Losing the Privilege When the Subsidiary is Sold

About the Authors:

Simon M. Lorne is vice chairman and chief legal officer of Millennium Management LLC, a New-York based alternative asset manager.

Susan is the general counsel of a mid-size corporation – we’ll unimaginatively call it Acme – that operates through several subsidiaries. She has a centralized legal department, which usually handles all of the legal work for all Acme entities. For a number of tax and business reasons, there is in place a “tax sharing agreement” between Acme and each of its subsidiaries; in essence, the agreements provide that each year the subsidiary makes a tax-equivalent payment to Acme based on the taxes that would have been payable if it were a stand-alone company, with appropriate provisions for the treatment of losses, etc. 

In a desire to focus on its core businesses, Acme management decides to sell the Beta subsidiary and LargeCo acquires it; as is customary, that work, too, was handled by the law department, with some minor assistance from outside counsel. A year after the closing, a question arises causing LargeCo to believe that Beta’s tax-equivalent payments to Acme in prior years were excessive. Unable to settle the matter, LargeCo causes Beta, now its subsidiary, to sue Acme. 

What is Susan’s Role in the Litigation as Acme’s General Counsel?     

The answer provided by the ethics rules of the various states is simple: None, except possibly as a witness, called by LargeCo. When Susan’s prior client, Beta, sues her current client, Acme, and her law department was involved in representing the former client with respect to the subject matter (all clearly true here), Model Rule 1.9(a) could not be more clear: 

A lawyer who has formerly represented a client in a matter shall not thereafter represent another person in the same or a substantially related matter in which that person’s interests are materially adverse. . . .               

Indeed, note that this disqualification does not simply attach when litigation is filed. When LargeCo first notified Acme of the concern, and the Acme CEO called Susan, her response should have been that she couldn’t advise on that topic. An exception is available for informed written consent (more about that later), but the likelihood is that LargeCo’s subsidiary, Beta, will not consent once the dispute has surfaced. Necessarily, the same result would obtain if the dispute were triggered by the acquisition agreement rather than the earlier tax sharing agreement.               

While this result may surprise many in-house lawyers, the conclusions are generally inescapable, although there is some degree of ambiguity as to what precisely this means for the modern general counsel, who wears a number of hats within the corporate enterprise. She is advisor on things legal, to be sure, but she is much more than that. She participates in many aspects of management, including risk evaluation, personnel review, oversight of at least some parts of the audit function, etc. Which of these activities is foreclosed by her disqualification? One would think that the disability extends only to those things that would constitute “representation” of Acme with respect to a relevant subject, but the line is unclear.               

The extremes may be easily set out. Susan may look at Acme’s other tax-sharing agreements with subsidiaries to see whether they ought to be amended in view of the issues raised in the Beta litigation. (A theoretical argument could be made for separate representation of the subsidiary – and there may be situations in which that is a useful approach – but the uniform view is that a parent and its wholly-owned subsidiaries may be represented by the same counsel. At least that question is resolved in the expected manner.) Susan may not, however, go into the courtroom and argue a motion in the case. She may not participate in formulating litigation strategy in the case, and she probably shouldn’t participate in a meeting between management and outside counsel regarding the case. Nor should she be involved in explaining the background of the case to the outside counsel chosen to represent Acme without being very careful to limit the nature of that discussion. As to the latter points, the problem isn’t that she can’t tell outside counsel what she knows – as discussed below, she may well be a witness, and anything she could testify to in court, she could obviously tell counsel. The problem is that the discussion may easily slide into a discussion of Acme’s litigation strategy, and since she can’t represent Acme, anything told to her probably is outside of the privilege. And lest one think otherwise, the other lawyers in the legal department are subject to the same infirmity – Model Rule 1.10 imputes the disqualification of one lawyer to all other lawyers in a law firm, and Model Rule 1.0(c) is clear that a corporate legal department is the equivalent of a law firm, although there may be some variations among different jurisdictions on some of these issues. (Explaining all of this to Susan’s CEO may not be easy, unless the CEO happens to be a lawyer by training – particularly if the matter involves a material exposure to the company – but that can’t change the conclusions.) 

As a Witness?

Unfortunately, disqualification from advising with respect to the dispute does not end the matter. Susan, or others in her law department, are likely to have detailed knowledge of factors relevant to the dispute, particularly when it involves an agreement that they prepared.

In this situation, the law department’s representation of Acme and Beta is likely viewed as a joint representation, with the consequence that either of the joint clients may waive the privilege otherwise attaching to any communications. So, yes, Susan may well be called as a witness, and compelled to testify about communications with Acme’s management relevant to the dispute.

In any given situation, of course, resolution of the issues involving which entity is a “client” of the office of the parent’s general counsel entitled to assert the privilege, and with the right to waive it, will be fact-specific, but it is clear that some general counsels have sometimes been surprised by the answers.

Conclusion

Most of us don’t think much in advance about what happens when the parent-subsidiary relationship changes, but the consequences can be very significant. The complicated litigation that culminated in the Third Circuit’s decision in Teleglobe, (In re Teleglobe Communications Corp., 493 F.3d 345 (3d Cir. 2007)), is only one of the more noteworthy exemplars. Fortunately, there is at least a possible solution, alluded to earlier: Model Rule 1.9(a) also provides that its restrictions apply “unless the former client gives informed consent, confirmed in writing.” While there has long been debate about the requirements for “informed consent,” in a corporate setting of this sort it should be possible to satisfy most requirements. One could, of course, establish subsidiaries with separate law departments and treat them in a completely arms’-length fashion, but while that would solve the conflict problem, it would probably sacrifice too much authority – for both the general counsel and the parent entity – to be satisfactory.               

In appropriate cases, and certainly when a subsidiary – or a minority interest – is being sold, it would clearly be good practice to reduce to a signed writing the expectations of the parties regarding matters of privilege and subsequent representation. Absent such a written waiver, if a dispute arises, the law department is in a very uncomfortable position.

Additional Resources

For other materials on this topic, please refer to the following.

John Villa, Corporate Counsel Guidelines (1999, updated annually), a joint project of Thomson Reuters and the Association of Corporate Counsel (ACC).

A Message from the Professional Responsibility Committee

Creating a Network of State and Local Bar Ethics Committee Liaisons

The Professional Responsibility Committee intends to create a network of State and Local Bar Ethics Committee Liaisons, charged to bring to the attention of the Committee significant ethics opinions, disciplinary rulings, judicial opinions, statutory developments, and changes in rules of professional conduct in their respective jurisdictions. The Committee has volunteers to serve as Liaisons for Colorado, New Jersey, Oregon, and Texas. If you would be willing to serve as a Liaison or if you would be interested in taking a broader leadership role in this initiative please contact the Committee Chair, Charlie McCallum, at cmccallum@wnj.com.

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