverage.   Therefore the doctor was at that point compelled to pay the expenses of defending a medical malpractice action which had been filed against him regardless of the outcome of that action.   Once the physician became obligated to pay those ongoing legal expenses he suffered “actual injury.”

Relying on Sirott, Niles argues ITT suffered actual injury when forced to incur legal fees in order to defend itself in the adversary proceeding.   Sirott is distinguishable, however.   There the legal fees which represented the “actual injury” were incurred after the arbitration award was confirmed which established the lawyer had committed malpractice in advising his client's insurance coverage survived, an award which meant the doctor would be financially responsible for defending any present or future malpractice action.  Sirott did not hold the legal fees incurred in litigating the arbitration proceeding itself represented “actual injury.”   It was only the legal fees incurred after the doctor lost that proceeding which the court found to be an “actual injury.”

The adversary proceeding in this case is analogous to the arbitration in Sirott rather than the post-arbitration proceedings in that case.   In the present case there was no determination the attorney's performance would cause ITT a loss until ITT was forced to settle on adverse terms with its debtor.   ITT incurred its legal fees in the course of defending its attorney's actions just as the doctor in Sirott incurred legal fees in defending its attorney's advice during the coverage dispute eventually resolved against him in the arbitration proceeding.

 The legal fees the doctor incurred while litigating the coverage dispute in Sirott were not considered “actual damages” triggering the statute of limitations.   For the same reason, the attorney fees ITT incurred during settlement negotiations over the sufficiency of its security arrangements do not constitute “actual damages” within the meaning of Code of Civil Procedure, section 340.6.   The statute of limitations remained tolled until ITT actually suffered an economic loss attributable to its attorney's alleged malpractice, that is, when it had to accept an unfavorable settlement.

Niles also cites Johnson v. Simonelli (1991) 231 Cal.App.3d 105, 282 Cal.Rptr. 205 where the court held the client sustained actual harm when the buyers defaulted on a loan.   At that point the client was deprived of sufficient security and the value of the fees paid to the defendants for their services.  Johnson is also distinguishable from the case at hand.   In Johnson it was clear the attorneys' behavior left their client with inadequate security.   Thus the court was able to easily determine when actual harm occurred.

In the present matter, unlike Johnson, ITT litigated the adequacy of the security issue for years before it was clearly determined Niles' behavior left it without ample security.   Therefore, it is not apparent when ITT was actually injured because ITT's damages were unclear until after the settlement conference.1  In fact, the whole question of whether ITT was damaged at all was contingent on the outcome of the adversary proceedings.2  Until that time the attorney fees it was paying were the result of California Solution's claim ITT's documentation was insufficient not Niles' actual failure to prepare adequate documentation.   Those same fees would have been incurred even if ITT “won” the settlement conference and obtained its full security or full payment of the debt.   Only after ITT “lost” that settlement conference could it be said the firm had sustained “actual damages” which in fact were attributable to the alleged negligence of its former lawyer, Niles.

II. THIS INTERPRETATION OF THE ACTUAL INJURY REQUIREMENT IS SUPPORTED BY PUBLIC POLICY.

There are several policy reasons why ITT should not be obligated to commence an attorney negligence action until after it is determined they in fact will suffer injury.

First, it would be impractical for a lender to commence an action against its attorney every time one of its debtors challenged the validity of the lender's legal position and thus the soundness of its lawyers' legal work.   This would be a substantial and unwelcome addition to the already overwhelming caseload our courts must handle.   In these specific circumstances it is more practical to wait until the debtor establishes the lender's legal position indeed is weak and the security is found to be inadequate, before commencing the statute of limitations on the attorney malpractice cause of action.

Second, it would be unreasonable to compel ITT to commence the malpractice action at the same time it was litigating the adversary proceeding.   ITT would have to defend Niles' performance as its lawyer in the “adversary proceedings” while simultaneously arguing this same performance constituted professional negligence in its legal malpractice action.   In a smaller jurisdiction this could entail defending the work of the attorney in the morning, while in the afternoon making the complete opposite argument, both times in front of the same judge.3  In a larger jurisdiction, where different judges would hear each matter, this could result in different outcomes based on the same set of facts.   Both of these situations, obviously, are to be avoided.

Finally, it is a waste of judicial time as well as private resources to require both matters to be litigated when the outcome in one may render the other unnecessary.   Had ITT prevailed in the adversary proceeding the legal malpractice action would have been unnecessary.   Even when the client loses the underlying action as was the case at hand, it makes sense to litigate the malpractice action second.   Normally many of the issues relevant in the malpractice action will have been decided in the underlying action thus shortening the malpractice case.

We therefore conclude the trial court did err in granting respondent Niles summary judgment on his statute of limitations defense.

DISPOSITION

The judgment is reversed and the cause remanded for further proceedings consistent with this opinion.   Appellant to receive costs on appeal.

FOOTNOTES

1.   Respondent's argument ITT was actually injured no later than July 11, 1990, when it accused respondent of malpractice in a letter is without merit.   Knowledge of malpractice is different from “actual injury.”  Code of Civil Procedure section 340.6(a)(1) tolls the statute of limitations until actual injury is sustained irrespective of whether the client has “discovered” the lawyer was possibly negligent in his representation.  (Some of the reasons for this tolling provision are discussed in the next section.)In fact, the letter achieved the major purpose of statutes of limitation—to give defendants notice to obtain and preserve evidence which might be relevant to their defense.   The letter alerted the defendant early on that he might be sued for malpractice if and when the plaintiff sustained “actual injury” as a result of his performance of certain identified legal tasks.   In this sense, the letter was a favor to the defendant.   It cannot be used to defeat the claim filed against him once the plaintiff sustained “actual injury” as a result of his malpractice.

2.   The recent decision of Kovacevich v. McKinney & Wainwright (1993) 16 Cal.App.4th 337, 19 Cal.Rptr.2d 692 can be distinguished on similar grounds.   There an investor in a proposed new bank found himself personally liable to a lending institution due to the malpractice of the law firm which advised the investors.   Subsequently, when the lender filed suit, the investor hired a lawyer.   As best can be determined from the appellate opinion, the investor did not employ this lawyer to challenge the claim the investor was personally liable but to mitigate his losses by arranging matters so he could sue some of his fellow investors and the original law firm as well.   The Court of Appeal affirmed summary judgment on grounds the statute of limitations for the legal malpractice suit began running when the investor started incurring legal fees to the lawyer he employed to mitigate the harm the prior legal malpractice caused him.   Those legal fees represented “actual harm” since they were incurred after the client accepted the adverse position in which his former lawyer's actions had placed him.   In the instant case, by way of contrast, ITT, until it “lost” the settlement conference was litigating earnestly whether it was in an adverse position at all.   For reasons explored below, a broader reading of Kovacevich making it applicable to the instant case would produce undesirable consequences in public policy terms.   To the extent Kovacevich can be so interpreted, we decline to follow its rationale.

3.   Although this would be impossible in this case where one action would take place in the United States Bankruptcy Court and the other in state court, under slightly different circumstances this remains an entirely possible scenario.

JOHNSON, Associate Justice.

LILLIE, P.J., and FRED WOODS, J., concur.