By: Nicole Strout
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
In Peterson v. Katten Muchin Rosenman LLP. , the Seventh Circuit held that the allegations in a legal malpractice complaint by the trustee for Lancelot Investors Fund and other entities in bankruptcy (collectively “the Funds”), was plausible on its face. In Peterson , the trustee filed suit against the Funds’ law firm for failing to detect the peril and curtail the risks pertaining to the Funds. The Funds loaned money to and invested in vehicles owned by Thomas Petters, which, in turn, was supposed to finance Costco’s consumer-electronics inventory. The Funds’ advances were to be secured by deposits made by Costco, not Peters, into a lockbox bank account. However, Costco never deposited money into the account. All the money came from a Petters entity. In reality, Petters never had any dealings with Costco, and the whole set up was a Ponzi scheme. Once the scheme collapsed, the Funds also collapsed. Consequently, the Funds filed for relief under chapter 7 of the Bankruptcy Code. The chapter 7 trustee for the Funds brought a cause of action against Katten, the law firm which acted as transactions counsel for the Funds, claiming that the law firm had a duty to inform its clients that the actual arrangement posed a risk because Petters was not actually running a real business. In granting the law firm’s motion to dismiss, the district court held the Funds “knowingly took the risk and cannot blame the firm for failing to give business advice.” After the trustee appealed the motion to dismiss, the court of appeals reversed the district court decision, holding the firm was liable not for failing to provide business advice but for failing to inform its clients of “the different legal forms that are available to carry out the business and how risks differ with different legal forms.” Clients do not have to take the advice of their attorneys, but attorneys need to advise clients.