September 13, 2019

When Good Deals Go Bad: Ethical Issues Raised By Failed Transactions

As lawyers, risk is all about us. Even the potential deals and transactions that demonstrate the most promise at the outset carry an unceasing risk of either collapsing or rankling the client, for reasons ranging from intractable differences in valuations and financial estimates to petty animosity between the principals on either side of the deal. And when disaster strikes, the attorneys responsible for negotiating the deal often must contend with the fallout.

From challenges to attorney-client privilege to potential malpractice claims, failed or dissatisfying transactions often thrust the ethics of the attorneys charged with consummating the deals to the forefront. The proliferation of start-up companies, sometimes run by individuals with less experience than the typical corporate executive, only escalates the risk that these ethical dilemmas may arise.

These program materials aim to explore the ethical issues raised when an attorney is engaged for a transaction—with particular focus on mergers and acquisitions and financing transactions—and when the deal, in some form, goes sideways. The materials focus specifically on three categories of ethical dilemmas that frequently arise in jurisprudence: (i) the possible relinquishment of attorney-client privilege to a hostile successor or purchaser; (ii) conflicts of interest that arise in the M&A and financing contexts; and (iii) the risk that attorneys can inadvertently "imply" an attorney-client relationship with individual constituents of organizational clients, thereby subjecting themselves to potential malpractice liability.

The first issue arises when an attorney represents a business and a successor acquires or assumes control of the business and thus assumes control of the attorney-client privilege with respect to communications between the attorney and a selling shareholder and/or former officers or directors. As the Supreme Court held in Commodity Futures Trading Commission v. Weintraub, "when control of a corporation passes to new management, the authority to assert and waive the corporation’s attorney-client privilege passes as well.” Most jurisdictions follow Weintraub's lead in holding that, when a new regime takes over an underlying business, the new regime has access to all pre-merger communications between the business and legal counsel that would otherwise be subject to attorney-client privilege from third parties. In the event this "new regime" becomes embroiled in conflict against selling shareholders or previous managers, its access to privileged communications could prove disastrous. It is thus crucial that, to combat the risk that a successor organization or new management has access to privileged communications during any ensuing litigation or conflict, an attorney representing a business and/or a seller in a transaction to acquire the business should take precautions to try to ensure that the client's confidential information is protected. This risk should inform the manner in which the attorney communicates with the client.

Attorneys should similarly be vigilant in detecting and guarding against potential conflicts of interest that could interfere with their representation of business clients. Both external conflicts (such as that posed when a client's business competitor seeks to retain the firm) and internal conflicts between shareholders and members can muddle the parameters of the duty of loyalty. Therefore, attorneys must practice vigorous assessment and reassessment of potential conflicts and seek informed consent as to any such potential conflicts when applicable.

Finally, attorneys should take measures to avoid unintentionally giving nonclients—particularly individual shareholders, officers, and agents of businesses—the belief the attorney is acting for those non-clients as its counsel. In addition to clearly identifying the clients and non-clients at the engagement stage and as frequently as possible thereafter, attorneys should always bear in mind that actions can speak louder than words when it comes to the question of whether an "implied" attorney-client relationship—and thus the exposure for potential to a legal malpractice claim—has formed.

For each of these categories, the materials will present: a hypothetical of "What Could Go Wrong," based on real case law; an identification of the potential ethical issues raised by the hypothetical; an overview of relevant law, with reference both the to the Model Rules of Professional Conduct and illustrative jurisprudence; and, finally, suggested means of preempting the potential ethical issues and protecting both the client and the attorney.

Forecasting every potential ethical pratfall that can arise in the event of a calamitous business deal would be an exercise in futility. Nonetheless, the hope is that these materials and the program for which they were prepared will encourage the attorney to adopt a preventative, attentive method to every business transaction. Attorneys should protect against the ethical fallout of potentially failed transactions on every stage of the representation, from the engagement itself; to the method and manner in which the attorney communicates with the client; to cognizance of potential conflicts of interests. "Hope for the best, prepare for the worst" may have become a cynical cliché. But it should also serve as the savvy, conscientious lawyer's mantra, even for those deals that seem too good to be true.

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