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Corporate Counsel Breached Duty of Loyalty by Promoting Interests of Dissident Faction

Tuesday, July 2, 2013

By Joan C. Rogers  

An attorney violated his duty of loyalty to a corporate client when he sued some of its officers and directors in the name of the corporation against the wishes of a majority of the board, the Kentucky Supreme Court held June 20 (Kentucky Bar Ass'n v. Hines, Ky., No. 2012-SC-000842-KB, 6/20/13).

The court, in an opinion signed by Chief Justice John D. Minton Jr., also ruled that the lawyer breached his obligation to communicate with the corporate client by not responding to requests from the entity's authorized agents to explain why he believed the board was not lawfully elected. Moreover, the lawyer acted unethically, it said, by turning over the client's files to an attorney representing the dissident shareholders. The court decided, however, that the lawyer did not violate his duty to explain the identity of his client to corporate constituents.

The court suspended the lawyer from practice for 120 days.

Infighting

The case centered on Kentucky attorney Ronald Hines and Cody Properties Inc., which was formed in 1991 on his recommendation to own and manage a large tract of property that was rich in timber and mineral resources. The land had descended to approximately 100 heirs, who became the shareholders in the corporation.


“[T]he simple fact is that [the lawyer] was hired by the corporation, which acts through its board and officers.”
Kentucky Supreme Court

In the late 1990s, while Hines was representing Cody Properties in matters involving timber and mineral rights, a split arose between two factions of the heirs. One faction was led by Marie Spencer, the company's president; Hines sided with the other. The dispute related partly to plans that were being made at the suggestion of another attorney, Carlton Neat, and a certified public accountant, Dennis O'Brien, to form a limited liability company to succeed the corporation.

At a meeting of the board of directors in 2000, the shareholders elected a new board of directors and officers. Of the board members then serving, all were reelected to their positions except one. Hines voiced concern that the elections were illegal because no notice had been given of certain changes in the election process.

After the election, the board hired O'Brien as the new general manager of the corporation and the LLC, and he informed Hines that the president had terminated his services except in one ongoing litigation matter.

Hines resisted, asserting that the elections of the board and officers were illegal, that the new manager had not been hired by a legal board, and that the LLC had been created with fraudulent papers.

Hines also maintained that he continued to be entitled to 20 percent of the corporation's income under an earlier fee agreement with the corporation. He did not respond to requests from the president and general manager that he explain in detail his reasons for asserting that the elections were unlawful and that the corporation was being operated illegally.

Suit Filed on Behalf of Corporation

Although Spencer notified Hines in mid-2001 that his services had been completely terminated, the lawyer continued to hold himself out as counsel for the corporation. In 2002 he filed suit on behalf of the corporation against Spencer, O'Brien, Neat's law firm, and three board members, seeking damages, an injunction, and a declaration that the corporation was being unlawfully managed. The complaint was verified by two individuals who signed as officers of Cody Properties, and several shareholders filed affidavits supporting the suit.

In 2003 Hines arranged for another attorney to take over the case, and the case was converted to a shareholder derivative action. Hines turned over all his files to that attorney rather than delivering them to the board.

Along the way, Spencer filed two bar complaints against Hines. Disciplinary authorities charged him with violating more than a dozen parts of the Kentucky Rules of Professional Conduct in connection with his representation of the corporation.

A trial commissioner found that some of the charges were not proved but that Hines breached two provisions relating to a lawyer's obligations as corporate counsel, as well as rules relating to lawyer-client communication, the duty of confidentiality, and a lawyer's responsibilities when a representation ends. The bar's board of governors accepted the commissioner's report.

Hines requested review. Applying the professional conduct rules in effect at the time of the events in question--before amendments to the rules in 2009--the supreme court upheld most of the commissioner's findings and went along with the recommended sanction.

Duty of Loyalty Violated

The court agreed with the commissioner that by siding with the dissident heirs in his representation of Cody Properties, Hines violated Rule 1.13(a), which stated that “a lawyer employed or retained by an organization represents the organization acting through its duly organized constituents.”

Hines contended that his conduct was appropriate within the overall context of what was happening within the corporation at the time. He emphasized that some officers, board members, and shareholders were clearly dissatisfied and that the 2001 board and officer elections deviated from past practice. There were legitimate questions about who was lawfully authorized to act on behalf of the company, and his decision-making was difficult because of the volatile situation, the lawyer argued.

