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NILS ROSENQUEST [SB# 87661]ROSENQUEST & ASSOCIATES2720 Taylor Street, Suite 420San Francisco, California 94133Telephone: 415-292-0980Facsimile: 415-292-0989Email: rosenquest@earthlink.net

MICHAEL S. DEVORKINJACQUELINE G. VEITGOLENBOCK EISEMAN ASSOR BELL & PESKOE LLP437 Madison Avenue New York, New York 10022Telephone: 212-907-7300Facsimile: 212-754-0330Email: mdevorkin@golenbock.comEmail: jveit@golenbock.com

Attorneys for the Plaintiff, Gerard A. McHale, Jr., P.A., Liquidation Trustee

UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA — SAN FRANCISCO DIVISION

GERARD A. MCHALE, Jr., P.A., as Liquidation Trustee for the 1031 Debtors Liquidation Trust,

Plaintiff,

v.

SILICON VALLEY LAW GROUP, a professional corporation,

Defendant.

Case No. CV 10-04864-JW

TRUSTEE’S MEMORANDUM OF POINTS AND AUTHORITIES IN OPPOSITION TO SVLG’S MOTION FOR SUMMARY JUDGMENT,

OR IN THE ALTERNATIVE, PARTIAL SUMMARY JUDGMENT

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TABLE OF CONTENTS

Preliminary Statement ..................................................................................................................1

Statement Of Facts .......................................................................................................................2

A. The Liquidation Trust Has a Legal and Equitable Interest in Exchange Funds Deposited With 1031 Advance................................................................................2

B. The Trustee’s Proof Of Damages ............................................................................3

C. Facts Concerning Unclean Hands Defense .............................................................6

ARGUMENT ...............................................................................................................................6

I. THE TRUSTEE HAS STANDING TO PURSUE CLAIMS FOR THE LOSS OF FUNDS HELD BY 1031 ADVANCE..............................................6

A. The Trustee Owns Claims for Injuries to 1031 Advance as a Result of the Taking of Funds It Held. ..........................................................................7

B. The Existence of Creditor Claims on a Different Theory Does Not Prevent the Trustee from Pursuing Its Own Claims...............................................9

C. Prior Opinions Here and in the Bankruptcy Court Should Not Cause a Different Result..............................................................................................12

D. The Trustee’s Alternative Claims Are a Basis For Standing. .....................................15

II. SVLG IS NOT ENTITLED TO SUMMARY JUDGMENT ON ITS UNCLEAN HANDS DEFENSE. ........................................................................16

A. The Standard for Unclean Hands In the Context of Summary Judgment ...................16

B. Unclean Hands Does Not Apply Because of The Innocent Nature Of 1031 Advance’s Conduct. ..........................................................................17

C. SVLG Has Not And Cannot Establish That Any Of The Alleged Misconduct Was “Directly Related” To SVLG Or Its Relationship With Its Clients............................................................................................................21

D. SVLG Cannot Impute Okun’s Conduct To 1031 Advance.........................................23

1. SVLG Cannot Impute to 1031 Advance Okun’s Conduct Prior to Buying 1031 Advance. ..........................................................................24

2. SVLG Cannot Impute to 1031 Advance Okun’s Post-Acquisition Conduct, Because He Acted Adversely To The Company. ...............................24

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3. Okun Was Not the Sole Decision Maker of 1031 Advance. ..............................26

a. SVLG is Not Innocent. .................................................................................26

b. There Were Innocent Decision Makers. ...................................................27

E. The Bankruptcy Code Does Not Bar The Trustee.......................................................31

F. Public Policy Does Not Support Absolving SVLG Of ResponsibilityFor Its Professional Malpractice And It Conflicts With California’s Scheme Of Tort Law. ..................................................................................................33

CONCLUSION ..........................................................................................................................35

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TABLE OF AUTHORITIES

Page(s)FEDERAL CASES

Albemarle Paper Co. v. Moody422 U.S. 405 (1975) ............................................................................................................... 8

American Modern Home Insurance Co., Inc. v. Gallagher2008 WL 357120 (S.D. Cal. Feb. 7, 2008)..................................................................... 16, 20

Ash v. Georgia Pacific Corp.957 F.2d 432 (7th Cir. 1992).................................................................................................. 26

AT&T Corp. v. Walker2006 U.S.Dist. LEXIS 64542 (W.D.Wash. Sept. 11, 2006)................................................. 11

Baena v. KPMG LLP453 F.3d 1 (1st Cir. 2006) ................................................................................................. 9, 11

Ball v. Johanns2008 WL 269069 (E.D. Ca. Jan. 29, 2008) .......................................................................... 17

Bankers Trust Co. v. Rhoades859 F.2d 1096 (2d Cir. 1988) ................................................................................................. 9

Battenfeld of America Holding Co. v. Baird, Kurtz & Dobson60 F. Supp. 2d 1189 (D. Kan. 1999).................................................................................... 26

BCCI Holdings (Luxembourg), S.A. v. Clifford964 F. Supp. 468 (D.D.C. 1997)............................................................................................ 27

Beck v. Deloitte & Touche144 F.3d 732 (11th Cir. 1998) ................................................................................................ 25

Breeden v. Kirkpatrick & LockhartLLP, 268 B.R. 704 (S.D.N.Y. 2001), aff’d, sub nom,In re Bennett Funding Group, Inc., 336 F.3d 94 (2d Cir. 2003) ......................................... 28

Caplin v. Marine Midland Grace Trust Co.406 U.S. 416 (1972) ............................................................................................................. 10

CarrAmerica Realty Corp. v. Nvidia Corp.302 Fed.Appx. 514, 2008 WL 5110821 (9th Cir. 2009) ....................................................... 12

Cenco, Inc. v. Seidman & Seidman686 F.2d 449 (7th Cir. 1982) ................................................................................................. 26

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Cobolt Multifamily Investors I, LLC v. Shapiro2009 WL 2058530 (S.D.N.Y. July 15, 2009) ............................................................... 24, 25

Cole v. Doe 1 Thru 2387 F. Supp. 2d 1084 (N.D. Cal. 2005)................................................................................ 18

Comeau v. Rupp810 F. Supp. 1127 (D. Kan. 1992) ....................................................................................... 33

Dawe v. Corrections USA2010 WL 682321 (E.D. Cal. Feb. 24, 2010) .................................................................. 16, 21

Dollar Sys. Inc. v. Avcar Leasing Sys. Inc.,890 F.2d 165 (9th Cir. 1989) ................................................................................................ 17

Dytch v. Yoon2011 WL 839421 (N.D. Cal. March 7, 2011)....................................................................... 16

FDIC v. O’Melveny & Myers, 969 F.2d 744 (9th Cir. 1992), rev’d on other grounds, 512 U.S. 79 (1994), on remand, 61 F.3d 17 (9th Cir. 1995) .......................................... passim

First Nat’l Bank v. Lewco Sec. Corp.860 F.2d 1407 (7th Cir. 1988) .............................................................................................. 27

Fisher v. Apostolou155 F.3d 876 (7th Cir. 1998) ............................................................................................... 7, 9

Frontier Pepper’s Ferry, LLC v. LandAmerica 1031 Exch. Servs.2009 Bankr. LEXIS 4133 (Bankr. E.D.Va. May 7, 2009) ..................................................... 2

Goldin v. Primavera (In re Granite Partners, L.P.)194 B.R. 318 (S.D.N.Y 1996) ................................................................................................ 7

Gower v. Farmers Home Admin. (In re Davis)785 F.2d 926 (11th Cir. 1986) .............................................................................................. 33

Hampton Hotel Investors v. Beeler (In re Hampton Hotel Investors, L.P.)289 B.R. 563 (Bankr. S.D.N.Y. 2003) ................................................................................. 28

Hanover Corp. of America v. Beckner211 B.R. 849 (M.D. La. 1997).............................................................................................. 33

Hirsch v. Arthur Andersen & Co.72 F.3d 1085 (2d Cir. 1995) ................................................................................................. 28

Imperial Credit Industries, Inc. v. Lerner2008 WL 4346785 (C.D. Cal. Sept. 18, 2008) ............................................................... 17, 22

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In re Bogdan414 F.3d 507 (4th Cir. 2005) ................................................................................................. 10

In re CBI Holding Co.311 B.R. 350 (S.D.N.Y. 2004); recons. grtd on other grds, 318 B.R. 761 (S.D.N.Y. 2004), rev’d on other grds,. 529 F.3d 431 (2d Cir. 2008) ................ 24, 27

In re Cendant Corp. Sec. Litig.139 F. Supp. 2d 585 (D.N.J. 2001) ...................................................................................... 25

In re Crown Vantage, Inc., 2003 WL 25257821 (N.D. Cal. 2003) ............................................ 33

In re Investors Funding Corp.523 F. Supp. 533 (S.D.N.Y. 1980) ....................................................................................... 27

In re Mediators105 F.3d 822 (2d Cir. 1997), aff'g 190 B.R. 515 (S.D.N.Y. 1995) ...................................... 28

In re Sharp Int’l. Corp.278 B.R. 28 (Bankr. E.D.N.Y 2002) .................................................................................... 28

Kalb, Voorhis & Co. v. American Financial Corp.8 F.3d 130 (2d Cir. 1993) ..................................................................................................... 11

Koch Refining v. Farmers Union Cent. Exch., Inc.831 F.2d 1339......................................................................................................................... 7

Loyd v. Paine Webber, Inc.208 F.3d 755 (9th Cir. 2000) ....................................................................................... 8, 12, 32

Martin Marietta Corp. v. Gould, Inc.70 F.3d 768 (4th Cir. 1995) .................................................................................................. 24

McCandless v. Furlaud296 U.S. 140 (1935) ............................................................................................................. 33

McHale v. Citibank, N.A.420 B.R. 178 (Bankr. S.D.N.Y. 2009) ............................................................................. 12, 1

Official Committee of Unsecured Creditors v. R. F. Lafferty & Co.267 F.3d 340 (3d Cir. 2001) ............................................................................... 11, 28, 31, 33

Pareto v. F.D.I.C.139 F.3d 696 (9th Cir. 1998) ................................................................................................. 11

Pershing Park Villas Homeowners Ass’n v. United Pacific Insurance Co.219 F.3d 895 (9th Cir. 2000) ................................................................................................. 11

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Plaza Mortgage & Fin. v. Basroon (In re Plaza Mortgage & Fin. Corp.)187 B.R. 37 (Bankr. N.D. Ga. 1995) .................................................................................... 33

Schacht v. Brown711 F.2d 1343 (7th Cir. 1983) ........................................................................................... 9, 26

Scholes v. Lehmann56 F.3d 750 (7th Cir. 1995) ................................................................................................... 32

Scottsdale Ins. Co. v. OU Interests2005 WL 2893865 (N.D. Cal. Nov. 2, 2005) ....................................................................... 18

Shearson Lehman Hutton, Inc. v. Wagoner944 F.2 114 (2d Cir. 1991) ....................................................................................... 11, 13, 28

Smith v. Arthur Anderson LLP421 F.3d 989 (9th Cir. 2005) .......................................................................................... passim

Southmark Corp. v. Cagan999 F.2d 216 (7th Cir. 1993)............................................................................................... 25

Terry v. SunTrust Banks, Inc.2011 WL 2444805 (D.S.C. June 15, 2011) ............................................................................ 2

