[Shareholder Oppression] Can communications with corporate counsel be withhel...
Eric Fryar
Tritek Telecom v. Superior Court, 169 Cal.App.4th 1385, 87 Cal.Rptr.3d 455 (Jan. 7, 2009).
Under California law, corporate directors have an "absolute right" to inspect and copy all corporate "books, records and documents of every kind." Cal. Corp. Code § 1602. This "absolute right" normally extends to documents otherwise subject to the attorney client privilege. 169 Cal.App.4th at 1387. In Tritek Telecom v. Superior Court, California Fourth Court of Appeals dealt with a particularly thorny issue in shareholder litigation involving closely-held corporations. The parties were two equal shareholders of a closely-held corporation, both of whom were directors. A third non-shareholder director apparently aligned with one of the shareholders thus giving that shareholder effective control. The controlling shareholder then proceeded to lock out the other shareholder, stop paying his salary, and misappropriate assets. The ousted shareholder sued the other two directors and the corporation alleging various causes of action and seeking the return of the shareholder's investment. Initially, corporation's lawyer represented both corporation and the individuals in the litigation. The trial court correctly disqualified corporation's lawyer from the dual representation and required new and separate counsel for both the corporation and the individual defendants. See, e.g., Bell Atlantic Corp. v. Bolger, 2 F.3d 1304 (3rd Cir. 1993); Clark v. Lomas & Nettleton Fin. Corp., 79 F.R.D. 658 (N.D. Tex. 1978); Cannon v. U.S. Accoustics Corp., 398 F.Supp. 209 (N.D. Ill. 1975), aff'd 532 F.2d 1118 (7th Cir. 1976); Messing v. FDI, Inc., 439 F.Supp. 776, 781-82 (D.N.J. 1977).
Thereafter, the plaintiff sought to inspect the documents and communications generated by corporation's attorney during the time of the dual representation. The defendants resisted the inspection on the grounds of attorney-client privilege. The trial court ordered the inspection. The appellate court reversed, holding that the plaintiff shareholder/director had no right to inspect attorney-client privileged documents that were generated in defense of the plaintiff's lawsuit filed against the corporation. 169 Cal.App.4th at 1392.
In reaching its conclusion the Court of Appeals acknowledged that the director's rights to access to corporate records is absolute, but then paradoxically noted that there are exceptions to its absoluteness. One California Court of Appeals had previously noted hypothetically that a director's absolute right of inspection might be denied where a disgruntled director announces his or her intention to violate his or her fiduciary duties to the corporation, such as by using inspection rights to learn trade secrets to compete with the corporation. Havlicek v. Coast- to-Coast Analytical Services, Inc., 39 Cal.App.4th 1844, 1855 (1995). That court had held that the director was entitled to inspection but had ruled that §1603(a) of the Cal. Corp. Code, which provides that a court may enforce the right of inspection "with just and proper conditions," permits a court to grant a corporation a protective order denying or limiting a director's inspection, but only if the corporation demonstrates by an evidentiary showing that the protective order is necessary to prevent a tort from being committed against the corporation by the director. Id. at 1856. The Tritek court also cited La Jolla Cove Motel and Hotel Apts. Inc. v. Superior Court, 121 Cal.App4t 773, 787-88, 17 Cal.Rptr.3d 467 (2004), for the proposition that corporate counsel has no duty to disclose privileged information to a dissident director with which the corporation has a dispute. Actually, the court in La Jolla Cove Motel and Hotel Apts. Inc. v. Superior Court had dealt with a very different issue. In that case, non-director minority shareholders had brought suit against the majority shareholders. The minority shareholders had elected two directors to represent their interests, and those directors were aligned with the minority shareholders in the dispute. During the litigation, the majority shareholders moved to have the minority shareholders' lawyer disqualified or disciplined for contacting and taking statements from the minority-aligned directors without the permission of the corporation's counsel. The Court held that the corporation's lawyer could not be deemed the lawyer of the minority-aligned directors because there was an actual dispute among the shareholders and directors which would have precluded the corporation's lawyer from representing the dissident directors against the corporation. The court also noted, in passing, that the corporation's lawyer was free to use communications by the dissident directors prior to the dispute to further the interests of the corporation, even if those interests were adverse to the dissident directors. This is not the same thing as holding that the dissident directors are not entitled to access to privileged communications between the corporation and its counsel to which the directors aligned with the controlling shareholders would have had access.
