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.

Scarce law?

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.

What if you’re about to initiate litigation on behalf of your client, or you are in the middle of litigation, and you find that a different client you represent in another matter has documents relevant to the case?  Can you subpoena the documents from your own client?  Can you cross-examine that client at trial?   Here is some background and some practical advice.

Current client conflicts

The ABA’s Ethics Committee analyzed this recurring scenario 25 years ago in its Formal Opinion 92-367, under the verbose-but-descriptive title “Lawyer Examining a Client as an Adverse Witness, or Conducting Third Party Discovery of the Client.”

The focus is on Model Rule 1.7, which deals with current-client conflicts.  It addresses representations directly adverse to existing clients and also situations where your representation of a client may be “materially limited” by your duties to another client.

The Committee concluded that cross-examining or directing third-party discovery to an existing client likely would be directly adverse to that client, and would create a disqualifying conflict of interest — unless both clients consented.  The circumstances would likely “pit the duty of loyalty to each client against the duty of loyalty to the other,” said the Committee.

The possibility of a “material limitation” on your representation of the litigation client is equally clear.  First, you could breach the duty of confidentiality you owe to your client who is the witness or the target of a document subpoena.  After all, in these circumstances, by definition, you have information that is relevant to the litigation you are conducting on behalf of the other client.

Second, there is a “punch-pulling” problem:  your interest in keeping the witness-client, or in not inconveniencing that client, may consciously or unconsciously cause you to go easier on that client, conducting a “‘soft’ or deferential” examination or document request, to the possible disadvantage of your litigation client.

The conflict issue is sharpened, of course, by Model Rule 1.10, the imputation rule:  if you are disqualified, so are all the other lawyers in your firm, by imputation.

Best practices?

The good news is that this conflict is generally viewed as being subject to the affected clients’ consent and waiver.  But how should you proceed?  Regarding the situation presented by third-party discovery against a current client, the experience of my firm and others suggests the following possible steps:

  • Advise the litigation client on whose behalf you want to serve the document subpoena that the target of the subpoena is another firm client in unrelated matters.
  • Get permission from the litigation client to inform the target of the subpoena about the subpoena and the subject matter of the request.
  • Determine if the subpoena target will be objecting to the subpoena or attempting to block production of any information called for by the subpoena.
  • If the answers to that question is “no,” then there is likely little risk of an actual conflict; but otherwise, there is a conflict that requires a waiver.

In the absence of a waiver from each client, or if your litigation client objects at the outset to the exploratory discussion with the subpoena target, you can’t proceed.

In that case, the  ABA Ethics Committee suggests that, as an alternative to withdrawing (which presents obvious and even acute problems, depending on the stage of the litigation), you might be able to co-counsel with an un-conflicted lawyer who would shoulder the third-party discovery.  A New York City Bar Association ethics opinion endorses that course of action.  But a California opinion questioned whether such co-counsel would be truly independent so as to alleviate the conflict.

The ABA’s ETHICSearch has a useful recent article on the ins and outs  of this quandary.

Clearly, there is a lot to think about when you are faced with this problem, and as always, you should make sure you know how your own jurisdiction approaches it.

potatoes covered in soil against whiteEven though a Mississippi lawyer’s conflict of interest lasted only one day, that was enough for a U.S. magistrate judge to disqualify him from representing a client adverse to Allstate Insurance Co. on a coverage claim, in a ruling issued last week.  Sending a termination letter to the insurer the day after accepting the new client’s case didn’t help the lawyer.  The judge found that the lawyer’s duty of loyalty required him to turn down the case, in light of the fact that he had pending cases in which he was directly representing Allstate.

Hot potato doctrine

The court recognized that the key issue in the case was whether the lawyer could drop Allstate as a client, turning it into a “former client” for purposes of the conflict-of-interest rules.  If so, then the “more lenient” substantial-relationship test would apply, in which the court looks at whether the new client’s matter is substantially related to the work the lawyer did for the former client.  But if the lawyer takes on the new client and represents it concurrently with the now-adverse existing client without both clients’ consent, then the duty of loyalty under Model Rule 1.7 has been breached.

The “hot potato” doctrine prohibits a lawyer from turning an existing client into a former client by “firing” it in order to accept an engagement adverse to the existing client.  The 1987 case that gave the principle its name is Picker International, Inc. v. Varian Associates, in which the federal district court judge said that “A firm may not drop a client like a hot potato, especially if it is in order to keep happy a far more lucrative client.”

Termination didn’t cure impropriety

In the Mississippi case, the court said that the lawyer’s conduct was understandable:  he hadn’t received any new work from Allstate in over a year; his firm was wrapping up its work on the “handful” of cases it still had, the majority of which were near the end of their life-spans; and the firm planned to end its relationship with the insurer based on the fact that it was not getting new work.

