Dual Representation in Derivative Litigation: Who Can Represent the Company?

Derivative litigation occurs when a shareholder sues another shareholder, officer, or director of the company for misconduct that harms the company. In many derivative lawsuits, the facts are similar: the majority in control of the company commits some wrongdoing (i.e. stealing corporate funds or misdirecting corporate opportunities), and the minority shareholders, with little power to stop it, must act on behalf of the company to sue the wrongdoers and protect the company from harm. That is, a shareholder can sue, derivatively, on behalf of the company.

However, what happens when the company and majority in control use the same legal counsel to defend themselves in a derivative suit. The “dual representation” of the company and derivative defendants can create conflicts of interest, and litigants should understand how far the legal representation can go in such cases.

To an extent, dual representation may be permissible, and certain conflicts can be waived.

Rule 4-1.13(e) of the Florida Rules of Professional Conduct directly addresses the issue of dual representation of a corporation and its directors, officers, or shareholders.  Rule 4-1.13(e) states:

(e) Representing Directors, Officers, Employees, Members, Shareholders, or Other Constituents of Organization.  A lawyer representing an organization may also represent any of its directors, officers, employees, members, shareholders, or other constituents, subject to the provisions of rule 4-1.7. If the organization’s consent to the dual representation is required by rule 4-1.7, the consent shall be given by an appropriate official of the organization other than the individual who is to be represented, or by the shareholders.

More specifically, the comments to Rule 4-1.13 address dual representation in the context of derivative actions:

Most derivative actions are a normal incident of an organization’s affairs, to be defended by the organization’s lawyer like any other suit. However, 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 the board. In those circumstances, rule 4-1.7 governs who should represent the directors and the organization.

In other words, the rule expressly allows dual representation, whereas the comments to the rule recognize derivative actions are often a legal controversy over the management of the organization, in which a conflict may or may not arise. If a conflict does arise, the company must identify a conflict-free corporate consent-giver—that is, “an appropriate official of the organization other than the individual who is to be represented.” See Rule 4-1.13(e).

The Rules are clear that a non-shareholder and conflict-free corporate representative can consent to dual representation. Rule 4-1.13(e). In the context of derivative litigation, many courts have interpreted their version of Model Rule 1.13(g)—Florida Rule 4-1.13(e)’s counterpart—to mean that the individuals named as a defendant to the derivative suit cannot consent to dual representation on behalf of the company. See e.g., In re Oracle Sec. Litig., 829 F. Supp. 1176, 1189 (N.D. Cal. 1993) (citing rules similar to Florida’s, and noting that “[i]t is . . . clear that an inanimate corporate entity, which is run by directors who are themselves defendants in the derivative litigation, cannot effectively waive a conflict of interest as might an individual under applicable professional rules[.]”) (Emphasis added).

When does the conflict of interest arise?

There is no bright-line rule that dual representation of a corporation and its defendant-directors in derivative litigation is per se improper.  See Bell Atlantic Corp. v. Bolger, 2 F.3d 1304 (3d Cir. 1993) (“[A]s a general matter, the case law is not uniform on the issue of joint representation of the corporation and individual defendants.”). Nearly all courts that have addressed this issue recognize the ethical issues arising from dual representation, however, that is where the case law diverges. Each court appears to conduct its own fact-specific inquiry that requires a thoughtful balancing of competing interests.  See e.g., Scott v. New Drug Services, Inc., No. 11336, 1990 WL 135932, at *4 (Del. Ch. Sept. 6, 1990) (“What circumstances will require separate representation [in a derivative action] is obviously a question that is highly fact-specific.”).

Many courts have permitted dual representation in certain factual settings and at early stages of litigation.  Those courts recognize that requiring separate representation at all stages of litigation in all cases ignores the practical considerations of derivative litigation.  The courts suggest that—at the motion to dismiss phase—the interests of the corporation and the defendant-directors are very much aligned, making it permissible for the same counsel to advocate for dismissal on behalf of both the corporation and defendant-directors.  See Respler on Behalf of Magnum Hunter Res. Corp. v. Evans, 17 F. Supp. 3d 418, 421 (D. Del. 2014) (holding “[I]n derivative actions, there exists no conflict of interest between a corporation and individual director defendants at the motion to dismiss stage, therefore a law firm may represent all defendants without impropriety.”) (emphasis added); Voss v. Sutardja, No. 14-CV-01581-LHK, 2015 WL 349444, at *12 (N.D. Cal. Jan. 26, 2015) (“At this [motion to dismiss] stage of the litigation, however, the Court is satisfied that any potential conflict which may exist has no bearing on the Court’s conclusion that, as a matter of law, Plaintiffs’ claims must be dismissed.”); Scattered Corp. v. Chi. Stock Exch., Inc., 1997 WL 187316, at *6–8 (Del.Ch. Apr. 7, 1997), aff’d on other grounds, 701 A.2d 70 (Del.1997), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000).

