2nd Circuit Affirms Dismissal of Negligence Claim Agst Consultant

We have previously discussed Ridge Seneca Plaza, LLC v. BP Prods. North America, No. 6:06-cv-06333 (W.D.N.Y. 3/28/11) where the federal district case from the western district of New York ruled that a purchaser could not bring a malpractice claim against a consultant who had been retained by a bank. . We picked this case because it illustrated the importance of purchasers/borrowers doing their own independent due diligence and not simply relying on approval of phase 1 reports by prior lenders. Recently, the Court of Appeals for the Second Circuit affirmed the dismissal of the malpractice case against the consultant.  Ridge Seneca Plaza, LLC v. BP Prods. North America, 2013 U.S. App. LEXIS 21999 (2nd Cir. 10/29/13).

In this case, a 2000 phase 1 report prepared for a potential purchaser concluded that a closed spill on the NYSDEC spills database was not a Recognized Environmental Condition (REC). As I turned out, the phase 1 did not identify a second spill had been reported in 1999 when the underground storage tanks at the gas station were removed. The consultant also failed to identify a former dry cleaner at shopping center because the consultant had used a wrong address.

The purchaser subsequently assigned its rights to the plaintiff who was an affiliated entity. The plaintiff closed on the shopping center in 2001 with a loan from a local bank. In October 2002, plaintiff requested a phase 1 update from the consultant in connection with a loan refinance and obtained another updated phase 1 in January 2003. Both of these updated reports did not mention the former dry cleaner or the active second spill.

In 2004, the plaintiff’s principals decided to refinance so they could take some equity out of the property. However, the new lender was not comfortable with the proximity of the gas station and required a phase 2. The plaintiff’s principal (who also happened to be the principal of the assignor or originally contracting party) discussed the lender’s request 2 with the original consultant who thought a phase 2 could “open a can of worms”.  The plaintiff decided to authorize the phase 2 and the investigation discovered floating petroleum product on a portion of the site near the gas station along with PCE contamination from the former dry cleaner. The bank declined to proceed with the refinancing and the plaintiff brought a lawsuit against the seller and the consultant.

To prevail on a claim for negligent misrepresentation, a plaintiff must show that there was either actual privity of contract between the parties or a relationship so close as to approach that of privity. Since the plaintiff had not been formed when the 2000 phase 1, the Second Circuit said plaintiff had to show it had a relationship with the consultant that approached privity by showing: (1) an awareness by the maker of the statement that it is to be used for a particular purpose; (2) reliance by a known party on the statement in furtherance of that purpose; and (3) some conduct by the maker of the statement linking it to the relying party and evincing its understanding of that  reliance. Since the plaintiff was not formed until 2001, the court found the plaintiff was not a “known party.” Therefore, plaintiff’s claims involving the 2000 phase 1 were properly dismissed.

The plaintiff’s amended complaint in 2008 claimed that the consultant had committed malpractice when it prepared the phase 1 update and when it advised plaintiff’s principal in the 2004 telephone conferences. Specifically, plaintiff alleged that the consultant had failed identify the possibility of petroleum or PCE contamination from the former the dry cleaner as RECs and failed to detect contamination or further investigation that would have detected contamination.

Defendant argued the amended complaint had been filed after the three-year statute of limitations (SOL) and should be dismissed. The plaintiff responded that the claims had not expired because they related back to the 2006 original complaint, the SOL had been was tolled or suspended by the NY discovery rule or remained viable under the continuous representation doctrine.

On the “relation back” doctrine, the district court had found that while the original and amended complaints both involved discovery of contamination during the Phase 2 investigation, the amended complaint did more than simply clarify the claims against the consultant. Instead, the court said the amended complaint added new transactions not alleged in the original complaint (e.g., the updated phase 1 reports and the 2004 telephone calls) even though those events had occurred prior to the original complaint. Moreover, the new transactions were alleged to allow plaintiff to achieve privity of contract with the consultant and proceed with its professional malpractice claim. Because the claims in the amended complaint did not arise out of the conduct alleged in the original complaint, the district court ruled the relation back doctrine did not apply.

The plaintiff asserted the discovery rule applied because it had not learned of the contamination until 2004. Therefore, its 2006 complaint had been timely filed. However, the court held that since the “relation back” doctrine did not apply, the plaintiff would have had to amend its complaint to add the new transactions within three years  after it learned of the contamination. Since the amended complaint was filed in 2008, the discovery rule could not preserve plaintiff’s claims.

Finally, the court ruled that the continuous representation theory because plaintiff did not have an actionable relationship with the consultant until 2002 when the Phase I report was updated.  Even assuming that the 2004 telephone conversations between the consultant and the plaintiff’s principal constituted actionable professional advice and was part of a continuing and uninterrupted professional relationship that began with the Phase I update, the SOL would have expired in 2007.

The appeals court found the trial court had properly ruled that the phase 1 updates and the 2004 phone conferences were separate transactions that did not arise out of the conduct alleged in the original complaint. Accordingly, the court affirmed the dismissal of the amended complaint for being filed after the expiration of the SOL.

On the surface, this decision seems to be a straight-forward instance of a different entity having hired the consultant and therefore seems rightly decided. However, the complicating factor is that the original assignor entity was owned by the same principal as the plaintiff in this case. In other words, the person who interacted with the consultant for each of the phase 1 assignments was the same person. From the perspective of the consultant, the “client” was the same person. However, the entity that hired the consultant was different. Some might suggest that the decisions in the case were form over substance that allowed a consultant avoid liability for its error.

In any event, an important lesson from this case for those with multiple LLC entities that are retaining consultants is to make sure you have the correct entity name on the contract with the consultant. Alternatively, the client should have the consultant extend reliance to that entity. And make sure your lawyer reviews the standard terms and conditions that are often attached to the engagement letter from the consultant for the reasons we have discussed in other posts.