No Conflict in Successive Representation of a Closely-Held Company and Its Insiders Where Insiders Already Possess Company’s Confidential Information

by Haight Brown & Bonesteel LLP

In Beachcomber Management Crystal Cove, LLC v. Superior Court (Salisbury) (No. G054078, filed June 28, 2017; pub. and mod. order July 28, 2017), the Fourth Appellate District granted a writ of mandate vacating a trial court’s order disqualifying defendants’ counsel.

In Beachcomber, plaintiffs filed a shareholder derivative action against defendants Beachcomber Management and Douglas Cavanaugh (collectively, “defendants”) alleging defendants abused their position and mismanaged nominal defendant and similarly named Beachcomber at Crystal Cove (“Beachcomber”). Between 2009 and 2011, defendants and Beachcomber had each hired Kohut & Kohut LLP (“Kohut”) to represent them on at least four different occasions. In the underlying action, defendants hired Kohut again to represent them, while Beachcomber hired another law firm to represent it.

Plaintiffs filed a motion to disqualify Kohut from participating in the case alleging conflicts of interest existed as to (1) Kohut’s concurrent representation of Beachcomber and defendants; (2) Kohut’s successive representation of Beachcomber and defendants in other matters; and (3) the need for Kohut to testify in the lawsuit about the services provided to Beachcomber and defendants. The trial court granted the motion to disqualify Kohut and defendants petitioned for a writ of mandate to challenge the order.

Conflicts of interest arise in the successive representations of different clients where an attorney owes a duty of confidentiality to the former client. The duty of confidentiality generally prevents an attorney from continuing to represent the second client if the representation conflicts with the representation of a previous client in a related matter if the prior client establishes a substantial relationship between the successive representations and that the attorney acquired confidential information material to the new matter from the former client. A court must disqualify the attorney from continuing to represent the second client because the law presumes the attorney received confidential information during the first representation that is relevant to the second.

An exception to the general rule exists, however, in the context of a small or closely-held company. Generally, a corporate shareholder or member in a limited liability company may bring a derivative lawsuit on the company’s behalf when insiders who control the company allegedly breach their duties and injure the company. In that instance, an attorney cannot represent both the company and its insiders concurrently in the derivative lawsuit. In a small or closely-held company, however, its operations and insiders are typically so intertwined there is no distinction between the two. In such a situation, the company’s insiders could provide a new attorney with all the information their previous attorney had, rendering disqualification of the prior attorney unnecessary. Unlike ordinary successive representation cases, an attorney’s representation in this specific instance does not threaten the attorney’s duty of confidentiality to the company because the insiders are already privy to the company’s confidential information.

In Beachcomber, seven of plaintiffs’ eight cases of action were derivative claims brought on Beachcomber’s behalf against the insider defendants. Although Kohut had previously represented Beachcomber in other matters, given the closely-held nature of Beachcomber, defendants had knowledge of confidential information relating to Beachcomber they could have provided to either Kohut or any other attorney representing them. Further, it was undisputed Beachcomber hired independent counsel in the new lawsuit. Accordingly, an exception to the general rule regarding successive representation applied as to Kohut’s representation of defendants in the action.

In its holding, the court concluded the trial court erred in granting plaintiff’s motion to disqualify and issued a writ of mandate directing the trial court to vacate its order disqualifying Kohut from representing defendants and determine whether Kohut could continue representing defendants in the lawsuit in accordance with the rules described in the opinion.

While an attorney’s duty of confidentiality is generally inviolate, Beachcomber further upholds the tenet that the duty of confidentiality does not prevent attorneys from representing insiders in a closely-held company who are already privy to confidential information they could provide to any other attorney they might retain about that company in a derivative lawsuit.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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