Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca7-14-03632/USCOURTS-ca7-14-03632-0/pdf.json

Parties Involved:
Katten Muchin Rosenman LLP
Appellee
Ronald R. Peterson
Appellant

Document Text:

In the

United States Court of Appeals

For the Seventh Circuit ____________________

No. 14-3632

RONALD R. PETERSON, as Trustee for the estate of Lancelot 

Investors Fund, Ltd.,

Plaintiff-Appellant,

v.

KATTEN MUCHIN ROSENMAN LLP,

Defendant-Appellee.

____________________

Appeal from the United States District Court for the

Northern District of Illinois, Eastern Division.

No. 12 C 3393 — Harry D. Leinenweber, Judge.

____________________

ARGUED APRIL 16, 2015 — DECIDED JULY 7, 2015

____________________

Before BAUER, EASTERBROOK, and SYKES, Circuit Judges.

EASTERBROOK, Circuit Judge. As we discuss in Peterson v. 

McGladrey LLP, No. 14-1986 (7th Cir.) (McGladrey II), also issued today, the Trustee appointed to marshal the assets of 

Lancelot Investors Fund and other entities in bankruptcy 

(collectively “the Funds”) has filed multiple suits against 

solvent entities that, the Trustee maintains, failed to detect 

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the peril the Funds were in and help curtail their risks. See 

also Peterson v. McGladrey & Pullen, LLP, 676 F.3d 594 (7th 

Cir. 2012) (McGladrey I); Peterson v. Somers Dublin Ltd., 729 

F.3d 741 (7th Cir. 2013); Peterson v. Winston & Strawn LLP, 729 

F.3d 750 (7th Cir. 2013).

This appeal concerns the Trustee’s contention that Katten 

Muchin Rosenman LLP committed legal malpractice during 

the six years it advised the Funds how to structure their 

transactions with entitles controlled by Thomas Petters. As 

we recount in the other opinions we have cited, the Funds 

loaned money to the Petters vehicles, which in turn supposedly financed some of Costco’s inventory. Petters insisted 

that the Funds not contact Costco; doing that, he said, would 

upset his favorable business relations with it.

Security for the Funds’ advances was supposed to come 

in two forms: paperwork showing the inventory Petters furnished and Costco’s undertaking to pay, and a “lockbox”

bank account into which Costco would deposit its payments

for the Funds to draw on, eliminating any risk that Petters 

would put his hand into the till. That is how the Funds described the arrangement to their own investors. Yet Costco 

never put a penny into the account; all of the money came 

from a Petters entity. Gregory Bell, who established and 

managed the Funds, asserts that Petters told him that Costco 

had insisted on paying one of Petters’s vehicles. As we observe in McGladrey II, however, Bell (and the Funds) lied to 

investors about the arrangements and asserted that the money came directly from Costco. The actual setup left the Funds 

at Petters’s mercy—and he had no mercy, just as he never 

had any dealings with Costco. When Petters’s Ponzi scheme 

collapsed, so did the Funds.

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No. 14-3632 3

The Trustee’s complaint contends that Katten violated its 

duty to its clients by not telling Bell that the actual arrangement (no checks with Costco, no money directly from Costco) posed a risk that Petters was not running a real business. 

Katten had been engaged to structure transactions, the Trustee asserts, and part of that duty entails telling the client 

what contractual devices are appropriate to the situation. 

The complaint focuses on two periods: first, a time during 

2003 when principal contracts were being negotiated and 

signed; second, a time during 2007 when Petters fell behind 

in payments to the lockbox (he asserted that Costco was late 

paying him) and the Funds consulted Katten about what to 

do. According to the complaint, in 2003 Katten did not advise the Funds to ask for additional protections—the Trustee 

believes that Katten’s lawyers did not recognize the risk from 

the combination of no contacts and no direct payments, plus 

the potential that the paperwork purporting transactions 

with Costco had been forged. The complaint also alleges that 

in 2007 Katten advised the Funds to defer the due dates on 

the payments, and that no other change was necessary, even 

though the delay coupled with the other indicators should 

have alerted any competent transactions lawyer to the possibility of fraud, and the lawyer should have counseled the 

client to obtain better security.

