Editor's Note:
State Bar Ethics Opinions cite the applicable California Rules of Professional Conduct in effect at the time of the writing of the opinion. Please refer to the California Rules of Professional Conduct Cross Reference Chart for a table indicating the corresponding current operative rule. There, you can also link to the text of the current rule.
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Is it ethically permissible for an attorney to undertake a representation adverse to a wholly-owned subsidiary of an existing corporate client?
As long as the attorney does not represent the subsidiary, it is ethically permissible to undertake such a representation, provided that the parent is not the alter ego of the subsidiary and the subsidiary has imparted no confidential information to the attorney with the reasonable expectation that the information would not be used adversely to the subsidiary.
Rules 3-310(B) and 3-600 of the Rules of Professional Conduct of the State Bar of California.
An attorney currently represents a parent corporation. The parent corporation has a wholly-owned subsidiary which the attorney has never represented. A third party client requests that the attorney bring a lawsuit against the subsidiary. If the lawsuit is successful, it could have a financial impact on the subsidiary and indirectly on its sole shareholder. The parent is not a party to the lawsuit and there is no prospect that it will be made a party. The parent is a large, publicly-held corporation.
Though the question of whether a parent and its subsidiaries must be treated as the same or different entities for conflict purposes is one of the most frequently arising questions in corporate practice, there are surprisingly few judicial or ethics authorities on the issue presented. The superseded Rules of Professional Conduct of the State Bar of California, while proscribing the representation of conflicting interests in former rule 5-102(B) (operative until May 26, 1989), did not, in the context of the representation of corporations, define who must be treated as the client for conflict purposes.
Rule 3-600 of the new Rules of Professional Conduct of the State Bar of California has, however, answered the question presented. Rule 3-600 is based on rule 1.13 of the American Bar Association Model Rules of Professional Conduct. Rule 3-600(a) provides:
In representing an organization, a member shall conform his or her representation to the concept that the client is the organization itself, acting through its highest authorized officer, employee, body or constituent overseeing the particular engagement.
The term "constituents" includes, among others, the officers, directors, employees and shareholders of a corporation. (See rule 3-600(D).) When dealing with the constituents of a corporation, the lawyer has a duty to:
. . . explain the identity of the client for whom the member acts, whenever it is or becomes apparent that the organization's interests are or may become adverse to those constituent(s) with whom the member is dealing.
A parent corporation, even one which owns 100 percent of the stock of a subsidiary, is still, for purposes of rule 3-600, a shareholder and constituent of the corporation. Rule 3-600 makes clear that in the representation of corporations, it is the corporate entity actually represented, rather than any affiliated corporation, which is the client. The attorney owes undivided allegiance only to the corporate entity which he or she represents rather than any affiliated persons or entities. (See Meehan v. Hopps (1956) 144 Cal.App.2d 284, 290 [301 P.2d 101].) Rule of Professional Conduct 3-600, subdivisions (D) and (E) recognize that parents and subsidiaries can take positions adverse to each other and even engage in litigation against each other. The attorney is therefore precluded from also representing a corporation affiliated with his or her corporate client unless there is no adversity between those entities on the subject of the representation.
The American Bar Association Model Code of Professional Responsibility1 provides further guidance on the identity of the client in the representation of corporations. Ethical Consideration 5-18 provides:
A lawyer employed or retained by a corporation or similar entity owes his allegiance to the entity and not to a stockholder, director, officer, employee, representative, or other person connected with the entity. In advising the entity, a lawyer should keep paramount its interests and his professional judgment should not be influenced by the personal desires of any person or organization. Occasionally a lawyer for an entity is requested by a stockholder, director, officer, employee, representative, or other person connected with the entity to represent him in an individual capacity; in such case the lawyer may serve the individual only if the lawyer is convinced that differing interests are not present.
Ethical Consideration 5-18 thus bolsters the conclusion that the client is the parent and not the subsidiary and that the attorney's duties are owed only to the parent corporation.
The American Bar Association Model Rules also support this conclusion. Model Rule 1.13(A) provides that ". . . [a] lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents." The Comment to the Model Rule cautions that ". . . [t]his does not mean, however, that constituents of an organizational client are the clients of the lawyer." As both the American Bar Association Model Code and Model Rules make clear, the sole client is the corporate entity actually represented. The Comment to Model Rule 1.13 also states that when the constituents of a corporation make confidential disclosures to an attorney, the holder of attorney-client privilege is the corporate client rather than the constituents. Indeed, the Comment notes that there are strict constraints on an attorney's ability to make disclosure of a corporate client's confidential information to a constituent, including its shareholders or parent.