In Tritek, the Court held that the dissidents director's "absolute right" to access to corporate records did not extend to privileged communications generated in defense of each suit that the director had filed against the corporation because the interests of the director were adverse to those of the corporation and because such access would violate the privileged between the controlling shareholder and the corporation's lawyer during the time that the corporation's lawyer represented the individual shareholder. 169 Cal.App.4th at 1391.
The Court's reasoning is very troubling on a number of levels. First, the Court fails to consider whether the attorney-client privilege ever existed in the first place. A communication is subject to the attorney client privilege only if the communication is made with the expectation of confidentiality. Cal. Evid. Code §952. The attorney-client privilege may be held jointly by two or more persons, and the assertion or waiver by one of the joint holders does not affect the others. Cal. Evid. Code §912. The very nature of the corporation is that it is controlled and managed by its board of directors. The directors exercise their power and authority over the corporation only as a group, not individually. Therefore, while the corporation is the holder of the attorney-client privilege with its corporate counsel, the privilege is exercised by and through the directors, and no one director has any more claim to access to privileged communications than any other. Therefore, communications between a corporation and its corporate counsel cannot be made with the expectation that they will be kept confidential from any member of the Board of Directors. Therefore the question arises, as to the sitting members of the Board of Directors, what attorney-client privilege can be asserted against them? One previous California case held that meetings with corporate counsel by one group of shareholders in a closely-held corporation could be withheld from another group of shareholders on the grounds of attorney-client privilege, where the evidence showed that the meeting had served a corporate purpose. Holles v. Superior Court, 157 Cal.App.3d 1192, 1200, 204 Cal.Rptr. 111 (1984). However, that court neatly side-stepped the difficult issue posed by the fact that one of the dissident group of shareholders was also a director by noting that the lawsuit had been brought in director's capacity as a shareholder, not a director. Id. at 1202.
The Delaware courts have grappled with this issue, and their conclusions have been markedly different from that reached in the Tritek case. Under Delaware law, when a corporation employs legal counsel, each of the members of the board of directors has a status co-equal with the corporation as "client." "The issue is not whether the documents are privileged or whether plaintiffs have shown sufficient cause to override the privilege. Rather, the issue is whether the directors, collectively, were the client at the time the legal advice was given. Defendants offer no basis on which to find otherwise, and I am aware of none. The directors are all responsible for the proper management of the corporation, and it seems consistent with their joint obligations that they be treated as the 'joint client' when legal advice is rendered to the corporation through one of its officers or directors." Kirby v. Kirby, 1987 WL 14862 (Del. Ch. 1987). Therefore, communications with corporate counsel during a director's tenure on the board cannot be privileged as to her because, as a matter of law, such communications could not legally have been intended to be kept confidential from her. "Absent a governance agreement to the contrary, each director is entitled to receive the same information furnished to his or her fellow board members." Intrieri v. Avatex, 1998 WL 326608 (Del. Ch. 1998). In fact, Delaware corporate law is clear that attorney-client communications to which a director should have had access during her tenure continue to be available to her after she ceases to be a director. In Kirby v. Kirby, 1987 WL 14862 (Del. Ch. 1987), the Delaware Chancellor held that, as to attorney-client communications that occurred during the tenure of former directors, it is not possible for any privilege to have been created for those communications, and therefore, there is no basis for the invocation of the attorney-client privilege at a later date. Independently, under Delaware corporate law, the corporation is prohibited from asserting the attorney-client privilege as to information to which a director is entitled. A corporation may not "assert the privilege to deny a director access to legal advice furnished to the board during the director's tenure." Moore Business Forms, Inc. v. Cordant Holdings Corp., 1996 WL 307444 (Del. Ch. 1996).
Perhaps more troubling are the explicit reasons for the court's holding, that the plaintiff is adverse to the corporation and that access to privileged communications would violate a privilege held independently by the controlling shareholder. The opinion does not give great detail about the exact procedural posture of the case and the exact causes of action asserted by the plaintiff. If the plaintiff asserted a cause of action against the controlling shareholder for breach of fiduciary duties as a result of misappropriation of corporate assets, then this claim must almost certainly have been brought as a derivative claim, in which case the plaintiff would have been asserting claims on behalf of the corporation rather than against it. In almost every lawsuit between a controlling shareholder and a non-controlling shareholder for wrongdoing done by the controlling shareholder, the law governing standing and capacity will almost always require that some of the claims be brought against the corporation. This very often results in the strange situation in which a plaintiff is both suing and representing the interests of the corporation in the same lawsuit. Courts, however, generally view the situation as a matter of substance over form. The true dispute is between the shareholders, and regardless of how the complaint is stated, the gravamen of the complaint is the manner in which the controlling shareholder has exercised his power over the Corporation. There is absolutely no reason for a court to assume that the party that controls the corporation is therefore acting in the interests of the corporation. If the claims made by the plaintiff in Triteck are true, then the plaintiff was acting on behalf of the corporation, and the controlling shareholder was adverse to the corporation.
