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Appaloosa Investment L.P.I. v. J.P. Morgan Securities

SUPERIOR COURT OF NEW JERSEY APPELLATE DIVISION


April 24, 2008

APPALOOSA INVESTMENT L.P.I; PALOMINO FUND LTD.; RELIANCE STANDARD LIFE INSURANCE COMPANY; MUTUAL SHARES FUND; MUTUAL BEACON FUND; MUTUAL QUALIFIED FUND; MUTUAL DISCOVERY FUND; MUTUAL EUROPEAN FUND; MUTUAL SHARES SECURITY FUND; MUTUAL DISCOVERY SECURITIES FUND; FRANKLIN NATURAL RESOURCES FUND; FRANKLIN NATURAL RESOURCES SECURITIES FUND; AND FRANKLIN GOLD AND PRECIOUS METALS, PLAINTIFFS-RESPONDENTS,
v.
J.P. MORGAN SECURITIES, INC.; BMO NESBITT BURNS CORP.; BMO NESBITT BURNS SECURITIES INC., A/K/A BMO NESBITT BURNS, INC.; HARRIS NESBITT INC.; BANK OF MONTREAL, SNC-LAVALIN GROUP, INC.; SNC-LAVALIN/KILBORN ENGINEERING PACIFIC, LTD.; P.T. KILBORN PAKAR REKAYASA AND BARRICK GOLD CORPORATION, DEFENDANTS.
BMO NESBITT BURNS, INC., BANK OF MONTREAL, BMO CAPITAL MARKETS CORP., AND J.P. MORGAN SECURITIES, INC., DEFENDANTS/THIRD PARTY PLAINTIFFS-APPELLANTS,
v.
APPALOOSA MANAGEMENT, LP, FRANKLIN RESOURCES, INC., FRANKLIN ADVISORS, INC. AND FRANKLIN MUTUAL ADVISORS, LLC, THIRD PARTY DEFENDANTS-RESPONDENTS.

On appeal from the Superior Court of New Jersey, Law Division, Morris County, Docket No. L-3059-05.

Per curiam.

NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION

Argued telephonically April 3, 2008

Before Judges C.S. Fisher and C.L. Miniman.

Plaintiffs are a group of mutual and hedge funds (the funds) that, by way of this action, seek damages based upon losses they claim to have sustained from investing in Bre-X Minerals Ltd. (Bre-X), a Canadian gold exploration company. Defendants are financial institutions that provided services for the now-bankrupt Bre-X; in the complaint filed by their attorneys, Gibbs & Bruns, LLP, the funds allege that "red flags" that went up should have made defendants understand that Bre-X was a fraud.

Defendants filed a third-party complaint against the managers and investment advisers (advisers) of the funds. Gibbs & Bruns thereafter appeared as counsel for the advisers. In this appeal, we review the trial judge's order that denied defendants' motion to disqualify Gibbs & Bruns as counsel because of its dual representation of both the funds and the advisers.

I.

This action has its genesis in Bre-X's report in 1994 that it discovered a rich gold deposit in Busang, Indonesia. With increasing estimates of the gold find, the share prices of BreX, and its affiliate, Bresea Resources, Ltd. (Bresea), rose on the stock exchanges here and in Canada. In March 1997, however, the market apparently realized that Bre-X's drilling results had been falsified, causing the share prices of both Bre-X and Bresea to plummet and generating losses for the funds.

The funds' complaint, which was filed on October 31, 2005, asserted common law claims and sought damages from defendants for the losses sustained as a result of the funds' purchases of Bre-X and Bresea stock. Defendants unsuccessfully moved for a dismissal of the complaint.*fn1 Once their motion to dismiss was denied, defendants filed a third-party complaint against the advisers.

In their third-party action, defendants alleged that the advisers were sophisticated financial firms that promised, for substantial fees, their robust and diligent examination of their investments -- that the advisers promised, among other things, to examine "original country, industry and company research," make "company visits and inspections," utilize "other publicly available information," and conduct "management interviews." Defendants alleged, apparently without dispute, that the decisions to purchase Bre-X and Bresea stock were made by the advisers with full and sole discretionary authority to make these purchases. Defendants also asserted that the advisers failed to live up to their promises of exercising due diligence and thereby breached their fiduciary duties; these assertions are disputed.

