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Delaware Supreme Court Weighs In on Discovery Rule And Dismisses Case

The issue that arises often in litigation is: when was the plaintiff put on notice that the lawyer may have breached the duty of care? The answer to this question often determines whether or not the statute of limitations bars a claim. A case decided by the Delaware Supreme Court earlier this year captioned, ISN Software v. Richards, Layton & Finger 226 A.3d 727 (Del. Supreme Court), offers a thoughtful discussion of that very issue.

ISN Software wished to convert to an S Corporation. However, four of its shareholders could not legally be shareholders of an S Corporation. Thus, the question was how can we remove these shareholders from our company? The law firm allegedly advised ISN to use a merger to cash out the four shareholders. The way it typically works is that the company offers the shareholder a cash payment. If the shareholder accepts the cash offer, that is the end of the matter. If the shareholder elects appraisal, there is a court case where a judge decides the value of the shares. In this transaction, all four shareholders were eligible for appraisal rights. The law firm told the client in 2013 that its legal advice on who was eligible for appraisal was incorrect.

The company proceeded to litigate the value of the shares. When the court made its decision, the value was substantially higher than ISN thought it would be. ISN then sued the law firm for malpractice. The Delaware courts held the the case was time-barred because the cause of action accrued in 2013 (when the firm told the client that the advice it had given was incorrect) not 2018 when the unfavorable litigation ruling occurred.

The reasoning:

RLF moved to stay discovery and to dismiss ISN’s complaint on statute of limitations grounds. The Superior Court granted RLF’s motion to stay and later its motion to dismiss.[10] According to the court, to decide when the action accrued for statute of limitations purposes, the “test is when the malpractice was discernable by a reasonably diligent plaintiff.”[11] The court found that ISN had actual notice of the disputed advice and its erroneous nature on January 15, 2013. By that date, ISN knew, or should have known, “of the potential for financial loss if the appraisal action resulted in a share valuation that would exceed” its cash reserves.[12] As a result, the cause of action accrued on the date that RLF informed ISN of the alleged negligent advice or, alternatively, when the appraisal action was filed in April 2013. Thus, the claim expired under the statute of limitations no later than April 2016. Because ISN did not file a malpractice suit until August 2018, the Superior Court dismissed the suit.

Under 10 Del. C. § 8106(a), a legal malpractice claim must be filed within “3 years from the accruing of the cause of such action.” The parties dispute when ISN’s cause of action accrued. According to ISN, its legal malpractice claim did not accrue until after it suffered damages when this Court affirmed the Court of Chancery’s appraisal award.

A cause of action “accrues” for statute of limitations purposes based on distinct triggering events. Some states accrue a cause of action when damages have been suffered or are ascertainable.[18] Other states accrue a cause of action at the time of loss.[19] Delaware, by contrast, declined to adopt these or other alternatives.[20]Instead, Delaware is an “occurrence rule” jurisdiction, meaning a cause of action accrues “at the time of the wrongful act, even if the plaintiff is ignorant of the cause of action.”[21] In Delaware, for contract claims, the wrongful act occurs at the time a contract is breached. For tort claims, like the legal malpractice claim here, the wrongful act occurs at the time of injury.[22] 733*733 Stated another way, “[a] cause of action in tort accrues at the moment when `an injury, although slight, is sustained in consequence of the wrongful act of another.'”[23]

Because of the harshness of the occurrence rule when a plaintiff is ignorant of the malpractice, this Court has applied a limited “time of discovery” exception to toll the time of accrual. “Under the `discovery rule’ the statute is tolled when the injury is `inherently unknowable and the claimant is blamelessly ignorant of the wrongful act and the injury complained of.'”[24] Otherwise, “[i]gnorance of the cause of action will not toll the statute[] absent concealment or fraud.”[25] Outside these exceptions, the statute of limitations continues to run even if the claimant is unaware of the facts supporting a cause of action.[26]

Turning to the facts alleged in ISN’s complaint, the circumstances surrounding the alleged faulty advice appear undisputed. RLF advised ISN that it could complete a cash-out merger of less than all of the non-qualifying stockholders, and the stockholder(s) left behind would not have appraisal rights. ISN completed the merger on January 9, 2013 to cash-out only three of the four non-qualifying stockholders. On January 15, 2013, RLF notified ISN that its advice could have been faulty. All of the non-qualifying stockholders were entitled to demand appraisal. Three of the four stockholders, including the stockholder ISN wanted to exclude, demanded appraisal. Thus, the question is when ISN suffered injury, no matter how slight, when RLF gave the alleged faulty advice.

We find that the injury occurred to ISN when the fourth stockholder—the largest of the group—obtained the right to demand appraisal. The transaction as intended contemplated cashing out three stockholders who owned a total of 356 shares, and excluding a fourth who owned 544 shares and would not have appraisal rights. Because of RLF’s alleged faulty advice, ISN ended up allowing the fourth stockholder to demand appraisal, meaning ISN could be liable to pay fair value for 544 more shares of stock than contemplated 734*734 by the intended transaction.[27]And, when stockholders B, C, and D filed for appraisal, ISN knew that the Court of Chancery would award the fair value of 745 shares of ISN stock—far more than the 356 shares at risk of appraisal by the intended transaction. Thus, under any circumstances, ISN was liable to pay the fair value of more stock than planned, which injured ISN financially.

The opinion essentially requires the client to sue the lawyer long before any actual damages are sustained from the allegedly incorrect advice. This ruling prompted a strong dissent from Justice Vaughan:

I would find that the statute of limitations begins to run when the plaintiff sustains an injury for which the law affords a remedy. More specifically, I would find as follows:

A tort claim accrues for limitations purposes when it becomes enforceable, that is, when all elements of the tort can be truthfully alleged in a complaint, and accordingly, when damage is an essential element of a tort, the claim does not accrue at the time of the defendant’s wrongful act or the plaintiff’s discovery of the injury, but when the harm is sustained.[13]The above-quoted text is subject to the qualification endorsed in Kaufman that “it 740*740 is not required that all the damages resulting from the act shall have been sustained at that time, and the running of the statute is not postponed by the fact that the actual or substantial damages do not occur until a later date.”[14]

This case has not followed a straight path. As mentioned, the question upon which the appeal is being decided—when did ISN sustain injury—was not addressed by the Superior Court. The questions presented as framed by the parties in their briefs bear little resemblance to the question the Majority now answers. It appears that RLF may not have believed in 2013 that a cause of action against it accrued when the fourth stockholder obtained the right to demand appraisal. In its February 14, 2013 letter, RLF represented to its client that ISN had only “potential causes of action” against the law firm.[15] To ensure the parties have been fully and fairly heard on the question which has emerged during this appeal—when was ISN injured —I would reverse the judgment of the Superior Court for the error which I discuss above and remand the case for further proceedings in that court, including proceedings to determine when ISN sustained an injury for which the law afforded a remedy.

Comment: this is a very important issue in the legal malpractice jurisprudence. There are often several possible answers to the question: When did the claim accrue?  Plaintiffs often fail to do this analysis until it is too late.

Ed Clinton, Jr.

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