The court rejected this line of argument and held that Hines violated his duty of loyalty to the corporation. “[T]he simple fact is that Hines was hired by the corporation, which acts through its board and officers,” it stated. The remedy for dissatisfied board members and shareholders was to file a shareholder derivative suit, yet Hines filed suit directly on behalf of the corporation without the required authorization from the board of directors, the court observed.

The court pointed out that the composition of the board was largely unchanged in the supposedly illegal 2000 election. By statute the term of a corporate director continues until his successor is elected, the court said. Therefore, even if Hines was correct that the 2000 elections were illegal and void, that meant only that the board as constituted before the election continued, it explained. A majority of that board still favored terminating Hines and was opposed to the lawsuit he filed in the name of the corporation, it noted.

The court acknowledged that Rule 1.13 does not automatically bar a lawyer representing a corporation from also representing officers, directors, or shareholders. But when a suit is a derivative action brought by minority shareholders alleging that officers and directors are acting wrongly, there is an inherent conflict, at least when the litigation commences, the court said.

Client Identity

The court also decided, however, that Hines did not violate Rule 1.13(d), which required a lawyer who is dealing with an organization's constituents to explain the identity of his client if it is apparent that the organization's interests are adverse to the constituents with whom the lawyer is communicating.

The trial commissioner found that Hines violated this rule when he became involved with the dissident faction and promoted its interests, because he had effectively stopped representing the corporation and embarked on representing the minority interests without telling the corporation.

The court did not agreed that Hines violated Rule 1.13(d). While the conduct underlying this charge may have created a conflict of interest, Hines was not charged with violating Rule 1.7 on current-client conflicts, it said.

Rule 1.13(d) is in place, the court explained, to prevent confusion so that a constituent--such as an officer accused of improper self-dealing--does not incorrectly believe that the lawyer represents him instead of the corporation. Bar counsel did not show, the court said, that Hines held himself out to the corporation as its counsel while he actually had decided to represent the dissident heirs individually, or that he failed to explain to the dissident heirs that he represented the corporation and thus misled them.

Other Misconduct

The court agreed with the commissioner that Hines violated Rule 1.4(a) (duty of communication), by failing to respond to letters from the president and manager of the corporation.

The court was unswayed by Hines's argument that he was acting at all times in the best interests of the corporation, which he believed the president and manager did not lawfully represent. A lawyer's duty to promote the best interests of the corporate client under Rule 1.13 simply does not trump the requirement to respond to requests for information from the client as required by Rule 1.4, the court declared.

A corporation is a legal fiction that can act only through its board of directors, officers, and other agents, the court emphasized. Here, it pointed out, the authorized agents were Spencer and O'Brien, both of whom asked Hines to explain his actions and provide certain information. Hines acted unethically by ignoring those requests, it found.

The court also held that Hines violated Rule 1.16(d) (duties on termination of representation) and Rule 1.6(a) (confidentiality) in the way he handled the corporation's files at the end of his participation in the suit he had filed on behalf of the corporation.

Although Hines claimed he believed he should give the files to his successor counsel in the litigation because that lawyer represented the legitimate governing authority of Cody Properties, the court reiterated that even if the 2000 elections were void a majority of the pre-2000 board--which would have been the legitimate board if the elections were indeed illegal--still opposed Hines's actions.

Hines's claim was “no more than window-dressing,” the court declared. At the very least, it said, “it demonstrates that Hines was not really answering to any corporate master and was acting as a maverick in what he presumed was the best interest of the corporation.”

Suspension

The court refused to review the commissioner's not guilty findings as to the other charges, since bar counsel did not file a notice of review and the court had not decided at the outset to review the matter independently.

It would be unfair, the court reasoned, if bar counsel could obtain review of not guilty counts by merely challenging the findings in its brief without formally requesting review. Hines would have had no real opportunity to rebut bar counsel's claims, and lawyers facing charges in other disciplinary cases might be chilled from seeking review, the court reasoned.

The court decided that the 120-day suspension the commissioner and board of governors recommended was an appropriate sanction for Hines's multiple acts of misconduct. A public reprimand for certain misconduct in an unrelated matter was unnecessary in light of the suspension, it decided.

Peter L. Ostermiller, Louisville, Ky., represented Hines. Jane H. Herrick, Kentucky Bar Association, Frankfort, Ky., represented the bar association.


Full text at http://www.bloomberglaw.com/public/document/Ky_Bar_Assn_v_Hines_No_2012SC000842KB_2013_BL_165407_Ky_June_20_2.

The ABA/BNA Lawyers’ Manual on Professional Conduct is a joint publication of the American Bar Association Center for Professional Responsibility and Bloomberg BNA.

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