Corporate counsel’s duties after ‘Baker v. WilmerHale’

October 5, 2017

Most attorneys representing closely held companies in Massachusetts likely took note of the recent decision in Baker, et al. v. Wilmer Cutler Pickering Hale and Dorr LLP, et al., in which the Appeals Court allowed the non-client minority members of an LLC to pursue breach-of-fiduciary-duty claims against the company’s counsel.

The significance of that holding arguably goes without saying. But the court’s analysis leaves several questions unanswered that are sure to complicate attorney-client relations in the closely held business context.

Implicit in the court’s holding are two important messages to counsel: (1) always be clear about who your client is; and (2) if you do represent a closely held company, pay attention to its operating documents — they may well determine both the company’s best interests (irrespective of what you think they are) and the extent of your duties to non-clients.

But while this framework at least partially clarified the attorneys’ duties in Baker, it doesn’t explain how to represent a company while owing irreconcilable duties to its warring constituents. Nor does it clarify what duties arise for counsel when the operating documents are essentially silent, and the owners therefore owe each other fiduciary duties by default.

In short, absent written clarification in corporate operating documents, or judicial clarification from the Supreme Judicial Court, Baker seems to have unnecessarily complicated things for outside corporate counsel.

Member conflict in ‘Baker’

Applied Tissue Technologies was a Massachusetts limited liability company founded by Robert Allison and Elof Eriksson. Allison was the principal minority owner, while Eriksson indirectly controlled the majority (75.5 percent).

In 2012, Allison and Eriksson disagreed on how to resolve a financial shortfall at ATT. Allison was unhappy with management and refused to contribute new capital unless new investors also came in with a new management team. Eriksson was fine with the existing management and wanted to provide the needed capital, but only in exchange for a greater equity stake.

Importantly, the company’s operating agreement, which could not be amended without the approval of both Eriksson and Allison, effectively foreclosed any resolution of the impasse. It prohibited any member’s interest from being altered or diluted without the member’s consent, and required that any additional member-supplied capital be treated as a loan.

Seeking a solution, Eriksson reached out to his daughter, an attorney at Gunderson Dettmer, who introduced him to another Gunderson lawyer, Gary Schall. At Eriksson’s behest, ATT’s CEO then executed an engagement letter with Gunderson, establishing it as ATT’s counsel and expressly disclaiming any attorney-client relationship with individual members.

When Schall left Gunderson two months later to join WilmerHale, ATT’s CEO executed another engagement letter appointing WilmerHale as company counsel and again disclaiming any attorney-client relationship with the members.

Attorney-supplied solution and resulting litigation

Because ATT’s operating agreement was silent about mergers, Schall recommended that Eriksson, the majority owner, use a provision in the LLC Act that expressly allows mergers by vote of a simple majority.

Using documents prepared by Schall, and without any notice to the minority members, Eriksson created a new Delaware LLC under the same name, but with an operating agreement that removed the explicit minority protections.

He then merged the Massachusetts LLC into the Delaware one, thereby freeing himself to invest more money and dilute Allison by approving more stock for himself and others (including his son-in-law), all without violating the newly governing agreement.

Allison and Baker, another minority owner, eventually brought suit against Eriksson, and later cast a wider net to include the lawyers and law firms, asserting claims for breach of fiduciary duty, aiding and abetting such a breach, civil conspiracy and violation of Chapter 93A.

The trial judge granted the law firms’ motion to dismiss all of the claims, concluding in relevant part that ATT’s counsel could not have owed any duties to the company’s minority members because of an “obvious” potential conflict between them and ATT. See Baker, et al. v. Wilmer Cutler Pickering Hale & Dorr, LLP, et al., 33 Mass. L. Rep. 267 (2016) (citing Robertson v. Snow, 404 Mass. 515, 524 (1989) (attorneys less likely to owe duties to non-client whose interests could conflict with existing client’s)).

Because “Allison was dead set against the course of action that Eriksson thought was best,” no lawyer could simultaneously represent ATT and still fulfill a fiduciary duty to Allison, so no duty could be owed.

The trial judge thus equated ATT’s interests with Eriksson’s, such that a conflict with Eriksson, who had engaged counsel, was a conflict with ATT, thus absolving the attorneys of any duty to the dissenting owners.