The district court dismissed the complaint under Fed. R. 

Civ. P. 12(b)(6) for failure to state a claim on which relief may 

be granted. Instead of taking the complaint on its own terms, 

the district court’s opinion narrates the events from the law 

firm’s perspective. Katten maintains, and the opinion states, 

that Bell knowingly bypassed verification with Costco in order to obtain a higher interest rate from Petters. Thus the 

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Funds knowingly took a risk and cannot blame a law firm 

for failing to give business advice.

There are three problems with this decision. First, it rests 

on a factual view extrinsic to the complaint and therefore is 

not an appropriate use of Rule 12(b)(6). The complaint alleges that Bell attributed the Funds’ high return at least in part

to the lack of direct verification with Costco and that he told 

some would-be investors about this tradeoff, but it does not 

allege that Bell was indifferent to legal advice concerning 

how to curtail risks given the no-contact constraint.

Second, the decision does not engage the complaint’s 

main contention—not that Katten was supposed to do something about Petters’s no-direct-contact edict, but that Katten

had to alert its client to the risk of allowing repayments to be 

routed through Petters, drafting and negotiating any additional contracts necessary to contain that risk. As the complaint depicts matters, Bell did not appreciate the difference 

between funds from Costco and funds from Petters. A competent transactions lawyer should have appreciated that the 

former arrangement offers much better security than the latter and alerted its client. If a client rejects that advice, the 

lawyer does not need to badger the client; but the complaint 

alleges that the advice was not offered, leaving the client in 

the dark about the degree of the risk it was taking.

The third problem is that the decision does not identify 

any principle of Illinois law that sharply distinguishes between business advice and legal advice. It is hard to see how 

any such bright line could exist, since one function of a 

transactions lawyer is to counsel the client how different legal structures carry different levels of risk, and then to draft 

and negotiate contracts that protect the client’s interests. A 

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No. 14-3632 5

client can make a business decision about how much risk to 

take; the lawyer must accept and implement that decision. 

But it is in the realm of legal advice to tell a client that the 

best security in a transaction such as this one is direct verification with Costco plus direct deposits to a lockbox; the second-best is direct deposits to a lockbox; and worst is relying 

wholly on papers over which Petters had complete control, 

for they may be shams with forged signatures by Costco 

managers who have never heard of Petters. Knowing degrees of risk presented by different legal structures, a client

then can make a business decision; but it takes a competent 

lawyer, who understands how the law of secured transactions works (and who also knows what’s normal in the 

world of commercial factoring that Petters claimed to practice), to ensure that the client knows which legal devices are 

available and how they affect risks.

The district court did not cite any Illinois statute or decision holding that a transactions lawyer never needs to supply a client with legal information that affects the degree of 

business risk attached to a transaction. Nor does Katten’s 

brief in this court. Our own search did not turn up any such 

case. The district court relied principally on a federal district 

court’s decision, Abrams v. DLA Piper (US) LLP, 2013 U.S. 

Dist. LEXIS 82484 (N.D. Ind. June 12, 2013), based on Illinois

law. The district court quoted this passage:

The Plaintiffs do not suggest that the Defendant breached a 

standard of care in the legal services it provided; rather, the 

Plaintiffs are alleging, in essence, that the Defendant should not 

have provided legal services at all because the transactions were 

disadvantageous to the Debtor, and because the Defendant represented the Debtor. The Plaintiffs also allege, however, that the 

Debtor itself approved every legal action taken by the Defendant 

on behalf of the Debtor. The advice the Plaintiffs challenge, then, 

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is not the legal advice provided by the Defendant. Rather, the 

Plaintiffs are challenging the Defendant’s failure to give the 

Debtor business advice—specifically, the Defendant’s failure to 

advise the Debtor against engaging in the [transactions]. Such allegations do not state a claim for legal malpractice.

