Applied Energetics, Inc. v. Gusrae Kaplan Nusbaum PLLC

Background

Applied Energetics, Inc. sued Gusrae Kaplan Nusbaum PLLC and Ryan Whalen, an attorney and partner in the firm. The company alleged legal malpractice and violations of Rules 1.5, 1.7, and 1.8 of the New York Rules of Professional Conduct.

The allegations arose from two related representations. In 2017, Defendants represented George Farley individually in a shareholder derivative lawsuit alleging that he breached duties to Applied Energetics by issuing himself 25 million shares. In early 2018, Defendants represented Applied Energetics in a shareholder proxy contest seeking Farley’s removal. Applied Energetics alleged that Defendants’ earlier representation of Farley created a conflict when they later represented the company in a contest concerning the same conduct.

Applied Energetics also alleged that Defendants negotiated with Farley to receive company stock instead of cash for legal fees from both representations. The company alleged that Defendants received 1,242,711 shares, that they did not disclose the conflicts or advise the company in writing to seek independent counsel, and that they did not obtain the company’s written informed consent. The company further alleged that the stock was worth more than the fees for the work performed.

Defendants’ Motion

Defendants moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint states a legally sufficient claim. They argued that Applied Energetics had not adequately alleged an attorney-client relationship for the earlier representation, negligence, proximate cause, or actual damages. They also argued that the New York professional-conduct rules did not support the company’s requested relief and that the claim was duplicative of legal malpractice.

Applied Energetics argued that it had adequately alleged that Defendants’ conflicts impaired their judgment during the proxy contest and the stock-for-fees transaction. It also argued that the stock issuance was an excessive fee and that rescission, restitution, or recoupment remained available for that alleged violation.

Court’s Analysis

The court applied New York law. At the motion-to-dismiss stage, it treated the complaint’s factual allegations as true and drew reasonable inferences for Applied Energetics. The court did not decide whether the allegations would ultimately be proven.

The court held that Applied Energetics adequately pleaded legal malpractice. It found that the company alleged an attorney-client relationship, attorney negligence, a plausible connection between the alleged negligence and the company’s losses, and actual damages. The alleged conflicts included Defendants’ prior representation of Farley and their negotiation of stock compensation while the proxy contest was underway. The court also found that the allegations concerning the stock’s value and the legal expenses incurred were sufficient at this stage to plead causation and damages.

The court treated the alleged violations of Rules 1.7 and 1.8 as potential support for the negligence element of the malpractice claim, but held that those rules did not support a separate, duplicative claim for rescission and restitution or recoupment. The court therefore dismissed the second cause of action to the extent it was based on Rules 1.7 and 1.8.

The court reached a different conclusion concerning Rule 1.5, which prohibits excessive or illegal fees. Relying on the legal principle that an allegedly excessive fee agreement may support rescission and recovery of excessive fees, the court held that Applied Energetics adequately pleaded a separate claim based on Rule 1.5. Questions about the fairness and value of the stock transaction were factual issues that could not be resolved on a motion to dismiss.

Disposition

Judge Debra Freeman granted in part and denied in part Defendants’ motion to dismiss. The motion was denied as to Applied Energetics’ first cause of action for legal malpractice. It was granted as to the second cause of action to the extent that it was based on alleged violations of Rules 1.7 and 1.8. It was denied as to the second cause of action to the extent that it was based on an alleged violation of Rule 1.5.