In Clark v. Lomas & Nettleton Fin. Corp., 79 F.R.D. 658, 661 (N.D. Tex. 1978), the court found no conflict of interest requiring disqualification at the motion to dismiss stage, since “[a]t this stage of the proceedings, when the court must make a determination on whether as a matter of law the defendants should be in the lawsuit, unless it can be shown that an actual conflict exists or that certain confidences are being jeopardized, . . . the client’s right to select counsel of his choice outweighs any potential conflict of interest[;] [o]nce that determination is made, or once it becomes necessary for active participation in the defense of the directors, then new counsel must be sought[.]”).

If independent counsel is required, original counsel may be permitted to continue representation of the individual defendants.

Even if disqualification is appropriate, disqualification of counsel from representation of both the corporation and the individual defendants may not be required. Campellone v. Cragan, 910 So. 2d 363 (Fla. 5th DCA 2005) (noting that “[t]he trial court found no Florida cases directly on point.”).

In Campellone, a minority shareholder filed a derivative action against a majority shareholder, claiming embezzlement, misappropriation of corporate assets and opportunities, breaches of fiduciary duty, and battery.  Id. at 364. The minority shareholder named three corporate entities as nominal defendants, and the same legal counsel appeared as counsel of record to defend both the corporations and the majority shareholder. Id. The minority shareholder filed a motion to disqualify the majority shareholder’s counsel on grounds that the representation violated Rules 4-1.13 and 4-1.7, and—after several evidentiary hearings—the trial court disqualified counsel from representing both the corporations and the majority shareholder.  Id. at 365.  On appeal, the court conducted a two-part analysis: addressing the disqualification of corporate counsel separately from disqualification of the individual shareholder’s counsel.

The Campellone court found no abuse of discretion in the decision to disqualify counsel from representing the corporations—particularly where the “trial court found that the interest of [shareholder] and the interest of the corporate entities were not aligned under any construction of the alleged facts, and observed that there would be no benefit to the corporate entities to align themselves with [shareholder] in this litigation.”  Id. at 365. Because it appears in Campellone that the corporations were actively engaged in litigating the merits of the dispute for over one year, the Campellone decision would not be inconsistent with the Delaware line of cases finding no conflict at motion to dismiss.

As to the second part of the analysis—disqualification of counsel from representation of the individual shareholder—the Campellone court reversed, finding that the trial court did abuse its discretion in disqualifying counsel from representing the majority shareholder.  Id.  The court reasoned that even if the shareholder were forced to retain substitute counsel, the dangers of jeopardizing confidences was non-existent, as the shareholder would still be privy to access all corporate information related to the derivative action.  Id.

Florida law is consistent with federal and state authority in the precise circumstance, which holds that when dual representation is impermissible, the attorney who formerly represented the corporation may continue to represent the individual defendants.  See Musheno v. Gensemer, 897 F.Supp. 833, 838 (M.D. Pa. 1995) (“[T]here is nothing to prevent [the attorney] from continuing to represent the Directors.”); Lewis v. Shaffer Stores Company, 218 F.Supp. 238, 239 (S.D.N.Y. 1963) (disqualifying counsel for corporation, but finding no impropriety with continued representation of the officers and directors); Forrest v. Baeza, 58 Cal. App. 4th 65, 71, 67 Cal. Rptr. 2d 857 (1997) (disqualified corporate counsel may continue to represent the individual defendants).

The reasoning behind Campellone and the other jurisdictions which support continued representation of the individuals is based upon the policies underpinning the ethical rules—the threat of jeopardizing confidences is virtually non-existent.  “[T]he functioning of the corporation has been so intertwined with the individual defendants that any distinction between them is entirely fictional, and the sole repositories of corporate information to which the attorney has had access are the individual clients.”  Forrest, 58 Cal. App. 4th at 82.  See Campellone, 910 So. 2d at 365 (“[E]ven if [shareholder] were forced to hire new counsel, he or she would be privy to the same information that [previous counsel] would have from his communications with [shareholder].”

Conclusion

It is not uncommon for a corporation to engage the same legal counsel for matters involving the company and matters requiring representation of the individual shareholders, officers, and directors. Those who manage the operation of the company’s affairs (and those who represent them) should be cognizant of these issues as they arise in derivative litigation.