06 October 2022, by by Randy Emanuel Dias, Officer, Bar Council Professional Indemnity Insurance and Risk Management Department
Lawyers may often find themselves in a position of trust with their clients, for example when the lawyer acts as a stakeholder-solicitor or as an escrow agent for an agreement between two or more parties. They will find themselves carrying out fiduciary obligations and stakeholder duties, which may lead to some unwanted complications if they are not careful. This article discusses several claim examples involving breaches of stakeholder duty recently notified to the Malaysian Bar Professional Indemnity Insurance (“PII”) Scheme and provides guidance on how such pitfalls may be avoided.
To begin: what does being a fiduciary mean?
A case from 2015 has stated that to be a fiduciary, a person must “first and foremost have bound himself in some way to protect and/or to advance the interest of another.… There must have been some undertaking on the part of the fiduciary to act with loyalty in the interest of the other party.… A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence”.
Next: when does a lawyer owe a fiduciary duty to any party in a given transaction?
Pursuant to case law, it is clear that the test for this is: what would the reasonably competent lawyer do with regard to the standards that are normally adopted in his/her profession? This duty is directly related to the confines of the lawyer’s retainer.
From this, we can see that a fiduciary relationship is clearly formed where there is a solicitor-client relationship, and that the extent of the duties arising from this relationship is guided by both the lawyer’s retainer and the standards of a reasonably competent lawyer.
Thirdly: what does it mean to be a stakeholder?
A case in 2013 stated that: “In our system of conveyancing, the word ‘stake’ is in common parlance used to apply to any money to be disposed of in accordance with what may happen in the future and whoever is in possession of the money is often described as a stakeholder. The manner in which the money is to be disposed of depends on the terms on which it is held.”
The scope of duties and obligations of the stakeholder-solicitor over the money or documents or assets greatly depends on the intent and purpose of being the stakeholder. As the case above makes clear, the manner in which these stake funds are to be dealt with will depend on a predetermined event happening during the transaction at a specified time in the future.
By becoming a stakeholder, the solicitor’s duty is now no longer just to their client. The solicitor now owes the counterparty and/or their solicitors to the contract or the stakeholding obligation, an independent duty or obligation to abide by and discharge that stakeholding function faithfully, even if it’s against their own client’s instructions.
Now, let’s move on to the following selected case studies to observe how problems can occur when a lawyer is acting in a position of trust and the various legal relationships a lawyer may find themselves entangled in when holding funds on trust, either as a stakeholder or as an escrow agent.
Names have been changed to maintain confidentiality.
Case Study #1:
Here, a law firm representing Donald, a seller of goods had received the full purchase price of goods from the buyer, Goofy in their client’s account. Unbeknown to Goofy, the law firm then received instructions from Donald to release a substantial amount of the funds to a supplier, various unknown consultants, and Donald himself. A week later, Donald attempted to instruct the same again for the remainder of the funds but the law firm informed Donald that the funds were insufficient as the law firm had taken their stakeholder’s fees. Donald then disbursed a significant portion of the remainder of the funds to the consultants.
The law firm were unaware of Donald’s non-delivery and was informed by Donald that the delivery was completed.
However, Donald later told the law firm to inform Goofy that there was a delay in the delivery due to a force majeure in the distributor’s premises. Due to the ensuing disputes, the law firm informed Donald that they were discharging themselves as the stakeholder for the sale and purchase agreement and that they would return the purchase price deposit in their possession back to Goofy.
Goofy claimed that the law firm had breached their fiduciary duty and the terms of their stakeholder’s duty by failing to refund the full purchase price. |
Case Study #2:
A law firm was appointed as an escrow agent for a buyer. In the law firm’s engagement letter, it was stated that the amount to be received, retained, and released by the law firm would be the total purchase price in United States Dollars. This was also reflected in the draft escrow agreement prepared by the law firm. However, upon being placed in the law firm’s client’s account, the currency was converted to Malaysian Ringgit. The law firm did not inform the buyer of the change.
Negotiations between the buyer and their intended supplier broke down and hence the sale did not go through. This led to the buyer requesting a refund of their money. The law firm converted the currency back to United States Dollars and returned it to the buyer. However, there was a shortfall due to the depreciation of the Malaysian Ringgit and the conversion fee. Unsatisfied with this explanation, the buyer demanded the remainder of the total purchase price and now claims that the law firm was in breach of trust. |
Case Study #3:
In this case study, Ted & Co was acting for the seller, who had entered into a sale and supply agreement with the buyer, Robin.
Robin had deposited an advanced payment with Ted & Co, who were the stakeholders as per the sale and supply agreement. Robin then instructed Ted & Co to release those funds to facilitate the delivery of the goods, but this was not in accordance with the clauses stated in the sale and supply agreement. These instructions were confirmed by Robin’s lawyers.
The seller then instructed Ted & Co to release the funds to Lily & Partners, a third-party firm acting for Marshall, a client who had previous engagement with the seller for the purchase of similar goods.
Ted & Co followed those instructions without informing Robin.
Note that Ted & Co’s undertaking as a stakeholder in the sale and supply agreement expressly states that the money shall only be authorised to be released to the seller.
The seller failed to deliver and defaulted in the sale and supply agreement. Their director also had disappeared.
Robin demanded a refund from Ted & Co for the advanced payment that was deposited with them but was told that it was released as per Robin’s instructions.
