Appendix — Bain v. Buechel

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APPENDIX A — OPINION OF THE COURT OF

APPEALS, STATE OF NEW YORK

DATED DECEMBER 20, 2001

COURT OF APPEALS OF NEW YORK

' No. 134

Dec. 20, 2001

Frederick F. Buechel, M.D., et al.,

Respondents,

V.

John N. Bain, et al.,

Appellants, et al., Defendants.

SMITH, J.:

The primary issue before this Court is whether parties

should be precluded from relitigating the validity of fee

arrangements determined to be illegal in an earlier action,

when they were in privity with the person against whom the

issue was decided. We conclude that collateral estoppel bars

relitigation.

Plaintiffs, Frederick F. Buechel, an orthopedic doctor

and Michael J. Pappas, a mechanical engineer, are the

inventors of a prosthetic shoulder device called the floating

center prosthetic joint. They retained the firm of Bain,

Gilfillan & Rhodes, P.C. “to undertake the preparation and

prosecution of a patent application covering the invention

on a contingency basis.” The fee agreement, executed on

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November 12, 1974, provided that the law firm would receive

a one-third interest in monies, profits or income resulting

from the invention.

In July 1975, the parties formalized their relationship

and incorporated Biomedical Engineering Corporation (BEC)

in New Jersey. The attorneys’ interests in the corporation

mirrored their fee agreement. Plaintiffs each held one-third

of the shares of the corporation, with the remaining one-third

interest divided equally among Bain, Gilfillan and Rhodes.

Plaintiffs, who had continued to collaborate on development

of prosthetic devices, assigned to BEC their interests in the

floating center prosthetic joint and any future prosthetic

devices invented by them. Significantly, Rhodes failed to

advise plaintiffs of the potential for conflicts of interest that

could result from converting the one-third interest in a single

invention into a one-third equity interest in a corporation

that would exploit all future inventions. A dispute

subsequently arose among the attorneys, resulting in Rhodes’

departure from the firm in December 1981. Defendants Bain

and Gilfillan, however, continued to render legal services to

plaintiffs on BEC matters.

In 1983, for tax purposes, BEC was dissolved, and its

assets were transferred to a newly formed entity, the

Biomedical Engineering Trust (Trust I), also with plaintiffs

as trustees. Again, the trust agreement continued the parties’

prior arrangement. The three attorneys, as shareholders of

the dissolved corporation, received equivalent equity interests

in the trust. In 1984, a second trust, the Biomedical

Engineering Trust II (Trust II) was created, again with

plaintiffs as trustees, and it held the marketing rights to a

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Appendix A

self-centering hip device. While neither Bain nor Gilfillan

held an interest in Trust II, their former partner, Rhodes,

provided patent protection services to the entity.

In 1987, after a dispute arose over trust distributions,

Rhodes commenced an action against plaintiffs as trustees

to recover monies that the trustees allegedly improperly paid

themselves. In response to plaintiffs’ motion to dismiss for

failure to join all the trustees, Rhodes amended his complaint,

adding defendants Bain and Gilfillan ia their capacity as trust

beneficiaries. In 1991, four years after Rhodes commenced

the action, plaintiffs asserted counterclaims against Rhodes

for breach of fiduciary duty and malpractice, alleging among

other things that “the agreements were unfair” and that

Rhodes “while acting as their attorney, induced [plaintiffs]

to enter into the unfair agreements by taking unfair advantage

of his fiduciary capacity and superior knowledge, by

deceiving [plaintiffs] as to the value of his and/or the law

firm’s services and by failing to disclose * * * the value of

the one-third interest relinquished by the inventors.” Plaintiffs

additionally asserted malpractice on the part of Rhodes in

that he represented that he and his law firm were qualified,

competent and experienced in patent and business affairs,

which representations were false. Plaintiffs did not, at that

time, name defendants as adverse parties. In a later letter

sent to defendants, Rhodes’ attorney made clear that if the

counterclaims were established, recovery for the

counterclaims “[would] be subject to contribution by

[defendants] Rhodes’ former partners.”

Recognizing their unity with Rhodes in regard to the

validity of the challenged fee arrangement, on March 12,

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1992, Bain wrote plaintiffs that he was unclear as to how the

counterclaims could be narrowly construed solely against

Rhodes. Bain wrote that he and Gilfillan were “concerned

that the counterclaims could be interpreted broadly to assert

overreaching either by the law firms in which Rhodes,

Gilfillan and I were involved or, at the least by Rhodes as a

partner or agent of those law firms, thereby potentially

extending the consequences of the alleged wrongdoing by

Rhodes to Gilfillan and myself.”

On January 5, 1995, after a number of disputes, Gilfilian

wrote plaintiffs:

“With the trial date apparently becoming

imminent, you have placed John [Bain] and I[sic]

in a position where we have to deal with the

question of whether or not we must become active

in the Rhodes’ litigation to protect our rights, vis-

a-vis the position of the Trustees regarding legal

fees. I would certainly not like to have to do that.

However, I will not waive any rights. We are

gravely concerned that if we do not raise the issue

in this litigation or otherwise provide for

preservation rights, we will be estopped in the

future from challenging the Trustees on this highly

improper conduct. Needless to say, we cannot let

this happen.”

On January 10, 1995, plaintiffs fired Bain and Gilfillan and

moved to amend their counterclaims in the Rhodes action to

assert specific claims against them. Defendants opposed the

motion. Supreme Court denied plaintiffs’ motion because

they failed to offer an acceptable excuse for the delay.

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Appendix A

Plaintiffs then commenced the present action against

defendants Bain and Gilfillan, alleging breach of fiduciary

and ethical obligations and legal malpractice. Plaintiffs

sought the termination of trust payments to defendants and -

the turnover of trust files. At defendants’ request, Supreme

Court stayed the action pending resolution of the Rhodes

action. In support of their request for a stay, defendants

submitted an affidavit to the court, arguing:

“Because of the similarity of the underlying facts

and transactions in both the Rhodes action and

this one, proceeding with this action at this time

would be duplicative and a waste of judicial

resources. Indeed, a decision in the Rhodes case

may estop or bar certain claims in this action.”

In 1998, following a bench trial, Supreme Court

determined in the Rhodes action that the fee arrangement

between plaintiffs and their original counsel, the firm of Bain,

Gilfillan & Rhodes, was invalid. The court found that, from

the outset of the attorney-client relationship, there had not

been full disclosure regarding the possibility of the firm’s

conflict of interest. The court further found that plaintiffs

were never advised to seek independent counsel before

entering into a business relationship with their attorneys, and

that Rhodes had “exploited his clients through affirmatively

pursuing a business relationship with them absent full

disclosure.” The court noted that Rhodes’ extensive ethical

violations constituted serious breaches of his fiduciary

obligation “not to take advantage of his superior knowledge

and position,” and that he failed to inform his clients that he

could be discharged as their attorney at any time.

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Appendix A

Consequently, Supreme Court held that the fee agreement,

from which Rhodes derived his interest in the trusts, was

unethical and unenforceable, and in its decision the court

ordered that “the trust agreements are rescinded.”

The Appellate Division affirmed, concluding “neither the

initial arrangement nor its subsequent incarnations were

entered into upon adequate disclosure * * * of other possible

fee arrangements and potential conflicts of interest, or with

the aid of independent counsel * * *. Rescission of the parties’

arrangements ab initio, with payment to plaintiff in quantum

meruit for his services, is an equitable result * * *”

(258 A.D.2d 274 [1999] [citations omitted] ). This Court

declined to hear the appeal (93 N.Y.2d 806 [1999] ).

By order dated February 5, 1998, Supreme Court lifted

the stay in the present suit, and on March 23, 1998, defendants

Bain and Gilfillan answered the complaint and asserted

counterclaims, seeking their reinstatement as beneficiaries

of the Trust. Defendants alleged that plaintiffs “repudiated

their agreements with Bain and Gilfillan and now contend

that all such agreements are void ab initio.” Both parties

moved for summary judgment. Supreme Court granted

plaintiffs’ motion for partial summary judgment, rescinding

and terminating defendants’ equity interests in Trust I and

ruled the fee agreements between plaintiffs and defendants

unenforceable, ab initio, “because they were entered into in

violation of the ethical duties owed to plaintiffs.” The court

directed defendants to return to plaintiffs all monies

distributed less reasonable attorneys’ fees.

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Appendix A

The court-explained that the issue of rescission was

thoroughly litigated in the Rhodes action, and that defendants

had elected to elude every opportunity to participate actively.

Supreme Court determined that defendants were in privity

with Rhodes, that they “actually did cooperate somewhat in

[his] trial preparation,” and that on “this score absolutely no

adverse relationship existed between them.” Finally, the

defendants had not shown that their failure to more fully

participate in the Rhodes action prejudiced them or affected

its outcome. The court stated, “judging by the context of

defendants’ affidavits in the present action, their testimony

in the Rhodes’ action, even assuming its veracity, would not

have met the standard of professional conduct applied in the

prior case, having failed to allege inter alia, that plaintiffs

were informed their attorneys could be replaced without

penalty.”

The Appellate Division unanimously affirmed. The court

rejected the contention that “Bain and Gilfillan were merely

nominal parties to the Rhodes matter,” explaining that:

“The issue presented for decision in Rhodes was

whether or not Buechel and Pappas, as trustees,

were required to make payments to an attorney

whose rights as a trust beneficiary derived from

the fee agreement between Buechel and Pappas,

individually, and the law firm of Bain, Gilfillan

& Rhodes. This action similarly addresses the

status of attorney-beneficiaries whose rights to

receive proceeds from the trust are predicated on

the identical fee agreement”

(275 A.D.2d 65, 71-72 [emphasis in Original]).

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Appendix A

On motion for reargument, defendants contended that

the claims against them for nullification of the fee agreement

were not precluded. They also argued, for the first time, that

plaintiffs were barred from bringing suit against them under

the doctrine against claim splitting. The Appellate Division

denied the reargument motion and certified the following

question to this Court: “Were the orders of the Supreme

Court, as affirmed by this Court, properly made?”

We conclude that they were.

Analysis

The equitable doctrine of collateral estoppel is grounded

in the facts and realities of a particular litigation, rather than

rigid rules. Collateral estoppel precludes a party from

relitigating in a subsequent action or proceeding an issue

raised in a prior action or proceeding and decided against

that party or those in privity (Ryan v. New York Tel. Co.,

62 N.Y.2d 494, 500 [1984] ). The policies underlying its

application are avoiding relitigation of a decided issue and

the possibility of an inconsistent result (D ‘Arata v. New York ,

Cent. Mut. Fire Ins. Co., 77 N.Y.2d 659, 664 [1990]).

Two requirements must be met before collateral estoppel

can be invoked. First, the litigant seeking the benefit of

collateral estoppel must demonstrate that the decisive issue

was necessarily decided in the prior action against a party,

or one in privity with a party (see, Gilberg v. Barbieri,

53 N.Y.2d 285, 291 [1981]). Second, the party to be precluded

from relitigating the issue must demonstrate the absence of

a full and fair opportunity to contest the prior determination.

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Appendix A

The doctrine, however, is a flexible one, and the

enumeration of these elements is intended merely as a

framework, not a substitute, for case-by-case analysis of the

facts and realities. “In the end, the fundamental inquiry is

whether relitigation should be permitted in a particular case

in light of * * * fairness to the parties, conservation of the

resources of the court and the litigants, and the societal

interests in consistent and accurate results. No rigid rules

are possible, because even these factors may vary in relative

importance depending on the nature of the proceedings * * *”

(see, Staatsburg Water Co. v. Staatsburg Fire Dist.,72 N.Y.2d

147, 153 [1988] [citations omitted] ).

Applying these principles, we conclude that defendants

are barred from now once again litigating the validity of a

trust agreement that was — after extensive pretrial and trial

proceedings involving them—found to be invalid.

In determining whether collateral estoppel applies here,

the initial question is whether defendants — parties in the

Rhodes action who were not named in the plaintiffs’

counterclaim — should, nevertheless, be bound by the

determination rescinding the Trust. Because for purposes of

collateral estoppel, defendants were in privity with their

former law partner Rhodes as to the validity of the fee

arrangements, we conclude they should be bound.

In the context of collateral estoppel, privity does not have

a single well-defined meaning (Matter of Juan C. v. Cortines,

89 N.Y.2d 659, 667 [1997] ). Rather, privity is “an amorphous

concept not easy of application * * * and includes those who

are successors to a property interest, those who control an

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action although not formal parties to it, those whose interests

are represented by a party to the action, and (those who are)

coparties to a prior action” (id., at 667-668 [citations

omitted]). In addressing privity, courts must carefully analyze

whether the party sought to be bound and the party against

whom the litigated issue was decided have a relationship that

would justify preclusion, and whether preclusion, with its

severe consequences, would be fair under the particular

circumstances. Doubts should be resolved against imposing

preclusion to ensure that the party to be bound can be

considered to have had a full and fair opportunity to litigate.

For present purposes, Bain and Gilfillan were in

privity with their former law partner, Rhodes, as he was a

co-signatory to the fee agreement and co-beneficiary to the

Trust proceeds arising from the fee agreement. Considering

the facts and realities of the matters before us, we agree with

the Appellate Division that defendants should be deemed to

be in privity with Rhodes for purposes of litigating the

validity of their fee arrangements as embodied in the trust.

Defendants’ rights to receive payments were coextensive with

Rhodes and derived from the identical arrangement entered

into when the three were law partners. As the Appellate

Division concluded, “[a]s partners in the law firm that entered

into the fee agreement with plaintiffs, [Bain and Gilfillan’s]

right to receive trust income-stands or falls with the contract.”

Indeed, defendants themselves recognized that adjudication

of Rhodes’ conduct as a partner or agent of the law firm would

have consequences for them. Defendants’ interests were

aligned with Rhodes with respect to the lawfulness of the

fee arrangements where millions of dollars were at issue.

Thus, it is appropriate to bind them by the judgment in Rhodes

under the doctrine of collateral estoppel.

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Appendix A

Defendant trustees — parties to the Rhodes action with

notice of the issues to be decided in that case —

acknowledged that they were themselves “unclear as to how

the wording of portions of the counterclaim [could be]

narrowly construed” to exclude them. Given these facts, asa

policy matter we agree with the Appellate Division that a

“party to a lawsuit cannot sit by idly while a contract, to

which he is also a party, is judicially construed without being

precluded by the result” (supra, 275 A.D.2d, at 74).

Knowing that the validity of the trust was being

vigorously contested in Rhodes, and knowing the potential

serious adverse consequences of the litigation, in this

particular case it is appropriate to deem defendants’ interests

represented by Rhodes. Defendants cannot be rewarded for

their conscious, tactical decision not to take a more active

role in that litigation by now allowing the very same issues

and facts to be relitigated. A contrary determination would

undermine a policy interest that is at the heart of collateral

estoppel — discouraging relitigation of issues and the

potential for inconsistent outcomes.

We turn next to whether the two basic requirements for

collateral estoppel have been met.

A comparison of the issue raised in the present action

with the issue raised in the Rhodes action reveals that the

identical issue was already litigated and decided. In the

Rhodes action, Supreme Court determined, after extensive

pretrial and trial proceedings, that the original fee agreement

was unlawful as it was procured in violation of the canons

of ethics. Supreme Court further concluded “that with regard

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Appendix A

to fees, the Trust Agreement merely recodified the prior fee

arrangements entered into” and that because “plaintiffs did

not have the benefit of truly independent counsel and were

never instructed to seek [independent legal] advice * * * the

trust agreements are rescinded.” This is the very issue that

defendants seek to relitigate in the present action hoping that

the second time around a court will reach a contrary

determination.

Defendants, moreover, have failed to establish the lack

of a full and fair opportunity to litigate the validity of the fee

agreement in the Rhodes action. Because defendants were in

privity with Rhodes, the critical question is whether Rhodes

had a full and fair opportunity to litigate the issue

(see, D’Arata v. New York Cent. Mut. Fire Ins. Co., supra,

76 N.Y.2d, at 666). We conclude that he did. In extensive

proceedings, Rhodes vigorously defended the validity of the

trust. Moreover, as noted by the Appellate Division,

defendants were not just nominal parties but, as trust

beneficiaries, were essential parties whose rights were

affected by the outcome of the Rhodes action. The record

reflects that defendants produced documents for the litigation,

received copies of select documents used in the trial

(including deposition transcripts), and agreed to testify as

witnesses on behalf of Rhodes before changing their minds

at the last minute.

Defendants make much of the fact that Supreme Court

denied plaintiffs’ motion to amend their counterclaims to

assert claims-against defendants. While true, this fact does

not undermine the holding of Rhodes which disposed of the

essential claim in the instant action in holding the fee

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agreement was unenforceable. All that denial of the motion

to amend guaranteed was that defendants would not be

subject to a monetary judgment in the Rhodes action.