Tew v. Chase Manhattan Bank728 F. Supp. 1551 (S.D. Fla. 1990) ........................................................................................ 33

Thabault v. Chait541 F.3d 512 (3rd Cir. 2008) ............................................................................................. 8, 11

United States v. Horizon Health Corp.565 F.3d 1195 (9th Cir. 2009) ............................................................................................... 16

United States v. Ianniello646 F. Supp. 1289 (S.D.N.Y. 1986), aff’d on other grounds,824 F.2d 203 (2d Cir. 1987) ................................................................................................. 14

U.S. Fire Ins. Co. v. Vesta Strategies, LLC, No. C 09-02388 JW (N.D. Cal. July 14, 2011) .................................................................... 34

Wechsler, Squadron, Ellenoff, Plesent & Sheinfeld L.L.P., 994 F. Supp. 202, 207 (S.D.N.Y. 1998) ............................................................................... 27

Wechsler v. Squadron, Ellenoff, Plesent & Sheinfeld L.L.P.212 B.R. 34 (S.D.N.Y. 1997) ......................................................................................... 14, 27

Wells Fargo & Co. v. Stagecoach Properties, Inc.685 F.2d 302 (9th Cir. 1982) ................................................................................................. 17

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Welt v. Sirmans3 F.Supp.2d 1396 (S.D. Fla. 1997)....................................................................................... 33

Wicker v. Hoppock73 U.S. 94 (1867).................................................................................................................... 8

Wight v. Bank America Corp., 219 F.3d 79, 97 (2d Cir. 2000) ............................................................................................. 27

Williams v. Cal. 1st Bank859 F.2d 664 (9th Cir. 1988) ................................................................................................. 10

CALIFORNIA CASES

Am. Motorcycle Assoc. v. The Superior Court of Los Angeles County20 Cal. 3d 578 (Cal. 1978) ................................................................................................... 34

Blain v. Doctor’s Co.,222 Cal. App.3d 1048, 272 Cal. Rptr. 250 (1990) ......................................................... 17, 19

Brown v. Grimes192 Cal. App. 4th 265 (Cal. Ct. App. 2011)................................................................... 21, 22

Casey v. U.S. Bank Nat. Ass’n127 Cal. App. 4th 1138 (Cal. Ct. App. 2005)....................................................................... 27

Chapman v. Superior Court130 Cal. App.4th 261 (Cal. Ct. App. 2005)........................................................................... 19

CrossTalk Productions, Inc. v. Jacobson65 Cal. App. 4th 631 (Cal. Ct. App. 1998)........................................................................... 17

Hunter v. Citibank, N.A.09-02079, Dkt. 264, 2010 WL 250993 (February 3, 2010)........................................... passim

Kendall-Jackson Winery Ltd. v. Superior Court76 Cal.App.4th 970 (1999) .............................................................................................. 17, 19

Lee v. Montgomery2008 WL 4052920 (Cal. App. 2 Dist. Sept. 2, 2008) ..................................................... 18, 19

Li v. Yellow Cab Co.13 Cal. 3d 804 (Cal. Ct. App. 1975)..................................................................................... 34

Mattco Forge, Inc. v. Arthur Young & Co.5 Cal. App. 4th 392 (Cal. Ct. App. 1992)............................................................................. 16

Merco Constr. Eng'rs v. Mun. Court,21 Ca1.3d 724, 729 147 Cal. Rptr. 631, 581 P.2d 636 (1978) ............................................... 25

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Meyer v. Glenmoor Homes, Inc.246 Cal. App. 2d 242 (Cal. Ct. App. 1966) ......................................................................... 24

Peregrine Funding, Inc. v. Sheppard Mullin Richter & Hampton LLP133 Cal.App.4th 658 (Cal. Ct. App. 2005)..................................................................... passim

Saks v. Charity Mission Baptist Church90 Cal. App. 4th 1116 (Cal. App. 2001) .............................................................................. 27

Theobald v. Byers13 Cal. Rptr. 864 (Cal. Ct. App. 1961)................................................................................. 34

Vacco Industries, Inc. v. Van Den Berg5 Cal. App. 4th 34 (Cal. Ct. App. 1992)................................................................................ 22

Wiley v. Wiley59 Cal. App. 2d 840 (Cal. Dist. Ct. App. 1943) ................................................................... 21

Wright v. Stang Mfg. Co.63 Cal. Rptr. 2d 422 (Cal. Ct. App. 1997)............................................................................ 34

OTHER CASES

Bd. of Trustees of Comm. Coll. Dist. No. 508 v Coopers & Lybrand8 Ill. App. 2d 331 (Ill. 2003)................................................................................................. 33

FDIC v. St. Paul Co.’s, 634 F.Supp.2d 1213, 1221 (D.Colo. 2008) .......................................... 27

Lincoln Grain, Inc. v Coopers & Lybrand216 Neb. 433 (Neb. 1984) .................................................................................................... 33

Lohmuller Bldg. Co. of Baltimore v. Gamble154 A. 41 (Md. 1931)........................................................................................................... 24

NCP Litigation Trust v. KPMG LLP187 N.J 353 (N.J. 2006) ......................................................................................................... 33

Official Committee of Unsecured Creditors of Allegheny Health Educ. and Research Found. v. PriceWaterhouseCoopers, LLP 605 Pa. 269 (Pa. 2010) ........................ 26

Universal Builders, Inc. v. Moon Motor Lodge, Inc.430 Pa. 550 (Pa. 1968)........................................................................................................... 33

FEDERAL STATUTES

11 U.S.C. § 541 ...................................................................................................................... 7, 31

Internal Revenue Code § 1031 ..................................................................................................... 2

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OTHER AUTHORITIES

Dobbs, Law of Remedies § 3.3(7), at 231-32 (2d ed.1993) ........................................................ 11

Prosser, Law of Torts, s. 50, p. 307 ............................................................................................ 34

Restatement (Third) of Torts: Apportionment of Liability § 7, Comment m, at 70 (2000) ....... 33

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Preliminary Statement

The Liquidation Trustee has a straightforward claim for malpractice that asserts that

SVLG’s negligence caused the misappropriation and dissipation of exchange funds, which

1031 Advance owned, and unquestionably held. Its claim does not rest on any complicated

notion of trust or aiding and abetting, or on SVLG’s knowledge of a trust or of the conduct of

others. The Trustee owns this claim and should be entitled to proceed to seek a judgment for

the full amount of the exchange funds misappropriated, plus the fees and costs of the

bankruptcy administration, including asset tracing and recovery.

We demonstrate why looting from a corporation, even by controlling insiders, is a

classic corporate injury that gives the Trustee standing to recover all the damages he seeks.

Since even under Judge Glenn’s decision, the Trustee has standing to recover certain damages,

McHale v. Citibank, N.A., 420 B.R. 178, 194 (Bankr. S.D.N.Y. 2009), once there is standing,

the Court need not and should not make a determination now as to exactly which damages

plaintiff can recover at trial, particularly when so many facts are in dispute.

We also demonstrate many reasons why SVLG has not met its burden of showing that

an “unclean hands” defense applies, and that many facts are in dispute. We should not,

however, lose sight of the central reason it does not apply. 1031 Advance and its principals

were innocent clients, who sought legal advice from SVLG about the potential sale of 1031

Advance, and who relied on SVLG’s advice to avoid becoming entangled in a Ponzi scheme.

The defense was designed to preclude claims by intentional wrongdoers, who pursue their

attorneys for participating with them in that wrongdoing, not to permit attorneys to escape

liability when their clients got into trouble only because they followed the attorneys’ advice.

Such a result would emasculate accountability for legal malpractice.

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We submit that the most prudent and efficient course is to let the jury make its

determinations on a full factual record, preferably at a consolidated trial.

STATEMENT OF FACTS1

A. The Liquidation Trust Has a Legal and Equitable Interest in Exchange Funds Deposited With 1031 Advance.

Under Section 1031 of the Internal Revenue Code and the regulations thereunder, and

1031 Advance’s exchange agreements (Sturmer Decl. Ex. BB) (i) upon deposit of the exchange

funds with 1031 Advance, the funds were assets of 1031 Advance, much like deposits received

by a bank from customers; (ii) the sole relationship between 1031 Advance and the exchangers

was one of contract debtor and contract creditor; (iii) the loss of the funds injured 1031

Advance; and (iv) 1031 Advance had the right to recover any money of this kind that were

misappropriated. SVLG’s own fact and expert witnesses have so testified. Devorkin

Motion/Amend Decl., ¶ 24; Devorkin Decl. Ex. 4 at 81-86.2

While SVLG studiously avoids this issue here, in the Hunter Action, it took the position

that exchange funds were not received in trust and that 1031 Advance had no fiduciary duties to

the exchangers, which supports the Trustee’s position. See SVLG Reply Brief in Hunter, Dkt.

447, p. 1. Other courts have agreed. Terry v. SunTrust Banks, Inc., 2011 WL 2444805 *4

(D.S.C. June 15, 2011); Frontier Pepper’s Ferry, LLC v. LandAmerica 1031 Exch. Servs., 2009

Bankr. LEXIS 4133 (Bankr. E.D.Va. May 7, 2009). As set forth in the Motion to Amend, the

1 The brief refers to facts, which are particularized in the Devorkin Declaration in support of the motion to amend (“Motion to Amend”) (“Devorkin Motion/Amend Decl.”), on which we rely and incorporate by reference, and in a second Devorkin Declaration submitted herewith (“Devorkin Decl.”). Capitalized terms have the same meaning set forth in the Motion to Amend. “Mem.” refers to SVLG’s memorandum in support of its motion for summary judgment. “Sturmer Decl.” refers to the Declaration of Debra Sturmer submitted by SVLG in support of that motion.2 The stock purchase agreement shows the bank accounts with exchange deposits as assets. Devorkin Decl. Ex. 23 at 4.09 and 4.20; Ex. 49; Ex. 50 at 54-68, 71-73. Just before its sale, 1031 Advance had $23 million in assets and liabilities, and the market (or enterprise value of its business) was at least $23 million (whether or not assets are on balance sheet). Id. Ex. 4 at 82-83, 87, 95-97.

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Trust has a claim for the same amount even if it is determined these funds were held in trust or

as bailed property.

B. The Trustee’s Proof Of Damages

Both case law, infra at p. 8 n. 11, and the testimony of the economic and damage

valuation experts agree that the central purpose of calculating damages is to put the injured party

in the same position that it would have been in but for the wrongdoing. Devorkin Decl. Ex. 46 at

8-11; Ex. 50 at 114-19; Ex. 4 at 48, 50, 52. 1031 Advance’s damages include (i) lost exchange

funds in its bank accounts; and (ii) the fees and costs of bankruptcy administration; asset

tracing, evaluation, and recovery; and loss mitigation. The basic facts are not really in dispute.

