Folly Farms I, Inc. v. Trustees of the Clients' Security Trust Fund of the Bar

Smith, J., delivered the opinion of the Court. In the second trip of this controversy to this Court we are obliged to determine whether claimants, Folly Farms I, Inc. et al. (Folly Farms or the claimants), are entitled to reimbursement from the Clients’ Security Trust Fund of the Bar of Maryland. 1 We shall consider whether the defalcation arose from an attorney-client relationship and whether the claimants were guilty of negligence. If the claim did not arise from such a relationship, or if the claimants were negligent, their claim for reimbursement by the Trustees of the Clients’ Security Trust Fund (the trustees) must be denied. We shall hold that the trustees erred when they declined to approve the claim. 1.

Background The concept of a fund established by the legal profession to reimburse clients in the few cases in which attorneys betray their trust and misappropriate funds began in New Zealand, and then spread to other English-speaking countries. 2 Reginald Heber Smith, The Client’s Security Fund: “A Debt of Honor Owed by the Profession, ”44 A.B.A. J. 125, 127 (1958), and Time, Sept. 16, 1966 at 69. Mr. Smith said, “Among the English-speaking and among the common law countries of the world, the United States is the laggard.” ⁶⁶² A.B.A. J. at 127 (Italics removed.) In Maryland a voluntary plan was established by the Bar Association of Baltimore City, followed by one set up by the Montgomery County Bar Association. After spirited debate the Maryland State Bar Association approved a proposal in July 1964 which would have requested the General Assembly to enact a bill establishing such a fund. See 69 Trans.

Md. St. B. A. 209-34 and 365-71 (1964). Thereafter, a revised plan was submitted to the State Bar in January 1965 and unanimously approved. See 70 Trans. Md. St. B. A. 9-16, 339-42 (1965).

It called for a legislative enactment authorizing this Court to promulgate rules and regulations for the creation and operation of such a fund. Subsequently, the General Assembly enacted Chapter 779 of the Acts of 1965, which became Md. Code (1957,1976 Repl. Vol.) Art. 10, § 43. Under it this Court may require payment of a sum not to exceed $20 per year as a condition precedent to the practice of law.

The general purpose of the fund, as set forth in the statute, is “for ... maintaining the integrity and protecting the good name of the legal profession by reimbursing, to the extent deemed proper and reasonable by the trustees, losses caused by defalcations of members of the bar of the State of Maryland, acting either as attorneys or as fiduciaries (except to the extent to which they are bonded)....” On March 28,1966, this Court adopted what is now Maryland Rule 1228. This was followed immediately by the appointment of trustees. The fund became fully operative on July 1, 1966, when the trustees began to collect assessments. The annual assessment for lawyers admitted to practice five or more years prior to the beginning of the fiscal year was initially set at $15.

This has since been reduced to $10. Under Rule 1228 i, “[t]he trustees are invested with the power to determine whether a claim merits reimbursement from the trust fund____” No claimant has any right in the trust fund as beneficiary or otherwise. In exercising their discretion, the trustees are to consider a number of factors, including the amounts available and likely to become available to the trust fund for payment of claims, the size and number of claims likely to be presented, the total amount of ⁶⁶³ losses caused by defalcations of any one attorney, the unreimbursed amounts of claims recognized by the trustees in the past as meriting reimbursement but for which reimbursement has not been made in the total amount of the loss sustained, the amount of the claimant’s loss as compared with the amount of the losses sustained by others who may merit reimbursement from the trust fund, the degree of hardship the claimant has suffered by the loss, and any negligence of the claimant which may have contributed to the loss. Rule 1228 j 2 provides for judicial review.