Additionally, it was defendants who beseeched the trial court

to stay this action pending a determination in Rhodes, fully

intending to invoke the benefits of the judgment if the

outcome was favorable to them. Although, as the dissenting

opinion points out, abolition of the mutuality of estoppel

doctrine authorizes such use of issue preclusion, nothing in

our case law correspondingly prohibits taking this fact into

account in analyzing whether-defendants — parties in the

Rhodes action whe had notice of all the proceedings—should

be bound by a determination against one with whom they

are united in interest as to the particular issue.” Moreover, it

was defendants who vigorously opposed the expansion of

the Rhodes case to include specific claims by Buechel and

Pappas against Bain and Gilfillan. Defendants based their

opposition on the prospect of additional delay in the Rhodes

litigation.

Finally, defendants’ claim that the present matter

is subject to exclusive Federal jurisdiction is without merit.

* Further addressing the dissent, no one factor is determinative

in our conclusion that defendants here were in privity with Rhodes.

It is, rather, a confluence of factors that persuades us to affirm,

including defendants’ relationship with Rhodes vis-a-vis the fee

arrangements, their involvement in the action, their awareness of

issues that would be decided, and their acknowledged tactical

decisions regarding the Rhodes litigation. Additionally, because we

hold that collateral estoppel bars relitigation of the validity of the”

trust, defendants’ conclusory affidavits (Dissenting Opinion, at 6)

are irrelevant in this action.

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~

This case is not preempted by patent law because plaintiffs,

the inventors, did not plead any substantive questions of

patent law as an element of the claims asserted against

defendants. A case arises under patent law “when a well-

pleaded complaint establishes either that federal patent law

creates the cause of action or that plaintiffs right to relief

necessarily depends on resolution of a substantial question

of federal patent law, in that patent law is a necessary element

of one of the well-pleaded claims” (Kroll v. Finnerty, 242

F3d 1359, 1363 [2d Cir 2001] ). Here, we agree with the

determination of Supreme Court that this case does not sound

in patent law because the “interpretation of the patent laws

on the issues of priority and infringement are hardly at issue.”

Further, Federal patent statutes do not preempt State law in

this case (see, 37 CFR § 10 .1 [stating that nothing in the

[code] “shall be deemed to be construed to preempt the

authority of each State to regulate the practice of law, except

to the extent necessary for the Patent and Trademark

Office to accomplish its Federal objectives”] ). Nor do lower

court decisions invalidate a patent attorney’s right to receive

an interest in a client’s patent as full or partial payment

(see, 37 CFR § 10.64 [3] ).

Rather, this case addresses the necessary disclosures

attorneys must make and the ethical obligations they must

maintain in the course of their interaction with clients.

Although Federal patent law recognizes that attorneys may

receive an interest in patents in lieu of traditional fee

arrangements, the need for disclosure mandated by the Code

of Professional Responsibility governing the practice of law

in this State is not obviated (see, 37 CFR § 10.1; see also,

Kroll v. Finnerty, supra, 242 F3d, at 1364-1365).

Vr

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The basic problem with the dissent is that it does not

acknowledge that the Rhodes judgment rescinded Rhodes’

interest in the trusts because it found that the agreements

from which the interest arose were invalid. Supreme Court

stated: “[It is] Ordered, Adjudged and Decreed that since all

of the agreements which purport to provide compensation

for legal services, by the payment of money or by providing

an interest in any trust * * * were entered into in violation of

ethical duties owed by attorneys to their clients * * * the

relief sought in the Third Counterclaim in the Verified

amended Answer to the Third Amended Complaint * * * is

granted, thereby terminating and rescinding, ab initio, any

interests Rhodes holds, or may have held, in Trusts I and II.”

Plaintiffs here raise a question that has already been

adjudicated, specifically, whether the fee agreement is invalid

as resulting from a breach of duty by attorneys to their clients.

The dissent also misconstrues the test for privity that

the Court employs. We do not adopt the so called “Virtual

Representation Doctrine.” That doctrine states that a nonparty

may be bound by the results of a trial where the nonparty has

sufficient ties to a litigant.

“Virtual representation demands the existence of

an express or implied legal relationship in which

parties to the first suit are accountable to non-

parties who file a subsequent suit raising identical -

issues. In reviewing cases decided under the

doctrine, we have described the types of

relationships contemplated: ‘estate beneficiaries

bound by administrators, presidents and sole

stockholders by their companies, parent

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Appendix A

corporations by their subsidiaries, and a trust

beneficiary by the trustee’. Southwest Airlines Co.

v. Texas Intern. Airlines, 546 F.2d 84, 97

(5 Cir. 1977)”

(Pollard v. Cockrell, 578 F.2d 1002, 1008-1009 [1978] ).

Moreover, Green v. Santa Fe Indus., Inc. (70 N.Y.2d 244

[1987] ) is clearly distinguishable. There this Court held that

an action by former minority stockholders against several

cornorations for breach of fiduciary duty was not barred by

collateral estoppel. In Green, the only relationship between

the party to be bound, and against whom the issue was

decided, “was that they owned separate blocks of stock in

the same company.” Plaintiffs were not litigants in the prior

Feaucral action and were determined by this Court not to be

in privity with plaintiffs in that action. Here, by contrast, the

relationship between defendants and Rhodes — former

partners and co-trustees entitled to trust funds based on the

identical fee agreement — coupled with defendants’ litigation

posture, compel a different result.

In the end, we cannot agree with our dissenting colleague

that defendants’ strategy was “understandable and legitimate”

(Dissenting Opinion, at 12). Rather, we agree with the trial

court and the unanimous Appellate Division that defendants,

as parties to the action, were well aware that their own fee

agreements were being challenged and construed, and they

had an obligation to take an active role in that litigation —

which went on for nearly a decade — or accept the

consequences. Indeed, the record shows that defendants

themselves knew of the potential costs of their gamble.

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Our holding makes plain that the law will not sanction such

tactical maneuvering at the price of efficiency and consistent

judgments where parties have not shown that they lacked a

full and fair opportunity to be heard.

Accordingly, the order of the Appellate Division should

be affirmed, with costs, and the certified auestion answered

in the affirmative.

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Appendix A

LEVINE, J. (dissenting):

I respectfully dissent. In this case, the majority upholds

the application of collateral estoppel to bar defendants from

litigating an issue that had been resolved, not against them,

but against a third party, at a prior trial. The majority so holds

notwithstanding that the judge in that trial had ruled that it

would have been unfair to bring them in as actual parties for

the litigation of that issue in that forum. This anomalous

(to say the least) result is purportedly reached by the majority

on the ground that defendants were in privity with the losing

party in the prior action. Nevertheless, the majority’s writing

is laced with party preclusion concepts, and it quotes

approvingly from the portion of the Appellate Division’s

decision relying on that ground for preclusion. Thus, I will

address both grounds, each of which-is unsoundly applied

here.

Party Preclusion

Defendants’ former law partner, R. Gale Rhodes,

commenced the prior action in 1987 against plaintiffs as

trustees of two trusts, the corpuses of which were patents

covering prosthetic devices plaintiffs had invented. Plaintiffs

were the named trustees and each a one-thirc beneficiary in

the two trusts. Rhodes and defendants were each a one-ninth

beneficiary of the total royalty income derived from the

patents held in “Trust I.” Their beneficial interests accorded

with the terms of a 1974 retainer agreement the plaintiffs

had signed when Rhodes’ and defendants’ law firm undertook

to provide the legal services for obtaining those patents,

mostly accomplished before Rhodes withdrew from the firm

Wey

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Appendix A

in 1981. Rhodes, but not defendants, was a beneficiary of

“Trust II,” compensating him for patent-related legal services

to plaintiffs after he left the firm.

Count I of Rhodes’ complaint pertained exclusively to

plaintiffs’ alleged breaches of fiduciary duty as the trustees

of Trust I. He charged that plaintiffs unlawfully diverted and

mishandled trust income for their own personal interests.

Rhodes sought an accounting from plaintiffs and that they

be personally surcharged and removed as trustees.

As beneficiaries of Trust I, defendants would have been

directly affected by the relief Rhodes requested. Hence, they

concededly were necessary parties as to that cause of action,

and Rhodes joined them as “defendant-beneficiaries”

in response to plaintiff’s motion to dismiss based upon

nonjoinder. It is uncontroverted that they did not actively

participate in the lawsuit, however.

Some four years after Rhodes initiated suit, plaintiffs,

as individuals, interposed five counterclaims against him

alone. Their third counterclaim sought ab initio rescission

of Rhodes’ interest in Trust I, on the ground that, as their

attorney in processing the applications for the patents held

in the trust, he had a conflict of interest and breached his

fiduciary duty to them by inducing them to enier into a

retainer agreement giving him a proprietary interest in their

inventions. Four years later, plaintiffs sought for the first time

to amend their answer to extend that counterclaim to

defendants. That motion was denied.

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Appendix A

Plaintiffs then brought this separate action against

defendants, which was stayed while Rhodes’ suit proceeded

to trial. The trial concluded with a judgment in plaintiffs’

favor on their third counterclaim.

On the foregoing procedural facts, the majority agrees

with the Appellate Division that defendants are collaterally

estopped, on the basis of their presence as “essential parties”

in the prior action (i.e., party preclusion), from defending

the validity of their interests in Trust I. The majority

quotes with approval the Appellate Division’s statement

that “ ‘[a] party to a lawsuit cannot sit by idly while a contract,

to which he 1s also a party, is judicially construed’ ”

(__N.Y.2d_.,at__ [Slip Opn, at 12] [emphasis supplied]).

There are two fatal factual flaws in the foregoing

reasoning, as a close examination of the pleadings and

procedural history of the prior suit discloses. First, defendants

were not parties to the entire prior litigation. Rhodes merely

joined them as trust beneficiaries on his claim in Count I of

his complaint. That cause of action related solelv to alleged

misconduct of plaintiffs as trustees of Trust I. In defending

against Rhodes’ claim in Count I, plaintiffs neither placed in

issue the validity of Trust I nor defendants’ status as trust

beneficiaries. Then, in counterclaiming individually (not as

trustees) against Rhodes to rescind only his beneficial

interests in Trust I and Trust II, plaintiffs again refrained from

challenging the validity of Trust I or defendants’ beneficial

interests in it. Had they done so, obviously, defendants would

have been necessary parties to the counterclaim, requiring

cross-claim joinder by plaintiffs, just as joinder had been

required on Rhodes’ Count I cause of action (see, CPLR

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Appendix A

3019[b]; Siegel, Prac Commentaries, McKinney’s Cons Laws

of NY, Book 7B, CPLR 3019, at 216).

Furthermore, in the former litigation, plaintiffs

themselves must have determined that defendants’ nominal

party status on Rhodes’ Count I cause of action was

insufficient to bind them conclusively to any judgment

favorable to plaintiffs on their third counterclaim. Otherwise,

plaintiffs would not have moved to join defendants on the

counterclaim, a totally unnecessary procedure if the liti gation

on the counterclaim with Rhodes alone would have preclusive

effect on defendants.' Plaintiffs, not defendants, were the

parties who “s[at] by idly” through eight years of the

litigation, including protracted discovery, before attempting

to join defendants as parties to the counterclaim—the _

procedural relief necessary to give the adjudication on their

counterclaim in the Rhodes action preclusive effect against

defendants.

The majority’s further conclusion, that defendants, as

“parties to the Rhodes action with notice of the issues to be

decided in that case”(__N.Y.2d__,at__ [Slip Opn, at 12]),

had a full and fair opportunity to litigate the validity of Trust

J and of their rights under it, is also unsupported by the record

and contrary to our collateral estoppel jurisprudence.

1. This conclusion is confirmed by plaintiffs’ averments in

support of their motion to join defendants on the counterclaim that

“[i]f the motion is denied, two full trials will be required to resolve

the issues herein” (emphasis supplied). This is an unmistakable

concession that par’y preclusion could not be applied against

defendants on their counterclaim, solely based upon their joinder as

nominal parties on Rhodes’ Count I cause of action.

22a

Appendix A

The trial judge in the prior action denied plaintiffs’ 1995

motion to amend their answer to extend their third

counterclaim to defendants. That ruling, which was not

appealed, was based in part on findings that the request came

after “the note of issue was filed following protracted

discovery,” and that to grant the request would have either

curtailed necessary additional discovery, or further delayed

the trial of “this eight-year-old lawsuit.”

New discovery would have been vital to all parties and

especially defendants, if they had been joined on the

counterclaim, because their affidavits herein show that they

had extensive dealings with plaintiffs separate from Rhodes,

both before and after his withdrawal from the law partnership.

Of pasticular importance in this regard, defendants have

averred that, independently of Rhodes, at or near the inception

of the lawyer-client relationship, they advised plaintiffs of

the potential conflict of interest and to seek independent

counsel regarding the parties’ proprietary interests/contingent

fee arrangement. Indeed, the majority finds especially critical

that Rhodes failed to so address plaintiffs at the time of the

proposed incorporation of Biomedical Engineering

Corporation (BEC) which resulted in “converting the

one-third interest in a single invention into a one-third

equity interest in a corporation that would exploit all future

inventions” (__N.Y.2d _, at __ [Slip Opn, at 2] ). While

Rhodes conceded never giving such advice, defendant Bain

stated in a sworn affidavit in this action:

“At this point and before the corporation was

formed, I personally undertook to advise Buechel

and Pappas that they should consult an

23a

Appendix A

independent attorney with respect to their dealings

with us which now was in the nature of a business

rather than legal representation alone. I did this

on two separate occasions in 1974 in our law

offices. On one occasion I was alone with Buechel

and Pappas and on the other Gilfillan, Buechel,

Pappas and I were present. On each occasion, |

explained to them that there was an inherent

conflict of interests in the proposed relationship.

I also explained to them that they should seek

independent counsel and could seek our services

from other attorneys.”

It would seem self-evident that, had the Rhodes trial court

granted the motion to join defendants on plaintiffs’

counterclaim and then ordered that the trial proceed

expeditiously, the resultant curtailment of defendants’ right

to engage in discovery would have denied them a full and

fair opportunity to defend the validity of their beneficial

interests in Trust I. Surely, then, the total absence of

participation, including the entire loss of opportunity for

discovery, occasioned by the Rhodes v. Buechel trial court’s

refusal to grant plaintiffs’ motion to join defendants on their

counterclaim, must also be a denial of a full and fair

opportunity to litigate.

The majority also disregards entirely our precedents

holding that a party is denied a full and fair opportunity to

litigate in a prior action when “a practical inquiry into ‘the -

realities of litigation’ ” reveals that the party lacked any

serious incentive to fully and vigorously participate (Gilberg

v. Barbieri, 53 N.Y.2d 285, 292-293). Under the uncontested

24a

Appendix A

facts in the record in Rhodes v. Buechel, defendants had every

disincentive to fully litigate there the issue of the validity of

Trust I and of their beneficial interests in it.

First, they were unwilling participants in that action,

joined only as “defendant-beneficiaries” when plaintiffs

moved to dismiss Rhodes’ complaint for failure to join them

__ aS necessary parties. Second, it is entirely undisputed that,

until the falling out between plaintiffs and defendants in 1995,

leading quickly to plaintiffs’ motion to amend the answer to

force defendants’ active trial participation on the issues raised

by their counterclaim, defendants continued to furnish legal

services to plaintiffs and the trust and to regularly receive

from plaintiffs as trustees their fractional share of the

substantial trust income. Third, defendants had no direct stake

in the outcome of the Rhodes suit. Plaintiffs’ counterclaim

unequivocally sought only to invalidate Rhodes’ interests in

Trust I because of his breach of fiduciary duty.” Indeed, in

their affirmative defenses, plaintiffs relied upon provisions

2. The counterclaim never ascribes any breach of fiduciary duty

to the Rhodes/defendants partnership or lawfirm as such, only to

Rhodes individually. Thus, “Rhodes knew that the agreements were

unfair” (counterclaim par. 93); “Rhodes, while acting as their attorney,

induced Drs. Buechel and Pappas to enter into the unfair Agreements”

(id., par. 94); “In breach and violation of his duties under the

Agreements, and of his fiduciary duties in connection therewith,

Rhodes failed fully, properly, accurately and truthfully to advise

Drs. Buechel and Pappas * * *” (id. par. 97). Most crucially, the ad

damnum clause of the counterclaim states: “By reason of his aforesaid

conduct, including, without limitation, his overreaching while a

fiduciary and his breach of his representation and warranties, Rhodes’

interests in Trust I and Trust II should be terminated and rescinded”

(counterclaim par. 107 [emphasis supplied] ).

25a

Appendix A

of the trust instrument and upon defendants’ approval, in their

Capacities as trust beneficiaries, of plaintiffs’ conduct as

trustees. Certainly then, through the nearly eight years of

litigation prior to plaintiffs’ 1995 motion to amend the

counterclaim, the last thing plaintiffs would have wanted was

the conversion of their harmonious lawyer/client, trustee/

beneficiary relationships with plaintiffs into a fully

adversarial one in the Rhodes. Buechel litigation.

It follows from the foregoing that here, even more than

in Staatsburg Water Co. v. Staatsburg Fire Dist. (72 N.Y.2d

147, 154), defendants were “[a]t most * * * interested, albeit

unwilling participant[s]” in the prior action. Likewise, “the

lack of any direct stake in the outcome of the proceeding left

defendant[s] with little incentive to fully litigate the issue”

(id.). Thus, even if it could be argued here that defendants

were “granted the opportunity to participate [in the

Rhodes litigation], this did not necessarily amount to a full

and fair opportunity to contest the determination” (id. ).