Looted 1031 Advance Exchange Funds. First, John Sordillo, the Trustee’s forensic

expert,3 determined the injury to 1031 Advance by tracing and identifying each dollar of

exchange funds held by 1031 Advance that was looted from December 19, 2006, through May

14, 2007. These were (i) $23.2 million in 1031 Advance’s bank account taken immediately

upon the December 19, 2006, sale to 1031 Tax Group; and (ii) an additional $11.7 million

taken in April–May 2007. Devorkin Decl., Ex. 42 at 14-18. The net amount of $31.2 million

was missing from 1031 Advance on the date of the bankruptcy, which prevented 1031 Advance

from closing exchanges in that amount. Id. Ex. 42 at 16; Ex. 12 at 221-25.4 Second, he

verified the amount that each 1031 Advance exchanger lost. See Ex. 42 at 19-20 (and exhibit 5

thereto); Ex. 12 at 25, 28, 36-37, 71-73, 87-88, 96, 103-06, 113, 114-15, 132, 224-25. The

Trustee does not dispute that the total amounts taken from 1031 Advance are amounts owed to

3 Sordillo testified to what happened, not as to damage or economic theory. He led the forensic team retained by the Trustee. He was deposed and will testify to the matters in his report, which includes a summary, Devorkin Decl. Ex. 42, six exhibits, Ex. 43, and a 500 page appendix with flow charts and tables. Ex. 44 contains the flowcharts excerpted from that appendix; Ex. 52 has the 1031 Advance flow charts.4 The $31.2 million figure is found in Ex. 47 at 1, an update that Sordillo prepared before testifying.

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its exchangers.5 SVLG makes much of the fact that Sordillo analyzed the loss this way, but

nothing more was needed to determine this part of the injury to 1031 Advance, and it does not

change that Sordillo testified to direct injuries to 1031 Advance, not direct injury to exchangers,

as we address in the argument.

The economic damages to 1031 Advance should be measured by the amount necessary

to restore it to the position it was in before these events, which is also the change to its total

business value, which is approximately $23 million just after December 19, 2006, and $31

million at the time of the bankruptcy filing. Devorkin Decl. Ex. 46 at 7-15; Ex. 50 at 114-19;

Ex. 4 at 90, 92-94.6 When the assets of a company are largely cash, as was true of 1031

Advance, and the cash is stolen, the most “straightforward way” to determine damage to the

company is to calculate the amount of cash stolen, and the company has a claim against the

person who took the asset to recover the value of the asset. Id. Ex. 4 at 85-86, 105-06.7

Costs of Forensic Investigation. The Trustee paid Deloitte approximately $7.1 million

for forensic accounting and related services prior to confirmation of the Plan and more than

$500,000 for work thereafter in order to determine what happened here. Devorkin Decl. Ex. 42

at 3-6; Ex. 12 at 196-97, 225-27, 229. These are incremental to the amount of looted exchanger

funds. Ex. 12 at 198-99. The Trustee seeks to recover a fair proportion of this from SVLG,

5 The total missing for all debtors is about $148,000,000. Devorkin Decl. Ex. 42 at 12. There are other creditors of 1031 Advance, albeit less than $500,000. Id. Ex. 51 at 71-72.6 Excerpts of testimony of SVLG’s damage expert are in Ex. 4. While Burr disagrees with Sordillo and Pump about methodology and ultimate conclusions, we cite his testimony because it supports the Trustee’s position that 1031 Advance was injured and on other fundamental points.7 The economic loss to 1031 Advance is no different than the loss to a bank if depositor funds are taken. Devorkin Decl. Ex. 50 at 97-98. Exchange deposits and liabilities exist but for accounting purposes are off the balance sheet. Ex. 50 at 46-50, 88. If the asset is looted, upon bankruptcy the liabilities to exchangers of $31.2 million would now go on balance sheet. Ex. 50 at 92-93, 112-13.

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based on a fair share of the worked relating to and required by 1031 Advance’s bankruptcy.8

SVLG contends that Deloitte’s work was only to determine the loss to 1031 Advance in terms

of the amounts owed to exchanges (not correct), and since the loss is not recoverable by the

Trustee (it claims), then neither is the cost of the forensic investigation. This is also not correct.

Deloitte’s work was not a simple calculation of amounts claimed by exchangers. The

Chapter 11 Trustee inherited a bankruptcy mess with massive numbers of transactions and

needed to find out accurately and completely what had happened, including how much was

missing from the estates, where the funds went, and whether there were potential recoveries,

and this work led to recoveries of more than $137 million. Devorkin Decl. Ex. 51 at 23, 99,

109.9 The complexity of the Ponzi scheme and the challenge of seeking recoveries to mitigate

the losses by identifying claims and tracing assets acquired with looted funds required this

effort. Id. Ex. 12 at 197-98.

Deloitte’s lengthy report, exhibits, and appendix show, inter alia, (i) the amount of

exchange funds on deposit with 1031 Advance and other debtors when the looting began and

the name of each exchanger who made these deposits; (ii) the amount and date of taking funds;

(iii) the destination, purpose, and use of funds taken; (iv) the amount and source of funds

returned, if any; (v) the net loss in funds to each 1031 Debtor; and (vi) the identity of

exchangers who could not close transactions and in what amounts. Id. Ex. 12 at 89-90; Ex. 42

at 7-21; Ex. 43; Ex. 44.

8 The Trustee will prove the sale of 1031 Advance prolonged the Ponzi scheme six months and made the process of unraveling what happened far more complicated.9 Scores of professionals analyzed in detail the financial affairs of the debtors. Ex. 12 at 69-71, 102; Ex. 42 at 3-4, 7-10. Deloitte worked three years to untangle the record of money moving in and out of various accounts; reviewed and analyzed millions of pages of records, including 536 banks accounts at 21 banks, with $12 billion of transactions; and creating a 59,000 line data base of bank records. Ex. 12 at 107, 229-30.

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C. Facts Concerning Unclean Hands Defense

Facts concerning SVLG’s unclean hands defense are included within the Trustee’s

argument, Section II, infra.

ARGUMENT

I. THE TRUSTEE HAS STANDING TO PURSUE CLAIMS FOR THE LOSS OF FUNDS HELD BY 1031 ADVANCE.

To advance SVLG’s strategy of denying any recovery to both the Trustee and the

exchangers despite its wrongdoing, SVLG contends that the Liquidation Trustee does not have

standing, because it “seeks to recover as damages losses incurred by the 1031 Advance

exchanger clients, whom the Trustee does not represent.” Mem. 18. However, the evidence

shows that the Trustee is pursuing an injury in fact to 1031 Advance for dissipation of its funds,

a well-recognized injury to a company, and its injury is (i) the amount of the looted funds or the

net amount missing, and (ii) the full costs of the bankruptcy and the forensic tracing and the

recovery required.

A claim is not merely a loss; it requires a duty, a breach, and an injury. The Trustee’s

claim is based upon malpractice, and it is separate and independent of any creditor claim. The

exchangers do not have a claim against SVLG for malpractice and cannot pursue 1031

Advance’s claims. The exchangers can only pursue SVLG on their separate claim for aiding

and abetting a breach of trust/fiduciary duty owed directly to them, if they can meet the high

burden for doing so. As discussed below, the law is clear that a creditor’s pursuit of a claim for

its loss on its own theory (i) does not prevent 1031 Advance from pursuing its own claim for

injury to the company on its separate theory, or (ii) transpose 1031 Advance’s claim into the

creditor’s claim.10

10 To the extent SVLG’s point is that there should be no duplicate recovery, to be clear, neither the Trustee nor the Hunter plaintiffs have ever contended that SVLG must pay damages twice. Rather, the

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SVLG argues that because the misappropriation of funds held by 1031 Advance caused

1031 Advance to be unable to pay its creditors in that amount, (i) the measurement of the losses

on the claims overlaps, and (ii) the exchangers may benefit from the estate’s recoveries. It

argues from this that 1031 Advance must be pursuing a loss to the creditors, and that thus, the

claim belongs to the creditors. Courts have repeatedly rejected this view. Two parties can

have the same amount of loss from the same conduct, yet each may have direct claims.11

A. The Trustee Owns Claims for Injuries to 1031 Advance as a Result of the Taking of Funds It Held.

Pursuant to 11 U.S.C. §541, the 1031 Advance estate included “all legal or equitable

interests of the debtor in property as of the commencement of the case,” including any action

by the debtor “to recover . . . for fiduciary misconduct, mismanagement, or neglect of duty. . . .”

Koch Refining v. Farmers Union Cent. Exch., Inc., 831 F.2d 1339, 1343-4 (7th Cir. 1987);

Fisher v. Apostolou, 155 F.3d 876 (7th Cir. 1998); see Goldin v. Primavera (In re Granite

Partners, L.P.), 194 B.R. 318, 328 (S.D.N.Y 1996). The Trustee’s claim arises from a breach

of duties that SVLG owed to its client 1031 Advance. The Trustee is bringing only the estate’s

claims and is not bringing any claims on behalf of creditors.

SVLG’s breach of its duty caused the dissipation of funds held by 1031 Advance, and

the Trustee asserts 1031 Advance’s right to recover as the owner of the funds and on the

alternative bases set forth in the Motion to Amend. A corporation has this right as a distinct

legal entity separate from its owners and officers, even when a single individual owns nearly all

of the stock. FDIC v. O’Melveny & Myers, 969 F.2d 744 (9th Cir. 1992) (“O’Melveny I”),

Trustee contends that it and the exchangers have separate claims with separate elements of liability, with some overlap of damages. The issue of duplication should be dealt with on satisfaction of judgment or otherwise, and it may never arise if both liability claims are not proven. 11 We recognize the Court has touched on this before on the Cordell motions. We first set forth the case law to support the Trustee’s position and then address the Court’s prior decisions infra at 12.

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rev’d on other grounds, 512 U.S. 79 (1994), on remand, 61 F.3d 17 (9th Cir. 1995)

(“O’Melveny II”).

There is no dispute that the exchange funds were in 1031 Advance’s bank accounts

(Devorkin Decl. Ex. 23 at Sched. 4.20 and Tab 16; Ex. 25), and numerous courts have held that

exchange funds belong to the QI, not the exchangers. Supra at 2. In addition, SVLG’s own

witness and others have testified that these funds were assets of 1031 Advance; and that when

the funds were looted, 1031 Advance had a massive liability, was worth that much less as a

business enterprise, and needed that same amount of money to restore it to the same position it

was in before the events causing the damage.12 Supra at p. 2, 4. At a minimum, this evidence

creates issues of fact as to whether the exchange funds are assets of 1031 Advance subject to

recovery by the Trustee. Hunter v. Citibank, No. C09-02079 JW (N.D. Cal. May 5, 2011) at 4

(summary judgment standard) (Dkt. 500).

Numerous cases make clear that when a company holds funds under similar

circumstances, and the funds are taken, or the company’s liabilities to creditors are increased by

such a taking or other misconduct, that the company itself has standing to pursue a claim for

taking its funds. Loyd v. Paine Webber, Inc., 208 F.3d 755, 758 (9th Cir. 2000), is a perfect

example. There, a sham corporation’s sole purpose was to run a Ponzi scheme. The controlling

insiders induced clients to deposit funds into the corporation, and the insiders then took the funds

for themselves, leaving the sham company insolvent with great liabilities and no assets to meet

them. The court found the company had standing to pursue claims to recover for these lost

funds. Similarly, in Thabault v. Chait, 541 F.3d 512 (3rd Cir. 2008), an insurance company

12 This is both the legal test for damages, Albemarle Paper Co. v. Moody 422 U.S. 405, 418 (1975); Wicker v. Hoppock 73 U.S. 94, 99 (1867), and the test that both the Trustee’s and SVLG’s expert agree is the correct economic yardstick to use for damages. SVLG’s expert agreed that 1031 Advance would have a claim to recover money taken from its accounts, and that the most straightforward way to determine a loss to a company with principally cash assets is to replace the cash taken.

