Dual Representations in Derivative Litigation: The Corporate Counsel's Role in Managing the Corporation's Conflicts of Interests - ABA YLD 101 Practice Series

By John P. DiTomo

Our ethical obligations to clients are governed in part by rules of professional conduct that prevent us from representing a client when a conflict of interest arises by reason of that representation. More specifically, the Model Rules instruct us that a conflict arises when "the representation of one client will be directly adverse to another client" or when "there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer." See MRPC 1.7.

For outside general counsel, the potential for a conflict of interests is particularly acute when the corporation becomes the subject of a derivative lawsuit. See generally MRPC 1.13. In particular, a shareholder suing derivatively seeks to enforce a cause of action belonging to the corporation against a third-party. While the board of directors is presumed to act in the best interests of the corporation, sometimes the board will not bring a lawsuit against a third-party, such as when the party is a director or officer of the corporation. Thus, with respect to a motion to dismiss a shareholder's derivative complaint for failure to meet the relevant jurisdiction's derivative standing requirements, the interests of the corporation and its directors appear aligned. That is to say, the corporation has an interest in managing the litigation and the individual directors have an interest in being dismissed from the suit. For this reason, it is a fairly common practice for the same law firm to represent the corporation and the individual directors when prosecuting such a motion. However, at least one influential court has recently called into question the practice of dual representations and, in light of the duties we owe our clients, perhaps a more nuanced consideration of the potential for conflicts is warranted.

In 2007, a series of opinions came out of the Delaware Court of Chancery questioning the proprietary of dual representations in particular contexts. In Conrad v. Black, for example, a stockholder of Staples, Inc. filed a derivative lawsuit challenging an alleged decade-long scheme of backdating option grants. 2007 Del. Ch. LEXIS 130, at *2 (Del. Ch. Sept. 7, 2007). The plaintiff based her complaint in part on an internal investigation that uncovered accounting errors "due to the use of incorrect measurement dates." The corporation and the individual directors were represented by the same law firm and jointly moved to dismiss the complaint. The motion argued that the shareholder failed to demonstrate with particularity that the directors were unfit to decide whether the action should proceed on behalf of the company. The court denied the motion and noted:

[T]he company continues to be represented by the same lawyers who represent the officers and directors who received those backdated options and the three directors who approved them. Given the finding of erroneous dating practices (by inference, backdating), the court questions how it is that the interests of the corporation are not, or at least do not appear to be, adverse to the interests of the individual defendants.

Id. at *20-*21.

A few months later in Weiss v. Swanson et al., the Delaware court considered a similar motion to dismiss and in denying that motion noted:

The whole idea of dismissing because of a failure to make a demand, in my mind, is a defense that belongs to the corporation, not to the directors personally. Tr. at 48. [M]y experience is that compensation committees of large corporations do rely on advice, and perhaps a viable defense here, on the part of the defendants ... is going to be that they relied on advice of counsel in doing what they did... . But it gives me little comfort to have ... the same firm who perhaps was giving that advice, ... standing in front of me making an argument to dismiss the case.

Weiss v. Swanson et al., Del. Ch., C.A. No. 2828-VCL, Lamb, V.C., Transcript (Nov. 28, 2007) at 49.

And finally, in Ryan v. Gifford (another suit concerning backdated options) the court considered a motion to compel the production of certain documents withheld on privilege and in ordering the production noted that: "If in fact, as plaintiffs alleges, the same law firm acts in a dual capacity as counsel for both [the company] before the SEC and the individual defendants in this litigation, this is a representational conflict about which the Court anxiously awaits to be enlightened." 2007 Del. Ch. LEXIS 168, at *13 & n.9 (Del. Ch. Nov. 30, 2007). This decision was issued after the defendants' motion to dismiss the case for lack of derivative standing was denied and highlights that our duty to evaluate conflicts is not fixed at the moment litigation is filed.

Although these three cases arose in the context of stock option litigation, the court's increasing skepticism of dual representations has broader implications for corporate counsel. The teachings of Conrad and Ryan are clear. First, if a corporate investigation or judicial determination makes a preliminary finding that the directors acted in a manner that was inconsistent with the best interests of the company, then the directors' interests are likely adverse to the corporation (or may at least appear to be to a judge) and separate counsel for the individual directors is prudent from the outset of the litigation. Second, the court's concern with the conflicts that arise from dual representations extends to a concurrent representation in any forum, not just before the court. See Ryan, 2007 Del. Ch. LEXIS 168, at *13 & n.9 (expressing concern with the same firm representing the company in front of the U.S. Securities and Exchange Commission and the individual directors in front of the court).

There are a few subtle lessons as well. If you or your firm regularly serve as outside general counsel and the corporation you represent later becomes the subject of derivative litigation, you and your firm ( see MRCP 1.10 imputation of conflicts) should be wary about representing both the corporation and its directors without first considering the potential conflicts that exist. This is particularly true if the advice you rendered concerned a shareholder demand and the board's response to that demand is challenged, or the subject matter of your advice is the focus of the derivative suit. In all events, if you undertake your corporate client's representation in a derivative suit and you determine that it is appropriate to represent both the corporation and the individual directors, it would again be appropriate to consider the need to secure separate counsel if your motion to dismiss for lack of derivative standing is denied. In that circumstance, there would have been a judicial determination that the directors were unable to press the corporation's cause of action disinterestedly and independently and separate counsel will be needed to manage the corporation's interests

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About the Author

John DiTomo is an associate with Morris, Nichols, Arsht & Tunnell, LLP, Wilmington DE. The views expressed in this article do not represent the views of Morris Nichols or its clients.

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