Trouble with Clients, Present and Past

Ontiveros v. Constable, No. D066412 (D4d1 Mar. 14, 2016)

and

Costello v. Buckley, No. D068536 (D4d1 Mar. 16, 2016)

These are a pair of attorney disqualification appeals decided by Division One of the Fourth District in a three-day period last month.

The first case, Ontiveros, deals with the very confusing problem of conflicts in the context of a stockholder derivative suit. The company at issue is a closely held one, and the facts involve the kind of inside dealing, nepotism, and personality disputes that come up in small companies with some frequency.

When a dispute arose between 60 percent majority stockholder X and 40 percent minority stockholder Y, company C cut a check to retain Counsel for X. Y sued, ultimately bring both direct counts against X as well as derivative claims where C was a nominal defendant. Counsel began representing both X and C in the litigation. Somewhat late in the game, Y moved to DQ Counsel, on the grounds that there was an unwaivable conflict that resulted from simultaneous representation of X and C. Y also argued that Counsel could not find a new lawyer for C and continue on with X because Counsel invariably learned C’s confidential information during the course of the ongoing representation. The trial court granted the motion.

The court starts out with couple pages of background on the rules about concurrent representation of multiple clients and the rules for attorney disqualification, mostly cribbing from the Supreme Court’s People ex rel. Dept. of Corporations v. SpeeDee Oil Change Systems, Inc.P, 20 Cal. 4th 1135 (1999) and Flatt v. Superior Court, 9 Cal. 4th 275 (1994). It’s useful background for a standards section if you ever happen to be in a DQ situation.

It then gets to the heart of the matter. In a derivative action, a stockholder is suing on behalf of the corporation itself. So although the corporation is a “nominal defendant” because the people who control it generally don’t really want to sue, the claims belong to the corporation itself. And when the derivative claim alleges fraudulent conduct against a director, controlling shareholder, or officer, there is necessarily some potential adversity between the interests of the company and those of the defendant on the derivative claim. So the general rule in California is that in a derivative case, Rule 3-310(C)—which bars concurrent representation of clients with potential or actual conflicts—requires that the same lawyer can’t represent the company and directors who are alleged to have committed fraud.

X argued that, notwithstanding the conflict, X and C could jointly agree to concurrent representation under Rule 3-600(E), which generally permits joint representations of a company and officers. When a potential conflict situation arises requiring informed written consent under Rule 3-310(C), Rule 3-600(E) says that the corporation’s consent to the joint representation must be obtained from (1) an appropriate constituent who is not the co-client or (2) the stockholders. Clearly X can’t consent under (1). The court further rules that (2) can’t also be satisfied when the majority of the stockholders who need to consent are themselves the co-client.

While it doesn’t say so, this ruling is in a bit of tension with the Coldren case from late 2015, in which the court said that the holder of a controlling interest in a partnership could consent to a joint representation of himself and the company in an action brought by the owner of the remainder of the partnership interest. Coldren was admittedly not a derivative claim. (It distinguished the cases this case relies on on that precise ground.) But in very closely held companies—like the two-stockholder company in this case—the practical difference between derivative and direct claims is a bit of a fiction.

It also presents a practical problem that isn’t really addressed. If the minority holder in a 60/40 company brings a derivative case against the controlling stockholder, the controlling stockholder is going to get to pick the lawyer.  And indeed, in a really small company like the one here, while there might be two “clients”—the company and the controller—there going to be a single human client representative. A lawyer representing a company in a derivative case isn’t akin to a receiver or trustee who can just make freestanding judgments about the best interest of the company. Someone needs to call the shots. Like it or not, that someone is going to the majority stockholder. So it’s not too clear that it makes much sense read an non-textual exception into Rule 3-600(E) that saddles the company with hiring a second lawyer without any practical benefit, just because the suit is derivative.  (Or, on the other hand, perhaps this is a reason why this kind of case involving a two-stockholder company maybe shouldn’t need to be brought in a derivative capacity in the first place.)

The second case, Costello, is a fair bit simpler. Boyfriend’s brother is a lawyer, who at one point in time represented Girlfriend in an easement dispute with her neighbor.  The couple became exes, and (now Ex-) Girlfriend asked Boyfriend for the return of $92k she had loaned him during the relationship, which Boyfriend says was a gift. Girlfriend ultimately sued and Boyfriend hired his brother the lawyer to defend him. Girlfriend moves to DQ, arguing that the brother/lawyer learned confidential stuff about the nature of their relationship during the easement case, which could be germane in the collection dispute.

The trial court granted the motion and the Court of Appeal affirms. Because this is a conflict based on a successive, not simultaneous representation, the dispute is governed by Rule 3-310(E) of the Rule of Professional Conduct. It turns on whether the attorney obtained confidential information in the first matter that could be used against his client in the new case. Because this is all usually somewhat shrouded in privilege, courts employ the substantial relationship test, which presumes that lawyer got relevant information in case 1 germane to case 2 when the subjects of cases 1 and 2 are substantially related. But that test isn’t needed in this case because the lawyer did, in fact, have information about the Boyfriend/Girlfriend relationship, including the loans/gifts. Given that the whole dispute is whether the $92k was a friendly loan or a lover’s gift is the crux of the case, that’s enough to create a conflict under Rule 3-310.