Nonetheless, said the judge, the lawyer and his firm had an attorney-client relationship with Allstate when the lawyer signed a contract to represent the claimant against the insurer, and he couldn’t abandon his existing client by dropping it like a hot potato:  “In withdrawing representation of Allstate to pursue a new, more attractive representation, [the lawyer] violated the duty of loyalty he owed to Allstate.”

Game of spuds

The question of when a client becomes a former client under conflict rules can be a nuanced one.  For instance, the hot-potato doctrine may not operate when a conflict is “thrust upon” a law firm as a result of a client merger, the addition or new parties or other circumstance over which the firm has no control.  Then, the firm may be able to choose to avoid disqualification by withdrawing from the representation that creates the conflict.  See, e.g., Sabrix, Inc. v. Carolina Casualty Ins. Co. (D. Ore. 2003) (hot-potato rule did not apply where withdrawal followed another party’s naming of additional defendant that created conflict).  And timing matters, too.  For example, if a firm has a new client in mind for the future, may it terminate an existing relationship in order to prevent a conflict?

Bottom line:  Be careful in working through these conflict issues so you don’t drop the ball — or the potato.

2017 Happy New Year typeYou may have some holiday leftovers lurking in your fridge (potato latkes, Xmas goose, black-eyed peas, New Year’s Eve caviar), and we too have some interesting ethics topics that we didn’t have room for during 2016 — so here’s a potpourri, touching on positional conflicts, coercive settlements and maybe how not to use your firm’s letterhead.

Arguing damage caps, pro and con

The U.S. district court for the Middle District of Tennessee in October turned back a disqualification motion aimed at Butler Snow, ruling that the firm could  continue representing a personal injury plaintiff who was potentially contesting the constitutionality of the state’s punitive damage caps, while at the same time asserting the caps defensively in at least one pending case for another client.

In its DQ motion, the trucking company defendant said those positions were inconsistent and raised a positional conflict in violation of Tennessee’s version of Model Rule 1.7 and its cmt. [24].

Not so, said the district court.  First, the trucking company waited until two months before trial to try to disqualify the law firm; it would cause severe prejudice to the plaintiff if she had to find new counsel.  Second, the firm retained separate counsel to represent the plaintiff on all post-trial issues challenging the damage caps, an arrangement that plaintiff agreed to at the beginning of her representation.  Third, there was no evidence that the potential conflict had actually affected the injury case, or was likely to compromise the firm’s representation of clients who simply asserted the caps to limit their liability rather than expressly defending their constitutionality.

On all these bases, the court held, the firm could stay in the case, part of which has now been settled.

Threat to publicize sexual allegations

In November, an Arizona lawyer who threatened to use press releases to alert the public to sexual allegations in order to obtain a settlement consented to a 30-day suspension.

In 2015 the lawyer filed a federal sexual harassment complaint on behalf of a client.  In a letter to the defendant, he announced he had created a specific website regarding the allegations, and said he would put up a public “shame on you” banner near the defendant’s restaurants.  He also told the defendant that he had scheduled meetings with police and the federal Department of Justice about the alleged hiring of undocumented workers.  In response to a settlement offer, the lawyer told the defendant’s lawyers that he “intended to destroy” the defendant’s businesses.

The judge in the federal case insisted that the lawyer stop his unprofessional behavior; the parties settled; and the state Disciplinary Judge accepted the lawyer’s admission that his conduct violated Arizona’s versions of Model Rules 4.4 (respect for the rights of others) and 8.4(d) (conduct prejudicial to the administration of justice).  The lawyer also agreed to two years probation and to pay costs.

The rules in my home jurisdiction, Ohio, include Rule 1.2(e), a specific prohibition against threatening criminal charges or professional misconduct allegations solely to obtain an advantage in a civil matter.  Interestingly, the Model Rules lack an express prohibition, although this case illustrates that disciplinary authorities can get there via other rules.

Using firm letterhead

Last, here’s a cautionary tale about using your firm letterhead for a personal legal dispute.

According to plaintiffs in a federal complaint filed in November, a Pepper Hamilton partner entered into a lease-to-own deal with a couple for a $750,000 house he owned.  The couple terminated the contract and moved out, and the lawyer claimed that they owed about $10,000.  The lawyer sent a demand letter for the money in September, using the firm’s letterhead.

That drew a suit from the couple against both the lawyer and the law firm for allegedly violating the federal Fair Debt Collection Practices Act.  “Once [the lawyer] sent the Sept. 19 letter … on [the firm’s] letterhead, he was no longer acting as an individual collecting his own debt, but rather a debt collector subject to the FDCPA,” the couple said in their complaint.

It remains to be seen whether that theory will fly — the case docket does not yet reflect any response to the complaint.  But it points to an issue that you should probably think about in your personal dispute before putting a piece of firm stationery in the printer.