In a case entitled Wo Yee Hing et al. v. Howard Stern, New York State Appellate Division, First Department, Index No. 115517/07 (7/31/12), the First Department recently determined in a 4-1 ruling that a real estate attorney might have acted negligently, but he cannot be sued for legal malpractice because his clients could not prove that his actions proximately caused their losses.
The First Department did note that there was “strong evidence” that attorney Howard Stern acted negligently when he assisted plaintiff to sell a building as part of an arrangement to defer capital gains taxes in a section 1031 exchange when he had zero experience handling such transactions. However, plaintiff was unable to prove that it would have been able to complete the transaction and defer the capital gains taxes had attorney Stern performed his services competently.
Repeating the critical standard for finding legal malpractice, the court noted that “To prevail on its claim of legal malpractice, plaintiff must prove not only that defendant was negligent, but also that defendant’s negligence was a proximate cause of its losses.”
The case arose six years ago when a corporation owned by three brothers retained attorney Howard Stern to represent it in the sale of a residential and commercial building in Manhattan. The sale was part of a 1031 exchange, named after the section in the Internal Revenue Code that permits deferring capital gains taxes on the sale of buildings under certain circumstances. The circumstances include selling commercial or investment property and replacing it with a similar property within 45 days and then taking possession of that replacement property within 180 days. The exchange must be done through a “qualified intermediary”, i.e., a third party.
According to plaintiff, Stern held himself out as someone who knew how to perform a 1031 exchange. Stern, however, claims that he repeatedly told plaintiff that he was unfamiliar with such transactions and the plaintiff assured him that they would handle the details.
In any event, according to the court, Stern acted negligently in undertaking the preparation of the sales contract since he was, admittedly, not qualified to handle a 1031 exchange. Stern mistakenly had the check for the sale proceeds made out to plaintiff instead of to the qualified intermediary as required by section 1031 of the Internal Revenue Code, hence making the transaction invalid.
Stern could not be held liable for malpractice because plaintiff was unable to prove that it could have completed the 1031 exchange for a replacement property even if Stern had done the work properly. In other words, Stern’s negligence was not the proximate cause of plaintiff’s losses. Specifically, plaintiff failed to prove that it had identified any replacement property that it was capable of buying within the statutorily-required time frame. It also failed to prove that it could have closed on the new property within the requisite 180 day period.
The dissent strenuously objected to the majority’s reasoning, noting that plaintiff had no incentive to locate a replacement property once they learned at the closing on the sale of the original property that the 1031 exchange was invalidated because of Stern’s mistake regarding the check for the proceeds.