Under this rule a claimant aggrieved by a final determination of the trustees may file exceptions with this Court within 15 days. The rule provides: “The decision of the trustees shall be deemed prima facie correct and the exceptions shall be denied unless it is shown that the decision was arbitrary or capricious, or unsupported by substantial evidence on the record considered as a whole, or was not within the authority vested in the trustees, or was made upon unlawful procedure, or was unconstitutional or otherwise illegal.” Pursuant to the authority granted to them, the trustees have adopted regulations approved by this Court concerning claims, by which they say they “will be guided, but not necessarily bound.” The first of these guidelines provides: “No claim will be recognized by the Trustees unless a fiduciary or client-attorney relationship existed with a member of the Bar of the Court of Appeals of Maryland when the loss was incurred and the said Maryland attorney defaulted.” 2. Facts of this case This case concerns the claims of four corporations, Folly Farms I, Inc.; Folly Farms II, Inc.; Folly Farms III, Inc.; and Folly Farms IV, Inc., to which we shall collectively refer as Folly Farms. Folly Farms filed a claim with the trustees on March 27, 1974, seeking reimbursement of losses caused by ⁶⁶⁴ the defalcations of William L. Jacob (Jacob). 3 The claim was denied on the ground that the evidence furnished by the claimants revealed that the proximate cause of the defalcations stemmed from Jacob’s having been made a corporate officer with the authorization to sign checks on behalf of the corporation.

The matter reached this Court in Folly Farms I, Inc. v. Trustees, 278 Md. 297 , 363 A. 2d 479 (1976). We amended Rule 1228 effective September 15, 1976, to provide for the filing of exceptions to final decisions of the trustees which denied claims. We said in Folly Farms: “In view of the amendment to the Rule during the pendency of this case, we think it appropriate in the circumstances to treat the petition filed by Folly Farms as an exception taken to the trustees’ decision and, without denying or sustaining the exceptions, to vacate the trustees’ decision and remand the matter to the trustees for further proceedings. In this connection, we note that the trustees’ decision denying the claim is not supported by any definitive factual findings relative to the application of the criteria governing the exercise of the trustees’ discretion specified in Rule 1228 i 3.

We think that the trustees, on remand, should give further consideration to the claim and state with specificity the reasons underlying their final determination.” Id. at 301 . Upon the remand the trustees took testimony and then prepared a detailed and carefully reasoned opinion denying the claims. Folly Farms owned land in Baltimore County. It was primarily concerned with the sale of undeveloped lots.

Daniel B. Brewster, Esq., a practicing lawyer, was its president and sole stockholder. His law firm usually engaged the services of Jacob to examine titles to real estate. A half-interest in Folly Farms was sold by Brewster to another individual, Colonel Drummond, to whom later reference will be made. ⁶⁶⁵ Brewster “retired” (as he put it) from the practice of law by virtue of the requirements of his duties in the Congress of the United States, first as a member of the House of Representatives and then as a United States Senator. Jacob was retained to represent the interest of the corporation at closings when lots were sold.

The other part owner’s health deteriorated, and Brewster’s time was occupied from 1969 onward by legal difficulties arising from his indictment by a Federal grand jury in the District of Columbia. Jacob was made a corporate officer and given the authority to sign checks. The trustees said, “In the normal course of transactions, Mr. Knatz [, a realtor,] would sell a lot and then notify Mr. Jacob of the sale.” Five defalcations are involved in these claims. Four stemmed from settlements concerning sales to Hoffman, Stone, Hearn, and Easter.

The trustees summarized the testimony relative to those matters: “(a) The Hoffman transaction, according to the settlement sheet furnished by the Claimants, indicated that settlement took place at No. 6 Calvert Street, Baltimore, Maryland. It appears that this address is the address of a title company. Further, that the check would have been made payable to the Corporations and not to William L. Jacob, as attorney; further, that Jacob believed his procedure, under those circumstances, would be to endorse the corporate check and put it into his escrow account. “(b) Settlement sheets submitted by the Claimants as to the Stone and Hearn settlements indicated that they were not closed by Jacob. Jacob testified that the settlement sheets were not in his handwriting, nor were the settlement sheets in the handwriting of his secretary.

