Introduction:
A corporation or limited liability company is as “real” as you are and has most of the same powers and rights.
A corporation or limited liability company is a legal entity and from the legal point of view operates as any other person before the law. It can sign contracts, engage in business, sue and be sued and pays taxes as if it were a human being. The entity is as legally real as any other individual. Indeed, the Supreme Court recently ruled that the corporation may participate in political activity as if it were a human, aside from voting.
It also hires on its own behalf accountants and lawyers to represent its own interests and hires employees, contractors and other professionals it considers necessary. It can hire or fire any of those people…and work with anyone it choses, including other corporations or limited liability companies.
The attorney for the entity represents the entity and has a fiduciary duty to it which is equivalent to the duty the attorney owes to any other client. The attorney must act at all times in the best interests of the entity and must not take any action that would conflict with the best interests of the entity. The attorney cannot represent any party in a conflict of interest with the entity.
All this seems simple until there is a dispute within the entity between owners and/or directors or between owners, directors and officers and then the vital question arises as to whom the legal counsel owes the duty of loyalty. For the corporation is only a legal fiction: it is actually operated by humans occupying roles within the entity. Those humans control the entity in varying degrees.
Assume the board of directors is at odds with the chief executive officer. The board wishes to fire him and schedules a meeting at which he is to be fired. The chief executive officer calls the lawyer and demands representation from him at the meeting, commenting that he has an employment agreement and the board has no right to fire him. Meanwhile, the chairman of the board of directors calls the attorney and demands that he represent the board in firing the chief executive officer since the officer is violating his duty to the corporation and should be fired.
Who has the right to have the attorney’s representation?
And if privileged information was given to the attorney by the chief executive officer, must the attorney so advise the board? Or vise versa?
This is not merely academic. In most corporate or limited liability company conflicts, this issue can become a vital one for the parties and can radically alter the strategy and odds of success for a particular party. Implicit in the argument is whether the lawyer is paid by the corporation or by the officer or director and since fees can run to tens of thousands or more, that becomes a key question on the table at the beginning of any dispute.
It is important for anyone connected with such an entity to know who the attorney must protect in such conflict. That is the theme of this article.
The Basic Law:
Both the Code of Legal Ethics and the concepts of fiduciary duty prohibit the attorney from engaging in any conduct that conflicts with the interest of his or her client. Indeed, absent full disclosure and prior informed written consent of the client, the attorney can not engage in any relationship which could potentially result in such a conflict of interest. Violation of this rule can expose the attorney to personal liability and could result in disciplinary action from the relevant state or Federal Bar.
That same duty requires the attorney to keep completely confidential any information received from the client and allows and compels the attorney to refuse to answer questions as to such communications deriving from any third parties, including law enforcement officials, if said answer would violate the attorney client privilege. The attorney-client privilege, discussed elsewhere on this website, is one of the most powerful of all the privileges under the law and belongs to the client, not the attorney.
The underlying theme of the duty of loyalty that an attorney owes to a client is that the attorney is obligated to use his or her best efforts to represent the interests of the client. That duty extends to any agents of the attorney and to any members of his or her firm. The client has a right to rely on that duty of loyalty and the obligations of the attorney-client privilege survive the ending of the relationship. Thus, if you tell your attorney some confidential information and terminate the relationship, then even five years later the privilege would still apply, though it would not apply to information imparted to him or her after the termination of the attorney-client relationship.
A corporation not only has owners (shareholders) but directors who run the company and make strategic decisions and the officers and employees who run the company day to day. The shareholders elect the directors, usually annually, and the directors elect the officers, either annually or on a longer-term basis, at times with written employment contracts. The officers can hire and fire employees, subject to terms of employment agreements, if any.
A limited liability company can either be run by its members or can have a managing member who operates it. It can also hire nonmember persons to operate the company. Depending on the terms of its operating agreement, the managing member or managers may have to obtain approval from the other members for specified actions, but usually the managing member or managers have broad discretion as to how to operate the company.
Of key importance is that directors and officers owe a “fiduciary duty” to the corporation and that managing members or managers also owe a fiduciary duty to the limited liability company. That fiduciary duty, discussed in detail on this website, imposes personal liability if breached.
Disputes between owners or between owners and fiduciaries in a business entity are not uncommon and are often complex, beginning in the board room and perhaps ending in a court of law. While majority shareholders normally have sufficient power to take control of a corporation, to use that power often takes months or years and they do not have the right to breach fiduciary duties or violate contracts protecting officers or employees and most such disputes end up with claims of such breach back and forth.
A good corporate attorney will carefully advise his or her clients both on the corporate tools available and the dangers of counter claims of breach of contract, breach of fiduciary duty and breach of the doctrine of corporate opportunity. Such advice is vital before any action is taken and before the first letter, e mail or board meeting in which one side or the other begins to asset its power.
