Barry M. Klayman and Mark E. Felger

When does a cause of action for professional negligence accrue? In ISN Software v. Richards, Layton & Finger, No. 110, 2019 (Del. Feb. 17, 2020), reargument den. (March 30, 2020), the Delaware Supreme Court, sitting en banc, held that for tort claims, such as legal malpractice claims, the wrongful act occurs at the time of injury, however slight, and the statute of limitations can start to run before any actual or substantial damages occur.

As alleged in the complaint, ISN wanted to convert from a C corporation to an S corporation for tax purposes. However, four of its eight stockholders could not qualify as S corporation stockholders. ISN consulted its law firm, Richards, Layton & Finger (RLF), which advised that ISN could use a merger to cash out some or all of the four stockholders. The cashed-out stockholders could then accept ISN's cash-out offer or exercise appraisal rights under Delaware law. ISN did not proceed with the conversion, but decided to use a merger to cash out three of the four non-qualifying stockholders. ISN completed the merger and reserved funds for the buyout or appraisal award based on the cash-out offer price.

After ISN completed the merger, RLF notified ISN that its advice might not have been correct, and that all four stockholders, including the stockholder whom ISN wanted to exclude from the offer, were entitled to appraisal rights. ISN decided to proceed with the merger and RLF agreed to litigate any appraisal action. RLF and ISN signed a conflict consent agreement, which recited that the proposed representation posed a "potential conflict," since litigating issues arising from the firm's prior legal work may generate a conflict of interest when there is a plausible claim that the firm's prior work was deficient. The agreement further provided that ISN's consent to RLF's representation did not constitute a waiver or release of ISN's potential claims, "if any," against the firm. ISN retained independent counsel to advise it whether to enter into the consent agreement; however, ISN did not raise the possibility of a tolling agreement to preserve its legal malpractice claim.

Three of the four stockholders filed for appraisal, including the largest stockholder whom ISN had hoped to exclude. Over three years later, the Delaware Court of Chancery decided the appraisal action, resulting in a total appraisal value in excess of the amount reserved for the buyout.

ISN then filed an action for legal malpractice against RLF relating to its advice concerning the merger and appraisal rights. The complaint alleged that ISN had been damaged to the extent that the total appraisal value exceeded the reserve amount. RLF moved to dismiss the complaint on statute of limitations grounds. The Superior Court granted the motion. It found that ISN's cause of action accrued on the date that RLF informed it of the alleged negligent advice or, alternatively, when the appraisal action was filed, both of which occurred more than five years before ISN filed suit against RLF.

A majority of the Supreme Court, sitting en banc, affirmed the judgment of the Superior Court, although it applied a different analysis. As the majority viewed the case, the question to be decided was when did ISN suffer injury, however slight, as a result of the alleged faulty advice. The majority concluded that the injury occurred to ISN when the fourth stockholder—the largest of the group and the one whom ISN sought to exclude from the cash out—obtained the right to demand appraisal. Because of RLF's alleged faulty advice, ISN ended up allowing the fourth stockholder to demand appraisal, meaning that ISN could be liable to pay fair value for more shares than contemplated in the cash out transaction. Thus, ISN was liable to pay the fair value of more stock than it had planned, which injured ISN financially.

The majority expressly rejected ISN's argument that its cause of action did not accrue until it could state a claim, whether for injunctive relief or for damages, and damages were not certain until the Court of Chancery's appraisal decision exceeded its reserve amount. ISN argued that it suffered no damages at the time of the merger because the costs to litigate an appraisal proceeding were the same regardless of the number of shares involved, and if the total appraised value of the stock did not exceed the amount it had set aside to  cover its expenses, it would not incur any damages. The majority said that ISN failed to distinguish between an injury sufficient for a cause of action to accrue and damages. Under the Delaware occurrence rule, injury is distinct from damages. The statute of limitations can begin to run before any actual or substantial damages occur. The unintended consequences of the merger injured ISN when the transaction closed because it could not proceed without new liabilities—providing greater appraisal rights than it had intended or unwinding the merger. Once injured, ISN could have brought its legal malpractice claim. As the majority opinion stressed, "Under the current state of Delaware law, however, regardless of complications, inefficiencies, and possible unfairness, a cause of action accrues at the time of the wrongful act, which in this case means when injury occurred and not when damages were certain."

In a rare dissenting opinion, Justice James Vaughn wrote that he would hold that the statute of limitations begins to run when the plaintiff sustains an injury for which the law affords a remedy. Specifically, he would have found that when damage is an essential element of a tort, the claim does not accrue at the time of the defendant's wrongful act or the plaintiff's discovery of the injury, but when the harm is sustained. However, it is not required that all the damages resulting from the act must have been sustained at that time, and the running of the statute of limitations is not postponed by the fact that the actual or substantial damages do not occur until a later date. Since the Superior Court never addressed the key issue—when did ISN sustain injury— Vaughn would have reversed and remanded the case for further proceedings, including proceedings to determine when ISN sustained an injury for which the law afforded a remedy.

Significantly, ISN's statute problem could have been avoided if at the time it agreed to the conflict consent agreement, which provided that ISN was not waiving but was preserving its malpractice claim, ISN had also insisted on a tolling agreement with RLF. If RLF had refused, ISN could have filed the malpractice action and sought to have the action stayed until the extent of the damages was certain. The fact that ISN had the advice of independent counsel when it decided to proceed with the merger and give appraisal rights to all four stockholders, and did not seek a tolling agreement with RLF, was not lost on the majority.

Barry M. Klayman is a member in the commercial litigation group and the bankruptcy, insolvency and restructuring practice group at Cozen O'Connor. He regularly appears in Chancery Court.

Mark E. Felger is co-chair of the bankruptcy, insolvency and restructuring practice group at the firm.