Apparently addressing the total absence of defendants’

incentive to litigate plaintiffs’ counterclaim in Rhodes v.

Buechel, the majority relies upon a January 1995 letter from

defendant Bain to plaintiffs’ counsel in which he questioned

“whether or not we must become active in the Rhodes

litigation to protect our rights” (__ N.Y.2d _, at__

[Slip Opn, at 5] ). The majority implies that this letter

demonstrated that defendants anticipated the preclusive effect

of a judgment in plaintiffs’ favor on their counterclaim. There

are two short answers to that suggestion.

26a

Appendix A

First, the issue raised by defendants in that letter had no

relationship whatsoever to plaintiffs’ counterclaim. It

concerned whether, under the terms of Trust I, the legal fees

paid to outside counsel in a specific foreign litigation, the

“Link suit,” regarding one of the trust’s patents were

chargeable to the lawyers/beneficiaries rather than

“considered to be out-of-pocket expenses or disbursements

[of the trusts].” That issue directly pertained to the kind of

trustee misconduct alleged in Rhodes’ Count I of the

complaint, to which defendants were nominal parties.

Defendants, on that issue, could very well have been

apprehensive as to whether they should participate in the

Count I litigation in Rhodes v. Buechel to protect their rights

“vis-a-vis the position of the trustees regarding [outside

counsel] legal fees.” Plaintiffs’ counterclaim, on the other

hand, dealt with the entirely separate issue of Rhodes’

misconduct as their attorney.

Even if the majority’s implication that defendants’ letter

demonstrated their apprehension as to the preclusive effect

of a judgment on the counterclaim in the former action is a

fair one (which it is not), it would not be sufficient to establish

an incentive to litigate on the part of defendants in their

individual capacity in the Rhodes v. Buechel action.

As we said in Staatsburg Water Co., “it would be * * *

fundamentally unfair to give preclusive effect to a

determination where the only incentive to litigate stems from

its potential collateral effects. Such a ruling would ill serve

the litigation-limiting purposes of collateral estoppel” (id.,

at 155 [emphasis supplied] ).

car J ne Se"

be er 8 LE fe Pe

27a

Appendix A

Defendants’ disincentive to fully litigate their rights

under Trust I in the Rhodes v. Buechel case did not cease

when hostilities between them and plaintiffs arose in 1995,

followed promptly by plaintiffs’ motion to amend their

counterclaim in Rhodes. These developments occurred after

protracted discovery and the filing of the note of issue, when

the trial of the action was imminent. As previously discussed,

to enter the litigation at that point would have entailed waiver

of the opportunity to engage in full discovery, a great

handicap for defendants. ;

Moreover, there was an even more imperative strategic

reason for defendants to avoid joinder on the countei :laim

in Rhodes v. Buechel, derived from New York’s earlier

abandonment of the mutuality of estoppel doctrine. Prior to

B.R. DeWitt, Inc. v. Hall (19 N.Y2d 141), New York

ostensibly adhered to the “so-called rule of mutuality of

estoppel, which provided that unless both parties [to the

subsequent action] are bound by the prior judgment, neither

may use it” (id., at 144). In B.R. DeWitt, however, we

announced that the “ ‘doctrine of mutuality’ is a dead letter”

(id., at 147) and that, henceforth, collateral estoppel could

be invoked, either defensively or offensively by a nonparty

to the prior litigation, providing that the requirements for

collateral estoppel (identity of issues and full and fair

opportunity to litigate) were met as to the party sought to be

precluded (see, id., at 148).

There being no mutuality of estoppel, defendants had

everything to lose and nothing to gain from active

participation in the counterclaim litigation regarding the

validity of the 1974 retainer agreement and of their beneficial

28a

Appendix A

interests in Trust I. Had those issues been resolved against

plaintiffs on their counterclaim in Rhodes, defendants could

have used the judgment defensively in any subsequent suit

by plaintiffs, such as the instant one, to preclude plaintiffs

from attacking the validity of the retainer and trust

instruments. On the other hand, as nonparties to the

counterclaim litigation in Rhodes, defendants ordinarily

would not be bound by a disposition of that counterclaim

favorable to plaintiffs.’

Refraining from active participation in the trial of the

issues raised by plaintiffs’ counterclaim in the Rhodes case,

was, thus, a completely understandable and legitimate

strategy for defendants. The umbrage against defendants

taken by the majority and the Appellate Division for “sit[ting]

idly by” in implementation of that strategy is better directed

at this Court’s abandonment of the mutuality of estoppel

doctrine, not at defendants for taking advantage of that

abandonment.

3. Nonmutuality of estoppel, under which plaintiffs would be

precluded in a subsequent litigation with defendants by an

unfavorable disposition of their counterclaim in Rhodes v. Buechel,

but not vice versa, as to defendants, nonparties to this counterclaim,

explains their averments supporting a stay of the instant action, relied

upon by the majority (see, __ N.Y.2d __, at __ [Slip Opn, at 5-6,

14-15] ). By no means can they be construed as an awareness that

defendants would be bound by a resolution of the counterclaim

favorable to plaintiffs.

"Bae Speen ges

29a

Appendix A

Privity

The majority’s primary ground for imposing issue

preclusion here is on the basis of defendants’ privity with

Rhodes in the Rhodes v. Buechel case. In adopting that theory,

the majority applies a standard which is contrary to our

precedents, is of highly dubious constitutionality and will

create uncertainty of application destructive to the litigation-

limiting purposes of collateral estoppel.

Our courts, adhering to the approach of the Restatement

(Second) of Judgments (Introductory Note to Chapter 4, at

344), have identified three general categories of privity that

have been applied to collaterally estop a nonparty in a

subsequent suit involving the same issue. Privity will be

found if the nonparty (1) “ha[s] a relationship with a party to

the prior litigation such that his own rights or obligations in

the subsequent proceeding are condition[al] * * * or

derivative of, the rights of the party to the prior litigation”

(D’Arata v. New York State Central Mutual Fire Ins. Co.,

76 N.Y.2d 659, 664; see, Matter of Juan C. v. Cortines,

89 N.Y.2d 659, 667); (2) controlled or substantially

participated in control of the prior action (see, David v.

Biondo, 92 N.Y.2d 318, 323-324; Matter of Juan C., supra;

Watts v. Swiss Bank Corp., 27 N.Y.2d 270, 277-278;

Restatement [Second] of Judgments § 39); or (3) had its

interests represented by the losing party in the prior litigation

(see, Matter of Juan C. v. Cortines, supra, at 668;

Restatement [Second] of Judgments § 41). Defendants fall

into none of these categories.

30a

Appendix A

There is no tenable basis to find that defendants’ rights

in the instant action are conditional or derivative of Rhodes’

rights in the prior litigation. In this respect, this case contrasts

decisively with D’Arata v. New York State Mutual Fire

Ins. Co. (supra), a quintessential derivative or conditional

rights privity case. There, the injured victim of an assault

asserted a claim against the liability insurance carrier of the

perpetrator solely as a subrogee of the insured’s rights under

the policy. As the insured’s subrogee, of course it was “subject

to whatever rules of estoppel would apply to the insured”

(id., at 665).

At stake here, according to the relief requested in

plaintiffs’ complaint, are defendants’ beneficial interests in

Trust I. Clearly and unmistakably, plaintiffs’ Rhodes v.

Buechel counterclaim was related exclusively to Rhodes’

interests in that trust. The trust agreement itself defines the

interests of each beneficiary separately and distinctly from

the others. Moreover, that instrument required defendants,

but not Rhodes, to provide legal services with respect to

enforcement or defense of the patents held in the trust.

Defendants’ juridical relationships and rights under the trusts

were thus separate and, in some aspects, quite different from

Rhodes’ interests.

The fact that Rhodes and defendants were law partners

when the 1974 retainer agreement was entered into does not

alter the conclusion that defendants’ rights were not

conditional or derivative of those of Rhodes in the prior

litigation over plaintiffs’ counterclaim. As the majority points

out, the original retainer agreement had been superseded and

broadened twice thereafter and no longer defined the rights

eee

3la

Appendix A

of any of the parties. Furthermore, even if the retainer

agreement had been in effect when plaintiffs’ counterclaim

was interposed, plaintiffs did not choose to assert any claim

against the partnership as such or sue Rhodes in any

representative capacity as a partner, and did not join or serve

defendants, Rhodes’ partners, as parties. Under such

circumstances, the judgment against Rhodes on the

counterclaim would not have had any preclusive effect

regarding the personal liability of defendants (see, CPLR

1025; CPLR 1501; Alexander, Practice Commentaries,

McKinney’s Cons Laws of NY, Book 7B, CPLR C1025:1, at

257; id., CPLR 1501, at 592). The fact that defendants, as

law firm members, might be bound by Rhodes’ conduct

during the existence of the partnership would have potential

relevance to the merits of this action but, as the foregoing

authorities establish, not to any preclusive effect of. the

judgment against Rhodes on the counterclaim in which

defendants were not joined as party litigants.

Nor can privity be established here because defendants

controlled or substantially participated in control of Rhodes’

defense to plaintiffs’ counterclaim. There is not a scintilla of

evidence that defendants and Rhodes shared key-titigation

decisions in defending against the counterclaim, such as

choice of counsel, legal strategy, presentation of evidence or

the order of proof. At most, they sporadically cooperated with

Rhodes following plaintiffs’ failed attempt to join them on

the counterclaim. Even a nonparty’s energetic cooperation

or assistance, such as testifying as a witness in the prior suit,

is insufficient to establish the requisite control (see, David

v. Biondo, supra, 92 N.Y.24d, at 324; see also, Bigelow v. Old

Dominion Copper Mining and Smelting Co., 225 U.S. 111,

32a

Appendix A

126, abrogated on other grounds by Parklane Hosiery Co. v.

Shore, 439 U.S. 322, 326-333 [recognizing the abandonment

of the doctrine of mutuality of estoppel] ). “To have control

of litigation requires that a person have effective choice as

to the legal theories and proofs to be advanced [on] behalf

of the party to the action. He must also have control over the

opportunity to obtain review” (Restatement [Second] of

Judgments § 39, comment c).

Privity likewise cannot be based on the theory that

Rhodes represented defendants’ interests on the counterclaim

in Rhodes v. Buechel. Rhodes had no fiduciary or other legal

obligation to act on defendants’ behalf in defending against

plaintiffs’ counterclaim, which implicated only his own

interests (see, Restatement [Second] of Judgments § 41[1] ).

Nor did Rhodes undertake or assume any de facto

responsibility to represent defendants’ interests in defending

against the counterclaim (cf, Matter of Slocum [on behalf of

Nathan A.] v. Joseph B., 183 A.D.2d 102, 104).

The record is devoid of any evidence that Rhodes would

have been motivated to protect defendants’ interests, or that

he did so in the prior litigation. The law partnership broke

up acrimoniously in 1981. Unquestionably, from Rhodes’

initiation of suit in 1987 until 1995, while defendants

continued to provide legal services to plaintiffs both

I mg as trustees of Trust I, the former partners’

interests were antithetical. In fact, after plaintiffs’

counterclaims were interposed, Rhodes threatened defendants

that he would cross-claim against them. Rhodes would not

have had any incentive to proffer evidence of separate lawyer-

client relations between plaintiffs and defendants, proof of

TT Ee |

33a

Appendix A

which might have mitigated or negated the taint of any alleged

breach of professional fiduciary duty under the 1974 retainer

agreement (see, Bain Affidavit, supra).

In actuality, the majority does not rely upon any of the

traditional privity grounds. The majority’s theory of privity

is explained instead as follows: “defendants should be

deemed to be in privity with Rhodes for purposes of litigating

validity of their fee arrangement as embodied in the trust

[because their] * * * rights to receive payments were

coextensive with Rhodes and derived from the identical

arrangement entered into when the three were law partners,”

and “[d]efendants’ interests were aligned with Rhodes with

respect to the lawfulness of the fee arrangements” (__ NY2

__,at__ [Slip Opn, at 11-12]).‘

Although the majority agrees that privity preclusion is

dependent upon “whether the party sought to be bound and

the party against whom the litigated issue was decided have

4. The majority finds a “basic problem” with the dissent in that

it does not acknowledge that “the Rhodes judgment rescinded Rhodes’

interest in the trusts because it found that the [fee] agreements from

which the interest arose were invalid” (__ N.Y.2d __, at __ [Slip

Opn, at 17] ). That finding, however, has no significance for

preclusion purposes absent an independent establishment of privity;

it does not itself demonstrate that privity exists. Thus, the majority’s

point begs the question.

Also irrelevant is the majority’s additional reliance on a portion

of the Rhodes court’s decision which “ordered that ‘the trust

agreements are rescinded’” (__ N.Y.2d_, at__ [Slip Opn, at 6] ).

Defendants protested that ruling because plaintiffs “did not seek

recission of the trusts themselves” (letter to Justice Lowe, 4/20/98),

and it was removed from the final judgment.

34a

Appendix A

a relationship” (id., at__ [Slip Opn, at 11] ), they have not

identified any formal or even informal relationship which

existed between Rhodes and defendants when plaintiffs’

counterclaim was litigated. For the majority, it is entirely

sufficient to establish privity that the rights of the losing

litigant and the nonparty were coextensive, derived from the

same source, and “aligned,” i.e., substantially identical.

Notice to nonparties that their interests are to be adjudicated

is not deemed necessary. Nor is the losing party required to

have assumed a duty of representation.

The majority’s rationale, thus, amounts to nothing more

than an application of the broad-form “Virtual Representation

Doctrine” which had a vogue in some Federal Circuits for a

period of time (see, Richards, Richards v. Jefferson County:

The Supreme Court Stems the Crimson Tide of Res Judicata,

38 Santa Clara L Rev 691, 706-710 [1998]; Johnson,

Due or Voodoo Process: Virtual Representation as a

Justification for the Preclusion of a Nonparty’s Claim,

68 Tul L Rev 1303, 1318-1320 [1994] ). Under the expansive

version of that doctrine, “a person may be bound by a

judgment even though not a party if one of the parties to the

suit is so closely aligned with his interests as to be his virtual

representa‘ive” (Aerojet Gen. Corp. v. Askew, 511 F.2d 710,

719, cert denied sub nom Metropolitan Dade County vy.

Aerojet Gen. Corp., 423 U.S. 908 [emphasis added] ). A

leading text on Federal procedure states that “[t]he broadest

form of [the virtual representation] theory would preclude

relitigation of any issue that had once been adequately tried

by a person sharing a substantial identity of interests with a

nonparty” (18 Wright & Miller, Fed Practice and Procedure

§ 4457, at 494 [emphasis supplied] ).

35a

Appendix A

This Court should not adopt any such version of virtual

representation, permitting preclusion merely because an issue

“had once been adequately tried by a person sharing a

substantial identity of interests with a nonparty” (id.). First,

it plainly is inconsistent with our own precedents. In Green

v, Sante Fe Indus. (70 N.Y.2d 244), the Court considered the

preclusive effect of an action commenced in Federal court.

The defendant parent corporation had utilized Delaware’s

“short form, freeze-out merger” procedure (id., at 249) to

acquire all remaining outstanding shares of its subsidiary.

A member of the five-percent minority class of shareholders

in the subsidiary brought the action in Federal court alleging,

among other things, a breach of fiduciary duty to minority

shareholders in offering them an unfairly low price for their

shares. The Federal suit was ultimately dismissed. The action

in Green was commenced in our State courts by other

shareholders of the same minority class seeking to attack the

same transaction. It was undisputed in Green that the minority

shareholder plaintiffs in the Federal suit had “made claims

identical in legal theory to those plaintiffs assert here” (id.,

at 252 [emphasis supplied] ). Additionally, the same counsel

represented the complaining minority shareholders in each

action. In Green, our Court rejected the application of privity

to preclude the shareholders who were not parties to the

Federal suit and instead decided the case on the merits.

Green vy. Sante Fe Industries is virtually indistinguishable

from the instant case with respect to the criteria relied upon

by the majority to find privity here. In Green, the rights of

the minority stockholders who sued in Federal court and those

who sued in New York Supreme Court were truly

coextensive. Plaintiffs in both suits were members of the

36a

Appendix A

same class of minority shareholders; their shares of corporate

stock were identical choses in action; their theory of recovery

was identical, as was their legal representation. The causes

of action asserted in the Federal and State courts arose out

of the identical transaction — the use of the Delaware short

form freeze-out merger procedure to eliminate their minority

interests. We soundly rejected privity in Green. The Federal

plaintiffs had not purported in any way to represent the State

plaintiffs, nor had the Federal court in any way undertaken

adjudication of the latter’s interests. The rejection of privity

in Green should be a fortiori controlling here.

The broad virtual representation standard for privity

applied by the majority is based solely on coextensiveness

(i.e., substantial identity) and alignment of the interests of

the parties in the successive litigations, and offends

traditional notions of due process guaranteeing that parties

must have their day in court before their rights are adjudicated

(see, Johnson, 68 Tul L Rev, supra, at 1323-1325).