There can be little justification for protecting the confidentiality of communications between the corporation's lawyer and the controlling shareholder/director as against another director when the very act of establishing the attorney client relationship between the corporation's lawyer and the controlling shareholder was a breach of both of their duties to the corporation "[A]s attorneys for [a] corporation, counsel's first duty is to [the corporation]." Meehan v. Hopps 144 Cal.App.2d 284, 293, 301 P.2d 10 (1956). "These cases make clear that corporate counsel's direct duty is to the client corporation, not to the shareholders individually, even though the legal advice rendered to the corporation may affect the shareholders." Skarbrevik v. Cohen, England & Whitfield 231 Cal.App.3d 692, 704, 282 Cal.Rptr. 627 (1991). A corporation's attorney is not permitted, either during or after that engagement, to represent any shareholder or director against the corporation (or the other shareholders when that would entail acting contrary to his prior representation of the interests of all the shareholders). See Metro-Goldwin Mayer, Inc. v. Tracinda Corp., 36 Cal.App.4th 1832, 1845, 43 Cal.Rptr.2d 327 (1995); Goldstein v. Lees, supra, 46 Cal.App.3d 614, 622, 120 Cal.Rptr. 253 (1975). Morover, a corporation is not permitted to defend a derivative action on the merits, Patrick v. Alacer Corp., 167 Cal.App.4th 995, 84 Cal.Rptr.3d 642 (2008) [see case analysis], and the corporation's lawyer has a duty to refrain from taking part in any controversies or factional differences among shareholders as to control of the corporation, so that he or she can advise the corporation without bias or prejudice. See Goldstein v. Lees 46 Cal.App.3d at 622. As for the controlling shareholder who elected to use the corporation's lawyer to defend claims brought against him personally based on his individual breach of duties to the corporation and to the other shareholder, the controlling shareholder has misappropriated corporate assets (the services and independence of the corporation's lawyer, not to mention the fees incurred by the corporation) for his individual benefit, and has directed the corporation's lawyer to violate his duties to the corporation and to cause the corporation to take a position that it is not legally permitted to take. It is very difficult to understand why the Tritek court believed that this was a valid exercise of the attorney-client privilege worthy of the court's protection, and the opinion does not address the issue.
Of course, if a dispute arises between a two groups of shareholders or between the corporation and one of its directors, the corporation may very easily preserve the attorney-client privilege and the integrity and confidentiality of the legal advice from the corporation's lawyer by establishing an independent litigation committee to consult with corporate counsel. As the Chancellor held in Moore Business Forms, inc. v. Cordant holdings Corp., 1996 WL 307444 (Del. Ch. 1996): "Holdings had alternative means to enable its directors (other than Mr. Rogers) to receive confidential attorney advice not discoverable by Moore. Holdings could have bargained for such protections in the Stockholders Agreement. Alternatively, and independent of the Stockholders Agreement, the Holdings board could have acted, pursuant to 8 Del.C. § 141(c) and openly with the knowledge of Moore and Rogers, to appoint a special committee empowered to address in confidence those same matters. Under either scenario the special committee would have been free to retain separate legal counsel, and its communications with that counsel would have been properly protected from disclosure to Moore and its director designee. Neither approach was followed here." Of course, this approach assumes that there are independent directors and that the corporation (as apart from the shareholders involved in the lawsuit) has some legitimate, independent reason for legal advice. This alternative would not have been possible in the Tritek case, where there were only two shareholders, no independent directors, and no reason for the corporation or the corporation's lawyer to be actively involved in defending one or the other shareholder. It is unfortunate that the California court of appeals seems to have validated a misuse and misappropriation of corporate resources by controlling shareholders.
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Posted By Eric Fryar to Shareholder Oppression at 3/03/2009 02:26:00 PM