Equity: Bona Fide Purchaser Rule Did Not Prevent Constructive Trust Being Granted To FTC When Attorney Did Not Properly Make Inquiry As To Source of Funds

However, Equitable Receipt of Fee Principle Used to Allow Reasonable Fee Before Freezing of Client’s Assets.

     This next case is an important, sobering one for any civil practitioners defending clients charged with Federal Trade Commission (FTC) Act violations, counseling that there is a duty of inquiry with respect to attorneys’ acceptance of retainers so as to avoid forfeiture/disgorgement under FTC freeze or other equitable orders. Pay attention closely to this one.

             Freezing.  Library of Congress. 1924.

     In FTC v. Network Services Depot, Case No. 09-15684 (9^th Cir. Aug. 16, 2010) (for publication), a district judge determined that attorney’s fees were paid from his client’s unlawful FTC activities and imposed a constructive trust over a portion of those fees. Specifically, the attorney representing the FTC-targeted client was paid $375,000 in a flat fee agreement, with the district judge requiring return of all but $136,700—a sum that the court, in equity, permitted the attorney to retain as fees rightfully earned up to the date of the freezing of client’s assets.

     Among other things, the Ninth Circuit affirmed the fee rulings.

     Constructive trust is an equitable remedy, with the federal court of appeals finding use of the remedy was justified where commingled funds (some from unlawful activities) had been used to pay attorney. Appellants mainly relied on the bona fide purchaser rule, arguing that client’s attorney accepted the ill-gotten money in good faith and after a diligent review of the circumstances. Not so much, in essence, was the Ninth Circuit’s response.

     Attorney had a duty of inquiry into the source of the funds under the circumstances, a duty he did not fulfill by primarily relying on the contrary representations of his client. (FTC v. Assail, Inc., 410 F.3d 256, 266 (5^th Cir. 2005).)

     However, this was not the end of the matter. The district judge did not err in allowing attorney to retain $136,700 (although the request was more) for fees incurred by attorney before client’s assets were frozen. Equity, equity, equity.

     An important case to read by attorney representing litigants involved in alleged FTC violations. The case was authored by U.S. District Judge Rebecca R. Pallmeyer (N.D. Ill.), sitting by designation, on behalf of a 3-0 panel.