Words Matter: Financial Advisors Need To Be Careful Using Form Engagement Letters

Author:Mr Laurence Lese, David J. Kaufman, Heather Carmody and Rosa M. Ertze
Profession:Duane Morris LLP

Financial advisors may be held liable to third-party beneficiaries for breach of contract and fiduciary duty claims based in part on the specific language in a form public-company engagement letter that was used for a private company transaction. The decision by the U.S. District Court for the District of Massachusetts in Baker v. Goldman Sachs1 demonstrates that some of the provisions in a form engagement letter designed to protect financial advisors in a public company deal may present distinct risks to the same financial advisors in a private company transaction.

Background Goldman Sachs & Co. ("Goldman") represented Dragon Systems, Inc. ("Dragon"), a closely held company founded and controlled by Janet and James Baker (the "Bakers"), in the merger of Dragon into a subsidiary of Lernout & Hauspie Speech Products N.V. (collectively "L&H") on June 7, 2000. The Bakers alleged that Dragon entered into an all-stock merger with L&H in reliance on Goldman's advice and that the collapse of L&H following an accounting fraud scandal uncovered by The Wall Street Journal within months after the Dragon-L&H deal closed resulted in a loss to Dragon's controlling shareholders of approximately $300 million.

In an attempt to recover the consideration they were to receive, the Bakers filed suit against Goldman, asserting the following claims: (1) breach of fiduciary duty, (2) violation of Massachusetts unfair-practices statute, (3) breach of contract, (4) breach of contract / third-party beneficiary, (5) breach of the implied covenant of good faith and fair dealing, (6) negligence and (7) negligent misrepresentation. Goldman moved to dismiss all claims, contending that the Bakers were not parties to the engagement letter between Dragon and the financial advisor, and that its contractual and fiduciary duties ran exclusively to Dragon.

U.S. District Court Decision Applying New York contract law, the court denied the motion to dismiss in principal part with respect to all counts, except for breach of contract. The court ruled that although the Bakers were not parties to the engagement letter, Janet Baker was an intended third-party beneficiary because she was a member of Dragon's board of directors and a majority shareholder at the time of Goldman's engagement by Dragon.

When interpreting the engagement letter, the court ruled that, while Goldman was hired by Dragon, the engagement letter showed an express intent of Goldman to benefit members of Dragon's...

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