That is why the Federal courts subsequently retreated

from applying a broad virtual representation doctrine, holding

that it would “transgress the bounds of due process” to base

privity solely on the identity of party and nonparty interests,

legal positions or the need to prove the same set of facts

(Hardy v. Johns-Manville Sales Corp., 681 F.2d 334, 340

[Sth Cir] ). Those courts that previously applied only the

foregoing virtual representation criteria for privity purposes

now further require “the existence of an express or implied

legal relationship in which parties to the first suit are

accountable to nonparties who file a subsequent suit raising

identical issues” (Pollard v. Cockrell, 578 F.2d 1002, 1008

37a

Appendix A

[5th Cir] [emphasis supplied]; see, Hardy v. Johns-Manville

Sales Corp., supra, at 340).

Richards v. Jefferson County (517 U.S. 793, 796) also

represents a rejection of privity-preclusion as violative of

due process when it is based solely on the fact that the party’s

and nonparty’s “respective interests [in the successive

litigations] were ‘essentially identical.’ ” The factors which

the Court weighed in Richards were, first, that the parties to

the prior suit never gave the petitioners (the plaintiffs in the

suit before the Supreme Court) notice that the earlier case

“would conclusively resolve their legal rights” (id., at 799).

Second, and even more crucial, the plaintiffs in the first suit

“did not sue on behalf of a class; their pleadings did not

purport to assert any claim against or on behalf of any

nonparties; and the judgment they received did not purport

to bind any * * * nonparties” (id., at 801). Thus, the Supreme

Court concluded, the nonparties to the prior litigation were

not represented adequately there to meet the requirements of

due process, despite the identity of their interests and those

of the plaintiffs in the first action.

Defendants here fall squarely under the factors relied

upon in Richards to find a due process violation. Never were

they put on notice that their interests in Trust I would be

adjudicated in the resolution of plaintiffs’ counterclaim in

Rhodes v. Buechel. Indeed, the denial of plaintiffs’ motion

to add them as parties in the counterclaim litigation sent the

diametrically opposite message.* Moreover, nowhere in the

5. The concerns expressed by defendants to plaintiffs’ counsel

in response to Rhodes’ threats to cross-claim for contribution — i.e.,

(Cont’d)

38a

Appendix A

record is there any indication that, in defending against the

counterclaim in that action, Rhodes purported to represent

defendants’ interests.

Thus, as in Richards, there was no full and fair

consideration of defendants’ individual interests in the

Rhodes v. Buechel case. That is because, especially after the

trial court rejected plaintiffs’ motion to join defendants on

their counterclaim, “there is no reason to suppose that [the

Rhodes court] took care to protect the interests of

[defendants], * * * [nJor is there any reason to suppose that

* * * [Rhodes] understood [his] suit to be on behalf of

[defendants]. Thus, to contend that * * * [Rhodes] somehow

represented [defendants], let alone in a constitutionally

adequate manner, would be ‘to attribute to [him] a power

that it cannot be said that [he] had assumed to exercise’ ”

(id., at 802).

Finally, in addition to its unconstitutional application

here, the broad “coextensive rights” standard announced in

this case to find privity will inevitably inject elements of

insecurity and uncertainty for nonparties who may be

substantially interested in the issues in litigation to which

the parties chose not to join them. Res judicata and collateral

estoppel, because of their harsh results, however, are areas

(Cont'd)

that defendants were unclear whether the counterclaims could be

interpreted as asserting claims against the former partners’ lawfirm

— cannot be construed as an acknowledgment of the preclusive effect

of the counterclaim litigation against defendants in their individual

capacity. No cross claim was ever interposed against defendants either

as Rhodes’ partners or individually.

39a

Appendix A

crying out for foreseeability and predictability. To avoid the

risk of preclusion, interested nonparties will be forced to

intervene in litigation to protect their rights. The imperative

to intervene flowing from the majority’s privity standard

stands on its head the traditional rule “put[ting] the burden

of joinder on the person who wishes to obtain the benefits of

the rules of preclusion, requiring him to bring in third parties

involved in the transaction. Hence, as between a silent

bystander and the party to prior litigation, the latter properly

bears the risk that the original litigation will not terminate

the controversy” (Restatement [Second] of Judgments § 62,

comment a; see also, Chase Manhattan National Bank v.

Norwalk, 291 U.S. 431, 441 [Brandeis, J.]; Johnson, 68 Tul

L Rev, supra, at 1314-1315).

In presumptively forcing formal early intervention by

an interested nonparty in pending litigation, the majority’s

privity rule “[will] ill-serve litigation-limiting purposes of

collateral estoppel; it would simply encourage over litigation

at an earlier stage” (Staatsburg Water Co. v. Staatsburg Fire

Dist., supra, 72 N.Y.2d, at 155). Therefore, I would vote to

reverse and remit for trial on all issues.

KEEKKEKHKKKKKKKKEKKKK KKK KK KK KK KOK OK KOK

Order affirmed, with costs, and certified question answered

in the affirmative. Opinion by Judge Smith. Chief Judge Kaye

and Judges Ciparick, Wesley, Rosenblatt and Graffeo concur.

Judge Levine dissents and votes to reverse in an opinion.

Decided December 20, 2001

a

40a

APPENDIX B — DECISION OF THE SUPREME COURT,

APPELLATE DIVISION, STATE OF NEW YORK

DATED SEPTEMBER 28, 2000

SUPREME COURT, APPELLATE DIVISION

First Department, June 2000

Betty Weinberg Ellerin J.P.

Israel Rubin

. David B. Saxe

John T. Buckley, JJ.

1567-1568

Frederick F. Buechel, M.D., et al.,

Plaintiffs-Respondents,

-against-

John N. Bain, et al.,

Defendants-Appellants,

-and-

Carella, Byrne, Bain, Gilfillan,

Cecchi, Stewart & Olstein,

Defendant,

4la

Appendix B

-and-

R. Gale Rhodes, Jr., et al.,

Defendants-Beneficiaries.

Defendants John N. Bain and JohnG. Gilfillan, III, appeal

from an order of the Supreme Court, New York

County (Richard Lowe, III, J .), entered January

19, 2000, which denied their motion to dismiss

the amended complaint, and order, same court

and Justice, entered February 4, 2000, which

granted plaintiffs’ motion for partial summary

judgment and denied defendants’ cross motion.

RUBIN, J.

This matter involves the propriety of an agreement to

compensate defendants for legal services rendered to

plaintiffs Frederick F. Buechel, M.D. and Michael J. Pappas,

Ph.D. in connection with the patenting of certain prosthetic

devices plaintiffs had developed. At issue is the preclusive

effect to be given to a decision rendered in a lawsuit brought

by R. Gale Rhodes, Jr., a former law partner of defendants

John N. Bain and John G Gilfillan, III, in which the same

Court (Richard Lowe, III, J .) ruled that the fee agreement

was improper and limited the amount due Rhodes to the value

of the services he had rendered to the two inventors (Rhodes

v. Buechel, Sup Ct, NY County, April 30, 1998, index

No. 8055/87). This Court affirmed the judgment, finding that

“neither the initial arrangement nor its subsequent

incarnations were entered into upon adequate disclosure to

defendants [plaintiffs herein] of other possible fee

arrangements and potential conflicts of interest, or with the

5 42a

Appendix B

aid of independent counsel retained for the purpose of

safeguarding [their] interests. Rescission of the parties’

arrangements ab initio, with payment to [Rhodes] in quantum

meruit for his services, is an equitable result (see, Howard v

Murray, 43 NY2d 417, 421; Matter of Cooperman, 83 NY2d

465, 473; Schlanger v. Flaton, 218 AD2d 597, lv. denied 87

NY2d 812)” (Rhodes v. Buechel, 258 A.D.2d 274, 275). No

further appeal was taken from this order.

In the present action, in which plaintiffs seek to terminate

any interest defendants might have in a certain trust,

defendant attorneys raise contentions that were not advanced

by their former partner. First, they note that the fee

arrangement found io be void in Rhodes v Buechel (supra)

is specifically permitted by a Federal regulation (37 CFR

§ 10.64). Second, they argue that the Federal courts have

exclusive jurisdiction over this issue, which they construe

as a matter of patent law, and that the Rhodes decision is

therefore void for lack of subject matter jurisdiction.

The essential facts are not in dispute. Plaintiff Buechel,

a resident in orthopedic surgery, and plaintiff Pappas, a

mechanical engineer, developed a prosthetic shoulder device

(the floating center prosthetic joint) which they sought to

protect with a patent. They retained the firm of Bain, Gilfillan

& Rhodes, PC “to undertake the preparation and prosecution

of a patent application covering the invention on a

contingency basis.” The subject fee agreement entered into

by the two inventors on September 12, 1974 provides that

the law firm will contribute capital to finance research and

marketing of the device and that “any or all monies, profits

or other income or benefits received, whether by way of

43a

Appendix B

royalties or otherwise, shall be shared proportionately

between the parties hereto on a one-third (1/3) basis”.

The gravamen of the dispute is the extent of the

disclosure made by the members of the law firm concerning

the potential conflict of interest arising from the attorneys’

stake in the devices they had undertaken to protect

against infringement. Affidavits submitted, respectively, by

defendants Bain and Gilfillan state that, on the suggestion

of their former partner, R. Gale Rhodes, the parties

subsequently agreed to form a corporation, both for tax

considerations and to insulate the entrepreneurs from

personal liability. With respect to the propriety of the fee

agreement, it is averred that, preliminary to the formation of

the corporation, defendant Bain specifically advised plaintiffs

of the potential conflict of interest inherent in the

arrangement. It is further alleged that the plaintiffs were

advised to obtain independent counsel, but elected not to do

so. Plaintiffs Buechel and Pappas, however, take the position

that at no time were they were advised either of the potential

conflict of interest or of their right to discharge the firm as

their counsel at any time. >

Biomedical Engineering Corporation was incorporated

in New Jersey on July 16, 1975. The corporation took title

to the prosthetic shoulder device and to other prosthetic

devices developed by plaintiffs in the interim. In accordance

with the fee agreement, Buechel and Pappas each held

one-third of the shares of the corporation, while the remaining

one-third interest was divided equally among the three

attorneys. A dispute subsequently arose among the law

partners, culminating in the departure of Rhodes in December

44a

Appendix B

1981. Bain and Gilfillan continued to perform legal work

for plaintiffs, and their responsibilities were expanded to

include litigation and patent maintenance. Gilfillan alleges,

however, that following his departure from the firm, Rhodes

covertly formed a corporation in Florida with plaintiffs, also

known as Biomedical Engineering Corporation, to hold any

future patents Buechel and Pappas might obtain.

In late 1982 or early 1983, an attorney named John Power

was retained by plaintiffs to assess the feasibility of

dissolving the original Biomedical Engineering Corporation.

The decision was made to dissolve the New Jersey

corporation and transfer its assets to a newly formed entity,

the Biomedical Engineering Trust (Trust I), with Pappas and

Buechel as trustees. The shareholders of the dissolved

corporation, including the three attorneys, received

equivalent equity interests in the trust, which thereupon

received royalty payments from the sale of some of the

prosthetic devices. At the trial in Rhodes v Buechel (supra),

John Power testified to conversations with Buechel and

Pappas, in which he “told them what they already knew * * *

that they had to rely upon the advice of the attorney partner

of theirs who possibly might have a financial disincentive to

give them advice that perhaps they should be receiving.”

In 1984, a second trust was formed, again with Pappas

and Buechel as trustees, designated the Biomedical

Engineering Trust II (Trust II), which held the marketing

rights to a self-centering hip device. While neither defendant

held any interest in Trust II, their former partner, R. Gale

Rhodes, undertook to provide legal patent protection services

to this entity. In 1987, a dispute arose over trust distributions,

45a

Appendix B

and Rhodes commenced his action against Buechel and

Pappas to recover millions of dollars which the trustees were

alleged to have improperly paid to themselves (Rhodes v

Buechel, supra). The ensuing judgment duly recites that his

former partners, Bain and Gilfillan, were joined as defendants

in their capacity as trust beneficiaries and that they were

represented by counsel in the Rhodes action.

Four years after Rhodes commenced the action, Buechel

and Pappas asserted counterclaims for breach of fiduciary

duty and malpractice, asserting that Rhodes had acted in

violation of his ethical responsibilities as a lawyer. They did

not, at that time, assert any claims against Bain and Gilfillan,

who apparently continued to provide legal services to

Trust I. It was not until 1995 that Buechel and Pappas sought

to expand their counterclaims to seek relief against Bain and

Gilfillan. Supreme Court denied their motion to amend the

counterclaims, noting that the attorneys had been

counterclaim defendants for seven years and that Buechel

and Pappas had brought their motion to amend some five

months after the filing of a note of issue, following protracted

discovery and without the proffer of any excuse for the

delay.

Pappas and Buechel commenced the instant action in

March 1995, naming Bain and Gilfillan as defendants.

The complaint contains five causes of action, alleging breach

of fiduciary and ethical obligations and legal malpractice.

This action, which seeks termination of trust payments to

Bain and Gilfillan and turnover of Trust files maintained by

the attorneys, was stayed by Supreme Court pending

resolution of the Rhodes matter.

46a

<——————_ Appendix B

The Rhodes litigation produced over 5,000 pages of trial

transcript and resulted in a 42-page decision, invalidating

the fee arrangement between plaintiffs and their original

counsel, the firm of Bain, Gilfillan & Rhodes. As Supreme

Court’s opinion states at the inception, the complaint was

brought against Buechel and Pappas, both individually

and as trustees of the two Biomedical Engineering Trusts.

It charged them with making improper payments to

themselves from the trusts and ought to remove them as

trustees and compel payment to Rhodes of his share of trust

income alleged to have been withheld since 1987. However,

Supreme Court found that the fee agreement from which

Rhodes derived his interest in the trusts was unethical. The

judgment recites the court’s finding that the complaint’s

allegation of a breach of fiduciary duty by the trustees was

without merit and, in any event, rendered moot by the

rescission, ab initio, of any interest Rhodes might have

acquired in either Trust I or Trust II under the fee agreement.

The court found that plaintiffs were never advised to seek

independent counsel before entering into a business

relationship with their attorneys and that Rhodes had

“exploited his clients through affirmatively pursuing a

business relationship with them absent full disclosure”

(DR 5-104[A]).

On this appeal, the parties dispute whether or not Bain

and Gilfillan, who portray themselves as merely nominal

parties in the unsuccessful suit by their former partner, were

afforded a full and fair opportunity to litigate the question of

the propriety of the fee arrangement in the Rhodes action.

Specifically, the attorneys regard as dispositive the denial of

the motion by Buechel and ‘Pappas (plaintiffs herein) to

47a

Appendix B

amend their counterclaims of breach of fiduciary duty and

malpractice in Rhodes to include Bain and Gilfillan.

Defendant attorneys note that the fee arrangement in question

is “expressly permitted under federal law governing the

conduct of federal patent practitioners” (citing 37 CFR

§ 10.64 [emphasis in original] ), which “permits patent

attorneys to take an interest in a patent in lieu of a fee.”

Furthermore, they argue that the determination in Rhodes

that “the parties’ fee agreement was void ab initio because it

violated New York ethics rules” is without effect on the

ground that “federal courts have exclusive jurisdiction over

all claims arising under federal patent law.”

Plaintiffs Pappas and Buechel claim that the jurisdiction

of the Federal courts is not exclusive; that Bain and Gilfillan’s

respective interests in Trust I did not survive their discharge

as attorneys in January 1995; that Bain and Gilfillan failed

to disclose fully the options available to the inventors in

retaining them as attorneys; that Bain’s and Gilfillan’s

violation of the Canons of Ethics warranted return of the

legal fees paid to them less the value of services actually

rendered; and that Bain and Gilfillan had a full and fair

opportunity to litigate all issues in the course of the Rhodes

litigation.

As the parties frame it, the issue presented on this appeal

is whether defendant attorneys have had their day in court so

as to invoke the principle of collateral estoppel on the

question of the validity of the fee agreement and,

consequently, the validity of their respective interests in

Trust I. This formulation suggests that the judgment rendered

in Rhodes determines the extent of the inventors’ obligation

48a

Appendix B

to defendants’ former partner under the fee agreement. It is

the attorneys’ position that, because their involvement in the

Rhodes action was merely that of nominal defendants, they

did not contest the validity of the fee agreement or otherwise

actively participate in the litigation. Therefore, they argue,

they should now be granted the opportunity to be heard with

respect to the contract dispute and to advance their theory

that Federal law is controlling.

