Nacio Investment Group, LLC v. Nacio Systems, Inc., a Nevada Corporation

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UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
In re
NACIO SYSTEMS, INC., 	No. 08-10078
Debtor(s).
______________________________________/
NACIO INVESTMENT GROUP, LLC,
Plaintiff(s),
v. 	A.P. No. 08-1098
NACIO SYSTEMS, INC.,
Defendant(s).
_______________________________________/
Memorandum re Security Interest of Donahue Gallagher Woods LLP
_________________
In 2002, a company known as Nacio Systems, Inc., a California corporation (“Nacio
California”), filed an Chapter 11 petition in this court. That case culminated in a confirmed plan of
reorganization in 2003. 	In 2005, the reorganized Nacio California entered into an asset purchase
agreement by which it transferred all of its assets to the current debtor, a Nevada corporation which
also took the name Nacio Systems, Inc. To avoid confusion, the court refers to this corporation as
“Nacio Nevada.” Nacio Nevada also assumed all of Nacio California’s obligations. 	Nacio Nevada is
Entered on Docket
June 17, 2009
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
Case: 08-01098 Doc# 86 Filed: 06/17/09 Entered: 06/17/09 14:12:43 Page 1 of 3

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1The court finds that the terms of DGW’s security interest are fair and reasonable, that DGW
properly advised Nacio California in writing of its right to seek outside legal advice and was given a
reasonable opportunity to seek that advice, and that Nacio California thereafter consented in writing to
the terms of the security agreement. Accordingly, adequacy of disclosure is the only issue.
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the Chapter 11 debtor in this case, and is the defendant and cross-claimant in this adversary
proceeding.
This adversary proceeding seeks to establish the validity of liens on the Nacio Nevada’s assets.
Now before the court is Nacio Nevada’s attack on the validity of a security interest it granted to its
former law firm, Donahue Gallagher Woods LLP (“DGW”). Nacio Nevada granted the security
interest in order to continue to receive legal services from DGW despite overdue bills from DGW for
services rendered to both Nacio California (whose debts Nacio Nevada assumed) and Nacio Nevada
itself.
Despite considerable bluster, there is but one simple issue in this dispute: whether delivery of a
security interest to the client by itself, without any additional disclosure or explanation, meets the
requirement of Rule 3-300(A) of the California Rules of Professional Conduct.1 That rule requires that
an attorney taking a security interest in a client’s assets fully disclose its terms “in writing to the client
in a manner which should reasonably have been understood by the client.”
The court has ruled in a prior case that where the client is a consumer and the security interest
is taken in the client’s home much more than transmittal of the security document is required to
constitute proper disclosure. See Taylor v. Kane, 2005 WL 3078991(N.D.Cal. 2005). 	Neither side
has cited a case involving a business client, nor has the court found one.
An attorney who takes a security interest in a client’s property has a duty to explain the
transaction fully to the client. Fletcher v. Davis, 33 Cal.4th 61, 71 (2004). 	DGW is less than
forthright with the court in finessing the fact that it undertook no explanation whatsoever. It is also
dead wrong in its assertion that requiring a separate writing explaining the terms of the transaction
“contravenes the plain language of Rule 3-300(A).” To the contrary, that is exactly what is required in
Case: 08-01098 Doc# 86 Filed: 06/17/09 Entered: 06/17/09 14:12:43 Page 2 of 3

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almost every instance.
However, in this case the record makes it clear that Nacio Nevada fully understood the nature
of a security interest and its consequences. It had entered into a detailed purchase agreement with
Nacio California to acquire its assets while assuming its debts, necessitating a full due diligence
investigation of security interests Nacio California had granted. In addition, Nacio Nevada had itself
granted security agreements and was clearly well-versed in their effect to make an intelligent decision
without the need of additional explanation.
The court believes that the terms of a security agreement are sufficient disclosure by an
attorney only in the very narrow situation where the client is a sophisticated business client already
very familiar with the nature of a security interest and the security interest being granted to the lawyer
by the client is in no way unusual or different from those already clearly understood by the client.
Only in these narrow circumstances is the security agreement itself considered adequate disclosure, as
only in these circumstances is disclosure made in a manner which is reasonably understandable by the
client. Therefore, despite strong disagreement with DGW’s interpretation of Rule 3-300(A), the court
will enter a judgment in favor of DGW and declaring that its security agreement is enforceable.
Consistent with prior rulings, the court will enter a single judgment when all issues have been
adjudicated.
Dated: June 17, 2009
SAlan Jaroslovsky
U.S. Bankruptcy Judge
Case: 08-01098 Doc# 86 Filed: 06/17/09 Entered: 06/17/09 14:12:43 Page 3 of 3