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sold policies and collected premiums (created liabilities). A receiver for the company brought

malpractice claims based on a faulty audit. The court held that the lost premium was an injury

to the company separate from an injury to its creditors, for which the company had standing.

“Today we hold that an increase in liabilities is a harm to the company and the law provides a

remedy when a plaintiff proves a negligence cause of action.” 541 F.3d at 523.

The courts have repeatedly recognized that this type of dissipation of corporate funds or

an increase of corporate liabilities is a clear injury to the corporate entity, which the company

has standing to pursue. Baena v. KPMG LLP, 453 F.3d 1, 5 (1st Cir. 2006) (incurred debt it

could not pay); Smith v. Arthur Anderson LLP, 421 F.3d 989, 1004 (9th Cir. 2005) (company

incurred debts it could not pay); Fisher, 155 F.3d at 878 (company took in investment, which

insiders stole in a Ponzi scheme); Bankers Trust Co. v. Rhoades, 859 F.2d 1096, 1101 (2d Cir.

1988) (creditors gave funds to company which it misused); Schacht v. Brown, 711 F.2d 1343,

1359 (7th Cir. 1983).

B. The Existence of Creditor Claims on a Different Theory Does Not Prevent the Trustee from Pursuing Its Own Claims.

In view of the testimony here and its position in Hunter, at least for purposes of this

motion, SVLG does not dispute that 1031 Advance held, or even that it owned, these exchange

funds. Thus, under the above-cited cases, 1031 Advance suffered an injury. If, by some of the

same acts SVLG aided and abetted a breach of a separate duty owed directly to the exchanger,

which injured the exchanger, or if the exchanger is a creditor of the estate for that amount, this

does not prevent the Trustee from recovery on 1031 Advance’s injuries. Bankers Trust Co.,

859 F.2d at 1101.13 In Bankers Trust, creditors gave funds to the debtor that it misused. The

Court held that the estate could proceed against the wrongdoer to recover the harm to the asset,

13 Bankers Trust also held that the best way to avoid duplicative recoveries is to see what the Trustee recovers and then allow the creditor to recover the balance, if it can, on its own theory.

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notwithstanding the creditors’ claims. To similar effect is Fisher, where insiders ran a Ponzi

scheme and used a corporation to take investors’ funds, and then looted the funds from the

corporation. Investors/creditors sued the wrongdoers for fraud, arguing that even if the

corporation were injured, they could pursue their own claims. The Court held that both the

Trustee and the individuals could proceed on their respective claims for looting, but stayed the

individual claims pending the outcome on the Trustee’s claims. 155 F.3d at 883.

In Smith, a Liquidation Trustee sued, inter alia, attorneys for malpractice for causing

the insolvent company to delay bankruptcy and incur debts it could not repay. 421 F.3d at 995.

Creditors/purchasers of the company’s stock brought their own claims based on the same

conduct. Non-settling defendants argued, as SVLG does here, that under Caplin v. Marine

Midland Grace Trust Co., 406 U.S. 416, 433 (1972), and Williams v. Cal. 1st Bank, 859 F.2d

664, 666 (9th Cir. 1988),14 the Trustee lacked standing to pursue claims because he was only

asserting claims of the company’s creditors. 421 F.3d at 996, 1002. The Court rejected this

argument and explained why Williams is inapposite. First, “[i]f the debtor suffered an injury,

the trustee has standing to pursue a claim seeking to rectify such injury.” Second, causing a

corporation to expend additional assets on a failing business is “an injury to the firm, which is

sufficient to confer standing upon the Trustee.” Id. at 1002-3.

Williams applied Caplin, but in neither case was the trustee bringing claims on behalf of

the estate for injury to the estate. Rather, in each case the trustee was only bringing claims “on

behalf” of, or which had been “assigned by,” creditors. Thus, the only issue was whether the

trustee had standing to bring the investors’ claims, not his own. Smith distinguished Williams:

Here, in contrast, the Trustee is not attempting to assert claims that were assigned to him by Boston Chicken’s creditors but rather seeks to rectify

14 Williams involved a limited assignment of the creditors’ own claims. While that limited assignment did not benefit all creditors, a trustee can enforce an unqualified assignment, if the proceeds do benefit the estate. In re Bogdan, 414 F.3d 507, 511-12 (4th Cir. 2005).

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injuries to Boston Chicken itself. Nothing in Williams suggests that creditors are the “real parties in interest” in an action pursuing compensation for injuries to the corporate debtor.

421 F.3d at 1003. The Trustee here is not seeking the money damages indirectly caused to

creditors but the direct damage to the company from funds taken from it.

To the same effect is Baena. “That the creditors will benefit if such a suit [by the

trustee] is successful does not mean that their own claims against KPMG are at issue. . . . There

is no threat that such a creditor or any other plaintiff will be allowed to recover twice for the

same loss. See Dobbs, Law of Remedies § 3.3(7), at 231-32 (2d ed.1993).” 453 F.3d at 5;

accord, AT&T Corp. v. Walker, 2006 U.S.Dist. LEXIS 64542 at *3 (W.D.Wash. Sept. 11,

2006); cf. Pareto v. F.D.I.C., 139 F.3d 696, 699 (9th Cir. 1998) (applying California law).

SVLG also cites Official Committee of Unsecured Creditors v. R. F. Lafferty & Co.,

267 F.3d 340 (3d Cir. 2001), but that case made the same distinction as Smith. Also, the quote

SVLG cites actually supports the Trustee’s position, because it says that a claim for injury to

the corporation is separate and can be pursued by the corporation, even if it leads to money

coming into the estate and the creditors are the only beneficiaries thereof. Id. at 351; accord,

Kalb, Voorhis & Co. v. American Financial Corp., 8 F.3d 130, 134 (2d Cir. 1993). Further, the

same circuit in Thabault followed Smith, and held that Lafferty did not limit the company’s

damages for this increased liability of more than $100 million, and that creditors’ claims did

not prevent the company from proceeding on its claims for that same injury. 541 F.3d at 520,

523; see also Pershing Park Villas Homeowners Ass’n v. United Pacific Insurance Co., 219

F.3d 895 (9th Cir. 2000).

SVLG’s reliance on Peregrine Funding, Inc. v. Sheppard Mullin Richter & Hampton

LLP, 133 Cal.App.4th 658 (Cal. Ct. App. 2005), is also misplaced. First, it relies on Shearson

Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114 (2d Cir. 1991) (“Wagoner”), which the Ninth

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Circuit does not follow. CarrAmerica Realty Corp. v. Nvidia Corp., 302 Fed. Appx. 514 (9th

Cir. 2009) [unpublished]. Second, while the court mentioned that the complaint did not

identify losses apart from losses to the investors, it did not rule on that basis and did accept as

sufficient allegations of lost investment contributions and other assets. Third, while indicating

that it might be relevant if the corporation were a sham, (i) the complaint did not allege that; (ii)

1031 Advance is clearly not a sham; and (iii) Peregrine does not address that O’Melveny and

Loyd hold that a separate corporate identity gives rise to claims, even for sham corporations.

While we do not dispute that a Trustee can only assert claims held by the corporation

itself, SVLG ignores the foregoing cases, which (i) hold that a corporation owns claims for

these injuries, and (ii) reject SVLG’s argument that because a creditor and the corporation have

a similar loss from acts of misconduct, and the loss of the corporation may in the end be

measured by what it owes those creditors, the corporation is asserting only the creditors’ claims

and not its own.

C. Prior Opinions Here and in the Bankruptcy Court Should Not Cause a Different Result.

SVLG relies on this Court’s decision in Hunter v. Citibank, N.A., 09-02079, Dkt. 264,

2010 WL 250993 (February 3, 2010) (“Cordell I”), and McHale v. Citibank, N.A., 420 B.R.

178, 194 (Bankr. S.D.N.Y. 2009) (“Citibank”).15 Cordell I denied the Cordell Defendants’

motion to dismiss and found that the Hunter plaintiffs could proceed notwithstanding the

channeling injunction issued by the Bankruptcy Court. It rejected Cordell’s argument that the

injunction barred any direct claims that the creditors had against Cordell. The precise question

before the Court here was not essential to, or even before, the Court on Cordell’s motion; it was

15 This Court issued two other Cordell decisions in Hunter v. Citibank, N.A.: (i) July 20, 2010, denying Cordell’s motion for reconsideration and to dismiss, Dkt. 354 (“Cordell II”); and (ii) May 5, 2011, denying Cordell’s motion to dismiss the third amended complaint, Dkt. 500 (“Cordell III”). The

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not fully briefed; this Court did not have the benefit of the authorities discussed above; and the

Trustee did not participate.

A review of the Cordell decisions demonstrates that the only issues then before the

Court that were necessary to decide were (i) whether the Hunter plaintiffs had a direct claim

against Cordell (which could be answered independent of determining what claims the Trustee

had) and, (ii) if so, whether the channeling injunction barred it. The reason for this is that if the

Hunter plaintiffs had a direct claim against Cordell, it could not be derivative of any claim the

Trustee had against Cordell, and it was unnecessary to decide what claims the Trustee could

pursue. Anything else was dicta.

Cordell II determined that the Second Amended Complaint sufficiently alleged that (i)

the QIs owed fiduciary duties directly to the exchanger plaintiffs as trust beneficiaries, and (ii)

a breach of that duty by Cordell.16 Hunter, 09-02079, Dkt. 354, 2010 WL 250993 at 8-9.

Cordell II concluded that while a corporation owns claims for “breach of a fiduciary duty owed

to the corporation, it would defy logic to extend this proposition to situations where a creditor

seeks to bring suit against a third party for assisting in the breach of a fiduciary duty that the

corporation owes to that creditor.” Id. at 9. We agree completely. Having found that, the

converse is also true. This was, however, as far as the Court needed to go to decide the injunction

issue.17 While Cordell I stated in dicta, p. 11-12, that the Trustee could not bring a hypothetical

action against Cordell to recover the loss of exchange funds, we respectfully suggest that this

Trustee was not a party to the Hunter action and did not brief or argue any of the three Cordell decisions. 16 Since this was a pleading decision, the Court did not and could not make findings that there was a trust or that there was a breach.17 The Court observed that Wagoner bars a trustee from seeking to recover for a wrong committed by management of the corporation to which the Trustee succeeds, but (i) this was dicta unnecessary to the issue then at hand; (ii) Wagoner has been rejected by the Ninth Circuit, see supra at 4, and (iii) the Trustee is suing for harms done to 1031 Advance by virtue of its sale, whereas the wrongdoing occurred thereafter. See infra at 17-20.

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was unnecessary because deciding that the exchangers did have their own direct claims

defeated Cordell’s injunction argument. Further, the Court did not consider the foregoing

substantial authority.

Cordell I also quoted Smith, 421 F.3d 989, to the effect that the trustee can only pursue

claims held by the debtor itself and not those for which the creditor has standing, a proposition

with which we do not quarrel. Nor is the quoted language of Smith unfavorable to the Trustee.