The parties misapprehend the nature of the adjudication

rendered in the Rhodes matter, the role of defendants in that

litigation and, therefore, the application of the doctrines of

res judicata and collateral estoppel. The Court of Appeals

explained the distinction in Ryan v New York Tel. Co.,

(62 NY2d 494, 500):

This rule of res judicata is founded upon the belief

that “ ‘it is for the interest of the community that

a limit should be prescribed to litigation, and that

the same cause of action ought not to be brought

twice to a final determination. Justice requires that

every cause be once fairly and impartially tried;

but the public tranquillity demands that, having

been unce so tried, all litigation of that question,

and between those parties, should be closed

forever.’ ” (Fish v Vanderlip, 218 NY 29, 36-37,

quoting Greenleaf’s Evidence, §§ 522, 523;

see also, Schuylkill Fuel Corp. v Nieberg Realty

Corp., 250 NY 304; Hendrick v Biggar,

209 NY 440.)

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Appendix B

The doctrine of collateral estoppel, a narrower

species of res judicata, precludes a party from

relitigating in a subsequent action or proceeding

an issue clearly raised in a prior action or

proceeding and decided against that party or those

in privity, whether or not the tribunals or causes

of action are the same. (Ripley v Storer, 309 NY

506, 517; see, also, Restatement, Judgments 2d,

§ 27; 46 Am Jur 2d, Judgments, § 415; 9 Carmody-

Wait 2d, NY Prac., Judgments, § 63:205.)

What the parties overlook is that the decision in Rhodes

is not simply a determination of the extent of the contractual

obligation undertaken by Buechel and Pappas under the fee

agreement. Rather it is an adjudication of their obligation

as trustees to make payment under the terms of Trust I, of

which defendants herein and Rhodes are all beneficiaries,

and Trust II, which concerns only Rhodes (see, Levine v

Gross, 177 AD2d 290, 291- 292). The issue presented for

decision in Rhodes was whether or not Buechel and Pappas,

as trustees, were required to make payments to an attorney

whose rights as a trust beneficiary derived from the fee

agreement between Buechel and Pappas, individually, and

the law firm of Bain, Gilfillan & Rhodes. This action similarly

addresses the status of attorney-beneficiaries whose rights

to receive proceeds from the trust are predicated on the

identical fee agreement. Therefore, Bain and Gilfillan, who

were parties to the Rhodes case, are barred by the doctrine of

res judicata from relitigating the question of their entitlement

to trust proceeds. That defendant attorneys did not participate

actively in the Rhodes action is immaterial, as is their failure

50a

Appendix B

to raise the preemption issue or their own measures to comply

with the Canons of Ethics. As this Court observed in Boorman

v Deutsch, 152 AD2d 48, 53, appeal dismissed 76 NY 2d 889,

“res judicata embraces not only those matters

which are actually litigated before a court but also those

relevant issues which could have been litigated (Schuylkill

Fuel Corp. v Nieberg Realty Corp., 250 NY 304), including

jurisdiction (Angel v Bullington, 330 US 183; Johnson v

Muelberger, 340 US 581; Reich v. Cochran, 151 NY 122.”

The contention that Bain and Gilfillan were merely

nominal parties to the Rhodes matter is without

merit. The parties’ freedom to chart their own procedural

course before the courts is not without limits (Stevenson v

News Syndicate Co., 302 NY 81, 87; Matter of Malloy, 278

NY 429). CPLR 1001(a) provides, “Persons who ought to

be parties if complete relief is to be accorded between the

persons who are parties to the action or who might be

inequitably affected by a judgment in the action shall be made

plaintiffs or defendants.” It further provides: “When a person

who should join as a plaintiff refuses to do so, he may be

made a defendant.”

The beneficiary of a trust has no legal estate in trust

property but has only the equitable power of enforcement

(EPTL § 7-2.1 [a]; Duvall v English Evangelical Lutheran

Church, 53 NY 500 [1873] ). Where the extent of the duty of

the trustees to disburse trust income is raised by one of its

beneficiaries, the resulting judgment will necessarily affect

the concomitant right of other beneficiaries, similarly

situated, to receive such payments. They are therefore not

merely incidental but essential parties to the action, subject

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Appendix B

to joinder under CPLR 1001(a). The purpose of the

compulsory joinder rule is both to prevent duplicative

litigation and to protect the rights of persons who may be

adversely affected by the outcome (see, Manufacturers

Hanover Trust Co. v Crossland Sav., 177 AD2d 78, 79, 82;

Parker v 151 East 83rd Street Tenants Corp., 171 AD2d 599;

3 Weinstein-Korn-Miller, N.Y. Civ. Prac. § 1001 .01). Having

been joined as parties to the Rhodes action for the purpose

of permitting them to protect their interests as beneficiaries

of Trust I, Bain and Gilfillan cannot complain that they failed

to avail themselves of the opportunity presented.

They certainly may not require the courts to entertain an issue

that could have been decided in the Rhodes action had it

been timely raised. Apart from avoiding the imposition on

limited judicial resources (see, Smith v Daca Taxi, 222 AD2d

209, 211 [vacatur]; Rabov v McCrory Corp., 210 AD2d

145, 147 [consolidation]), the bar against duplicative

litigation obviates the potential for “conflicting rulings

on identical issues” (Bank of Tokyo-Mitsubishi, Ltd. v

Kvaerner a.s., 243 AD2d 1, 9). The judgment rendered in

Rhodes decides not only the propriety of the conduct of the

trustees, but also the validity of the agreement under which

the attorney-beneficiaries, as partners in a law firm, derived

their interest in the trusts. No appeal was taken from this

Court’s affirmance of the judgment in that case, and the

outcome is conclusive of the issues sought to be raised by

defendants in this matter. 7

Application of the doctrine of collateral estoppel,

as urged by defendants, does not alter the disposition.

In applying the doctrine, “the fundamental inquiry is whether

relitigation should be permitted in a particular case in light

52a

Appendix B

of what are often competing policy considerations, including

fairness to the parties, conservation of the resources of the

court and the litigants, and the societal interests in consistent

and accurate results” (Staatsburg Water Co. v Staatsburg

Fire Dist., 72 NY2d 147, 153). To be estopped, the party to

the present litigation must either have been a party to the

prior proceeding or in privity with a party to that proceeding

(D’Arata v New York Cent. Mut. Fire Ins. Co., 76 NY2d

659, 664). Under the concept of privity, collateral estoppel

has been said to extend to “those whose interests are

represented by a party to the action” (Watts v Swiss Bank

Corp., 27 NY2d 270, 277, citing Restatement of Judgments

§§ 81-90).

As this Court recently noted in A// Terrain Props. v Hoy,

265 AD2d 87, 93:

Privity has been described as “an amorphous term

not susceptible to ease of application” (Gramatan

Home Investors Corp. v. Lopez, 46 NY2d

481, 486). The doctrine extends to “persons who

were not parties to the previous action but who

were connected with it to such an extent that they

are treated as if they were parties” (id.). “What is

controlling is the identity of the issue which has

necessarily been decided in the prior action or

proceeding” (Ryan v. New York Tel. Co., supra,

62 NY2d 494, 500).

Privity clearly extends to the partners comprising the law

firm that is party to the subject contract, and Supreme Court’s

assessment of the validity of the fee agreement before it in

53a

Appendix B

Rhodes was essential to its determination that the trustees

have no obligation to make any payments to a beneficiary

who derives his interest from that agreement. Irrespective of

their capacity in the Rhodes litigation, whether as essential

or merely nominal parties, Bain and Gilfillan are clearly in

privity with Rhodes. As partners in the law firm that entered

into the fee agreement with plaintiffs, their right to receive

trust income stands or falls with the contract. The three

attomeys are united in interest with respect to the enforcement

of the agreement and are therefore estopped from relitigating

its validity, an identical issue necessarily decided in the prior

action (id.).

Defendant Bain additionally asserts that “there was

simply no basis to apply New York’s code of ethics to an

agreement entered into in New Jersey between federal patent

practitioners resident in New Jersey and their New Jersey

clients involving conduct governed — and expressly

sanctioned — by federal patent law.” The question of what

state’s law should be applied to the obligation of the trustees

to make payments to the attorney beneficiaries, likewise,

could have been raised in the context of the Rhodes litigation,

but was not. A party to a lawsuit cannot sit by idly while a

contract, to which he is also a party, is judicially construed

without being precluded by the result. Implicit in.a court’s

entry of judgment is a determination of its power to render it

and, similarly, the preemption of State law was an issue

necessarily resolved in Rhodes with preclusive effect against

the parties and their privies.

Were this Court to reach the arguments sought to be

advanced by defendants herein, it would find them to be

54a

Appendix B

without merit. That a Federal regulation (37 CFR 10.64)

permits an attorney to take an interest in a patent in lieu of a

fee for services rendered is not dispositive of either the

validity of defendants’ conduct nor the jurisdiction of the

courts of this State. As 37 CFR 10.1 of the regulations

provides, “Nothing in this part shall be construed to preempt

the authority of each State to regulate the practice of law,

except to the extent necessary for the Patent and Trademark

Office to accomplish its federal objectives”. While the patent

regulations are pertinent with respect to the interest bestowed

on the attorneys by the inventor-clients, the regu_ations do

not obviate the full disclosure required by the Canons of

Ethics governing the practice of law in this State.

Consequently, the propriety of the fee arrangement at issue

in this case is not a question that arises exclusively under

patent law, and Supreme Court had subject matter jurisdiction

to rescind the fee agreement upon the finding that it was

made without the necessary disclosure of the potential

conflict of interest and without the advice of independent

counsel.

Accordingly, the order of Supreme Court, New York

County (Richard Lowe, III, J.), entered January 19, 2000,

which denied defendants’ motion to dismiss the amended

complaint, should be affirmed, without costs. Order, same

court and Justice, entered February 4, 2000, which granted

plaintiffs’ motion for partial summary judgment and denied

defendants’ cross motion for summary judgment, should be

affirmed, without costs.

All concur.

55a

Appendix B

THIS CONSTITUTES THE DECISION AND

ORDER OF THE SUPREME COURT, APPELLATE

DIVISION, FIRST DEPARTMENT.

ENTERED: SEPTEMBER 28, 2000

s/ Catherine [illegible] Wolfe

CLERK

56a

APPENDIX C — ORDER OF THE SUPREME COURT,

COUNTY OF NEW YORK, STATE OF NEW YORK

FILED FEBRUARY 4, 2000

SUPREME COURT OF THE STATE OF NEW YORK

COUNTY OF NEW YORK: IAS PART 22

PRESENT:

Hon. Richard B. Lowe, III

Index No. 106963/95

FREDERICK F. BUECHEL, M.D. and MICHAEL J.

PAPPAS, Ph.D., individually and as Trustees of certain trusts

entitled Biomedical Engineering Trust,

Plaintiffs,

-against-

JOHN N. BAIN, JOHN G. GILFILLAN, III] and CARELLA,

BYRNE, BAIN, GILFILLAN, CECCHI, STEWART &

OLSTEIN,

Defendants,

-and-

R.GALE RHODES, JR. and PAUL A. WITTE, as beneficiaries

of a certain trust entitled BIOMEDICAL ENGINEERING

TRUST,

Defendant-Beneficiaries.

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Appendix C

ORDER

Plaintiffs, Frederick F. Buechel and Michael J. Pappas

having moved far partial summary judgment pursuant to

CPLR Section 3212, and defendants John N. Bain and John G

Gilfillan, I, and Carella, Bye, Bain, Gilfillan, Cecchi, Stewart

& Olstein, having cross-moved for partial summary judgment

pursuant to CPLR Section 3212, and such motions having

regularly come to be heard on the 19" day of January, 1999;

Now, upon reading and filing plaintiffs’ Complaint, dated

March 21, 1995 (the “Complaint”), plaintiff’s notice of

motion, dated July 27, 1998, the affidavits of Arnold Weiss,

Esq., sworn to, respectively, February 10, 1995, July 24, 1998

and February 19, 1999, the affidavit of David N. Ellenhorn,

Esq., sworn to November 18, 1998, the affidavit of Michael

J. Pappas, sworn to February 10, 1995, and the exhibits

annexed thereto, in support of plaintiffs’ motion for partial

summary judgment and in opposition to defendants’ cross

motion for partial summary judgment, and defendants’ notice

of cross-motion, dated September 18, 1998, the affidavits of

John N. Bain, sworn to, respectively, October 2, 1998,

December 11, 1998, February 8, 1999 and March 2, 1999,

the affidavits of John G Gilfillan, II, sworn to, respectively,

September 18, 1998, December 11, 1998, February 8, 1999 and

February 26, 1999, the affidavits of Lorna McKenzie, Esq.,

sworn to, respectively, September 17, 1998 and December

11, 1998, and the exhibits annexed thereto, in opposition to

plaintiffs’ motion for partial summary judgment and in

support of defendants’ cross-motion for partial summary

judgment, and due deliberation having been had and the Court

having rendered its written decision, dated May 26, 1999,

58a

Appendix C

NOW, upon motion of Power, Weiss & Kurnit, LLP and

Solomon, Zauderer, Ellenhorn, Frischer & Sharp, attorneys

for plaintiffs, it is

ORDERED, that plaintiffs’ motion for partial summary

judgment on the First, Second and Third Causes of Action in

the Complaint (which assert the same claims as the First,

Second, and Third Causes of Action in the Amended

Complaint, dated April 12, 1999 (the “Amended

Complaint”)) is granted in its entirety and the interests of

defendants Bain and Gilfillan in the Biomedical Engineering

Trust (“Trust I’) are hereby rescinded and terminated ab initio,

and it is further

ORDERED, that the fee agreements, whether in the form

of a trust, corporate entity, partnership and/or contingent fee

agreement, between plaintiffs and defendants Bain and

Gilfillan, are unenforceable and rescinded ab initio because

they were entered into in violation of the ethical duties owed

to plaintiffs, and it is further

ORDERED, that defendants’ motion for partial summary

judgment is granted to the limited extent that two claims in

the Fourth Cause of Action of the Complaint alleging

malpractice with respect to inventions that are the subject

matter of U.S. Patent Nos. 4,619,658 and 3,916,451 are

dismissed with prejudice, but the claim in the Fourth Cause

of Action of the Complaint alleging malpractice concerning

the invention entitled the “Floating Rotating Platform

Bearing,” (which alleges the same claims as the Fourth Cause

of Action of the Amended Complaint) which was not the

subject of defendants’ cross motion, is not dismissed, and is

severed, and it is further

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59a

Appendix C

ORDERED, that Bain and Gilfillan are jointly and

severally liable to return to plaintiffs the total amount of

compensation they received from Trust 1, or its predecessors,

as well as interest, accruing from the date of each payment

to Bain and Gilfillan through entry of judgment, and costs

and disbursements, less the quantum meruit value of the legal

services provided by Bain and Gilfillan in an amount to be

determined by the Court, appropriate accrued interest to be

also applied thereto, and it is further

ORDERED, that the issues of the precise aggregate fees

received by the attorneys plus accrued interest and the

quantum meruit value of their legal service are referred to a

Special Referee to hear and report (with recommendations),

the parties to submit affidavits and supporting documentation

on each issue by the first hearing date together with requests

for any disclosure that may still be required, and it is further

ORDERED, that the motion are held in abeyance pending

receipt of the report and recommendations of the Special

Referee [Judicial Hearing Officer] and a motion pursuant to

CPLR 4403, and it is further

ORDERED, that a copy of this order with notice of entry

shall be served on the Legal Support Office (Room 311) to

arrange a date for the reference to a Special Referee [Judicial

Hearing Officer].

ENTER:

J.S.C.

a 60a

APPENDIX D — ORDER OF THE SUPREME COURT,

COUNTY OF NEW YORK, STATE OF NEW YORK

FILED JANUARY 19, 2000

SUPREME COURT OF THE STATE OF NEW YORK

COUNTY OF NEW YORK: IAS PART 22

INDEX No:106963/95

FREDERICK F. BUECHEL, M.D. and MICHAEL J.

PAPPAS, PhD., individually and as Trustees of certain trusts

entitled Biomedical Engineering Trust,

Plaintiffs,

- against -

JOHN N. BAIN, JOHN G GILFILLAN, III, and CARELLA,

BYRNE, BAIN, GILFILLAN, CECCHI, STEWART

& OLSTEIN,

Defendants,

- and -

R. GALE RHODES, JR. and PAUL A. WITTE, as

beneficiaries of a certain trust entitled BIOMEDICAL

ENGINEERING TRUST,

Defendant-Beneficiaries.

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Appendix D

RICHARD B. LOWE, III, J.:

Motions Nos. 8 and 9 and the calendar of October 14,

1999 are consolidated for disposition.

The individual defendants, patent attorneys, move by

separate applications to dismiss the amended complaint

sounding in legal malpractice and recission of their long term

fee arrangement with plaintiffs, as pre-empted by Federal

Patent Law, or in the alternative, to stay this action pending

a ruling by the federal courts on the substantive issues raised

herein. Defendants also seek to vacate this court’s order dated

February 8, 1999, enjoining defendants from having recourse

to “any (other) court to adjudicate the merits of any

substantive claim at issue in the instant matter ... ,”

and related procedural relief. Defendants’ motion and

cross-motion are disposed of as follows.

Firstly, there is no merit to the defendants’ contention

that “plaintiffs’ exclusive remedy for alleged violation

of federal patent laws lies in the federal courts.”

The interpretation of the patent law on issues of patent

priority and infringement are hardly at issue in this action.