Further, Jacob did not remember how the checks were made payable, although he testified that he believed they were made payable to the Corporations and endorsed by him for deposit into his escrow account. Jacob testified that he attended settlements handled by ⁶⁶⁶ outside attorneys in order to deliver the deed of the Corporations to the purchaser at settlement, and that he also looked over the documents and papers as attorney for the corporations. “(c) No settlement sheet was produced on the Easter settlement, although Jacob had testified that all his records had been delivered to Mr. Staehlin, CPA, for the Corporations.” As the trustees put it: “The fifth defalcation represented a mortgage payoff by Elwood A. Sinsky on a purchase money mortgage. In this case Mr. Jacob’s file was given to the Trustees and this file indicated that the mortgage was executed on January 16,1973, to the Corporations, with the first payment being due on April 16, 1973. “By letter dated May 9,1973, Mr. Jacob wrote Mr. Sinsky to make the April 16,1973 payment payable to ‘Folly Farms I, Inc. and Folly Farms II, Inc.’ and forward to ‘my attention’.” The trustees summarized the issues as: (1) whether Jacob was acting as an attorney or a fiduciary when the defalcations took place, (2) whether he gained access to the funds by virtue of the fact that he was a corporate officer, and (3) whether the negligence of Folly Farms was so great that it precludes recovery in the instant case. They concluded: “It is the opinion of the Trustees that William L. Jacob was able to commit the defalcations because he was a corporate officer authorized to endorse checks of the Corporations.

This authority was given to him on October 15, 1971. Before that date the Corporations did not suffer any losses while Jacob was acting as attorney for them. “Further, that four of the five defalcations arose out of settlements, not handled by William L. Jacob, but by either title companies or attorneys. No evidence was presented by the claimants which ⁶⁶⁷ would indicate that the checks from the settlements were made payable to William L. Jacob as attorney. To the contrary, the record indicates that these checks were probably made payable to the Corporations. “The Trustees recognize that in many instances such as the instant case an attorney at law may perform services as an attorney as well as a corporate officer.

They further believe that it was necessary for an officer of the Corporation to attend the settlements (as Mr. Jacob did as Vice-President) but that it was unnecessary for an attorney for the Corporation to be present. The proceeds of the sales and the Sinsky mortgage payment were net amounts with no necessity for further negotiation of the checks through Jacob’s escrow account. They should have been delivered by him as Vice-President of the Corporation to Martin J. Staehlin, Jr. for deposit and credit to the proper Corporation. The Trustees believe that William L. Jacob came into possession of the monies, which he later appropriated to his own use, by virtue of the fact that he was a corporate officer with the power to sign checks for the Corporations. “To extend the cloak of the Clients’ Security Trust Fund to cover attorneys such as William L. Jacob, who are acting in dual capacities, without making any distinction as to the proximate cause of the defalcations may very well jeopardize the future funding of the Clients’ Security Trust Fund. “The remaining point considered by the Trustees is the negligence of the officer-owners and director-owners.

Such gross negligence on the part of the claimants is clearly depicted in the testimony of Mr. Brewster and dictates that the claimants ought not to recover on the evidence presented. ⁶⁶⁸ “We deny the claim on two grounds: “1. Jacob was the Vice-President of Folly Farms and the claim ■ arose from his relationship as an officer of the Corporations, rather than from an attorney-client relationship or because he was an attorney acting in a fiduciary capacity. “2. The negligence of the President of the Corporations contributed to the loss.” The record reflects that Jacob was not compensated as an officer or director, but for services as an attorney on an hourly basis. The trustees in denying the claim quoted the following testimony of Mr. Brewster: “...

In the ’60 years Colonel Drummond’s health rapidly deteriorated and he was totally inactive at the end. In 1969 I was indicted by a Federal Grand Jury for a serious crime and thereafter was involved in legal proceedings in Federal Court for a period of some six years. “In the late -sixties Colonel Drummond was in serious health [sic]. My time and attention was totally devoted to my affairs in Washington and I did not have the time to watch over the corporate affairs, to attend settlements. It became infinitely more convenient to have Bill attend to all of these details, therefore at his suggestion we named him as an officer and a director of the corporations .... “During the year '72 and ’73, as I've said heretofore, I had no office, I was often in the hospital, and just as often it seems like in Federal Court or involved in Federal proceedings.