Rather, the balance of Smith did address the issue here, and it held that a “dissipation of assets”

constitutes harm to the company, which the trustee can recover, even if (i) the misappropriation

also injured the creditors, and (ii) the creditors have their own claims. Id. at 1004. Further, “it

is a recognition of the economic reality that any injury to an insolvent firm is necessarily felt by

its creditors,” but notwithstanding the injury to creditors, “it is ‘axiomatic’ that a trustee has

authority to bring” such actions. Id. Proceeding further at this time to parse the damages is

premature. Once standing exists for any damages, questions regarding the proper measure of

damages should be addressed by the trial court when defendants are held liable on the Trustee’s

claims. Id. at 1005.18

Finally, both this Court and SVLG point to Citibank, which dismissed the complaint

with leave to replead an innocent insider exception to the adverse interest exception.19 Citibank

did not concern a defendant who owed a duty directly to a QI. It held that the Trustee had

18 “[S]o long as at least one legally sufficient damage theory exists, a motion to dismiss is directed towards a cause of action, not to different damage theories that may be asserted under a cause of action.” Wechsler v. Squadron, Ellenoff, Plesent & Sheinfeld, L.L.P., 212 B.R. 34, 41 (S.D.N.Y. 1997) (“Wechsler I”); see United States v. Ianniello, 646 F. Supp. 1289, 1290 (S.D.N.Y. 1986), aff’d on other grounds, 824 F.2d 203 (2d Cir. 1987).19 In that case, the Chapter 11 Trustee filed a complaint, and Citibank moved to dismiss on grounds unrelated to constitutional standing or damages. At oral argument, the Court raised constitutional standing sua sponte, and Citibank and the Trustee submitted supplemental briefs. Citibank then argued the Trustee could not bring claims on behalf of creditors. The Trustee maintained that the Trustee was not doing so, but was bringing its own claim. The Trustee did not brief why it owned the claim or the scope of damages, since there was clearly standing for some damages. Devorkin Decl.¶ 90.

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constitutional standing to recover for some damages and also that “it is unnecessary at this

stage of the case to parse with precision for what injury the Trustee may seek to recover” Id. at

195-196. As Smith stated, this should have been the end of it. Any further statements are dicta.

The full scope of damages and the case law cited above was not briefed there, because the only

issue that required decision was whether the Trustee had constitutional standing against

Citibank for any damages. This was the only issue addressed by the Trustee. This was a non-

appealable order. Before the court decided the motion to dismiss the amended complaint

(which included the same damages claims and more), the parties settled, and the Trustee had no

opportunity to appeal.

SVLG cannot change the facts and the testimony of its own witnesses that 1031

Advance’s funds were misappropriated and that there is resulting injury to it. What is important

about Citibank is that the court found the Trustee has standing to pursue claims for damages to

1031 Tax Group for damages caused by the bankruptcy investigation. 40 B.R. at 196. For this

reason, there is no reason for the Court to go further at this time and decide precisely what

damages can be recovered by each plaintiff. It is more prudent and efficient to do that on a full

record. To the extent Citibank is read as holding that the Trustee cannot recover for exchange

funds taken from it, we respectfully submit this has been rejected by the cases cited above.

D. The Trustee’s Alternative Claims Are a Basis For Standing.

While the Trustee disputes SVLG’s argument that based on the original pleading, the

Trustee does not have standing to recover for the loss of the exchange funds, for the reasons set

forth in the Motion to Amend, there are four alternative grounds for standing for such recovery.

The Trustee should be entitled to present them to a jury, whether in support of the original

complaint or as separate claims.

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II. SVLG IS NOT ENTITLED TO SUMMARY JUDGMENT ON ITS UNCLEAN HANDS DEFENSE.

SVLG argues that 1031 Advance had “unclean hands” and should not be able to

recover.20 To the contrary, 1031 Advance and its principals were innocent clients, who sought

and relied on SVLG’s advice in selling 1031 Advance to Okun’s company, which caused 1031

Advance to become tangled in the Ponzi scheme. Dashiell and Allred testified that they would

not have sold 1031 Advance to Okun if SVLG had given proper legal advice. This defense

does not permit attorneys to escape liability when their innocent clients get into trouble only

because they follow the attorneys’ advice, nor would such a result be equitable or further any

public policy objective.

A. The Standard for Unclean Hands In the Context of Summary Judgment

In California, “application of the unclean hands doctrine [remains] a question of fact . . .

[and] is not properly determined on a summary judgment motion.” Mattco Forge, Inc. v.

Arthur Young & Co., 5 Cal. App. 4th 392, 407-08 (Cal. Ct. App. 1992); see also Dawe v.

Corrections USA, 2010 WL 682321, at *8 (E.D. Cal. Feb. 24, 2010). In the malpractice

context, when a law firm seeks to avoid liability by blaming its client for allegedly engaging in

bad acts, the courts avoid summary judgment determinations. See American Modern Home

Insurance Co., Inc. v. Gallagher, 2008 WL 357120 (S.D. Cal. Feb. 7, 2008) (whether plaintiff’s

20 SLVG’s brief does not raise the different defense in pari delecto, perhaps because 1031 Advance’s conduct does not remotely meet that standard. Although some of its unclean hands cases also discuss that defense, SVLG does not. While the Trustee has many responses to such a defense, because SVLG does not raise or discuss it, we do not address it, although some of the same principles discussed hereafter as responses to unclean hands are also responses to in pari delicto. This or any other defense not raised until reply is waived. United States v. Horizon Health Corp., 565 F.3d 1195, 199 n. 1 (9th Cir. 2009); Dytch v. Yoon, 2011 WL 839421, at *3 (N.D. Cal. March 7, 2011) and cases cited therein.

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conduct rose to level of bad faith is fact issue). Even Peregrine, on which SVLG relies, accepts

that this defense “generally rests on questions of fact.”21

Courts apply a three prong analysis in determining if it is appropriate to apply the

unclean hands doctrine to bar a claim. This analysis requires the court to address: “analogous

case law, the nature of the misconduct, and the relationship of the misconduct to the claimed

injuries.” CrossTalk Productions, Inc. v. Jacobson, 65 Cal. App. 4th 631, 641 (Cal. Ct. App.

1998), citing Blain v. Doctor’s Co., 222 Cal. App.3d 1048, (Cal. Ct. App. 1990).

B. Unclean Hands Does Not Apply Because of The Innocent Nature Of 1031 Advance’s Conduct.

Only a plaintiff’s intentionally bad or criminal conduct, not negligence, supports this

defense. Dollar Sys., Inc. v. Avcar Leasing Sys, Inc., 890 F.2d 165, 173 (9th Cir. 1989); Ball v.

Johanns, 2008 WL 269069, at *3 (E.D. Ca. Jan. 29, 2008). “Bad intent is the essence of the

defense.” Wells Fargo & Co. v. Stagecoach Properties, Inc., 685 F.2d 302, 308 (9th Cir. 1982).

The defense is fundamentally an equitable doctrine, to be applied only where equity demands

the extreme result of allowing the law firm fully to escape liability notwithstanding its

malpractice. Imperial Credit Industries, Inc. v. Lerner, 2008 WL 4346785, at *10 (C.D. Cal.

Sept. 18, 2008), quoting Dollar Sys. Inc., at 173 (plaintiff must violate “conscience, good faith

or other equitable principles in his prior conduct”).

The record shows that 1031 Advance engaged in no intentionally bad or criminal acts

during the course of SVLG’s representation, and SVLG admits as much in its Answers (see

Devorkin Decl. ¶ 5).22 The facts support a jury’s finding that if SVLG gave proper advice,

21 There, the Court applied the defense on a motion to strike only because “plaintiff’s own pleadings contain admissions that establish the basis of an unclean hands defense,” a circumstance that does not exist here. 133 Cal. App. 4th at 681. See also Kendall-Jackson Winery Ltd. v. Superior Court, 76 Cal.App.4th 970, 978 (1999) (whether unclean hands “applies is a question of fact”).22 Dashiell and Allred were operating the 1031 Advance as a legitimate qualified intermediary; were neophytes in selling a business; and hired SVLG for expert legal advice about whether, and how, to sell

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1031 Advance would not have been sold to 1031 Tax Group and thus would not have been

injured. Id. ¶¶ 29, 34-36, 44-46, 48. Certainly the record does not support summary judgment

for SVLG on this issue.

The unclean hands defense does not come into play at all where, as here, the clients

were innocent at the time of representation and only engaged in the allegedly wrongful acts

because they followed their attorneys’ advice. Lee v. Montgomery, 2008 WL 4052920 (Cal.

App. 2 Dist. Sept. 2, 2008),23 is nearly identical to this case. Lee, a bank loan officer, consulted

Montgomery, an attorney, about possibly representing the bank concerning a loan transaction

involving an entity “SIT.” Lee consulted Montgomery about the following arrangement: (i)

Lee’s brother’s company (the “Company”) would assist SIT; (ii) SIT would grant stock options

to the Company; and (iii) the Company would give Lee SIT stock in return for Lee helping SIT

obtain the loan from the Bank. When Montgomery told this to the Bank, it terminated Lee. Lee

sued for legal malpractice, and the law firm initially obtained summary judgment on the grounds

that Lee had unclean hands because his transaction violated federal bribery laws and the Bank’s

Code of Conduct. The appellate court reversed and held that Lee did not have unclean hands,

because he “sought advice from . . . Montgomery about [the] very question [of] whether there was

anything wrong with pursuing that business arrangement.” Id. at *7. Montgomery failed properly

to advise Lee about the violations, and if she had done so, he would not have proceeded and his

1031 Advance to suitors, including Okun. Devorkin Decl. ¶¶ 4-9. The proper advice should have included, inter alia, informing the clients about many red flags about Okun revealed during negotiations and the significance thereof; undertaking appropriate factual and legal due diligence in light of these red flags; and giving proper legal advice about these events and the transaction documents to prevent the sale or the risk. Id. ¶¶ 17-48. The key disclosures would have stopped the deal cold. Id. ¶¶ 29, 34-36, 44-46, 48. Dashiell and Allred had walked away from a prior suitor on the same business terms, when they learned the potential buyer was misusing exchange funds. Id. ¶¶ 11-15, 36.23 While Lee is an unpublished state court decision, courts in this district have held that they may rely on unpublished state court decisions as “persuasive authority,” even though they are not binding on the federal court. See Scottsdale Ins. Co. v. OU Interests, 2005 WL 2893865, at *7 (N.D. Cal. Nov. 2, 2005) (relying on unpublished “persuasive” California decision with “virtually identical” facts); see also Cole v. Doe 1 Thru 2, 387 F. Supp. 2d 1084, 1103, n. 7 (N.D. Cal. 2005).

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hands would have been “clean.” “To conclude as a matter of law that a party has unclean hands

based on his or her inquiry about the propriety of a proposed business arrangement would

defeat the very purpose of seeking legal advice.” Id. at *8.

Peregrine, on which SVLG heavily relies, is fundamentally different from the case at

bar because there the firm represented the perpetrators of the scheme while they were engaged

in it and then helped them to avoid detection and prosecution. 133 Cal.App.4th at 665-67. Here,

precisely the opposite was true: (i) SVLG represented 1031 Advance when it was innocent, and

the wrongdoers sought to buy it; and (ii) if SVLG had provided proper advice, 1031 Advance

would never have been sold and would have been protected from harm. Blain is also

distinguishable. It applied the defense because the client’s wrongdoing -- perjury -- did not result

from his reliance on counsel’s advice that he lie under oath. The court held that no client needs to

rely on an attorney to know that lying under oath is wrong. It also distinguished situations that

are like 1031 Advance and Lee, when a client needs to rely on his attorneys to understand the

propriety of the conduct and the course to take. 222 Cal. App.3d 1048 at 1062.24

In sum, 1031 Advance does not “have unclean hands if [it] did nothing more than

consult counsel to find out about how, or whether, to proceed.” Lee, 2008 WL 4052920, at *9.