Nor have defendants made any showing to support their

contention that the issues of professional ethics central to

this litigation fall under the exclusive jurisdiction of the

Patent Trademark Office (PTO Code) enacted to guide the

performance of patent and trademark attorneys. Rather,

the holdings cited to support this novel thesis merely stand

as authority for the general principle that state courts may

not abridge rights accorded to patent attorneys under the

ethical-code applicable to their legal specialty. To prevail on

62a

Appendix D

this point defendants would have to establish that plaintiffs’

successful allegation in their first, second and third causes

of action (i.e. that defendants were lacking candor as to the

potential consequences of certain profit-sharing agreements)

violated rights acquired by the patent attorneys under the

PTO Code. No serious effort has been made in this regard

nor with respect to the single malpractice claim now pleaded

in the fourth cause of the amended complaint (cf. Sperry v.

Florida. 373 US 379, 396, 397; Silverman v. State Bar of

Texas, 405 F2d 410, 413).

Equally untenable is defendants’ argument that this

court’s decision of May 26, 1999 (entered June 1, 1999) is

invalid because plaintiffs served an amended complaint on

June 2, 1999 alleging the identical recission claims originally

pleaded and repleaded a revised fourth cause of action for

legal malpractice omitting two of the three patent matters

concededly time-barred patent application claims specified

in the original complaint. While defendant correctly invoke

a principal of law generally applicable in this area, i.e.,

that “orderly procedure contemplates that a defendant be

afforded an opportunity to answer an amended complaint,”

(Inland Credit Corp. v. Blvds, 27 AD2d 928), this salutary

procedural rule does not rigidly apply without exception

regardless of the circumstances of a given case.

Even assuming the amended complaint technically

superseded the original complaint before the decision

granting recession on res judicata grounds was rendered, the

court was not thereby bound to await the formal service of a

predictably repetitive answer before ruling on plaintiffs’

recission claims. Defendants submitted comprehensive

affidavits in response to plaintiffs’ motion for summary

judgment, thereby obviating the need for the court to await

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63a

Appendix D

service of a formal answer. The parties having charted their

own procedural course, defendants may not now rightly urge

that summary disposition of the recession claims be

recalendered. (See, Huggins v. Whitney, 239 AD2d 174).

Parenthetically, the court wishes to clarify its May 26,

1999 decision insofar as it inadvertently dismissed the

entire original fourth cause of action as time-barred. The court

intended to dismiss only the two patent applications

referred to on Page “5S” of the decision that were addressed

in defendant’s cross-motion to dismiss and overlooked the

more current “Bahlen patent malpractice claims”

~ that were never challenged by the defendants. The May 26,

1999 decision is so amended while the main motion and

cross-motion are denied insofar as they seek to dismiss the

amended complaint or obtain a stay of further proceedings.

Finally, the branch of defendant’s applications seeking,

in effect, reconsideration of the order of February 8, 1999 is

granted relieving defendants of the injunctive relief awarded

in that order. In the court’s view barring defendants from

recourse to the federa! courts in connection with the

already resolved recission claims would tend to further the

need for “the harmonious cooperation of federal and

state tribunals,” emphasized in Princess Lida v. Thompson,

305 U.S. 456, 466. Nevertheless, it has been clearly decided

in a later Supreme Court decision that a defeated party in

state court litigation may still raise before a federal court

issues already decided against him, regardless of the

likelihood of the issuance of an additional adverse decision

under the doctrine of res judicata (See, Donovan v. City of

Dallas, 377 U.S. 408, 412).

64a

Appendix D

This shall constitute the decision and order of the court.

Dated: January , 2000

s/ Richard B. Lowe III

Judge Richard B. Lowe III

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APPENDIX E — MEMORANDUM DECISION OF

THE SUPREME COURT, COUNTY OF NEW YORK,

STATE OF NEW YORK FILED MAY 26, 1999

SUPREME COURT OF THE STATE OF NEW YORK

COUNTY OF NEW YORK: IAS PART 22

INDEX NO:106963/95

FREDERICK F. BUECHEL, M.D. and MICHAEL J.

PAPPAS, PhD., individually and as Trustees of certain trusts

entitled Biomedical Engineering Trust,

Plaintiffs,

- against -

JOHN N. BAIN, JOHN G. GILFILLAN, IT], and CARELLA,

BYRNE, BAIN, GILFILLAN, CECCHI, STEWART

& OLSTEIN,

Defendants,

- and -

R. GALE RHODES, JR. and PAUL A. WITTE, as

beneficiaries of a certain trust entitled BIOMEDICAL

ENGINEERING TRUST,

Defendant-Beneficiaries.

66a

Appendix E

RICHARD B. LOWE, II], J:

Plaintiffs, an orthopedic surgeon and a mechanical

engineer engaged in the invention, research and

extraordinarily successful marketing of prosthetic devices

over the past 25 years (the plaintiffs) move for partial

summary judgment on their first three causes of

action seeking to rescind all equity interest held by two

attorneys in a trust agreement (Trust 1) entered into in

December 1983 with one R. Gale Rhodes, Esq. and his then

former patent law partners John N. Bain and John G. Gilfillan

(the defendants, both of whom were discharged as attorneys

for the trust in January 1995) who cross move to dismiss the

first four causes in the complaint. Defendants, residents of

New Jersey, participated in the operation of the business

venture until 1983 while prosecuting and defending numerous

patents from its inception in 1974 until their discharge

in January 1995.

The first three causes of action seek, essentially, to

recover the approximately $7,000,000 in rovalties received

by the defendants pursuant to their combined 22% interest

in the various business ventures and to relegate them to the

payment of legal fees on a quantum meruit basis in reliance

on a similar outcome in the earlier litigation (the Rhodes

action) tried under index no. 8055/87, in which plaintiffs

prevailed under the doctrine of collateral estoppel invoked

on their counterclaims in the Rhodes’ action. This courts

judgment, following a lengthy trial, was issued on May 14,

1998 (aff , NYLJ, 2-8-99 p 26 c3), “rescinding ab initio any

interests Rhodes holds, or may have held in Trusts I and IT”

(the second trust was formed to segregate certain inventions

67a

Appendix E

on which Rhodes had performed all relevant patent law

services) based on the finding that the business ventures

jointly formed by plaintiffs and Rhodes “were entered into

in violation of the ethical duties owed by attorneys to their

client.” According to the appellate affirmance” the record

supports the trial court’s findings that neither the initial

arrangement (a partnership formed in October 1 974) nor its

subsequent incarnations (Biological Engineering Corp.,

(BEC) established in July 1975 and its successor-in-interest

created by the 1983 trust agreements) were entered into upon

adequate disclosure “of other possible fee arrangements and

potential conflicts of interest.”

The main motion is granted rescinding Trust I and

awarding a conditional judgment for all moneys distributed

to defendants less reasonable attorney fees and dismissing

plaintiffs’s fourth cause for legal malpractice. Conversely,

the cross motions are denied and defendants’ counterclaims

alleging breach of contract and fiduciary duty and seeking

an accounting on the parties invalid trust agreement are

dismissed as moot with the exception of the attorney fees

pleaded in the sixth counterclaim. The issue of rescission

was essential to the outcome and was thoroughly litigated in

the Rhodes trial, in which defendants had ample opportunity

to participate. Actively recision issue was squarely placed in

issue in the counterclaims served in December 1991 in the

Rhodes action and defendants were fully familiar with the

ethical scope of these claims. Their basic awareness of the

“potential preclusive effect” of an outcome favorable to

Rhodes is conceded in the opposing papers by defendants’

counsel and defendants acknowledged informally during the

course of the Rhodes litigation that their own stake in the

68a

Appendix E

business venture might very well hinge on its outcome.

It fact, they applied in 1995 to stay this action pending

resolution of the Rhodes trial arguing the likelihood of its

having an estoppel effect.

Nevertheless, defendants, who were nominal parties in

the Rhodes case, elected to elude every opportunity afforded

them to participate actively in trial preparation or the trial

itself, where Rhodes presented extensive expert testimony

on the central issue of professional ethics and otherwise

offered a vigorous defense to the rescission counterclaims.

Defendants successfully opposed a belated motion to add

them on the eve of trial as parties to the counterclaims along

with Rhodes and later quashed subpoenas citing them as

witnesses based on their New Jersey residence. In addition,

Rhodes’ attorneys announced at the trial’s inception the

well-founded intention of calling defendants to the stand as

voluntary witnesses. Hence, defendants protestations of

entitlement to litigate de novo because they were never in a

position to oppose plaintiffs’ rescission claim is manifestly

unconvincing. :

Defendants’ contentions that they were not in legal

privity with and had actually adverse interests vis a vis

Rhodes during the prior litigation, is also unpersuasive and

runs counter to fundamental principles of fairness and equity.

The three attorneys had identical interests in the success of

BEC and defendants maintained their same beneficial

share in the successor Trust 1 entered into after Rhodes left

the law firm. The fact that their role in the management of

the business venture was curtailed and the 1983 trust

documents created a separate source of income for Rhodes

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69a

Appendix E

(i.e., Trust 1), thereby reducing defendants’ equity tees on

plaintiffs prosthetic inventory did not alter the three attorneys’

basic mutuality of interest on the litigated issue of

professional ethics. That is, all three were equally exposed

to financial loss in the event plaintiffs prevailed on their

counterclaims for rescission. On this score absolutely no

adverse relationship existed between them. On the contrary,

having acted in concert in the formation of their business

venture with plaintiffs in 1974 the attorneys had every

incentive to join forces in the Rhodes action and actually

did cooperate somewhat in Rhodes trial preparation. More

importantly, they have not shown that their failure to fully

participate in the Rhodes action affected its come.

In sum, judging by the context of defendants’ affidavits

in the present action, their testimony in the Rhodes action,

even assuming its veracity, would not have met the standard

of professional conduct applied in the prior case, having

failed to allege, inter alia, that plaintiffs were informed their

attorneys could be replaced without penalty.

Moreover, there is no merit to the contention that

plaintiffs waived their right to rescind Trust 1 by continuing

to retain defendants vntil their discharge in January 1995

and by lulling them into a sense of security by not proceeding

against them directly in the context of the Rhodes action.

First, since it was most unreasonable for defendants to rely

on a disputed laymen’s oral exchange with plaintiffs on the

complex legal issues of professional ethics and estoppel,

no material issue of fact is raised on the rescission claims by

the purported reassurance given by plaintiffs. Also, no

prejudice has been shown since defendants are fully entitled

70a

Appendix E

to recover for all legal services rendered until their discharge.

Further, defendants’ claim of deceptive conduct as to their

continued retention without complaint long after defendant

became aware by 1982 of alleged deficiencies in the

prosecution of two patent applications has been mooted by

the dismissal of plaintiffs’ time barred fourth cause of action

for legal malpractice. ;

Nevertheless, while defendants maintain correctly that

these discreet transaction are not covered by the doctrine of

continuous representation relied by plaintiffs, the doctrine

clearly applies to the issue of professional ethics at the heart

of the present litigation. In short, given the fact that

“the parties relationship ... remained at all times that of

attorney-client” (as noted in the appellate affirmance cited

above), the Statute of Limitations did not accrue until the

termination of plaintiffs uninterrupted course of reliance

on defendants’ legal representation in January 1995.

This conclusion is especially compelling here, where the

fundamental issue of professional ethics is at stake rather

than the far less serious issue of professional negligence

raised in plaintiffs’ fourth cause of action.

Accordingly, plaintiffs are awarded partial summary

judgment on their first, second and third causes of action

terminating and rescinding ab initio defendants’ equity

interest in the three legal entities negotiated by the parties

and Rhodes between i974 and 1983 and directing defendants

to return all fees distributed to them less the reasonable value

of their legal services rendered following resolution of the

attorney fee issue on a quantum meruit basis. The fourth cause

of action for legal malpractice is dismissed.

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Appendix E

Settled order, providing for a severance of the remaining

claims.

Dated: May 26", 1999 .

s/ Richard B. Lowe III

JUDGE RICHARD B. LOWE III

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APPENDIX F — ORDER OF THE SUPREME COURT,

COUNTY OF NEW YORK, STATE OF NEW YORK

FILED FEBRUARY 23, 1995

SUPREME COURT OF THE STATE OF NEW YORK

COUNTY OF NEW YORK: IAS PART 25

Index No.: 8055/87

Cal. No.: 222 of 2/17/95

R.GALE RHODES, JR..,

Plaintiff,

-against-

FREDERICK F. BUECHEL and MICHAEL J. PAPPAS,

individually and as Trustees of certain trusts entitled

Biomedical Engineering Trust and Biomedical Engineering

Trust II,

Defendants,

-and-

JOHN N. BAIN and JOHN G. GILFILLAN, III, as

beneficiaries of a certain trust entitled Biomedical

Engineering Trust, and PAUL A. WITTE, as beneficiary

of certain trusts entitled Biomedical Engineering Trust and

Biomedical Engineering Trust II,

Defendants-Beneficiaries.

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Appendix F

DeGRASSE, J.:

This motion by defendants for leave to amend their

counterclaims is denied. The stated purpose of the proposed

amendment is to expand the prayer for relief against John N.

Bain and John G Gilfillan II] who have been counterclaim

defendants for the past seven years. The instant motion was

made five months after the note of issue was filed following

protracted discovery. Defendants have not offered an

acceptable excuse for their delay in making the instant

application. The supporting affidavit alludes to an October

1994 decision of the German High Court for Patents.

However, it has not been shown that the proposed amended

counterclaims did not accrue and could not have been

interposed at a more appropriate time. To grant the requested

relief would require plaintiff to either waive discovery to

which he would be entitled or face the prospect for further

delay of this eight year old lawsuit.

Plaintiff's cross-motion for an order striking defendants’

supplemented responses to plaintiff’s expert interrogatories

is granted to the extent that defendants shall be precluded

from calling Geoffry C. Hazard, Jr., Michael P. Ambrosio

and Eugene Rzucedlo as expert witnesses unless defendants

pay the firm of Leventhal, Slade & Krantz a counsel fee of

$8,000 and produce the said witnesses for depositions to be

conducted at defendants’ expense on March 13, 1995 at 10:00

a.m. at the office of plaintiff’s counsel or at such other time

and place as the parties shall agree to in writing. The expert

witness interrogatories which relate to defendants’

counterclaims were served on November 4, 1993.

Defendants’ December 8, 1993 response indicated that as of

~ 74a

Appendix F

that date defendants had not decided who their expert

witnesses would be. The supplemental response naming the

expert witnesses was not served until January 10, 1995, four

months after the note of issue had been filed. Plaintiff has

been prejudiced by defendants’ delayed response which limits

plaintiff’s time to engage his own expert witness to offer

testimony in rebuttal. Accordingly, the conditions imposed

herein are within the sound exercise of this court’s discretion

(see, McDermott v. Alvey, Inc., 198 AD2d 95). The required

counsel fee shall be paid by March 13, 1995. Plaintiff’s

application for sanctions is denied in light of the foregoing.

Copies of this order have been mailed to the parties on the

date of signature.

This constitutes the decision and order of the court.

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APPENDIX G — ORDER OF THE SUPREME COURT,

COUNTY OF NEW YORK, STATE OF NEW YORK

FILED MARCH 4, 1998

SUPREME COURT OF THE STATE OF NEW YORK

COUNTY OF NEW YORK: IAS PART 54

Index No. 8055/87

R. GALE RHODES, JR.,

Plaintiff,

-against-

FREDERICK F. BUECHEL and MICHAEL J. PAPPAS,

individually and as Trustees of certain trusts entitled

Biomedical Engineering Trust and Biomedical Engineering

Trust II,

Defendants,

-and-

JOHN N. BAIN and JOHN G. GILFILLAN, III, as

beneficiaries of a certain trust entitled Biomedical

Engineering Trust, and PAUL A. WITTE, as beneficiary

of certain trusts entitled Biomedical Engineering Trust and

Biomedical Engineering Trust II,

Defendants-Beneficiaries.

76a

Appendix G

HON. RICHARD B. LOWE, III:

A bench trial was held before me from April 24,1995 through

July 10, 1998. R. Gale Rhodes, Jr., plaintiff sued Frederick F.

Buechel and Michael J. Pappas, individually and as Trustees

of Biomedical Engineering Trust and Biomedical Engineering

Trust II. Plaintiff seeks to recover millions of dollars for

improper trust payments which defendant trustees Buechel

and Pappas have made to themselves. Further, plaintiff seeks

to remove them as trustees and to require the trusts to pay

plaintiff his share of trust income which has been withheld

since 1987. In sum, Plaintiff seeks more than $6 million

dollars, also a share of future royalties.

Defendants Buechel and Pappas counterclaim, seeking

the forfeiture of trust income to Rhodes as a result of alleged

unethical activity. Further, defendants seek monetary

damages of $4,013,367.00 plus interest, as a result of the

alleged acts of patent malpractice. More specifically, defendants

Buechel and Pappas claim that Rhodes was negligent in

connection with two patent applications. First, defendants claim

that they incurred $2,013,367.00 in damages as of April 25,

1995 for the °451 Patent. Additionally, defendants Buechel

and Pappas seek $2,000,000.00 in damages as a result of

Rhodes’ alleged negligence in the prosecution of the 658 patent.

In an effort to render a concise decision this Court has

elected to address the ethical issues raised by defendants

Buechel and Pappas at the outset, because any conclusion

that plaintiff Rhodes acted in violation of his ethical

responsibilities may result in the forfeiture of legal fees.

