Introduction
Not that long ago, the worst claims facing TLIE were related to attorney's "non-legal" business ties to clients. During the savings and loans/real estate crisis in the mid to late 1980s, many claims centered on alleged conflicts relating to service on the boards of client financial institutions and on attorney's personal interests in business deals. With an overall pickup in the economy, we are now getting questions about whether it is really that bad to serve on a board or to become a coventurer with a client on a deal. This article will discuss the problems with attorneys getting involved with clients in a role beyond that of a legal advisor.
Corporate Directorships
Attorney service on corporate boards used to be routine. The attorney on the board often knew more about the corporate client's day to day affairs than anyone else who did not devote full time to the company. Aside from the prestige of being a board member, the attorney might receive a relatively small stipend and often would have a chance to develop other business for the law firm through connections with business contacts of the company involved. For example, service on the board of a bank might lead to contact with borrowers with substantial legal needs of their own. Board members were almost never sued. In most cases, service on a board was a "win-win" situation.
That situation seldom exists any more. Corporate directorship for attorneys is fraught with perils. Suits against directors have mushroomed in recent years. While Directors and Officer's insurance is available for many businesses, prices have increased substantially in recent years. An attorney who sits on a board is not covered for their acts as a director under most legal malpractice insurance policies. Plaintiffs often single out attorney directors for criticism, citing their increased level of or access to knowledge about the duties of the company.
Nature of Conflicts
The greatest danger for an attorney sitting on a board arises from actual or alleged conflicts between his or her role as a director and as the attorney for the company. As a member of the board, the attorney has a duty to assist the company in securing legal representation of highest quality at the best price. As an attorney practicing law, the attorney wants to maximize the profit flowing from legal services rendered. This conflict has been the source of many claims that an attorney director urged a board to follow a course that was likely to boost his or her law firm's fees at the expense of the well being of the company. For example, the government alleged in a number of financial institution cases that attorneys on the board who also documented loan transactions "created business" by leading the financial institution to make more and riskier loans.
If the attorney or his or her firm makes a mistake, the attorney as board member has a duty to take steps to prevent damage to the company, and as attorney has a duty to disclose the error. In practice, however, an attorney will be prone to take a cautious attitude toward admitting error, either because of the human tendency to deny bad news or because many legal problems just work out without harm to a client. When the attorney is on a board and bad news is not disclosed, two duties may be violated at once. A number of the malpractice claims against attorneys related to financial institutions alleged failure to disclose error.
Going Into Business With Your Clients
As the economy has turned around, we have received an increasing number of inquiries about the ability of attorneys to become involved in business deals with clients. Texas Disciplinary Rule 1.08(a) provides that an attorney is prohibited from entering into a business transaction with a client unless:
1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed in a manner in which can be reasonably understood by the client;
2) the client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and
3) the client consents in writing thereto.
When an attorney sees an opportunity to get involved with a potentially lucrative business deal with a client, the third requirement is the only one seen. Judging whether the transaction is fair and reasonable to the client will be done with hindsight, and often by a lay jury instead of a panel of lawyers. Full disclosure is a difficult concept: if you don't disclose the potential problem that becomes an actual problem, all the rest of the disclosures may be meaningless in the long run.
TLIE's experience with failed transactions from the 1980s is that sophisticated clients can be made to look like newborn babes by experienced malpractice counsel. If the client loses more than the attorney, a case will be presented showing the transaction favored the attorney over the client was thus unfair and not reasonable. In one case handled by TLIE, members of the law firm became a limited partner with a general partner client erecting a multistory office building. The client general partner needed the cash and the lease provided by the firm to have any chance of making the deal work. The general partner had lots of business experience, and negotiated very forcefully with the firm in putting the deal together. Eventually, the venture failed when rental rates plummeted and a sufficient number of tenants could not be found. Despite testimony by one of the leading ethics experts in the country that the transaction was fair and reasonable to the client, a jury was willing to believe that the firm had taken advantage of the client.
Conclusion
TLIE strongly recommends against attorneys serving on corporate boards. While not a guarantee of suit or an automatic disqualification to obtaining insurance, the risk involved warrants special attention. Entering business deals with clients presents great risk as well. Suits arising from alleged failure to disclose risks and from allegations that the deal was not fair to the client are difficult to defend before lay juries.
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