Eventually, Robin discovered that the advanced payment was released to Lily & Partners — a breach of Ted & Co’s stakeholder undertaking. He also found out that the seller wound up eight months prior to the sale and supply agreement and its director had been declared bankrupt two months after the sale and supply agreement. Robin claims that Ted & Co had no capacity to act for the seller, which had no capacity to enter the sale and supply agreement. |
The case examples above are a few of many claims involving breach of stakeholder duty reported to the PII Scheme. The lawyers in the selected case files, sometimes by some form of negligence or through no egregious fault of their own, found themselves facing legal challenges, and on top of that, were sued for one or more of the following reasons:
- Breach of trust;
- Gross negligence;
- Professional negligence;
- Breach of sale and purchase agreement or escrow agreement;
- Breach of contract;
- Misrepresentation;
- Cheating;
- Fraud;
- Unjust enrichment; and
- Conspiracy to defraud or harm.
This list is by no means exhaustive.
The real question, and truly the crux of this article, is what could they have done to avoid being put in the position to be sued? Lawyers and firms may consider the following measures to mitigate the risk of acting in breach of trust when discharging their stakeholder duties:
(1) Read the escrow agreement or sale and purchase agreement carefully.
This seems like the first and most obvious thing you should do as a lawyer. And yet, far too many lawyers have found themselves in trouble for not adhering to the strict instructions provided in the agreement. It may be easy to overlook precise details such as when exactly to release the stakeholder funds, whose instructions are needed in order to release those funds, and the purposes for those funds to be released. However, these are details that must not be missed because failed business transactions, funds that are not accounted for, and failure to strictly follow these terms in an agreement can lead to the lawyers being held liable in court. To avoid errors, do not rely on memory. Always refer and rely on the terms of stakeholding prior to any release.
Furthermore, a failure to identify and demarcate exactly what obligations the solicitor has inadvertently assumed can lead to unnecessary risks and issues. In many cases, clarity in drafting such an obligation could have resolved such ambiguity. Better yet, don’t assume such stakeholder obligations unless they are absolutely necessary. When it is necessary, then state the stakeholder obligations explicitly and clearly.
(2) Ensure both parties are aware of the status of the stakeholder funds.
As evidenced in the case studies above, there are instances where one party — often the seller or supplier — will give instructions regarding the stakeholder funds held by the lawyer while the other party (who is likely the buyer who placed those funds with the lawyer) is unaware of such instructions. Here we enter dangerous territory and in order to be careful, lawyers are advised to do these two things. Firstly, ensure that the instructions that deal with the stakeholder funds are in line with the terms of the agreement. Failure to do so would spell trouble. The second is the lawyers must ensure that everyone involved in the sale and purchase agreement knows what is going on – and have it in writing. This can easily be done by including a clause in the agreement that states that any movement with regard to the funds require the consent of both parties and to ensure that all parties are informed (and acknowledge the information) when disbursing stakeholder funds. In the event of any disagreement or dispute, the assistance of the court may be obtained through an interpleader application that can be filed at the courts.
(3) Be wary of suspicious clients / parties.
Care must be taken when dealing with all clients and parties involved. At the end of the day, not all parties are friends or can be treated as such. Some may be opportunists or even enter into contracts with malicious intent. Lawyers are advised to always be cautious with their clients, regardless of how familiar they are with them. This is even more imperative when clients start acting suspiciously.
Based on claims reported to the PII Scheme, here are some red flags which should prompt lawyers to act more diligently in transactions undertaken:
- Clients demanding an unreasonably high amount of deposit when the other party is in urgent need of the supply of goods;
- Clients committing to supplying goods to multiple buyers and failing to deliver on each agreement;
- Clients giving instructions to immediately release the funds to be paid to unknown persons; and
- Clients lying about delivering the goods.
(4) Conduct basic due diligence.
A couple of notable examples from the case files reviewed were:
- the lawyer failed to conduct a background check of the company with SSM;
- the lawyer failed to obtain the resolution from the company on its appointment to represent the company, and its scope of work;
- the lawyer failed to ensure that the bank guarantee they received a month late under highly suspicious circumstances was one that was valid and capable of being honoured; and
- the lawyer failed to do a simple winding-up check and in the end, acted for a company in a sale and supply agreement that had wound up several months before the date of the agreement.
Lawyers — whether junior or senior — should not take these matters for granted.
(5) Clarify the terms of the agreement.
In Case Study #2, the law firm had failed to inquire about the terms of the escrow agreement and why the escrow sum was transmitted to them. They relied on the fact that there was no draft sale and purchase agreement given and that there was no escrow agreement finalised. Doing so had cost them dearly. The lawyers should have clarified with the buyer before accepting the offer. If they had done so, then they would have known definitively to hold the money in United States Dollars.
(6) Do not mishandle funds for your own purposes.
In Case Study #1, part of the argument that the firm had breached their fiduciary duty was the fact that they withdrew their stakeholder fees from the stakeholder sum without express consent and not in accordance with the sale and purchase agreement. It was not disclosed why this had happened, but this conduct clearly did not meet the standards of a reasonably competent lawyer.
To sum up, the foundation of solicitor-client relationships is built on trust and confidence. Solicitors are often fiduciaries to their clients and must discharge their duties in good faith. When acting as stakeholder for two or more parties, a solicitor is entrusted to act strictly in accordance to the stakeholder terms at all times. A breach of stakeholder duty is a breach of trust and a prima facie act of professional misconduct.
Strict adherence to stakeholding terms may sound simple enough in theory, but not always in practice. These guidelines too may seem rather simple on the surface, but they may be invaluable to practising lawyers, who should bear them in mind whenever entering into stakeholder obligations.
A little extra precaution never hurt anyone.