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Appendix G

The Court’s findings of fact and conclusions of law are

as follows:

FINDINGS OF FACT

Plaintiff R. Gale Rhodes, Jr., is a member of the Bar of the

State of New Jersey, whose practice is primarily in the area of

patent law. He received his training in the area of patent law at

Western Electric and has been a private practitioner since 1964.

Defendant Frederick F. Buechel is an orthopedic surgeon

associated with several New Jersey medical institutions.

He is also a professor of orthopedic surgery at New Jersey

Medical School.

Defendant Michael Pappas is a mechanical engineer who

has worked on inventions since 1958. His past employment

included working as a professor at the New Jersey Institute of

Technology and for Lockheed and Sheppard Industries. He was

the proud owner and operator of Orginetics, a company which

commercially exploited many of his inventions.

In 1974, at the suggestion of the Chief of Orthopedics at

the New Jersey Medical School, Frederick F. Buechel and

Michael Pappas met. This was the beginning of a successful

and prosperous joint venture, the collaboration to invent

prosthetic devices. Their goal clearly was to enhance the

quality of existing products on the market thereby enhancing

the quality of life for persons in need of prosthetic devices and

to make money in the process. Today, they are extremely

successful businessmen, both holding a large number of patents

on important developments in the field of joint replacement.

78a

Appendix G

As a result of their accomplishments being widely published

they have gained great notoriety and success.

Defendants began working together and soon developed

drawings and a prototype for a “Floating Center Prosthetic

Joint.” In September 1974, they displayed a brass model of

their shoulder prosthesis device to Howmedica, a prominent

manufacturer of prosthetic devices. During their conversations

with Howmedica they learned that Howmedica was working

on a similar device with others. Therefore, Howmedica declined

the opportunity to work with them. :

The knowledge that Howmedica was working on a similar

device caused them to become anxious. They wanted their

invention patented and on the market first. Thereafter, believing

that they needed urgent legal assistance, Pappas recommended

to Buechel that they immediately consult Rhodes, a patent lawyer

with whom he had previously worked.

At this time, Rhodes was in a partnership with two other

patent lawyers, John N. Bain, Esq. and John Jack Gilfillan Il, Esq.

The partnership dissolved in December 1981.

The parties met several times during the fall of 1974

and agreed that Rhodes and his law partners, Bain and

Gilfillan, would receive one-third interest in any inventions

that Buechel and Pappas would bring to them, in return for

legal work to include drafting and prosecuting patent

applications, both foreign and domestic, working on licenses

for exploiting the inventions, and providing other assistance

and advice as became necessary. Rhodes and his law partners

had never before accepted a contingency fee for patent law

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Appendix G

services. Further, the testimony revealed that the acceptance

of a contingency fee is not a customary practice in the area

of patent law.

In an effort to induce a contingency fee arrangement

Rhodes told Buechel and Pappas that a one-third contingency

fee arrangement “was a usual arrangement.” Further, Rhodes

informed them that it was essential to file a patent application

promptly in order to obtain priority over Howmedica.

Moreover, Rhodes warned them that Howmedica would

probably initiate an “interference proceeding” challenging

Buechel and Pappas patent rights. Thus, ieading them to

believe that legal protection was necessary immediately.

Simultaneously, Rhodes lead Buechel and Pappas to believe

that they would incur a great expense defending (a possible)

an interference proceeding.

With regard to their individual contributions to the joint

venture, Beuchel and Pappas would be required to spend a

tremendous amount of time and energy developing their

inventions and bringing them to commercial viability. This,

along with the inventions, would be their contribution to

the joint endeavor, for which they would each receive a

one-third interest.

A one paragraph fee agreement was executed on

October 8, 1974, but a copy was never furnished to Buechel

and Pappas. Thereafter, their agreement was memorialized

in a simple three page document dated November 12, 1974.

The agreement set forth that Bain, Gilfillan and Rhodes

agreed to provide patent legal services in return for an

assignment of a one-third interest in the floating - center -

80a

Appendix G

prosthetic joint device. Further, all parties agreed to

contribute their pro-rata share of any “out of pocket expenses

associated with such patent prosecution,” as well as a tester

for the device and any other development or marketing

expenses mutually agreed upon. The agreement further

provided that proceeds received by any party would have to

be shared by all.

Buechel and Pappas executed an assignment to the law

firm of a one-third equity interest in the invention and, in

any patents and proceeds that issued therefrom. The effect

of such was that Buechel, Pappas, Rhodes and his partners

had become involved in a joint venture.

The Court notes that Rhodes failed to discuss with

Buechel and Pappas alternative payment arrangements, such

as a Sliding scale fee, a cap on royalties or compensation

based on the reasonable value of the services rendered.

Although the parties had crystallized their understanding

in writing, the fee agreement did not reflect all of the

promised services. For example, the fee agreement omitted

certain important responsibilities of Rhodes and his partners.

More specifically, the fee agreement failed to set forth that

Rhodes and his partners would prosecute and defend both

infringement and interference proceedings.

Rhodes concedes that at this stage he failed to advise

Buechel and Pappas to obtain independent counsel. Further, the

Court finds that Rhodes failed to inform Buechel and Pappas of

the potential conflicts of interest that might occur when a

lawyer enters into a business transaction with his client.

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Appendix G

Thereafter, Rhodes formalized the relationships between

inventors and lawyers by forming Biomedical Engineering

Corporation. The purpose of Biomedical Engineering

Corporation was to exploit their inventions and make money.

Rhodes believed that a corporation was the best vehicle

because a corporation could use pretax dollars to fund

research, development and marketing. Further, Rhodes

believed that a corporation could retain the resulting tax

“losses” to be applied against future income. This was something

which Rhodes believed individuals and partnerships could not

offer. Thus, Rhodes believed the corporate form proposed a more

suitable vehicle for doing business.

The Court finds that at this stage, Rhodes again failed to

advise Buechel and Pappas to consult independent counsel.

On July 7, 1975, Biomedical Engineering Corporation, a New

Jersey Corporation, was formed. Beuchel, Pappas and Rhodes

were designated as the officers and directors of Biomedical

Engineering Corporation. Rhodes served as President,

running the corporation out of his law offices.

The first patent application, entitled “Floating Center

Prosthetic Joint” was rapidly developed. Rhodes prepared

the claims expressly setting forth the invention as explained

to him by Buechel and Pappas. The claims reflected all

information brought to his attention at that time. Thereafter,

Rhodes broadened the claims beyond the shoulder prosthesis

which the inventors had brought to him, after ascertaining

that the invention could be used in other joints such as knees,

fingers, ankles, etc. At the same time, Rhodes did not seek

to redefine or broaden the invention itself, which the

inventors now say, 20 years after the fact, was his obligation

as a patent lawyer. However, the Court notes that at the time

82a

Appendix G

Rhodes and Buechel believed that the claims drafted by

Rhodes accurately reflected their invention and sufficiently

protected their rights.

The app!-ation was approved and a patent was issued on

November 14, 1975. This patent represented the first of eighteen

patents issued which were prepared and filed by Rhodes.

Buechel and Pappas continued to collaborate on the

development of the prosthetic devices such as the knee, hip

and shoulder implants, including an “Integrated Knee

Replacement System.” On July 16, 1975, they assigned to

Biomedical Engineering Corporation their interest in the

invention, and in any patents that might issue therefrom.

Thereafter, stock was issued as follows: one-third of the shares

to Beuchel, one-third to Pappas, one-ninth each to Bain, Gilfillan

and Rhodes individually. From 1975 to 1983, Biomedical

Engineering Corporation served as the vehicle for exploitation

of the inventions until it was dissolved and its property tumed

over to Biomedical Engineering Trust in late 1983.

The Court finds that Rhodes failed to perform certain

key tasks. More specifically, Rhodes failed to prepare a

shareholders agreement. Further, he failed to memorialize

his oral promise that the lawyers would earn their equity in

Biomedical Engineering Corporation only in exchange for

their future performance of legal services. Rhodes had

become an owner of the corporation, entitling him to share

equally in the profits with his partners.

Here again, Rhodes failed to advise Buechel and Pappas

of potential conflicts of interest that would arise as a result

of converting the attorney’s one-third interest in a single

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Appendix G

invention, into a one-third equity interest in a corporation

which would exploit all of their future inventions. At no time

did Rhodes disclose the existing conflict of interest involved

in his firm serving as counsel while having an equity interest

in the corporation. Further, Buechel and Pappas were not

informed that they could discharge their lawyers at any time,

without penalty and thereby extinguish the lawyers’

contingency equity interest in the corporation. In this case,

they could discharge their lawyers at any time because the

proper disclosure was not made.

Rhodes informed Buechel and Pappas that they “could

not go into a business which would be in the same area

that was of interest to Biomedical Engineering Corporation.”

The Court finds this statement to be significant because it

reflects that Rhodes primary concern had become making

money and not his clients’ best interest. Further, the statement

mislead Beuchel and Pappas, causing them to believe that

all of their future inventions would belong to Biomedical

Engineering Corporation. ¥

In 1977 Biomedical Engineering Corporation entered

into an agreement with DePuy, a prominent manufacturer of

prosthetics and a division of Bio-Dynamics, Inc. The

agreement licensed DePuy to manufacture, sell and distribute

a “Floating Center Shoulder Prosthesis” and a “N.J. Knee.” The

first license dated April 25, 1977 provided for a very high royalty

rate, including a rate of 15% for the “New Jersey knee.” This

uniquely high royalty rate proved to be a contributing factor

for the endeavor’s financial success. The agreement with DePuy

was simply remarkable. Another extraordinary feature of the

agreement was that the license covered the “devices” not merely

84a

Appendix G

the patent rights. Thus, DePuy would have to pay royalties

whether or not patents were granted. Further, royalty payments

would continue after the expiration of the patents. The license

was amended and superseded by a later agreement.

Ultimately, the collaborative efforts of Buechel and Pappas

led to the successful development and marketing of many

prosthetic-related devices and equipment. Such efforts have

resulted in the payment to date of approximately $50 million

in royalties.

The Court finds that from the outset all parties realized

the significant effort involved and that their compensation

for their particular contributions would be their eventual share

of the proceeds obtained from exploiting the inventions, if any.

This appears to have been clearly agreed on.

With regard to the first patent, the “451 Patent” previously

mentioned, Rhodes filed the patent application on October

25, 1974, with each of the original seventeen claims defining

the proposed monopoly as requiring that both the first and

second surfaces of the floating bearing surface have a “cross-

section conforming to a circular arc.”

Buechel and Pappas now contend that there was no

reason for this limitation. Further, they argue that this

particular limitation substantially reduced the scope of the

patent monopoly received. The Patent office allowed all of

the clams in the first office action (except one, claim 11,

which was rejected on procedural grounds).

Defendants, Buechel and Pappas now contend that

Rhodes should have noted and removed the unnecessary

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Appendix G

“circular arc” limitation which made the claims prepared by

Rhodes unduly narrow. This contention forms the basis of

their alleged patent malpractice claim herein.

As aresult of broad language contained within a Goodfellow-

Oxford patent, the company successfully asserted a claim

against DePuy. DePuy was sued as the result of being the

holder of the license of the Buechel-Pappas knee device.

As aresult of DePuy’s inability to assert an infringement

claim or negotiate a cross-license with Goodfellow-Ox ford.

DePuy was forced to pay royalties to Goodfellow-Ox ford.

Defendants assert that the failure of Rhodes to draft the

’451 patent’ claims broadly, cost them a great deal of money.

More specifically, DePuy paid royalties to Goodfellow-

Oxford under a license for the invention which cost

defendants $2,013,367.00, that is, reduced the royalties

which they received by such amount.

The testimony further revealed that in 1980 Pappas

informed Rhodes that he believed Mr. Robert Averill had a

patent which conflicted with a Beuchel-Pappas invention

licensed to DePuy. Further, he asked Rhodes to bring a lawsuit

against Mr. Averill. Although Rhodes prepared a draft

complaint and forwarded it to Mr. Averill along with

supporting documents, a settlement was not reached.

Thereafter, Rhodes refused to bring the lawsuit unless he

was paid an hourly rate.

During the period of time from October 8, 1974 through

late 1983, Rhodes worked diligently on behalf of Buechel and

Pappas securing patents. However, the record fails to establish

86a

Appendix G

that Buechel and Pappas were ever informed of the potential

conflicting interests which had entangled their interests.

Pnor to October 16, 1979 Buechel and Pappas provided

Rhodes with the disclosure for the °658 Patent’, which included

a “split-collar” and “split bearing” embodiment. The testimony

reveals that in July 1980 Pappas submitted to Rhodes a patent

disclosure, essentially a patent application for both the “split

collar” and “split bearing” embodiments. Further, the record

revéals that Rhodes did not file the application for more than

two years because he was instructed by the defendants to

wait until they had discussed and resolved important issues

with DePuy. The patent office cited an item of prior art which

prevented Buechel and Pappas from obtaining broad claims.

Dr. Ramos successfully sued Biomet company, the

company that marketed the infringing device, for patent

infringement and received a judgment for compensatory

damages of $2,000,000.00. The Court finds that the

defendant’s device was different from that of Dr. Ramos.

At the end of 1981, Rhodes withdrew from his law

partnership with Bain and Gilfillan. The dissolution proved to

be apocryphal. The testimony revealed that Rhodes had difficulty

resolving the issue of what would occur with respect to the

inventions that Rhodes was working on after the dissolution.

Now Rhodes was a solo practitioner and the desire to share

compensation with Bain and Gilfillan was gone. Rhodes was

seeking a new understanding and wrote several aggressive letters

to his former partners in support of such.

87a

Appendix G

Over the next thirteen years, Rhodes worked diligently

on the Buechel and Pappas inventions. He worked on 27 patent

applications during this period of time, which resulted in more

than 20 United States patents. Further, through extraordinary

efforts Rhodes secured several foreign patents and licensing

agreements. Unequivocally, the Court finds that Rhodes worked

diligently on behalf of the defendants over the next several years.

Further, the Court finds that Rhodes worked without

compensation in complete reliance on the agreement of 1974.

However, troublesome to the Court is the fact that Rhodes

engaged in the following questionable activity:

? ¢ Unbeknownst to Bain and Gilfillan, Rhodes

f incorporated a company named Endomedics,

; and allocated its stock one-third to Buechel,

one-third to Pappas and one-third to himself.

hae

* Endomedics began to develop, manufacture and

market products already licensed to DePuy by

Biomedical Engineering Corporation.

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* In January 1983, Rhodes formed a Flonda corpora-

; tion naming it Biomedical Engineering Corp.

¢ Rhodes caused checks from DePuy intended for

Biomedical Engineering Corporation (New

Jersey) to be deposited in an account owned by

Biomedical Engineering Corporation (Florida).

; * Unbeknownst to Bain and Gilfillan, Rhodes

: opened a second New Jersey bank account in the

; name of Biomedical Engineering Corporation.

88a

Appendix G

¢ Rhodes caused a $22,500.00 check from DePuy

to Biomedical Engineering Corporation to be

deposited in the above stated account.

In January 1983 Rhodes exchanged letters with Bain and

Gilfillan, copies of which were sent to Buechel and Pappas.

Rhodes indicated the firm breached its obligations to perform

continuing services for Bueche! and Pappas by breaking up.

Further, Rhodes acknowledged that the diversion of inventions

to Endomedics and of funds to Biomedical Engineering

Corporation Florida could expose Buechel and Pappas to a

claim for the misappropriation of a corporate opportunity.

Rhodes suggested that by “unanimous consent of the

stockholders” Biomedical Engineering Corporation be

dissolved and “the inventions be reassigned to Mike and Fred

jointly.” The Court finds that this particular letter mislead

Buechel and Pappas into believing that the unanimous

consent of the parties was required to dissolve Biomedical

Engineering Corporation, when in fact, Buechel and Pappas

could discharge their attorneys at any time. Further, Rhodes’

letter suggested that he was amenable to the equity interests

being returned to Buechel and Pappas, jointly.

In 1981, Rhodes was advised by an accountant that the

shareholders of Biomedical Engineering Corporation would

be exposed to a substantial tax liability on any royalty income

received by the corporation. The adverse tax consequences

were not immediately brought to the attention of Buechel

and Pappas. Two years expired before they were made aware

of this fact. Further, Rhodes did nothing to correct the tax

consequences until 1983. In late 1982, Beuchel’s accountant,

89a

Appendix G

Patrick Power, suggested that Buechel consult his brother,

John Power, Esq., a New York City tax attorney, with regard

to the Biomedical Engineering Corporation tax problem.

Buechel and Pappas, concerned about the tax consequences

which they faced and the turn of events with regard to Rh des

and his firm, consulted John Power, Esq. Patrick Power,

Buechel, Pappas and Rhodes met with John Power for the

first time to discuss the tax problems facing Biomedical

Engineering Corporation and the dissolution of the law firm

of Bain, Gilfillan and Rhodes. Thereafter, Power met twice

with Buechel, Pappas, and either Rhodes, Bain or Gilfillan

were in attendance.

