ITT Small Business Finance Corp. v. Niles

• Decision Date: 28 December 1994
• Docket Number: No. S036386,S036386
• Citation: 885 P.2d 965,36 Cal.Rptr.2d 552,9 Cal.4th 245
• Court: California Supreme Court
• Parties: , 885 P.2d 965 ITT SMALL BUSINESS FINANCE CORPORATION, Plaintiff and Appellant, v. Edward I. NILES, Defendant and Respondent.

Page 552

36 Cal.Rptr.2d 552

9 Cal.4th 245, 885 P.2d 965

ITT SMALL BUSINESS FINANCE CORPORATION, Plaintiff and Appellant, v. Edward I. NILES, Defendant and Respondent.

No. S036386.

Supreme Court of California In Bank.

Dec. 28, 1994.

Carrick & Dale, George D. Dale, Donald J. Aberbook, David T. Hayek, LeBouef, Lamb Greene & MacRae, John W. Cotton and Vincent J. Davitt, Los Angeles, for plaintiff and appellant.

Brandon & Rhin, Dennis W. Rhin, David L. Brandon, Meyers, Bianchi & McConnell and Martin E. Pulverman, Los Angeles, for defendant and respondent.

LUCAS, Chief Justice.

This is a professional negligence action brought against an attorney, defendant Edward I. Niles, based on Niles's alleged failure to exercise reasonable care in preparation of loan documents for plaintiff ITT Small Business Finance Corporation (hereafter ITT). Although Niles prevailed on summary judgment after the trial court concluded that the action was time-barred, ITT persuaded the Court of Appeal to reinstate its cause of action. We now consider the narrow issue whether ITT suffered "actual injury" under the one-year statute of limitations for attorney malpractice actions (Code Civ.Proc., § 340.6; all statutory references are to the Code of Civil Procedure unless otherwise indicated) when ITT (i) incurred legal fees defending a third party action that disputed the adequacy of the loan documents, or (ii) received substantially less in settlement from its debtor than ITT contemplated under its security agreement. Section 340.6 provides that legal malpractice actions shall commence running when the client discovers or should have discovered the facts constituting the malpractice, but the statute is tolled under section 340.6, subdivision (a)(1), during the time, inter alia, the client "has not sustained actual injury." Applying section 340.6 to the facts of this case, we conclude ITT's action was timely filed. We therefore affirm the judgment of the Court of Appeal.

FACTS

In December 1984, ITT retained Niles to prepare a promissory note and certain loan documents in connection with the closing of ITT's $200,000 loan to California Solution, Inc. (hereafter debtor), not a party to this action. The documents granted ITT a first security interest in machinery, equipment, furniture, fixtures, inventory, accounts receivable, and leasehold improvements in exchange for a $200,000 loan to debtor. In addition, the agreement granted ITT second liens on three pieces of real property and a pledge of certain stock as collateral securing the guaranty.

On February 16, 1988, debtor filed for bankruptcy. On February 14, 1990, debtor filed an adversary proceeding (in effect to avoid ITT's lien on its property) against ITT in United States Bankruptcy Court to contest inadequacies in the loan documents prepared by Niles on ITT's behalf. ITT retained independent counsel to represent it and defended the adequacy of the loan documentation during the adversary proceeding, claiming it was sufficient to protect debtor's interests. At the same time ITT was defending the documentation in the adversary proceeding, it informed Niles that it expected him to indemnify ITT for any losses suffered due to negligent preparation of the loan documents. ITT also advised Niles to contact his malpractice insurer.

On January 28, 1992, almost two years after commencement of the adversary proceeding, ITT entered into a settlement with debtor under which it accepted an amount less than the full value of its security. On March 16, 1992, over two years after the commencement of the adversary proceeding, but only two months after signing the settlement agreement, ITT filed its claim of professional On May 5, 1992, Niles filed a demurrer to ITT's complaint on the ground that the malpractice claim was time-barred under section 340.6, because it was filed over two years after ITT discovered the alleged substandard nature of the loan documents and incurred legal fees defending those documents in the adversary proceeding. The demurrer was overruled, but two months later the trial court granted Niles's motion for summary judgment under section 340.6.

[885 P.2d 967] negligence against Niles, asserting that it was compelled to enter into the settlement agreement with debtor for an amount less than the value of its security because Niles had negligently prepared the loan documents.

The Court of Appeal reversed summary judgment in favor of Niles after concluding that the statute of limitations in "transactional malpractice" cases must commence on settlement or trial court judgment of the third party action involving the documents. We granted review to resolve a perceived conflict over the statute of limitations issue, and our review of cases interpreting section 340.6 leads us to affirm the Court of Appeal judgment.