Unlike the plaintiffs in Blain and Peregrine, but like Lee, at the time of the representation, 1031

Advance had not yet engaged in the conduct that SVLG contends constitutes unclean hands.

SVLG does not discuss Lee, but nevertheless in the background section of its brief (but

nowhere in its legal argument), SVLG makes a half-hearted effort to blame Dashiell and

24 Kendall-Jackson Winery Ltd., oft-cited by SVLG, is not a legal malpractice case, but a “disfavored” malicious prosecution case, to which unclean hands is applied more readily. 76 Cal. App. 4th at 986-87. Further, unlike here, the wrongful acts occurred at the same time as the events in the lawsuit underlying the malicious prosecution action, and were thus “directly related” to it. Id. at 985, 987.

Chapman v. Superior Court, 130 Cal. App.4th 261 (Cal. Ct. App. 2005), is not an unclean hands case at all. Far from the innocent actions of SVLG’s clients, the client there pled guilty to a criminal offense,

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Allred. It asserts (inaccurately) that Dashiell and Allred on their own arranged for the transfer

of the $23.2 million of exchange funds from 1031 Advance to 1031 Tax Group upon the sale,

with no involvement of SVLG. Mem. at 2, 3.

First, the record is replete with contrary facts to the effect that SVLG was fully aware

that the transfer of those exchange funds from 1031 Advance’s control was a part of this deal;

that SVLG did not advise its clients properly as to this transfer; and that Dashiell and Allred

would not have transferred the funds if SVLG had provided appropriate advice.25 Devorkin Decl.

¶¶ 37-47. These facts refute SVLG and, at a minimum, raise issues of fact that preclude

summary judgment. American Modern Home Ins. Co., 2008 WL 357120 at *5. Second, SVLG

provides no evidence -- indeed, does not even argue -- that this alleged behavior was intentionally

wrongful, as the defense requires. To the contrary, the evidence shows that the clients were

unaware of any impropriety in transferring the funds, because SVLG failed to advise them

properly. Devorkin Decl. ¶¶ 38-39, 45-46. In fact, SVLG’s Answers admit that “any

involvement by SVLG was prior to any alleged wrongdoing” and that “SVLG assisted only in

innocent acts.” Id. ¶ 5.

This $23.2 million transfer is significant. It occurred on December 19, 2006, immediately

upon the acquisition of 1031 Advance. With SVLG’s full knowledge, 1031 Advance complied

with Okun’s request to transfer those funds from a 1031 Advance bank account to 1031 Tax

Group’s control. Devorkin Decl. ¶¶ 37-47. SVLG has offered no evidence that 1031 Advance

engaged in intentionally bad or criminal conduct in making that transfer, or that 1031 Advance

was somehow controlled by wrongdoers in connection with it. Nor could it, because this

and was wrongly trying to rely on advice of a town attorney to sue the town for malpractice even though he had violated a penal statute designed to protect the town from his misconduct. Id. at 277.25 The Trustee contends that the circumstantial evidence shows that SVLG knew or should have known this account was in the name of 1031 Tax Group. SVLG disputes that. In any event, SVLG knew that Tax Group would be in control even if its name was not on the account.

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happened at a time when Dashiell and Allred, who make the transfer on behalf of 1031 Advance,

were plainly innocent and had not received proper legal advice from SVLG.

For this reason, there is a $23.2 million injury to 1031 Advance to which the unclean hands

defense cannot possibly apply, even if the Trustee is unsuccessful as to the later transfers from 1031

Advance. The Court thus need not proceed further at this time to sort out the extent to which the

disputed facts are a basis for an unclean hands defense with respect to subsequent events.

C. SVLG Has Not And Cannot Establish That Any Of The Alleged Misconduct Was “Directly Related” To SVLG Or Its Relationship With Its Clients.

SVLG fails to meet its burden under the third prong of the unclean hands test to

conclusively establish that the plaintiff “engaged in misconduct that directly relates to the

claim(s) brought by plaintiff.” Dawe, 2010 WL 682321 at *8. Absent “undisputed evidence

that plaintiff[ ] engaged in any misconduct directly related to [its] claims,” summary judgment

should be denied. Id. (emph. added). Accord Wiley v. Wiley, 59 Cal. App. 2d 840, 842 (Cal.

Dist. Ct. App. 1943) (defendant’s “misconduct must be so intimately connected to the injury of

another with the matter from which he seeks relief, as to make it inequitable to accord him such

relief. It must have been conduct which, if permitted, inequitably affects the relationship

between the plaintiff and the defendant . . .”).

California courts have interpreted this prong strictly and have consistently rejected the

unclean hands defense where it is not met. “If [the wrongdoer] is not guilty of inequitable

conduct toward the defendant in that transaction, his hands are ‘as clean as the court can

require.’” Brown v. Grimes, 192 Cal. App. 4th 265, 283 (Cal. Ct. App. 2011) (emphasis added;

internal citations omitted). This “directly related” requirement means that the conduct must

cause direct injury to the defendant.

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In Brown, for example, attorney Brown was referred cases by Ross, a former attorney.

Brown in turn entered into an agreement with attorney Grimes for each to receive 40% of the

fees recovered; for local counsel to receive 20%; and for Brown to compensate Ross out of his

40%. At trial, after Brown sued Grimes to recover amounts due, the Court barred recovery to

Brown for his unclean hands in entering an unethical fee-splitting agreement with Ross, a non-

lawyer. The appellate court reversed, holding:

[a]lthough Brown’s agreement with Ross to pay Ross from Brown’s share of the fees is related to the transaction in issue, such a relationship is attenuated. . . . The unclean hands emanating from the Brown-Ross agreement did not directly affect or infect the relationship between Grimes and Brown and, most importantly, was not inequitable conduct towards Grimes.

Id. at 283. See also Vacco Industries, Inc. v. Van Den Berg, 5 Cal. App. 4th 34 (Cal. Ct. App.

1992) (misconduct “must relate directly to the transaction concerning which the complaint is

made, . . .and affect the equitable relations between the litigants.”) Imperial Credit Industries,

Inc., 2008 WL 4346785, also rejected the defense. Imperial sought to void an inside director

transaction for the director’s failure to disclose certain illegal “straddle transactions” and his

intent to have his own corporation take the same tax loss as Imperial sought to take. The director

attempted to invoke the unclean hands defense on the grounds that Imperial also engaged in an

illegal straddle transaction and other related intentional misconduct. The court assumed these

allegations were true but rejected the defense, for two reasons: (i) the defendants did not allege

“they have suffered any serious harm as a result;” and (ii) “Imperial did not have a hand in the

interested director transaction.” Id. at *11.

SVLG does not make the necessary showing that that the complained of conduct injured

SVLG directly, because the acts on which it relies are not connected to it. SVLG does not even

attempt to argue that any post-acquisition conduct meets this test. It is undisputed that all of the

acts of malpractice by SVLG occurred in connection with the sale transaction, and thus prior to

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the involvement of any wrongdoer. Neither the Trustee nor SVLG claims that SVLG

participated in the wrongdoing with Okun. After the December 19, 2006, transfer, SVLG no

longer represented 1031 Advance. Devorkin Decl. ¶ 10. SVLG did not represent 1031

Advance at the time that SVLG alleges it was engaged in the alleged bad act or when it alleges

Okun owned and controlled it, and such events could not have been directed at or injured

SVLG in its relationship with 1031 Advance. As to this element, SVLG offers only one

argument: “Okun’s conduct in purposefully buying 1031 Advance in order to utilize its funds

to perpetuate his ongoing Ponzi scheme is clearly ‘misconduct in the particular transaction,’

and is ‘connected to the subject matter of the litigation’ and ‘affects the equitable relations

between the litigants.’” Mem. at 17. But Okun’s activities prior to the sale are irrelevant, and

certainly were not directed at SVLG.

D. SVLG Cannot Impute Okun’s Conduct To 1031 Advance.

SVLG does not really rely on any conduct of 1031 Advance prior to the sale and the

transfer of the $23.2 million on December 19. As we have shown, there is none on which to

rely. SVLG really relies on Okun’s conduct, principally after the sale, and after SVLG’s

representation ended. 26 As we discussed above, however, this is not directly related to and did

not injure SVLG. We now discuss additional reasons why the defense fails, because this

conduct should not be imputed to 1031 Advance, at least on summary judgment.

SVLG creates a confused and conflated version of events and their sequence to suggest

an appearance of intentional wrongdoing by 1031 Advance that did not exist. The alleged

“misconduct” is conduct by Okun (i) as acquiror prior to the closing, when SVLG did not

represent Okun but represented his adversary; and (ii) in the weeks and months after that

transaction closed and after SVLG ceased its representation. Neither supports this defense.

26 If Okun were suing his own attorney for helping him commit the wrongdoing, then the defense might work.

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1. SVLG Cannot Impute to 1031 Advance Okun’s Conduct Prior to Buying 1031 Advance.

SVLG must prove that 1031 Advance engaged in willful misconduct in a manner that

directly relates to the claims and the relationship between SVLG and its clients, i.e., that such

conduct injured SVLG. SVLG does not and cannot establish a basis for imputing Okun’s pre-

acquisition conduct to 1031 Advance, because it is undisputed that Okun had no relationship to

1031 Advance at that time of SVLG’s representation and malpractice.

2. SVLG Cannot Impute to 1031 Advance Okun’s Post-Acquisition Conduct, Because He Acted Adversely To The Company.

To hold 1031 Advance accountable for unclean hands, one must hold it accountable

for Okun, and to do that one must impute his conduct to the company. Imputation is a legal

fiction based on the presumption that the agent will communicate his knowledge to the

principal, whether he or not actually does so. Martin Marietta Corp. v. Gould, Inc., 70

F.3d 768, 773 (4th Cir. 1995); In re CBI Holding Co., 311 B.R. 350, 370 (S.D.N.Y. 2004),

recons. grtd on other grds, 318 B.R. 761 (S.D.N.Y. 2004), rev’d on other grds, 529

F.3d 431 (2d Cir. 2008); Since imputation rests on this fiction, when the interests of the

agent and the principal are not identical, “the reason for the rule ceases and the rule should

fail.” Lohmuller Bldg. Co. of Baltimore v. Gamble, 154 A. 41, 43 (Md. 1931). In other

words, an agent's knowledge will not be imputed to the principal where the agent is acting

adversely to the principal and for his own benefit. Meyer v. Glenmoor Homes, Inc., 246 Cal.

App. 2d 242, 264 (Cal. Ct. App. 1966) (not chargeable with officer who collaborates with an

outsider to defraud it”); cf. Cobolt Multifamily Investors I, LLC v. Shapiro, 2009 WL

2058530 (S.D.N.Y. July 15, 2009) (in pari delicto context).

In the Ninth Circuit, any discussion of disqualifying the Trustee on grounds of unclean

hands misconduct by another party is controlled by O’Melveny I and O’Melveny II, which

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SVLG ignores. In O’Melveny I, the FDIC, as a receiver on behalf of a failed savings bank,

brought a claim against a law firm for breach of duty. The Court rejected the implication that if

the client is doing something wrong, of which the attorney may not be aware, that wrong

cancels the attorney’s duty to use due care. 969 F.2d at 748. In O’Melveny, unlike here, the

lawyer had assisted the client in its misconduct, but the Court nonetheless specifically held that

the “unclean hands” defense did not bar the FDIC from pursuing the wrongdoing corporate

insiders, on the grounds that the client was the banking institution, not the insiders.