I was difficult, if not impossible, to get hold of. The considerations that transpired about corporate affairs would be between Jacob and Bobby.” ⁶⁶⁹ The trustees stated that the “gross negligence on the part of the claimants [was] clearly depicted in the testimony of Mr. Brewster____” They may have had reference to that which we have just quoted or they may have had in mind Mr. Brewster’s description of his discovery of the defalcations: “In February of 1974 I was personally short of liquid assets because of the dreadful drain upon my personal assets for the extensive litigation I was then involved in and I went to Robert Knatz and Martin Staehlin, my personal friends, and in this case the realtor for and the accountant for the Folly Farms corporations, to see if we couldn’t drain some money from the corporations to help me with current expenses. In reviewing the books with Martin Staehlin and Robert Knatz I immediately saw that Knatz had more lots sold than Staehlin had received funds for, there was a discrepancy. So, the minute that occurred to me, or the possibility occurred I that day went to Robert Knatz’s office in Reisterstown and told Bobby that the corporate records show monies received for these lots, how many have you sold.

There was a discrepancy. Bobby Knatz called Bill Jacob, in my presence, from his office and Bill stated to Bobby that he had personally taken the money for his own use.” Folly Farms has filed three exceptions to the holding of the trustees, (1) that it “was arbitrary and/or capricious,” (2) that it “is unsupported by substantial evidence on the record considered as a whole,” and (3) that it “is based on an erroneous conclusion of law.” 3. Standard for review As has previously been noted, under Rule 1228 j 2, the decision of the trustees is to “be deemed prima facie correct and the exceptions shall be denied unless it is shown that the decision was arbitrary or capricious, or unsupported by substantial evidence on the record considered as a whole, or ⁶⁷⁰ was not within the authority vested in the trustees, or was made upon unlawful procedure, or was unconstitutional or otherwise illegal.” The standard for review of the decision of an administrative agency, to which this review is analogous, was stated for the Court by Chief Judge Hammond in Insurance Comm'r v. Nat’l Bureau, 248 Md. 292, 309 , 236 A. 2d 282 (1967), as “whether a reasoning mind reasonably could have reached the factual conclusion the agency reached.” This has been repeated in a host of cases since then. See, e.g., Shell Oil Co. v. Supervisor, 278 Md. 659, 670 , 366 A. 2d 369 (1976); Pemberton v. Montgomery County, 275 Md. 363, 367-68 , 340 A. 2d 240 (1975); Dep’t of Nat.

Res. v. Linchester, 274 Md. 211, 225 , 334 A. 2d 514 (1975); Public Serv. Comm’n v. Balto. Gas & El., 273 Md. 357, 362-63 , 329 A. 2d 691 (1974); Dickinson-Tidewater v. Supervisor, 273 Md. 245, 256 , 329 A. 2d 18 (1974); St. Comm’n on Human Rel. v. Malakoff, 273 Md. 214, 224 , 329 A. 2d 8 (1974); Warlick v. Supervisor of Assess., 272 Md. 540, 546 , 325 A. 2d 587 (1974); Supervisor of Assess., v. Ely, 272 Md. 77, 84 , 321 A. 2d 166 (1974); and Fairchild Hiller v. Supervisor, 267 Md. 519, 521-22 , 298 A. 2d 148 (1973). See also Tomlinson, Constitutional Limits on the Decisional Powers of Courts and Administrative Agencies in Maryland, 35 Md. L. Rev. 414 (1976). 4.