DISCUSSION

1. Section 340.6

Section 340.6 provides in pertinent part that "An action against an attorney for a wrongful act or omission, other than for actual fraud, arising in the performance of professional services shall be commenced within one year after the plaintiff discovers, or through the use of reasonable diligence should have discovered, the facts constituting the wrongful act or omission, or four years from the date of the wrongful act or omission, whichever occurs first." (§ 340.6, subd. (a); hereafter section 340.6(a).) There are four exceptions that toll the limitations period, including a provision tolling the statute while "[t]he plaintiff has not sustained actual injury." (§ 340.6, subd. (a)(1); hereafter section 340.6(a)(1).) That provision is the focus of this appeal.

Under section 340.6, a malpractice action accrues once a former client "discovers" the malpractice, and is tolled until the client suffers "actual injury" from the malpractice. There must be a nexus between the discovery and the harm, and without both elements the filing of the malpractice action is premature. Thus, discovery of the facts essential to the malpractice claim and the suffering of actual harm from the malpractice establish a cause of action and begin the running of the statute of limitations. (§ 340.6(a)(1).)

Recently, in Laird v. Blacker (1992) 2 Cal.4th 606, 611, 7 Cal.Rptr.2d 550, 828 P.2d 691 (hereafter Laird ), we addressed the issue whether the statute of limitations of section 340.6 is tolled during the time a legal malpractice plaintiff appeals from the underlying judgment on which the malpractice claim is based, or instead commences on entry of the adverse judgment or final order of dismissal. (Laird, supra, 2 Cal.4th at p. 615, 7 Cal.Rptr.2d 550, 828 P.2d 691.) We concluded that because the focus of a legal malpractice action involving negligence that occurs in the handling of a client's litigation is the attorney's conduct in the underlying case, the statute of limitations should commence "on entry of adverse judgment or final order." (Ibid.) In so holding, we recognized that "success on appeal or proof of the total amount of monetary damages suffered by the former client ... does not negate an action for legal malpractice." (Id., at p. 614, 7 Cal.Rptr.2d 550, 828 P.2d 691.) We emphasized in Laird that the focus of the limitations period is on the fact of damage or actual harm giving rise to a cause of action in negligence, not the amount of damage, and disapproved language from earlier cases implying that actual harm may always occur at the point the client initially suffers monetary damage, including attorney fees, as a result of the negligence. (Id., at p. 612, 7 Cal.Rptr.2d 550, 828 P.2d 691 [warning litigants against literal interpretation of similar language in Budd v. Nixen (1971) 6 Cal.3d 195, 200-201, 98 Cal.Rptr. 849, 491 P.2d 433].) We also disapproved cases that held "actual injury" did not occur until the negligent attorney's error became "irremediable," noting that the irremediable damage rule had been rejected by the Legislature when it adopted section 340.6. (Laird, supra, 2 Cal.4th at p. 617, 7 Cal.Rptr.2d 550, 828 P.2d 691.)

Since Laird, several Courts of Appeal have struggled with the question of when "actual injury" occurs under section 340.6(a)(1) in cases involving "transactional malpractice," or malpractice that is based on the negligent preparation of documents that causes the client harm. This is an issue separate from that addressed in Laird, but one subject to analogous reasoning. Unlike the Laird plaintiff, who sought to toll the statute of limitations during the pendency of an appeal of an adverse judgment caused by her former attorney's negligent representation, the plaintiff here seeks to toll the statute of limitations while the adequacy of the documents that formed the basis of the transaction is initially litigated. In other words, plaintiff is claiming that actual injury does not occur until judgment or settlement of the transactional litigation.

In reversing summary judgment in favor of Niles, the Court of Appeal concluded ITT did not suffer "actual injury" until January 28, 1992, when it was forced to accept an adverse settlement with debtor at the trial court level in the adversary proceedings. Although ITT incurred attorney fees in defending the loan documentation, the nexus between the discovery of malpractice and "actual injury" that is required before a cause of action for legal malpractice will accrue did not occur until settlement of the adversary proceeding. Had ITT prevailed in the adversary proceeding, it would have suffered no "actual injury" from the initial attorney's preparation of the loan documents, just as the plaintiff in Laird suffered no "actual injury" until the moment the trial court dismissed her complaint. Guided by these principles, the Court of Appeal concluded that the statute of limitations under section 340.6 commenced on final settlement of the adversary proceeding.

2. Actual Injury

Niles contends that the better rule in transactional malpractice cases is stated in several Court...