In 1983, Biomedical Engineering Corporation retained

Power. Power was hired to give the corporation tax advice,

and determine from a tax perspective whether or not it was

feasible to dissolve the corporate entity and, if so, to

determine what should happen with respect to the patents

and other corporate assets.

The Court notes that Power was not asked to review the

propriety of the fee arrangements. Power merely recodified

the existing fee arrangement within the Trust instrument.

Further, the Court notes that Power was not asked to

determine whether or not such arrangement had been made

after full disclosure of conflicts or to evaluate the overall

fairness of the business venture.

Power did seek copies of all documents conceruing the

origin of the relationship amongst the parties from Rhodes.

However, the 1974 Fee Agreement executed by the parties

90a

Appendix G

was never sent to Power. Moreover, Rhodes informed Power

that no such document existed.

In April 1983, Power advised the shareholders that

Biomedical Engineering Corporation could be dissolved and

its assets “transferred to its shareholders without the

imposition of substantial additional taxes.” This could be

accomplished if the assets were transferred to a trust created

for the benefit of the s*areholders in proportion to their

respective stock holdings. “his would solve the tax problems

caused by the corporate form.

In late 1983 Biomedical Engineering Corporation was

dissolved and its assets transferred to Biomedical Engineering

Trust, hereinafter referred to as “Trust I.” The trust also served

to collect and distribute any royalty income from the licenses

with DePuy. The shareholders of Biomedical Engineering

Corporation received a beneficial interest in Trust I,

equivalent to their former equity interests in Biomedical

Engineering Corporation, as follows: one-third to Buechel,

one-third to Pappas, and one-ninth each to Rhodes, Bain and

Gilfillan (less one-and-one-half percent to Paul Witte).

The trust agreement, drafted by Power, made Bain and

Gilfillan specifically responsible for prosecuting and defend-

ing the patents. Further, it released Rhodes from any further

obligation in this regard. Additionally, it discusses the role

of the trustees in general terms. The trust agreement is silent

on whether or not the trustees may pay themselves for work

outside of their fees as trustees. Fees are 2% per year of

moneys received and distributed to the beneficiaries.

9la

Appendix G

The Trust II agreement specifically obligated Rhodes to

prosecute and defend patents owned by Trust II, although it

provided that Rhodes could decline to provide those services

or the trustees could retain other counsel in the best interest

of the Trust.”

As a result of the dissolution of the law firm, a second

trust had to be formed. Rhodes’ former partners agreed, albeit,

reluctantly to waive any interest in the inventions which

Rhodes had principally worked on, after their partnership

dissolved. Hence, the second trust, “Trust II” was formed.

This trust was created to be the assignee of all the inventions

on which Rhodes worked after leaving Bain and Gilfillan,

which had not been assigned to Trust I, principally the

components of the “New Jersey Integrated Hip.” The beneficial

interests of Trust II were allocated as follows: one-third to

Buechel, one-third to Pappas, and one-third to Rhodes (less

a one-and-one-half percent interest to Paul Witte).

In June 1983, Rhodes demanded that Power include

language in the Trust Agreement that would release him from

responsibility for the legal work for the knee and shoulder

devices, or threatened that he would not give any release to

his former partners. Power included the proposed release

language in Article 32 of the trust agreements; Bain and

Gilfillan would be responsible for all legal services related

to the knee and shoulder devices (Trust I), while Rhodes

would be solely responsible for the legal services related to

the hip devices (Trust II). Further, Rhodes was released from

any other obligations.

The Court accepts the contentions of Buechel and Pappas

that they agreed to Rhodes demand because Rhodes, Bain

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Appendix G

and Gilfillan were no longer able to work together and if the

trust agreements were not executed, they would be subject

to the adverse tax effects of continuing Biomedical

Engineering Corporation. Defendants’ contentions are

supported by the fact that Rhodes demanded to be released

from his obligation to work on the knee device as a condition

precedent to agreeing upon the formation of the Trust. The

Court finds that at this crucial point, Buechel and Pappas

were not advised that they had a right to terminate the Fee

Agreement - that was reflected in the equity structure of

Biomedical Engineering Corporation by discharging the

attorneys without financial penalty.

Plaintiff asserts that Power was retained by Buechel and

Pappas and served as independent counsel. Defendant’s deny

this claim arguing that he was retained by the corporation.

Despite the fact that Power closely scrutinized the—

previous acts of Rhodes and Rhodes’ role in the joint venture,

1.e., in a letter to Rhodes he wrote “your incorporation of

Fred and Mike in 1975 was a very serious mistake, which,

under the circumstances, would subject you to a malpractice

action”, he was not hired by them in their individual capacity,

but rather retained by the corporate entity. The Court finds

that Power’s criticism of Rhodes’ roles in the business venture

was squarely grounded in the Rules of Ethics and in all

likelihood what any other lawyer would have stated.

Thereafter, Power recommended that Buechel and

Pappas be the sole trustees because Rhodes active role in

protecting the inventions from competition precluded his

being a trustee. Power informed Rhodes that a trustee could

not have two conflicting active roles in a trust fund.

93a

Appendix G

Rhodes was removed as legal and business advisor to

the enterprise. The roles of Rhodes and his former partners

was limited to prosecuting and defending their patents.

Further, the lawyers were responsible for bearing the financial

cost of the legal work necessary to protect and maintain the

patents, notwithstanding whether or not they performed the

work. After the trust agreements were executed and until 1987,

Rhodes continued to render legal advice to Buechel and

Pappas with respect to a variety of personal matters.

Buechel and Pappas were given a list of their duties as

trustees, which included the following: opening bank

accounts, depositing the royalty checks from DePuy,

distributing royalties to the beneficiaries and hiring an

accountant to audit books and records of DePuy.

During the summer of 1986 DePuy sought from Buechel

and Pappas evidence which they could use to rebut a claim

of patent infringement against DePuy made by the holders

of the “Noiles patent.” Buechel made several requests for

this evidence from Bain and Gilfillan, patent attorneys for

Trust I, but it was never furnished. In sum, DePuy settled

with the Noiles interests which resulted in the loss of

substantial royalty income to Trust I. Based on this and other

incidents Buechel and Pappas came to believe that the lawyers

were not performing promised legal services and having

obtained an interest in the proceeds of the business venture

only cared about the money to be made.

From 1984 through the beginning of 1987, Rhodes

worked on a number of inventions and filed several patent

applications. The inventors continued their research and

94a

Appendix G

development efforts. Trust I finally began to generate income.

In the first fiscal year it generated $182,518.00; in the second

$314,284.00 and in the third $1,519,409.00. The parties

received their pro rata shares one-third each to Buechel and

Pappas ($29,380.00 in the first year; $82,901.00 in the second

and $393,655.00 in the third) and one-ninth each to Bain,

Gilfillan and Rhodes ($9,785.00 in the first year; $27,463.00

in the second year, and $129,406.00 in the third year).

In mid 1986, Buechel became aware that the hip prosthesis

designed by defendants and manufactured by Howmet Turbine

Components Corp., contained small “beads” that separated from

the prosthesis after they were implanted in approximately a

dozen of his patients. Upon gaining this information, Dr. Buechel

took measures to have the product recalled.

Further, defendants created an emergency program to test ,

the product and to ensure that the defective devices were

discarded. Rhodes assisted the defendants in this endeavor.

Further, Rhodes discussed the matter with Howmet and

assured the company that all appropriate measures to correct

the problem were being taken.

During this time period Buechel and Pappas devoted

substantial time to improving their inventions through research

and development. Further, they devoted substantial efforts to

promotional marketing activities designed to induce surgeons

and others to use the inventions. Their efforts lead to the

tremendous success of their products. Thereafter, Buechel con-

sulted with Pappas and Rhodes as to his belief that he and

Pappas should be compensated for services to the trusts

outside of their duties as Trustees and suggested that they

95a

Appendix G

meet to discuss the subject of compensation for work

performed. Rhodes declined to meet with Buechel and Pappas

unless he could bring along litigation counsel. The parties

had reached an impasse. Rhodes had become entangled with

defendants in a dispute concerning compensation for research

development and marketing of the inventions.

After having consulted with Power, Rhodes, Bain and

Gilfillan and in reliance on opinions by Power and the written

consent of Bain, Gilfillan and Witte, Buechel and Pappas

took compensation for their services to the Trusts.

The Court finds that the trust agreements, although -

specifically silent on the issue of payment for work outside

of fees, contained broad provisions authorizing the

continuation of research and development and marketing

activities previously conducted by Biomedical Engineering

Corporation, and authorizing payment of compensation

thereof. Further, the trust agreement provides that the trustees

shall have the specific powers “to perform any act authorized,

permitted or required” under the licenses. This Court finds

that the licenses to DePuy required Buechel and Pappas to

engage in research, development and marketing.

Most significantly, the trust agreements provide for

ratification of the trustees’ actions by votes of the

beneficiaries. The Trust I agreement contains a provision that

rendered Buechel and Pappas’ actions “final and binding” if

approved by 75% of the beneficial interests in the Trust.

In April 1987, Buechel and Pappas issued their report

and account for Trust I for the fiscal year ending January 31,

96a

Appendix G

1987. The report disclosed past and anticipated compensation

to Buechel and Pappas for research and development and

marketing services. All of the certificate holders constituting

89% of the interests except for Rhodes, signed and ratified

the report.

On December 23, 1986 after rejecting an invitation by

Pappas to discuss Buechel and Pappas’ desire for payment

for their research, development and marketing services,

Rhodes sued Buechel and Pappas in New Jersey and sought

to have them removed as trustees. Rhodes alleged that they

were dishonest and had breached their fiduciary duties by

taking compensation for their services to the trusts.

In January 1987, at the advice of Power, and as a result

of being sued by their attorney, Buechel and Pappas

terminated Rhodes’ services. As a result of being discharged,

Rhodes engaged in the following questionable activity, much

of which he candidly admits was irrational at the time:

¢ Rhodes filed an affidavit with the New Jersey

Superior Court disclosing confidential informa-

tion concerning the bead separation problem.

¢ Rhodes threatened to depose Buechel’s patients

on the issue of pain and suffering. This stemmed

from Rhodes’ allegations that Buechel’s patients

might be suffering pain as a result of the device.

¢ Rhodes threatened to hire Buechel’s supervisor,

Dr. Andrew Weiss, as an expert to establish that

Buechel had committed acts of negligence.

97a

Appendix G

* Rhodes threatened to publicize the alleged acts

of negligence by Buechel, if Buechel and

Pappas failed to yield to his demands that they

step down as Trustees.

* Rhodes sought the names of Buechel’s patients

so that he could solicit their assistance in suing

Buechel.

* Rhodes sought an advisory opinion form the

New Jersey Supreme Court Advisory Commit-

tee on Professional Ethics as to whether or not

he could bring a malpractice action against

Buechel, a former client. Rhodes sent a copy

of such to Buechel.

Thereafter, Rhodes brought the present action against

defendants in New York. To date, Rhodes has been paid

approximately $500,000.00 for legal services rendered.

CONCLUSIONS OF LAW

At the outset, the Court points out that the choice of law

is largely irrelevant, as New Jersey law is no more favorable

than New York law on the issues presented. The Court finds

that plaintiff R. Gale Rhodes, Jr. violated his professional

and fiduciary obligations in contravention of the Code of

Professional Responsibility.

A lawyer is prohibited, except with the client’s consent

after full disclosure, to accept employment if the exercise of

his professional judgment on behalf of the client will or may

98a

Appendix G

reasonably be affected by the lawyer’s own financial or

personal interests. DR5-101(A); 22 NYCRR 1200.20(A).

DRS5-104(A) (22 NYCRR 1200.23(a)) states, in pertinent

part, that “|a] lawyer shall not enter into a business transaction

with a client if they have differing interests therein .....

unless the client has consented after full disclosure.” In

addition, to the dubious propriety of Rhodes having gained

a business interest in his clients’ invention, by turning such

into an investment opportunity for his own benefit, he

simultaneously failed to discuss with his clients the legal

implications of his assuming a one-third share of the subject

corporation, Biomedical Engineering Corporation.

Although an attorney is not prohibited from entering into

a contract with a client, such an agreement is not advisable.

Greene v. Greene, 56 NY2d 86, 92 (1982). Upon forming

the corporation, accepting one-third of the profits of the

inventions in return for legal services, and failing to fully

disclose the potential conflicts, it is clear that Rhodes violated

DR 5-101(a), 5-104(a) and his fiduciary obligations.

In Matter of Cooperman 83 NY2d 465, 472 (1994) the

Court of Appeals stated the following:

This unique fiduciary reliance, stemming from

people hiring attorneys to exercise professional

judgment on a client’s behalf_ “giving counsel”-

_ is imbued with ultimate trust and confidence.

The attorney’s obligations, therefore, transcend

those prevailing in the commercial market place.

The duty to deal fairly, honestly and with undivided

loyalty superimposes onto the attorney-client

99a

Appendix G

relationship a set of special and unique duties,

including maintaining confidentiality, avoiding

conflicts of interest, operating competently,

safeguarding client property and honoring the

client’s interests over the lawyers’s.

Historically, courts have treated this area of law, attorney-

client fee arrangements with special concern applying

principles different from those set forth by commonplace

commercial contracts so as to uphold the integrity of our

legal and judicial systems. See, Matter of Schanzer, 7 AD2d

275 (1st Dept. 1959) aff'd 8 NY2d 972 (1960); Martin v.

Camp, 219 NY 170 (1916).

The law requires that an agreement between an attorney

and client be construed most favorably for the client. Shaw

v. Manufacturers Hanover Trust Company, 68 NY2d 172,

177 (1986). This Court recognizes the special nature of the

attorney-client relationship. Further, the Court believes that

such relationships and public perception may be undermined

by the unethical conduct of a lawyer.

Rhodes attempts to justify and excuse his actions by

asserting that he made such disclosure as was appropriate to

highly educated, worldly and sophisticated businessmen.

However, this line of reasoning was specifically rejected in

Forrest Park Assocs. Ltd. Partnership v. Kraus, 175 AD2d

60 (ist Dept. 1991), where the Court stated that “the Code

of Professional Responsibility” places the burden upon

counsel irrespective of the sophistication of the client, to

obtain his consent after full disclosure before entering into a

business transaction, such as the one in issue, where the

100a

Appendix G

differing interests of counsel and the client, may interfere

with the exercise of professional judgment for the client’s

protection.

Additionally, “for over 100 years our courts have made

it clear that a transaction between a lawyer and his client

will be regarded with suspicion and that it will be

presumptively void, subject to proof by the lawyer, usually

through disinterested persons, that the transaction was fair

and fully intended by the client.” Radin v. Opperman, 64

AD2d 820 (4th Dept. 1978). With clarity, the Court placed

the burden of coming forward with clear and satisfactory

evidence in these transactions, squarely on the shoulders of

the attorney. Moreover, the Court further stated that “other

than in exceptional circumstances, a lawyer should insist that

an instrument in which his client desires to name him

beneficially be prepared by another lawyer selected by the

client. . . . and meticulously adhere to this principle of law.”

Radin v. Opperman, supra at 820-821.

While the full disclosure contemplated by DRS-104(A)

is not specifically defined therein, an attorney should explain

to the client the importance of obtaining independent counsel

and insist on a memorialization of their agreement. Jn the

Matter of Daniel T. Coxeter and Susan J. Coxeter, 208 AD2d

1178 1179 (3rd Dept. 1994).

This Court is unable to contemplate all of the various

ways in which a conflict might arise as a result of Rhodes’

failure to fully disclose their differing interests. However,

the following constitutes a few:

10la

Appendix G

Rhodes failed to inform his clients to seek in-

dependent counsel perhaps because it was not in

his best interest to do so. More specifically, it is

likely that independent counsel would advise

against a percentage ownership of the property,

as opposed to payment of services rendered based

on a quantum merit basis. Such would alieviate

the imbalance of equities found herein.

Rhodes failed to advise his clients of the great

potential for a lawsuit in cases the attorney is

also a co-owner of a business entity.

Rhodes failed to disclose that as a result of

wearing two hats he might be rendered objectively

incapable of deciding what is in the clients’ best

interests. For example, as the profit margin widens

and the personal stakes become increased, Rhodes

objectivity may become lessened.

_ Rhodes is desirous of a percentage of the proper-

ty interest because of the unique entrepreneurial

opportunity presented and its likelihood of great

success. This he fails to disclose.

Rhodes failed to inform his clients that it might

be in the client’s best interests to perform

particular legal services but not in his best interest,

because such could substantially reduce profits

and trigger hours of hard work.

Rhodes failed to inform his clients that he was

an employee at will and as such could be

102a

Appendix G

terminated at any point in time, giving rise to

the false perception that they had to be co-

owners infinitely.

* Rhodes failed to set forth in the fee agreement

what legal responsibilities he and his partners

would undertake.

This list is not intended to be exhaustive of all conflicting

interests contemplated. Surely, the mere fact Rhodes, Buechel

and Pappas are embroiled in such complex and expensive

litigation is the most demonstrative proof of their divergence

in interests. Of course, hindsight is better than foresight.

Rhodes admits that upon execution of the fee agreements

he failed to advise Buechel and Pappas to con

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