A few weeks ago, Rob, an attorney friend of mine, told me about a terrific settlement he had achieved for a corporate client after 26 months of litigation. At the inception of the case, the plaintiff had demanded $3.8 million. After four months of litigation, Rob had collected enough information to conclude that the value of the case, based on a risk assessment of liability and damages, was approximately $350,000. However, because plaintiff’s demand was outlandish, Rob and his client agreed they should send a message, so Rob’s client offered $25,000. The plaintiff did not respond to the offer. At mediation almost two years later, the parties agreed to settle for $375,000. Rob said his client was thrilled because it had saved more than $3 million even after taking the litigation costs into account. I congratulated Rob and then asked, “How do you know?”

“How do I know what?” Rob responded.

“How do you know that your client saved $3 million?”

“Obviously, since plaintiff had demanded $3.8 million and we ultimately settled the case for $375,000, with less than $400,000 incurred for the defense, the client saved more than $3 million.”

“But how do you know plaintiff would not have taken $375,000 two years ago? If your client had not slapped plaintiff in the face with a $25,000 offer, perhaps plaintiff would have made a reasonable counter-offer or suggested an early mediation to try to close the gap.”

Rob patiently explained to me that I was missing the point. “You cannot reward a plaintiff’s outlandish demand with a reasonable offer. If I had done what you suggest, the case never would have settled for a reasonable amount.”

Maybe. But this logic places enormous power and control in the hands of an opponent, allowing the opponent to dictate whether negotiations will be based solely on posturing or whether they will be based on a realistic evaluation of the case. While attorneys generally loathe relinquishing power and control to an adversary, most attorneys readily do so in negotiations, just as Rob did.

There may be good strategic reasons to make an offer or demand that is equally as outlandish as the opposition’s. However, responding in kind is sometimes a counter-productive reaction based on emotion and habit, not strategy.

In many cases, ignoring the other side’s offer or demand, and instead making a demand or offer more attuned to the true value of the case, can save months or years of litigation. I am not suggesting that Rob should have immediately offered $350,000, which was his evaluation of the case. But if he had responded, for example, at 50 percent of that amount, the parties may have settled almost two years earlier, saving Rob’s client hundreds of thousands of dollars.

While Rob’s opponent should have known that the initial very low offer from Rob’s client was simply tit for tat, his experience has taught him that two years of litigation would likely turn that low offer into a realistic settlement. In other words, we litigators have fallen into patterns of behavior that are very difficult to break.

The key to breaking the pattern is to convey to your opponent that there is a genuine opportunity to settle for a realistic amount. The goal is to make the opposition sweat, at least metaphorically, in fear of passing up an opportunity. In Rob’s case, the defendant’s offer for less than 10 percent of the value of the case had no prospect of making the plaintiff or his attorney sweat.

Of course, if you accept my premise, then you may do some sweating of your own when you try to explain it to your client. Clients hate wimpy attorneys, and they sometimes confuse bravado with strength. I often hear, “Yes, but we will look weak and will lose our negotiating power.” I disagree. An unreasonable position does not convey strength, but it does wonders for increasing the cost of litigation and generating revenues for lawyers. Strength is better conveyed by confidence and the resolve to take the case to trial if a reasonable settlement cannot be achieved.

Farley J. Neuman, a partner of Jenkins Goodman Neuman & Hamilton LLP in San Francisco, has litigated many types of cases, including business and commercial cases, and cases involving accounting malpractice, employment law, securities laws and consumer class actions.

PG&E and the owner/general contractor had settled prior to trial, and the trial proceeded only against Baja, which designed and installed approximately 60,000 sq. ft. of metal storage buildings for an RV storage park. Mr. Hawkins died on his first day on the job when a 20’ piece of flashing he was carrying up a ladder contacted a 12,000 volt overhead power line. Plaintiffs argued that Baja designed and constructed the buildings too close to the power lines and failed to warn of the overhead power lines or take other precautions to prevent injury or death. JGNH argued that responsibility rested with PG&E, with the owner/general contractor and with decedent’s employer.

