A Pennsylvania state court judge disqualified Drinker Biddle & Reath LLP earlier this month from appearing for either defendant in a shareholder dispute involving a Philadelphia LLC that provides services to pharmaceutical companies. The opinion spotlights the conflict issues that can come up when representing an entity and its controlling member against a claimed minority owner.
Pharma company faceoff
The plaintiff and the individual defendant apparently agreed to form a company in 2010, and the resulting LLC retained Drinker Biddle. In his complaint, the plaintiff alleged that Drinker Biddle prepared operating agreements that (although unexecuted) resulted in an implied agreement giving him an 18 percent stake in the company.
Three years later, however, the plaintiff claimed, the same Drinker Biddle lawyer prepared another operating agreement that froze the plaintiff out and gave the individual defendant 100 percent of the company.
When the plaintiff sued the company and the individual defendant, he included a derivative claim on behalf of the company, asserting that the individual defendant had breached his fiduciary duties. Drinker Biddle lawyers entered appearances for both the company and the individual, leading to the DQ motion.
Organization as client
The court said that Pennsylvania’s version of Model Rule 1.13 (they are substantively identical) governed. Titled “Organization as Client,” a rule comment deals with the question “whether counsel for the organization may defend … [a derivative] action.” The comment says that “if the claim involves serious charges of wrongdoing by those in control of the organization, a conflict may arise between the lawyer’s duty to the organization and the lawyer’s relationship” with individual constituents of the organization.
The court said that such a conflict arises “because the interests of those who control the company (and with whom the attorney has had a preexisting relationship) may diverge from the interests of the company itself.” Quoting a federal Third Circuit case, the court said that “except in patently frivolous cases[,] allegations of directors’ fraud, intentional misconduct, or self-dealing require separate counsel.”
That was the case here, the court said, because the plaintiff alleged that the individual defendant engaged in self-dealing, facilitated by legal advice from Drinker Biddle, and involving an agreement that excluded the plaintiff.
In a Law360 article, counsel for the plaintiff said that there was surprisingly little law on the issue, given that “any time there’s a closely held [company] dispute, you routinely have one firm representing the company and also representing the majority and the founding shareholder.”
The court also ruled that Drinker Biddle couldn’t drop one defendant and stay on as counsel to the other, reasoning that its lawyers might be witnesses (Model Rule 3.7), and that remaining for one of its clients in the case would involve the firm in a conflict with the other client (Model Rules 1.7 and 1.9), particularly given the possibility of cross-claims.
Although the opinion is from a state trial court, it is instructive reading if you are involved in a derivative claim situation like this, or are considering representing more than one party in a company control dispute.