Once the third-party complaint was filed and served, Gibbs & Bruns appeared for the advisers. Defendants argued that this created "a clear conflict for Gibbs & Bruns because, in the same action, Gibbs & Bruns is asserting on behalf of one set of clients the very allegations against which they are defending another set of clients." That is, defendants claim that the theory that the funds are pursuing against them -- that there were certain "red flags" about the Bre-X gold find that "would have put any sophisticated person on notice that Bre-X was a fraud" -- is essentially the same theory that is being pressed by defendants against the advisers. In short, defendants contend that Gibbs & Bruns will be both advocating and resisting the same theory, for different clients, in the same case.

Defendants unsuccessfully moved in the trial court to disqualify Gibbs & Bruns. After we denied defendants' motion for leave to appeal, defendants moved in the Supreme Court for leave to appeal. The Court granted this motion and summarily remanded the matter to us to consider the appeal on its merits. 193 N.J. 218 (2007).

II.

Because the "appearance of impropriety" no longer provides a basis for the disqualification of counsel from litigation when a conflict of interest is asserted, In re Supreme Court Advisory Comm. on Prof'l Ethics Opinion No. 697, 188 N.J. 549, 552 (2006), we are required to consider whether there is any substance in defendants' contention that the interests of the advisers are "directly adverse" to the interests of the funds, R.P.C. 1.7(a)(1), or whether there is "a significant risk" that Gibbs & Brun's representation of one of these groups of clients "will be materially limited by [its] responsibilities" to the other, R.P.C. 1.7(a)(2). The trial judge found, and we agree, that in the circumstances presented the funds and the advisers are not directly adverse to one another but instead share a common interest that may be advocated without separate counsel.

The funds acknowledge that their action is based on the contention that the advisers reasonably relied upon defendants' alleged misrepresentations. In addition, they assert "there is no evidence . . . to support the notion that the [a]dvisers were acting outside the scope of their authority," summarizing that their claim is dependent upon: proof that their [a]dvisers, who had full and sole discretionary authority to purchase securities on [their] behalf, reasonably relied on [d]efendants' misrepresentations. . . . In other words, [the funds] can only prove they reasonably relied on [d]efendants' fraud if their [a]dvisers relied: without the [a]dvisers' reliance, [the funds] cannot recover.

Because this appears to be a plausible description of the nature of the funds' claims, we agree there exists an identity of interests between the funds and the advisers, and that the funds' pursuit of a claim against the advisers -- based upon a contention that the advisers grossly breached their obligations to the funds -- would run counter or conflict with the main thrust of the funds' claim against defendants that defendants misled the advisers.

It should also be observed that the record reveals that the advisory agreements entered into by the funds and the advisers contain limitation-of-liability clauses that bar the funds from suing their advisers in the absence of "willful misfeasance, bad faith, gross negligence, or reckless disregard of obligations or duties." The funds persuasively argue that their pursuit or ultimate success against the advisers on claims which are not foreclosed by the limitation-of-liability clauses would necessarily negate or significantly hamper their ability to prove the advisers' reasonable reliance on defendants' alleged misrepresentations in their claims against defendants. In other words, the claims against the advisers that the funds have chosen to forego -- the very claims that, if asserted, would generate a conflict of interest -- would tactically damage, if not prove fatal, to the claims they have already asserted against defendants. The funds were entitled to make this choice among their potential claims, and the fact that the funds deemed it better to pursue a claim against defendants than pursue claims against the advisers that might in fact be barred by the advisory agreements does not create a conflict that would require the disqualification of their counsel.

Moreover, it is noteworthy that many of the funds are required to indemnify their advisers for the cost of defending suits arising from actions falling within the scope of the advisers' authority.*fn2 Were the funds to pursue claims against the advisers based on what the funds have already alleged in their claims against defendants -- that the investments were within the scope of the advisers' authority and the advisers were misled by the alleged misrepresentations of defendants --the funds would likely be obligated to bear the cost of the advisers' defense.