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Accounting firm PricewaterhouseCoopers LLP was hired to audit two limited partnerships, Grafton Partners LP and Allied Capital Partners. Both partnerships were vehicles for investing in loans issued by Pinnfund, USA Inc., a mortgage company. In the course of conducting the audit, PwC noticed irregularities indicating possible fraud. PwC told James Hillman, owner and manager of Peregrine Funding, the general partner of Grafton and Allied, that it could not issue audit reports on Grafton and Allied until the questions were resolved. Hillman then terminated the auditor-client relationship. PwC neither issued an audit report on Grafton and Allied nor reported its suspicion of fraud to anyone other than Hillman.

It later came to light that Pinnfund’s owner was misappropriating the money invested in it, and that Hillman, who directed the limited partnerships’ investments into PinnFund, was implicated in the scheme. After the Securities and Exchange Commission shut down PinnFund, Grafton’s and Allied’s limited partners (the investors) sued PwC for aiding and abetting fraud and conspiracy to defraud, among other theories, asserting that PwC should have told them what it knew. The trial court granted PwC’s motion for summary judgment, ruling that PwC had no duty to communicate with the investors.

The First District Court of Appeal affirmed on the conspiracy and third party-beneficiary breach of contract claims, but reversed on the claim of aiding and abetting fraud. Liability for aiding and abetting an intentional tort may arise if the defendant ”knows the other’s conduct constitutes a breach of duty and gives substantial
assistance to the other to so act.” 134 CA4th at 407, quoting Saunders v Superior Court (1994) 27 CA4th 832, 846, 33 CR2d 438, and adding italics. It was undisputed that PwC had some knowledge of the fraud. PwC knew that the partnerships’ only significant assets were funds they had loaned to PinnFund. If PinnFund could not repay those loans, Grafton and Allied had little value. But when PwC asked for PinnFund’s audited financial statements, Hillman responded that they were not yet complete. He and PinnFund later produced reports that PwC discovered were falsified. PwC also realized Hillman had lied about the reports not being completed.

A triable issue exists as to whether PwC provided substantial assistance to the fraud. An audit report would have described the forged financial statements and the absence of verification of assets, and would have been available to the investors. The absence of the written audit report postponed public detection of the fraud, giving Peregrine/Hillman and PinnFund time to solicit and obtain additional investments. It allowed them to maintain the secrecy critical to their fraudulent scheme. This could lead a trier of fact to conclude that PwC provided substantial assistance to Peregrine/Hillman with knowledge of the fraud, which precludes summary adjudication of the aiding and abetting claim.

COMMENT: PricewaterhouseCoopers LLP was between a rock and a not-quite-so-hard place, and unfortunately chose the rock. It discovered strong evidence of fraud and was faced with the dilemma of either (1) disclosing [PAGE 49]that evidence to limited partners, thereby risking a lawsuit by the partnership and/or its general partners, or (2) withdrawing from the audit and remaining quiet, thereby risking a lawsuit by the innocent limited partners. It chose the latter, which in my opinion was a mistake from both a legal and an ethical perspective. It did nothing to prevent a massive fraud from continuing and exposed itself to liability to the victims of that fraud.

The court was obviously troubled by Pricewaterhouse’s decision and was thus willing to stretch existing law to reach what it considered to be an equitable result. Under earlier cases, auditors were granted some protection from liability to third parties (including investors and shareholders) for claims of negligence and negligent misrepresentation, but no protection for claims of fraud. See Bily v Arthur Young & Co. (1992) 3 C4th 370, 11 CR2d 51. In Frame, the court breaks new ground by holding that an auditor’s failure to issue an audit report or otherwise notify limited partners of potential fraud may support a claim for aiding and abetting the fraud, even though the court acknowledges that the auditor did not commit fraud and did not conspire to commit fraud. The Frame court somewhat surprisingly concludes that the auditor’s lack of action could be construed as providing “substantial assistance” to the fraud, although the court agrees with prior decisions holding that auditors do not owe a duty of due care to nonclient investors.

Because of ambiguities in the professional standards for accountants (Generally Accepted Accounting Principles (GAAP) and Generally Accepted Auditing Standards (GAAS)), many accountants believe that they may withdraw from an audit on discovery of facts indicating fraud or other illegal acts. This case strongly suggests otherwise. For many years, I have advised accountants in similar situations to carefully and prudently disclose evidence of fraud to innocent third parties, including limited partners and creditors, based on my belief that it is almost always preferable to be sued by the apparent crooks rather than by the innocent victims. —Farley J. Neuman