Attorney-client relationship We shall first consider whether, in the words of the rule, a “client-attorney relationship existed with a member of the Bar of the Court of Appeals of Maryland [, i.e., Jacob,] when the loss was incurred and the said Maryland attorney defaulted.” What constitutes an attorney-client relationship is a rather elusive concept. Richard L. Amster, Esq., treasurer and trustee of the Clients’ Security Fund of New Jersey, has commented that defining such a relationship has been a major problem in the matter of administration of the New Jersey fund. See Amster, Clients’ Security Funds: The New Jersey Story, 62 A.B.A. J. 1610 (1976): “During the eight years in which the fund has been operating a constantly recurring problem has ⁶⁷¹ been the difficulty of the trustees in fitting the varied factual situations that have come before the fund within the definition established for the payment of claims. The definition of the lawyer-client relationship, which is a condition precedent to the consideration of a claim, is not always easily satisfied.

The question as to when a lawyer is acting as a lawyer as opposed to acting as an investment adviser or a businessman continually recurs, and the trustees have struggled to interpret claims criteria so as to achieve the basic purpose of the fund.” Id. at 1613. This Court has considered the attorney-client relationship in a variety of situations. In Brown v. Hebb, 167 Md. 535 , 175 A. 602 (1934), our predecessors discussed an attorney’s power to “bind his principal by admissions of facts not in dispute, made when no cause is pending.” The Court spoke in terms of agency, saying: “The question is finally referable to the law of agency, for apart from his connection with actually existing litigation, an attorney would appear to be a mere agent, and, as a mere agent, his authority to bind his principal by his admissions or statements should depend upon the real or apparent scope of his agency, or, as announced in the Restatement of the Law of Agency, A.L.I. secs. 284,286____” Id. at 546 . See Prescoe v. State, 231 Md. 486, 494-95 , 191 A. 2d 226 (1963), relative to the power of an attorney to bind his client in the course of litigation, and Cloverfields Imp. v. Seabreeze Prop., 280 Md. 382, 401-04 , 373 A. 2d 935 , 374 A. 2d 906 (1977), concerning a concession by an attorney made in this Court.

Judge Shehan said for the Court in Buechner v. Goodman, 174 Md. 131, 136 , 197 A. 586 (1938), “An attorney bears a fiduciary relation to his client with respect to any money received or collected by him,” a statement which all will regard as beyond dispute. Several Maryland cases have involved the question of whether an attorney-client relationship existed. In Smith v. ⁶⁷² Martin, 154 Md. 462, 140 A. 593 (1928), our predecessors were faced with the question of whether such a relationship existed between a landowner and a lawyer-lessee who had drawn the lease in question. Judge Pattison said for the Court: “It is true he was a lawyer, but he had at no time been [the lessor’s] attorney, nor was he acting as her attorney in this transaction. ... [I]t was only to oblige and accommodate her that he agreed to prepare [the lease]....

The fact that the defendant, a party to a contract, was an attorney, and that he was willing to prepare the lease without compensation, was not enough to establish the relation of attorney and client.” Id. at 473-74. We found the presence of an attorney-client relationship between an attorney and the assured in Central Cab Co. v. Clarke, 259 Md. 542, 548-50 , 270 A. 2d 662 (1970), where an insurance company had sent a file to an attorney and he had written letters relative to the case to the plaintiff’s counsel. Our predecessors concluded in Penrose v. Page, 145 Md. 1 , 125 A. 549 (1924), that a Baltimore attorney employed as “special counsel” in an effort to save a failing bank was entitled to a fee for his extensive services. The matter returned to this Court in Page v. Penrose, 147 Md. 225 , 127 A. 748 (1925).

What Judge Offutt said for the Court there is significant because the Court found Mr. Penrose to be entitled to attorney’s fees even though his services were not of a legal character and could have been performed by a non-lawyer bank executive: “Mr. Penrose was employed as a lawyer, and it is possible that his training and experience as a lawyer may have rendered his assistance more valuable to the bank, but it is difficult to point out any services rendered by him which could not have been rendered in ordinary course by a capable and experienced bank executive familiar with the needs, operation and management of banks. Indeed, there is great force in this suggestion of the learned and careful judge who heard this case in the lower court. In ⁶⁷³ speaking of the difficulty of separating the services