In light of these circumstances, we conclude there is a substantial identity of interests between the funds and the advisers. Defendants' claim of a conflict of interest arises from the fact that the funds could have commenced a suit against the advisers. That is true, but the funds have chosen not to pursue that course -- and for arguably sound reasons: (a) the claims that the funds have pursued against defendants might be compromised or hampered by any attempt to pursue claims against the advisers; (b) the claims against the advisers, if asserted, would likely be barred, in whole or in part, by the limitation-of-liability clauses; and (c) the assertion of those claims would open the door to the funds' potential liability for the counsel fees of the advisers. In short, there appears to be much risk and small reward for the funds if they pursued the claim the existence of which forms the basis for defendants' motion to disqualify counsel. As has been argued by the funds and the advisers, the essence of defendants' argument for disqualification is that because the funds "may sue the [a]dvisers in limited circumstances, and might have the same 'red flag' arguments against the [a]dvisers that they have against the [d]efendants, or might not have to indemnify their [a]dvisers in certain circumstances, they may never be jointly represented -- no matter how much it lowers costs or enhances [the funds'] recovery." These are the circumstances presented by defendants in support of their attempt to disqualify counsel. For the reasons we have outlined, we are satisfied that this scenario does not generate a conflict of interest within the meaning of R.P.C. 1.7(a).

In addition, we are also persuaded that, even if a conflict of interest could be found in these circumstances, the funds have waived it in the manner permitted by R.P.C. 1.7(b). An effective decision by the clients involved to forego asserting rights that would cause a conflict of interest if asserted removes the basis for a finding of any such conflict. Here, the funds contend that they were fully informed, both at the inception of the suit and later once questions were raised by defendants, of the potential conflicts; the parties waived any such potential conflicts after receiving the advice of independent counsel. We find insufficient merit in defendants' arguments that there was a lack of an informed waiver to warrant discussion in a written opinion, R. 2:11-3(e)(1)(E), adding only that having carefully reviewed the record, we are satisfied that the funds and the advisers made an effective decision in this regard.

III.

We are mindful that the funds and the advisers have argued that defendants are without standing to seek the disqualification of their counsel. They contend that, generally speaking, only the client, or a former client whose rights are affected by counsel's representation of another, such as were the circumstances in Dewey v. R.J. Reynolds Tobacco Co., 109 N.J. 201 (1988), may be heard to complain of such a dual representation. It is true that a brief comment in a published trial court decision, which we affirmed "substantially" for the reasons set forth by the trial judge, indicates that an adversary, in order to seek disqualification, must demonstrate that it has been harmed by an attorney's dual representation of other parties allegedly in conflict. See In re Trust for the Benefit of Duke, 305 N.J. Super. 408, 445 (Ch. Div. 1995), aff'd, 305 N.J. Super. 407 (App. Div.), certif. denied, 151 N.J. 73 (1997). But we are not persuaded that such a rule has been firmly established or that the Duke court intended to adopt such a sweeping holding as suggested by the funds and the advisers. Indeed, other persuasive authorities stand in contrast to the limited standing rule urged by the funds and the advisers. See Pressman-Gutman Co., Inc. v. First Union Nat'l Bank, 459 F.3d 383, 402 n.20 (3d Cir. 2006); Essex County Jail Annex Inmates v. Treffinger, 18 F. Supp. 2d 418, 430-31 (D.N.J. 1998). We would also note that R.P.C. 8.3(a) imposes a reporting obligation on "[a] lawyer who knows that another lawyer has committed a violation of the Rules of Professional Conduct that raises a substantial question as to that lawyer's honesty, trustworthiness or fitness as a lawyer in other respects." This rule arguably suggests that counsel for a litigant is obligated to pursue disqualification of an attorney regardless of the lack of harm to the reporting attorney's client; however, we realize that it is also just as arguable that this reporting obligation is satisfied by a reference to an ethics committee, and need not be read to establish a broad standing rule such as that urged by defendants herein.

In light of our disposition of the other issues raised, we need not reach these interesting questions about standing. However, we would lastly note that we share the concerns raised by the funds and the advisers regarding the scope to which an adversary may inquire -- by having filed a disqualification motion -- into the communications between counsel and client. Motions to disqualify that are motivated by a party seeking only an advantage in litigation are to be discouraged if for no other reason than their potential for opening an avenue into confidential attorney-client communications.

In any event, because we have found no substance in defendants' assertion of a conflict of interest or an insufficient waiver of the alleged conflict, we need not plumb the depths to which such an inquiry into confidential communications in such matters may be made nor attempt to delineate who has standing to pursue the disqualification of counsel.

Affirmed.


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