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May 12, 2003


The opinion of the court was delivered by: Robert P. Patterson, Jr., United States District Judge


Kaye, Scholer, Fierman, Hays and Handler LLP ("Kaye Scholer"), former counsel for Diversinet Corp. ("Diversinet"), seeks attorneys' fees from in the amount of $247,342.98, following a fee dispute, ancillary to the underlying action. For the following reasons, Diversinet is ordered to pay Kaye Scholer $244,282.87.


By notice of motion dated July 24, 2002, Kaye Scholer moved this Court for an order, pursuant to 28 U.S.C. § 1367 and Local Rule 1.4, permitting Kaye Scholer to withdraw as counsel for Diversinet, formerly known as The Instant Publisher Inc., and for attorneys' fees. On July 25, 2002, the Court denied the motion for failure to show that notice of the application had been served on Diversinet or to give notice of the total amount of attorneys' fees and expenses allegedly owed by Diversinet to Kaye Scholer. By letter dated July 30, 2002, Kaye Scholer identified Bruce D. Margles, Diversinet's in-house counsel, as having received notice of the motion, and renewed its application that Diversinet be ordered to pay Kaye Scholer's outstanding fees and expenses of $247,342.98 contained in invoices dated December 7, 2001, January 30, 2002, and April 20, 2002.

On August 19, 2002, Mr. Margles, general counsel of Diversinet, filed an affidavit ("Margles Affidavit") in further support of Diversinet's opposition to the motion of Kaye Scholer for its fees and expenses, stating: (1) Diversinet did not have a written retainer agreement with Kaye Scholer; (2) Kaye Scholer applied an inordinate amount of resources to the Silva Run file without Diversinet's approval after the fall of 2001; (3) Diversinet explicitly directed Kaye Scholer to seek its prior approval for attendance at depositions and other expenditures after receipt of Kaye Scholer's November 27, 2001 letter to Diversinet's auditors; (4) Diversinet was misled by Kaye Scholer during the January, February and March 2002 period about work being performed by Kaye Scholer at a time when Kaye Scholer knew Diversinet was very short of financial resources. (Margles Aff. ¶¶ 2-10.) Mr. Margles suggested the matter be resolved by binding arbitration before the New York County Lawyers Association. (Id. ¶ 19.)

At a hearing on August 22, 2002, Kaye Scholer rejected Mr. Margles' suggested binding arbitration but indicated that it might accept non-binding mediation. (August Hearing Transcript at 3, 8.) Kaye Scholer agreed, however, to turn over their attorney file to James D. Christo, Esq., of Robert Christo & Associates, incoming counsel for Diversinet, and waived its attorneys' lien. (Id. at 6-7.) The Court agreed to exercise ancillary jurisdiction over that portion of Kaye Scholer's fee claim that related to unpaid fees for this litigation and recommended the parties settle or mediate the matter. (Id. at 5.)

By letter dated December 13, 2002, Kaye Scholer notified the Court that Diversinet had refused to discuss settlement, that the Christo firm was not returning its telephone calls, and requested a Court determination of its fee application. On December 16, 2002, the matter was set for hearing on January 8, 2003, and, thereafter, adjourned to January 23, 2003, at which time an evidentiary hearing was held.

January 2003 Hearing

At the hearing on January 23 and 24, 2002, Mr. Fredric Yerman of Kaye Scholer testified that in May 1999 Kaye Scholer, previously retained as counsel to Diversinet on corporate matters, was asked by Ms. Crystal Witterick, a Canadian lawyer, then general counsel for Diversinet, a Canadian company, to substitute as counsel for Diversinet in this litigation, replacing the Proskauer firm which was in a fee dispute with Diversinet. (January Hearing Transcript at 13-14.) In retaining Kaye Scholer, Ms. Witterick explained to Mr. Yerman that Diversinet "needed a sophisticated, competent litigation firm," with "sufficient staff and resources to handle the securities litigation, Silva Run Worldwide Limited v. Gaming Lottery, et al., 96 Civ. 3231 (RPP). (Id. at 16.) Ms. Witterick instructed Mr. Yerman that Kaye Scholer should do what was necessary to defend the case, to `try to be efficient and cost effective, but also to handle the case as [Kaye Scholer] would normally handle litigation" of this type, i.e., "do what ever was necessary to protect the interests of the company." (Id. at 16-17.) Bills were to be rendered on a timely basis at Kaye Scholer's regular rates. (Id. at 17.)