Applying California law, the Court held that principles of corporate identity and agency

law precluded imputation of the insiders “unclean” conduct to the entity, because the

wrongdoers were acting adverse the corporation. O’Melveny I rejected imputation and held

that the adverse interest exception applies even when “a single individual owns nearly all of

the corporation's stock.” 969 F.2d at 750. It did so because a “corporation is a distinct

legal entity separate from its stockholders and from its officers,”27 and a corporation may

sustain distinct, actionable harm despite the wrongful conduct of its officers and sole

shareholders in causing that harm. 969 F.2d at 750 (quoting Merco Constr. Eng'rs v. Mun.

Court, 21 Ca1.3d 724, 729 147 Cal. Rptr. 631, 634 (1978)); accord, Cobolt, at *9 n. 5. Looting

corporate funds is the classic example of adverse interest. Beck v. Deloitte & Touche, 144 F.3d

732, 737 (11th Cir. 1998); Southmark Corp. v. Cagan, 999 F.2d 216 (7th Cir. 1993). There is

no dispute that Okun acted adversely to 1031 Advance.

Courts have also applied principles of flexibility and fairness in refusing to impute to a

successor corporation. In re Cendant Corp. Sec. Litig., 139 F. Supp. 2d 585 (D.N.J. 2001),

held that it would be “unfair to impute” to the surviving corporation of a merger the

knowledge and fraud perpetrated by the company’s pre-merger managers to immunize

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auditors from liability for their part in the fraud. Id. at 597-98; see also Battenfeld of America

Holding Co. v. Baird, Kurtz & Dobson, 60 F. Supp. 2d 1189, 1218 (D. Kan. 1999) (refused to

impute fraud to surviving corporation that was a victim of the original corporation).

3. Okun Was Not the Sole Decision Maker of 1031 Advance.

To the extent SVLG argues that adverse interest principles should be discarded and

Okun’s conduct should be imputed to 1031 Advance because he was the sole shareholder of

1031 Tax Group, which owned 1031 Advance after the sale, O’Melveny I and II held that

under adverse interest, unclean hands should not disqualify a plaintiff even in the case where

the corporation is owned by the wrongdoers. While this often arises in the in pari delicto

context, it makes equal, if not more sense, as to unclean hands. Some courts have recognized a

sole decision-maker exception to the adverse interest exception to imputation if the agent is the

sole representative of the corporation with respect to the transaction at issue, see Ash v. Georgia

Pacific Corp., 957 F.2d 432, 436 (7th Cir. 1992), but that exception to the exception should not

be applicable if (1) the person invoking the defense is himself guilty of wrongdoing; or (2)

other relevant decision-makers could and would have stopped the wrongdoing had they known

the truth.

a. SVLG is Not Innocent.

For SVLG to invoke the exception to the exception it must be innocent. See O'Melveny I,

969 F.2d at 751 (cannot invoke estoppel defense unless party is innocent itself). A person who

knowingly participates or acquiesces in wrongdoing or does not act in good faith cannot invoke a

defense based on company misconduct. Official Committee of Unsecured Creditors of Allegheny

Health Educ. and Research Found. (“AHERF”) v. PriceWaterhouseCoopers, LLP, 605 Pa. 269

(Pa. 2010). The rule imputing an agent's knowledge to the principal protects “only those who

27 The Court followed Schact, 711 F.2d 1343 (7th Cir. 1983); Cenco, Inc. v. Seidman & Seidman, 686

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exercise good faith, and is not intended to serve as a shield for unfair dealing by third person[s].”

BCCI Holdings (Luxembourg), S.A. v. Clifford, 964 F. Supp. 468, 480 (D.D.C. 1997). See Saks

v. Charity Mission Baptist Church, 90 Cal. App. 4th 1116, 1140 (Cal. Ct. App. 2001).

This Court has already found in Hunter sufficient evidence that SVLG knew that Okun was

acting adversely and that SVLG participated in aiding and abetting a breach of fiduciary duty. On

this basis, SVLG would not be “innocent” and could not invoke the sole decision-maker exception.

Thus, it is premature to determine the applicability of this defense on summary judgment.

b. There Were Innocent Decision Makers.

The root of the sole actor rule is that the agent and the principal are literally the same

person, but it should not apply where there are innocent decision makers who can correct the

course of conduct, particularly where creditors are affected in light of insolvency threatened by

looting. The sole actor exception should only apply if all relevant decision makers are involved

in the wrongdoing. See Wight v. Bank America Corp., 219 F.3d 79, 97 (2d Cir. 2000); First

Nat’l Bank v. Lewco Sec. Corp., 860 F.2d 1407, 1418 (7th Cir. 1988); FDIC v. St. Paul Cos.,

634 F.Supp.2d 1213, 1221 (D. Colo. 2008); Wechsler, 212 B.R. at 36 n.1, 46; Casey v. U.S.

Bank Nat. Ass’n, 127 Cal. App. 4th 1138, 1143 (Cal. Ct. App. 2005); Wechsler, Squadron,

Ellenoff, Plesent & Sheinfeld L.L.P. (“Wechsler II”), 994 F. Supp. 202, 207 (S.D.N.Y. 1998)

(two innocent outside directors could and would have stopped the fraud). Wrongful conduct

should not be imputed to the plaintiff entity if there is evidence of at least one innocent member

of management who could have prevented the fraud had he known about it. Wechsler I at 36;

see In re CBI Holding Co., Inc., 311 B.R. at 364-65; In re Sharp Int’l. Corp., 278 B.R. 28

F.2d 449 (7th Cir. 1982); and In re Investors Funding Corp., 523 F. Supp. 533 (S.D.N.Y. 1980).

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(Bankr. E.D.N.Y 2002).28 At a minimum, whether there exists an “innocent insider” is an issue

of fact. Id. at 38; Wechsler II at 203.

SVLG relies on Lafferty, in which the court, applying Pennsylvania law, imputed to two

corporations the fraudulent conduct of the sole shareholder who, together with his family,

dominated and controlled the corporations. 267 F.3d, at 360. Lafferty, relied on plaintiff’s

admissions in the complaint of such control. Lafferty acknowledged that the rationale behind the

sole decision-maker rule is that a “sole agent has no one to whom he can impart his knowledge, or

from whom he can conceal it . . . .”, and in that situation, “the corporation must bear the

responsibility for allowing an agent to act without accountability.” Id. at 359. This conclusion

and rationale does not apply here, because the Trustee alleges and evidence shows that Okun

and others affirmatively concealed their wrongful conduct from independent decision makers,

who could and would have stopped it.

There is ample proof here raising questions of fact as to Okun’s alleged control and the

existence of independent decision makers. Okun was not an officer of 1031 Advance. Dashiell

and Allred served as the President and Vice President of 1031 Advance before and after the

acquisition. Devorkin Decl. ¶¶ 4, 49. Okun was not a shareholder of 1031 Advance, but rather,

1031 Tax Group became the sole shareholder upon the sale in December 2006. Id. ¶ 50.

Individual QI’s affiliated with 1031 Tax Group, including 1031 Advance, operated through

28 Generally, where a sole shareholder's wrongful conduct has been imputed to the entity, that sole shareholder was also the sole decision-maker who exercised control over the operations and business activities of the entity. See, e.g., In re Mediators, 105 F.3d 822, 827 (2d Cir. 1997), aff'g 190 B.R. 515, 528 (S.D.N.Y. 1995) (sole shareholder and decision-maker); Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1095 (2d Cir. 1995); Wagoner, 944 F.2d at 119 (sole stockholder and decision-maker); Breeden v. Kirkpatrick & Lockhart, LLP, 268 B.R. 704, 711 (S.D.N.Y. 2001), aff'd, sub nom, In re Bennett Funding Group, Inc., 336 F.3d 94 (2d Cir. 2003) (only two shareholders delegated unfettered control to son Patrick, who “was running the company”); Hampton Hotel Investors v. Beeler (In re Hampton Hotel Investors, L.P.), 289 B.R. 563, 576 n.22 (S.D.N.Y. 2003) (sole general partner and “no other decision makers to stop his activities.”). Thus, the sole decision-maker exception is not about sole ownership, but rather the culpable agent's total control and decision-making power over the operations of the principal.

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separate offices throughout the country and acted independently to a large extent. Id. ¶ 51.

SVLG offers no basis to disregard this corporate management structure and to collapse the

parent and subsidiary relationship between 1031 Tax Group and 1031 Advance in order to

attribute the act of the owner of the parent to the subsidiary. There is also substantial evidence

that Dashiell remained in control of the company. Dashiell testified that she had no knowledge

of the scheme, had relied on SVLG to believe that limited borrowing was not improper, and

that she did everything she could to uncover, stop, and report the scheme to the authorities,

once she knew about it. Devorkin Decl. ¶¶ 21, 24, 28-29, 63, 64, 66-70. She (and McCabe, the

corporate decision makers of other QI’s in the 1031 Tax Group) could and would have stopped

the fraud at 1031 Advance, so that one cannot equate Okun and the company, at least for

purposes of unclean hands. Devorkin Decl. ¶¶ 52-54, 71-81.

As for the document on which SVLG repeatedly relies to show that Okun made “all

final decisions,” Dashiell’s testimony is diametrically opposed to the conclusion that SVLG

seeks to draw. Devorkin Decl. ¶ 55. She said that the statement had nothing to do with the

QI’s, but related only to Okun Holdings, Inc. and to a dispute in the tenant-in-common real

estate business of Investment Properties of America (“IPofA”).29

SVLG makes inaccurate and incomplete references to Dashiell’s post-acquisition

conduct, but such post-acquisition conduct is not directly related to the claims or SVLG,

because it did not occur during the period of SVLG’s representation of 1031 Advance, had no

relationship to SVLG, and could not cause SVLG injury. See supra at 17-23. SVLG offers no

29 SVLG also misrepresents the testimony of James Lukenda, the Chief Restructuring Officers for the 1031 Debtors for a time in 2007. He nowhere states that “the Debtors were controlled by Okun” or other portions of the quote attributed to him. Mem. at 14. He only says that Okun was the sole member of the parent, 1031 Tax Group. Devorkin Decl. ¶ 56. SVLG also refers to testimony from Coleman about various people who knew that Okun stole money and were unable to stop him, but these individuals worked for IPofA or Okun Holdings, had nothing to do with 1031 Advance, and most of them left before 1031 Advance was ever acquired. Two are Okun’s criminal co-conspirators. Id. ¶ 57.

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evidence that Dashiell acted with bad intent, a requirement of unclean hands. To the contrary,

the evidence reveals that Dashiell was the whistleblower, who reported activities at The 1031

Tax Group to the federal government, made government sponsored recordings to obtain critical

evidence, and was instrumental in stopping the fraud. Devorkin Decl. ¶ 75. Any argument as

to her conduct must be made at trial, on causation and comparative fault, which are the only

issues for which this is proper.