And because the minority members had no knowledge of either Gunderson or WilmerHale’s involvement, they could not have reposed any trust or confidence in those lawyers, which precluded application of cases such as Cacciola v. Nellhaus, 49 Mass. App. Ct. 746 (2000), or Fassihi v. Sommers, Schwartz Silver, Schwartz & Tyler, P.C., 309 N.W.2d 645 (Mich. App. Ct. 1981), in which a fiduciary relation arose because the non-client placed trust and confidence in corporate counsel. See Baker, 33 Mass. L. Rep. 267, at *22 (Mass. Super. 2016).

Reversal and resulting implications

For the Appeals Court, ATT’s counsel could not so easily accept Eriksson as the arbiter of the company’s best interests (and certainly could not do so in secret), because the company’s operating agreement expressly required “[c]onsensual decision-making … on important matters despite the obvious potential for conflict.”

Because of the minority protections in ATT’s operating agreement, acting “according to the interests of the corporation,” and not just those of one “nonclient stockholder, director, officer, employee, or other [corporate] representative,” (Clair v. Clair, 464 Mass. 205, 216 (2013) (quotation omitted)), required ATT’s counsel to consider everyone’s individual interests in any corporate action. The operating agreement’s protections thus extended counsel’s duties to all members and trumped whatever counsel (or Eriksson) believed was best for ATT.

In one sense, this decision makes perfect sense on the facts presented. The law has long been clear that close corporations resemble partnerships. Blank v. Chelmsford Ob/Gyn, P.C., 420 Mass. 404, 408 (1995); Donahue v. Rodd Electrotype Co., 367 Mass. 578, 586 (1975).

And “[j]ust as an attorney for a partnership owes a fiduciary duty to each partner, it is fairly arguable that an attorney for a close corporation owes a fiduciary duty to the individual shareholders.” Schaeffer v. Cohen, Rosenthal, Price, Mirkin, Jennings & Berg, P.C., 405 Mass. 506, 513 (1989).

As for how company counsel should reconcile potentially conflicting duties to the company and all of its constituents, Baker’s instruction to simply look to the operating documents is not much use.

ATT’s lawyers nonetheless acted solely — and secretly — for Eriksson’s benefit, to the exclusion of the company’s minority members, whose rights were compromised as a result. Had the attorneys simply been clearer about whose interests they were protecting (i.e., Eriksson’s alone), there could be no argument that they owed duties to a non-client minority. See Kurker v. Hill, 44 Mass. App. Ct. at 187-88 (“we decline to extend the fiduciary duty owed among shareholders of a closely held corporation to their individual attorneys”).

In this sense, it isn’t surprising that the above dicta from Schaeffer became an affirmative holding on these facts; despite purporting to represent the company as a whole, counsel had clearly prioritized one member’s interests over others.

But as for how company counsel should reconcile potentially conflicting duties to the company and all of its constituents, Baker’s instruction to simply look to the operating documents is not much use.

If the documents actually require a consensus for all major decisions, as they did in Baker, then no one can legitimately act on the company’s behalf without being exposed to a claim, and counsel will face a disabling conflict on any disputed action.

And if the documents are silent about the rights and duties of owners, then counsel will likely feel just as hamstrung, because the fiduciary duties of utmost good faith and loyalty would then arise by default, and counsel — well aware of those duties — would face a nearly identical conflict in doing anything that might harm an owner constituency.

Baker therefore tacitly suggests that attorneys would do well to understand their relationship with closely held companies, and the scope of their corresponding duties, as creatures of contract that are best clarified through documentation.

As long as a company’s operating documents define the rights and duties of both the owners and company counsel, and empower counsel to act for the company without triggering any additional duties, and establish a process for resolving disputes among owners, then all is clear, and counsel can advise the business with confidence.

(Of course, achieving such clarity would have its own ethical implications for any lawyer preparing the necessary documents that limited his or her duties; again, Baker complicates things.)

But the all-too-common reality is that clients don’t seek counsel until after a dispute arises, and the available documentation is typically thin, at best. For that more likely scenario, Baker’s essential lesson is that attorneys should not purport to represent business entities whose owners are at odds; you just might end up in a fiduciary relationship with someone you’ve never met.