And therein lies the central issue. Who gets that advice and who pays for it?
Who precisely does the attorney represent?
The Corporate Officers:
The attorney must follow the directions of those in immediate control and who are operating the company and who have the statutory powers and also the powers described in the Bylaws of the corporation or the operating agreement. It is the CEO or President (dual names for the same office) who makes the decisions for the entity until replaced (or the Managing Member for a limited liability company) and that is the person who directs the attorney. If that person directs the attorney to contest efforts by the board of directors, shareholders or members to replace him or her, the attorney is so obligated. Thus, in a fight between shareholders and the CEO or the directors and a CEO, until the CEO is replaced the attorney must adhere to instructions of the CEO who can also instruct the company to pay the attorney as well.
And note that while the directors or shareholders may eventually be able to replace the CEO, until they do so the CEO can insist upon loyalty to his or her directions and such removal may be months or years away. And, of course, by the time the CEO is removed (assume he or she is) the attorney by then would have had access to much privileged information and could no longer represent the entity in any event since the CEO would then object.
The attorney certainly cannot represent the Board of Directors or shareholders against the CEO absent prior consent of the CEO. They are not “the corporation” but owners or fiduciaries to the corporation and their rights and powers are normally restricted to voting for the actual officers or directors who, thereafter, operate the company. Most such elections occur annually, so replacing the CEO is seldom an immediate event and while the CEO can be replaced more quickly for wrongdoing, that is often precisely the issue before the corporation’s board (since the CEO will contest that) and the CEO will instruct the attorney to defend him or her.
The directors or members are normally deeply upset when their trusted advisor suddenly advises them that he is representing that officer against their wishes, the very officer they hope to replace. But the attorney normally has no choice other than to refuse to represent either side once a dispute begins.
Practicalities:
A corporate counsel who elects to represent the CEO or officers against the owners or directors will almost always face claims of breach of the attorney client privilege and conflict of interest. Any outside attorney representing the shareholders or directors will petition the court to have that attorney removed or even make complaint to the Bar claiming that he or she was privy to privileged information or has a selfish interest connected to the CEO that is at odds with the fiduciary duty to the entity. One can expect similar reactions from the members of a limited liability company. The degree of emotion against the “disloyal” attorney is often remarkable, exacerbating an already tense conflict.
As a result, most of the time the wise attorney will simply refuse to represent either side in such a dispute and refer both sides to outside counsel. Almost all attorneys find themselves in possession of confidential information that would possibly result in a conflict of interest or violation of the attorney client privilege. Long before the dispute becomes acute it is common for the directors or shareholders to discuss the matter and the interpretation of the Bylaws and/or powers they may have with corporate counsel, sometimes at board or shareholder formal meetings, sometimes in e mails or over the telephone. Such discussions can easily result in the attorney being exposed to comments and plans of the directors or owners that would be privileged communication, thus compelling the attorney not to represent the CEO. Indeed, it is a strategy for the directors or owners to contact the corporate attorney precisely to have him or her hear privileged information and have to withdraw from representing the CEO if there is any dispute.
Oddly, some corporate counsel insist upon trying to stay involved in the dispute, claiming they have the right to represent the CEO and did not hear privileged information and that position often results in tens of thousands of dollars in additional fees being spent as the respective sides argue the matter before the judge or, at times, before the Bar. It is a distraction from the underlying dispute, but attorneys are emotional human beings as well and become committed to one side or the other and insulted that their motivations or ethics are challenged.
This writer normally advises such counsel that they are not serving either the entity or the CEO by such an approach, only costing a great deal of money to both sides over an issue that should not be central to the company. The wise counsel will locate excellent corporate attorneys capable of representing the respective parties with skill and step back from the dispute.
Note that since corporate counsel may be a witness to various aspects of the case, and since percipient witnesses may be challenged not to represent a party, that is yet another complication in the matter that could be avoided by the wise counsel withdrawing.
For the parties, it is also important to determine if they want to object to corporate counsel remaining in the case. One businessperson known to the writer knew she could force corporate counsel to withdraw but refused to do so, thinking that a lawyer she knew and respected could do much to restrain the CEO from taking actions that would be harmful to all parties.
Conclusion:
Disputes within entities are widespread and as discussed in the article on this website on such corporate struggles, the party moving the soonest and with careful strategic planning most often prevails. The role of corporate counsel in the coming dispute is one such strategic situation that must be considered and planned for.
And if the reader is corporate counsel, be sure to carefully consider your own motivations for wanting to stay involved. One cannot serve two masters under the Bar rules and often the greatest service one can do for the entity is remove oneself from the dispute.