There are also significant disputes of fact with respect to these events. For example

only, SVLG states that Dashiell learned that Okun transferred funds without her consent in

February 2007. Mem. at 15. The evidence shows, however, that (i) the February 2007 “loan”

was returned quickly and deliberately to lull Dashiell into believing that nothing out of the

ordinary was afoot (Devorkin Decl. ¶ 63); (ii) Dashiell had no knowledge that significant funds

were missing (id. ¶ 67); and (iii) SVLG’s improper advice had led her to believe that limited

borrowing was acceptable (id. ¶¶ 24, 28-29, 68). Further, Dashiell objected vociferously and

pushed for repayment when subsequent takings occurred from accounts of 1031 Tax Group in

March 2007. Id. ¶ 66. The efforts to amend the exchange agreements used at the QIs does not

prove Dashiell was a wrongdoer either. That project had multiple objectives, including to unify

the agreements used, and all were aware that the version circulated at Simring’s request on

January 31, 2007, was withdrawn for further revision by Okun’s lawyers the very next day.

Id. ¶¶ 59-61.

SVLG, having led Dashiell to believe that borrowing is acceptable, is hardly in a

position to accuse Dashiell of engaging in intentional bad conduct when she learned of limited

borrowing post-acquisition but did not realize its significance or act quickly enough. In short,

this case is distinguishable from the cases cited by SVLG because in those cases there was no

dispute of fact as to who engaged in misconduct, and to Okun’s wrongdoer’s ownership and

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control of theplaintiff. See Peregrine, 133 Cal. App. 4th at 679 (complaint conceded the issue);

Lafferty, 267 F.3d at 359 (same).

E. The Bankruptcy Code Does Not Bar The Trustee.

Finally, relying on Lafferty and law of other circuits, SVLG argues that as a matter of

law, under Section 541 of the Bankruptcy Code, 11 U.S.C. § 541(a)(1), a bankruptcy trustee

has no more rights than the debtor had at the commencement of the case.30 Mem. at 15. While

this rule is much criticized and we submit the more correct view is that taken by the Ninth

Circuit and other courts, even under the Lafferty line of cases, it is equally true that a trustee has

no fewer rights than the debtor. Thus, the ultimate question is what rights did 1031 Advance

have under California state law, when there are allegations of misconduct by some of its agents.

267 F. 3d, at 340. All of the arguments set forth above explain why the unclean hands defense

is inapplicable to this case and unavailable to SVLG. Since 1031 Advance could bring these

claims unbarred by this doctrine, the Trustee may do so too.

In addition, the Ninth Circuit has indicated that Trustees are not burdened by insiders’

bad acts. As noted above, O’Melveny I applied California law to reject the unclean hands

defense on the grounds that the client was the banking institution, not the insiders. Id. at 750.

On remand, O’Melveny II adopted its “earlier opinion in haec verba” (with an exception not

applicable here), id. at 19, and reaffirmed that “unclean hands” is not generally a defense

against a receiver. It did not limit its reasoning to receivers:

. . . there is little reason to impose the same punishment on a trustee, receiver or similar innocent entity that steps in the party’s shoes pursuant to court order or operation of law. Moreover, when a party is denied a defense under such circumstances, the

30 These cases stand for the limited proposition that, under federal law, the trustee’s status does not make him innocent and free him from any restriction that state law applies on the corporation at the time of commencement of the case. State law allows the Trustee’s claim here and other cases discussed below hold otherwise.

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opposing party enjoys a windfall. This is justifiable as against the wrongdoer himself, not against the wrongdoer’s innocent creditor[].

Id. (emph. added). The Court then repeated a critical section of O’Melveny I that makes clear

that in California, this point applies with equal force to the Liquidation Trustee:

A receiver, like a bankruptcy trustee and unlike a normal successor in interest, does not voluntarily step into the shoes of [the bankrupt]; it is thrust into those shoes. It was neither a party to the original inequitable conduct nor is it in a position to take action prior to assuming the [bankrupt's] assets to cure any associated defects [quoting from O'Melveny I, 969 F.2d at 751-52].

The Court concluded: “to [do] otherwise would be to elevate form over substance-something

courts sitting in equity traditionally will not do.” Id., 61 F.3d at 19.

Loyd, 208 F.3d at 758, is even more compelling, in that an entity’s claim survives for a

bankruptcy trustee. It held that a bankruptcy trustee can proceed even though insiders owned a

“virtually insolvent” sham corporation, whose sole purpose was to bilk its insurance clients of

premiums and divert them to the insiders via a Ponzi scheme. Scholes v. Lehmann, 56 F.3d

750, 754 (7th Cir. 1995), applied these principles with great eloquence. The wrongdoer’s acts

were not imputable to the plaintiff corporation, because it could have “lawfully have ratified

the diversion of corporate assets . . . only if creditors were not harmed.” Id.

[T]he appointment of a receiver removed the wrongdoer from the scene. The corporations were no more [his] evil zombies. Freed from his spell they became entitled to the return of the moneys --for the benefit not of the [wrongdoer] but of innocent investors --that [the wrongdoer] had made the corporations divert to unauthorized purposes. . . . That the return would benefit the limited partners is just to say that anything that helps a corporation helps those who have claims against its assets. The important thing is that the limited partners were not complicit in [the] fraud; they were its victims. Id.

The rationale of O’Melveny and Scholes has been applied equally in the case of claims

brought by a bankruptcy trustee. Tew v. Chase Manhattan Bank, 728 F. Supp. 1551 (S.D. Fla.

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1990).31 While Lafferty and several circuits have barred claims by a bankruptcy trustee, each case

recognized that the debtor’s rights to proceed at the commencement of the case are determined

under applicable state law.32 Indeed, a professional, who is held to a higher standard of duty,

should be less able to invoke the doctrine and discard normal rules of fault. See O’Melveny I and

II. Many states do not allow professionals to blame the client for their own neglect,33 NCP

Litigation Trust v. KPMG LLP, 187 N.J 353, 372, n. 2 (N.J. 2006), or significantly limit it.

Universal Builders, Inc. v. Moon Motor Lodge, Inc., 430 Pa. 550 (Pa. 1968).

F. Public Policy Does Not Support Absolving SVLG Of Responsibility For Its Professional Malpractice And It Conflicts With California’s Scheme Of Tort Law.

Unclean hands is an equitable doctrine. Even if SVLG had met its burden of proving

each element, it should be applied only where equity is served. Here, no equitable result will

be achieved by barring the Trustee’s claim against SVLG. SVLG did not represent the

perpetrators of the Ponzi scheme as was true in Peregrine.34 Rather, its clients were innocent

31 See,e.g., Hanover Corp. of America v. Beckner, 211 B.R. 849, 858-59 (M.D. La. 1997); Welt v. Sirmans, 3 F.Supp.2d 1396, 1402 (S.D. Fla. 1997); Comeau v. Rupp, 810 F. Supp. 1127, 1141-43 (D. Kan. 1992) (same); Plaza Mortgage & Fin. v. Basroon (In re Plaza Mortgage & Fin. Corp.), 187 B.R. 37, 47 (Bankr. N.D. Ga. 1995). See also McCandless v. Furlaud, 296 U.S. 140, 156-61 (1935); Gower v. Farmers Home Admin. (In re Davis), 785 F.2d 926, 927 (11th Cir. 1986).32 SVLG has not cited In re Crown Vantage, Inc., 2003 WL 25257821 (N.D. Cal. 2003), which is not an unclean hands case, but an in pari delicto case. The Trustee agrees that it is inapplicable to SVLG’s motion. Among other things, the Court held that none of the claims to which in pari delicto applies “is governed by the law of any state other than Virginia.” Id. at *9. Unlike California, Virginia still applies contributory rather than comparative negligence. Also, the Court failed to acknowledge the mandate of O’Melveny I and II and Loyd that a corporation is to be treated as a separate entity from the individual wrongdoers and that under California law, bankruptcy trustees, like receivers, are not barred in the such circumstances if innocent victims will benefit.33 See, e.g., Lincoln Grain, Inc. v Coopers & Lybrand, 216 Neb. 433, 441-2 (Neb. 1984); Bd. of Trustees of Comm. Coll. Dist. No. 508 v Coopers & Lybrand, 8 Ill. App. 2d 331, 336 (Ill. 2003); (relying on the Restatement (Third) of Torts: Apportionment of Liability § 7, Comment m, at 70 (2000): “a client's poor business practices cannot be asserted as a defense to the auditor's negligent failure to discover and report the client's non-compliance with ... legal requirements).” 34 For the company that was admittedly owned and controlled by the perpetrator of the Ponzi scheme “to now complain of [its lawyers’] role in enabling it to commit the fraud is unfair, and it is precisely

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victims of the wrongdoing, which would not have been swept into the scheme if SVLG had

performed appropriately. To bar the Trustee’s claims against SVLG effectively rewards SVLG

for the very conduct that caused 1031 Advance to become caught in the Ponzi scheme and

makes no sense.35

Furthermore, expanding the use of unclean hands to bar a malpractice suit against

one’s own attorneys on these facts should be disfavored in light of California’s replacement

of contributory negligence as a bar to plaintiff’s recovery with a comparative fault system,

under which a tortfeasor is responsible for the proximate consequences of his misconduct. Li

v. Yellow Cab Co., 13 Cal. 3d 804, 829 (Cal. Ct. App. 1975).36 This doctrine eliminates the

obvious unfairness of contributory negligence, which, like unclean hands, “completely

exonerated a negligent defendant whenever an injured plaintiff was partially at fault.” Am.

Motorcycle Assoc. v. The Superior Court of Los Angeles County, 20 Cal. 3d 578, 607 (Cal.

1978). Comparative fault allows relief to the more innocent party, who is not entirely

blameless, and is the antithesis of “unclean hands.” The entire burden of a loss should not be

“shouldered onto one alone, . . . while the latter goes scot free.” Id., quoting Prosser, Law of

Torts, s. 50, p. 307.

Equity is not served by precluding the Trustee’s claim. The wrongdoers were not

involved at the time of the malpractice, and they are no longer in control and will not benefit

this sort of unfairness the unclean hands doctrine seeks to address.” Peregrine, at 681. Such concerns are irrelevant in the context here.35 This Court has recognized that public policy is not served by imputing insider wrongdoing to bar a company’s claim where an innocent successor will assure that the funds go to the company’s innocent creditors rather than to the wrongdoers. U.S. Fire Ins. Co. v. Vesta Strategies, LLC, No. C 09-02388 JW (N.D. Cal. July 14, 2011) (Ware, J.). Devorkin Decl. Ex. 48 at 11. There the wrongdoers were directly running the company at the time of the wrongdoing.36 Comparative fault is a proper defense in a malpractice case. Theobald v. Byers13 Cal. Rptr. 864, 867 (Cal. Ct. App. 1961). As with unclean hands, comparative fault principles involve factual issues for which summary judgment is inappropriate. Wright v. Stang Mfg. Co., 63 Cal. Rptr. 2d 422, 431 (Cal. Ct. App. 1997).

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from any recovery. Innocent parties likely will be injured by barring the Trustee and may

recover nothing (or at best a few of them may recover if they succeed on their much more

difficult aiding and abetting claims). As for deterrence, holding SVLG responsible for its

misconduct will serve to deter others similarly situated from engaging in similar wrongdoing at

the expense of the companies they serve.

CONCLUSION

For all of the foregoing reasons, SVLG’s motion should be denied.

Respectfully submitted,

Dated: October 29, 2011 GOLENBOCK EISEMAN ASSOR BELL & PESKOE LLP

s/ Michael S. DevorkinMichael S. Devorkin Pro hac viceJacqueline G. Veit Pro hac vice

Attorneys for Plaintiff Gerard A. McHale Jr., P.A. as Liquidation Trustee for the 1031 Debtors Liquidation Trust