Like EC 5-18 and American Bar Association Model Rule 1.13, rule 3- 600, subsections (D) and (E) establish that a parent and subsidiary's interests can be adverse and that circumstances can arise where each corporation needs counsel to represent it in a dispute or litigation against the other. If this committee were to opine that a parent and its subsidiary are to be treated the same for conflict purposes, it would become impossible for these corporations to retain counsel when they have disputes against each other. The new Rules of Professional Conduct and the American Bar Association Model Code and Rules repeatedly recognize that the interests of a parent and its subsidiaries can become adverse and preclude the joint representation of parents and subsidiaries unless their interests are not adverse. (See rule 3-600(E); EC 5- 18; American Bar Association Model Rule 1.13(E) and Comment.)
There may be instances, such as those presented in this inquiry, where the parent corporation is the sole shareholder of the subsidiary. Under these circumstances, the parent corporation can ultimately act for and make the decisions of its subsidiary by exercising the rights of its stock ownership. Nevertheless, we do not believe that majority or even sole ownership of a subsidiary corporation should be controlling in determining who is the client for conflict purposes, subject to the alter ego discussion below. Notwithstanding the ownership interest which a person or entity has in a corporation, the ethical rules make clear that the client is the corporation which is represented by the attorney. When the subsidiary involved is a wholly-owned subsidiary, instances will be infrequent, though not impossible, where parent and subsidiary can have interests adverse to each other. Regardless of the ownership of his or her client, the duty of the lawyer to keep paramount the interests of the entity which he or she actually represents is still the same. The fact of total ownership does not change the parent corporation's status as a constituent of the subsidiary. The duties which an attorney owes to a constituent are defined in and go no further than those set out in rule 3-600.
The duty of loyalty prevents an attorney from undertaking a representation which is directly adverse to an existing client, even if it is on a matter wholly unrelated to the existing representation. (See Rule of Professional Conduct 3-310, subsection (B); Model Rule 1.7(A); Jeffrey v. Pounds (1977) 67 Cal.App.3d 6, 10 [136 Cal.Rptr. 373].) The further issue therefore arises whether bringing suit against the subsidiary would violate the attorney's duty of loyalty to the parent.
An attorney's representation of one client will often have indirect effects on other existing clients. For example, simultaneously representing business competitors on unrelated matters may indirectly impair the interests of each. It will be rare indeed when an attorney's representation of a client will not have numerous indirect adverse effects on others. Obtaining a benefit for a client will often mean disadvantaging another person or entity, and indirect consequences may follow to all who may be dependents or owners of the attorney's opponents.
The attorney's duty of loyalty, however, extends only to adverse consequences on existing clients which are "direct." (American Bar Association Model Rule 1.7(A).) As we have stated in the context of issue conflicts, "Normally the scope of 'adversity' which gives rise to a conflict is limited to party identification . . . . [T]he 'interests' usually arise within the context of the same legal matter." (See State Bar Formal Opinion No. 1989-108.) Of the numerous and varied consequences which a representation of one client may have on other clients, well-established legal authority interpreting the duty of loyalty limits the scope of ethical inquiry to whether the other affected clients are parties to the case or transaction in which the attorney is acting.
On the facts presented here, the parent is not a party to the suit against the subsidiary, and there is no prospect that it will be made a party. The representation against the subsidiary can therefore have no direct consequences on the parent; the only adversity can be that indirect adversity which might result from the diminution in the value of the parent's stock in the subsidiary if the attorney's suit against the subsidiary is ultimately successful. This possible indirect impact is insufficient to give rise to a breach of the duty of loyalty owed to the parent. If such indirect adverse consequences were prevented by the duty of loyalty, attorneys would be conflicted out of representations where the indirect adverse impact was slight and unpredictable. Moreover, there would be no way to construct any meaningful standard to distinguish among indirect consequences. We can determine no principled basis to distinguish the facts presented here from the situation where an attorney brings suit against a publicly-held corporation in which numerous of his or her clients may own relatively small amounts of stock. The indirect impact on the non-party client shareholders would certainly not give rise to that kind of adversity which would create a conflict of interest.
As with issue conflicts, there are also compelling policy reasons for reaching the conclusion we do here. If the committee were to conclude that the representation at issue were within rule 3-310(B), the attorney would be in a position of seeking the consent of a nonclient, with a usually predictable result. Moreover, to conclude otherwise could create conflicts of interest which are undetectable. Banning representations adverse to entities in which existing clients own interests would make conflict screening difficult, if not impossible. While an attorney is able to determine the ownership of publicly-held corporations, making this determination for other entities or individuals may not be possible. The only way an attorney could determine whether there were private ownership interests would be by asking all of his or her clients for an exhaustive list of all their holdings of stock, partnership and business interests. Not only would this impose undue constraints on the attorney-client relationship, but it could also prove impossible in practice to implement.