Id. at *20–21. That may or may not be a correct statement of 

Illinois law, but it has nothing to do with the Trustee’s 

claims. The Trustee does not fault Katten for failing to advise 

the Funds to refuse to do business with Petters. The Trustee 

faults Katten for not advising the Funds about the value of a 

direct-deposit lockbox and for not recognizing, even after 

Petters fell behind in payments, that the existing arrangements were insecure, compared with other arrangements 

that could have been adopted. Advising clients how best to 

maintain security for their loans using legal devices is a vital 

part of a transactions lawyer’s job.

The only other case on which the district court and Katten rely comes from the Supreme Court of New Jersey, 

which wrote:

Malpractice in furnishing legal advice is a function of the specific 

situation and the known predilections of the client. An attorney 

in a counselling situation must advise a client of the risks of the 

transaction in terms sufficiently clear to enable the client to assess the client’s risks. The care must be commensurate with the 

risks of the undertaking and tailored to the needs and sophistication of the client.

Conklin v. Hannoch Weisman, P.C., 145 N.J. 395, 413 (1996).

It’s awfully hard to see how Conklin helps Katten, whether or not it represents the law of Illinois—Conklin has been

cited by two Illinois decisions, but not for the point in the 

quoted passage, see Lopez v. Clifford Law Offices, P.C., 362 Ill. 

App. 3d 969, 975 (2005); Community College District No. 508 v. 

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Coopers & Lybrand, 208 Ill. 2d 259, 272 (2003)—since the complaint alleges that Katten did not advise its clients “of the 

risks of the transaction in terms sufficiently clear to enable 

the client to assess the client’s risks.” The complaint alleges, 

indeed, that Katten did not advise the Funds at all about how 

different legal devices for securing and collecting on loans 

affect the risks to which the lenders (i.e., the Funds) are exposed.

Moreover, it is hard to see how Conklin’s principle could 

be applied at the pleading stage. One part of Conklin that 

Lopez endorsed is the proposition that legal advice “must be 

... tailored to the needs and sophistication of the client.”

Lopez, 362 Ill. App. 3d at 975, quoting from Conklin. The 

“needs and sophistication of the client” is a factual issue unsuited to a motion under Rule 12(b)(6). The complaint does 

not tell us how sophisticated Bell and the Funds were about 

commercial factoring and the legal devices available for 

lenders’ protection. Nor does it reveal what Katten was hired 

to do—what kind of advice the Funds wanted, what kind of 

advice Katten promised to provide. Without knowing these 

facts, which are matters for summary judgment or trial, it is 

not possible for the court to determine whether Katten performed its undertaking negligently.

We take the point that a transactions lawyer’s task is to 

propose, draft, and negotiate contractual arrangements that 

carry out a client’s business objective, not to tell the client to 

have a different objective or to do business with a different 

counterparty. See Behrens v. Wedmore, 698 N.W.2d 555, 572–73 

(S.D. 2005) (a lawyer did not commit malpractice by overseeing the closing of an unsecured loan to a borrower that became bankrupt; as “experienced business people” the clients 

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assumed the risk of the borrower’s default). A lawyer is not a 

business consultant. But within the scope of the engagement 

a lawyer must tell the client which different legal forms are 

available to carry out the client’s business, and how (if at all) 

the risks of that business differ with the different legal 

forms. Even if Bell was determined to do business with Petters, the Fund’s lawyers still could have explained how to 

structure the transactions in a less risky way, and if Petters 

refused to cooperate then Bell might have reconsidered lending the Funds’ money to his operations. The Trustee alleges 

that Katten did not offer any advice about how relative risks 

correspond to different legal devices, and its complaint 

states a legally recognized claim for relief. Whether the law 

firm has a defense—and whether any neglect on its part 

caused injury—are subjects for the district court in the first 

instance.

The judgment is reversed, and the case is remanded for 

proceedings consistent with this opinion.

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