From June 15, 1999 to April 12, 2002, Kaye Scholer rendered the following bills in this matter to Diversinet, most of which have been paid:

6/15/99 5/1/99 - 5/31/99 18,407.60 9/9/99 2 7/28/99 6/1/99 - 6/30/99 9,772.99 9/9/99 2 9/28/99 7/1/99 - 8/31/99 63,293.94 12/10/99 2 11/9/99 9/1/99 - 10/31/99 12,188.91 12/30/99 2 12/10/99 11/1/99 - 11/31/99 8,995.47 2/14/00 2 2/23/00 12/1/99 - 1/31/00 8,635.18 6/19/00 3 4/14/00 2/1/00 - 3/31/00 44,931.19 5/3/00 3 10/26/00 4/1/00 - 9/30/00 109,963.90 12/26/00 3 12/15/00 10/1/00 - 11/30/00 3,634.20 2/12/01 3 2/27/01 12/1/00 - 1/31/01 630.70 5/7/01 5 7/16/01 2/1/01 - 6/30/01 18,982.46 12/26/01 6 10/31/01 7/1/01 - 9/30/01 1,790.70 1/15/02 9 11/21/01 10/1/01 - 10/31/01 52,357.85 2/6/02 10 12/7/01 11/1/01 - 11/30/01 84,931.06 UNPAID 4 1/30/02 12/1/01 - 12/31/01 60,992.61 UNPAID 7 4/12/02 1/1/02 - 3/31/02 101,419.20 UNPAID 8
TOTAL BILLED $600,990.06 TOTAL PAID 353.647.79 TOTAL OUTSTANDING $247,342.87
On cross examination, Mr. Yerman testified that he had never been instructed by Diversinet not to do any particular work or not to do anything without checking first with anyone at Diversinet. (Id. at 61.) He acknowledged, however, being told by Mr. Margles in November/December 2001, "[t]he bills are getting high, we want to try to keep the costs down, it's getting expensive, very expensive, and we want you to spend as little as possible." (Id. at 60-61.) As a result, he stated Kaye Scholer did not act aggressively and only reacted to the moves of other litigants in the action, but that the contentiousness between other counsel and Diversinet's role as a key defendant made it difficult to keep costs down. (Id. at ¶ 1-62.) Mr. Yerman stated that it was his understanding that Kaye Scholer was to "perform such work as we deemed necessary to protect the interests of [Diversinet]" (id. at 59) and that Diversinet's exposure in the lawsuit was in excess of $6M. (Id. at 61.)

Michael A. Lynn, counsel at Kaye Scholer, testified that he had done some work on the reply brief to Diversinet's motion to dismiss in the summer of 2000 (Id. at 92), but took on a more active role in May 2001 after the Court had denied the defendants' motions to dismiss. (Id. at 93.) He recalled advising Mr. Margles that Diversinet had to file an answer to the third amended complaint and prepare for discovery in the case. (Id. at 94-95.) He also testified that he was not told by Mr. Margles not to engage in discovery. (Id. at 95.) Mr. Lynn stated that due to the events of September 11, 2001, the discovery got pushed back into November (id. at 97-98), and that he had advised Mr. Margles of the scheduled depositions of the principals of Silva Run (Mr. Salazar and Mr. Gomez) (Id. at 98.) Mr. Lynn stated that, prior to those depositions, he and Ms. Holly Levinson, a junior associate, did an extensive review of all documents that had been produced in the case, particularly those produced by Silva Run, focusing their efforts primarily on the transaction involving the private purchase by Silva Run of the common stock of Instant Publisher (now Diversinet) in August 1995 ($16 million of common stock pursuant to a Regulation S offering). (Id. at 98-99; Third Amended Complaint ¶ 165.) Although Mr. Lynn testified that he reported what was going on in the case to Mr. Yerman, he testified that Mr. Yerman was not billing his own time due to the economic concerns of the client. (Jan. Hrg. Tr. at 102.)

By letter dated November 26, 2001, Kaye Scholer responded to Diversinet's request to report to Peat Marwick, Diversinet's auditors, as to the status of the litigation and the amount of unpaid fees, and stated that Diversinet then owed Kaye ...

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