The Committee therefore concludes that for purposes of rule 3-310(B) of the Rules of Professional Conduct, an attorney does not represent conflicting interests when he or she acts adversely to a wholly-owned subsidiary of an existing corporate client. The attorney's duty of loyalty does not encompass the obligation to refrain from actions which may have only indirect adverse effects on existing clients in matters unrelated to those which the attorney is handling for such clients.
There are certain limited instances when parent and subsidiary corporations should be treated as the same client for conflict purposes. Ordinarily, regardless of ownership, corporations are separate legal entities with an existence and legal recognition apart from their shareholders or other constituents. (See Erkenbrecher v. Grant (1921) 187 Cal. 7, 9 [200 P. 641].) The corporation and its shareholders are distinct parties in contracts made by one or the other and are not bound by each other's contracts. (See 6 Witkin, Summary of California Law (8th ed. 1974) section 4, p. 4316.)
The law, however, does recognize in some instances that the corporate form should be disregarded. The doctrine of alter ego, which has been established to avoid injustices in permitting entities or individuals to hide behind the corporate veil, provides helpful principles in determining when affiliated corporations should be treated as the same entity for conflict purposes. When a corporation is the alter ego of another entity or has a sufficient unity of interests, they should be treated as the same entity for conflict purposes. In determining whether there is a sufficient unity of interests to require an attorney to disregard separate corporate entities for conflict purposes, the attorney should evaluate the separateness of the entities involved, whether corporate formalities are observed, the extent to which each entity has distinct and independent managements and board of directors, and whether, for legal purposes, one entity could be considered the alter ego of the other. (See 6 Witkin, supra, section 11, at p. 4323.)2 In this regard, the committee believes that the percentage of ownership of stock, while a factor to consider, is by no means itself determinative. Id.
Having determined that the subsidiary is not the client of the attorney and that the potential impact on the parent is indirect, our inquiry is not yet at an end. As we opined in State Bar Formal Opinion No. 1981-63, the prohibitions of the predecessor to rule 3- 310(B) may arise from an attorney's relationship with a nonclient if the attorney has received confidential information from the nonclient under circumstances which create a reasonable expectation that the attorney has a duty of fidelity to the nonclient. (See, e.g., Westinghouse Electric Corp. v. Kerr-McGee Corp. (7th Cir. 1978) 580 F.2d 1311, 1319 [when an attorney represents trade association and solicits and obtains confidential information from the members of the association, the attorney cannot act adversely to the members in matters in which the attorney has obtained such confidential information from them]; William H. Raley Co. v. Superior Court (1983) 149 Cal.App.3d 1042, 1047 [197 Cal.Rptr. 232].)
Thus, if the attorney has obtained confidential information directly from the nonclient subsidiary under circumstances where the subsidiary could reasonably expect that the attorney had a duty to keep such information confidential, the attorney might be precluded from acting adversely to the subsidiary in matters related to the subject on which the attorney had obtained such confidential information. The instances in which this prohibition will apply will be infrequent. As noted in rule 3-600(D), the attorney under appropriate circumstances has a duty to explain the identity of the corporate client that he or she represents when soliciting information from its constituents. As long as the attorney has complied with rule 3-600(D) and not misled the ". . . constituent into believing that the constituent may communicate confidential information to the member in a way that will not be used in the organization's interest if that is or becomes adverse to the constituent, . . . " no duty to the subsidiary will be created when the subsidiary imparts information to the attorney. If the attorney has sufficiently explained the identity of the client to the constituent and the fact that he or she does not represent the constituent, the nonclient constituent would not have a reasonable expectation that the attorney owes it a duty of loyalty or fidelity.
It bears repeating and emphasizing that what we have said in this opinion relates only to an attorney's ethical duties. Prudent counsel will be advised, for client relations purposes, to disclose to the parent the nature of the proposed representation before undertaking such a representation as that described in this inquiry. We caution, however, that there may be circumstances where such a disclosure may not be permissible without the consent of the third party client. Though disclosure to the parent is not ethically required, it is recommended to avoid surprise and to enable the parent to decide whether to continue to use the services of the attorney.
This opinion is issued by the Standing Committee on Professional Responsibility and Conduct of the State Bar of California. It is advisory only. It is not binding upon the courts, the State Bar of California, its board of governors, any persons or tribunals charged with regulatory responsibilities, or any member of the State Bar.
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