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“Whaddya Mean I Need to Get Another Attorney!”: Companies, Their Owners, and the Conflicts of Interest that Follow

| Deana A. Labriola Deana A. Labriola

A closely-held company and its owners often are intertwined to such an extent that they are almost indistinguishable to the outside world.  But while the interests of such a company and its owners are difficult to separate (at least during the "good times"), the fact is that companies and their owners are distinct parties for legal purposes. 

As a result, an attorney serving as legal counsel to a company ("Company Counsel") is required to treat the entity and its owners separately.  First and foremost, Company Counsel must represent and advocate the company's interests at all times.  This is so even though Company Counsel works closely, sometimes on a daily basis, with the company's founders, owners, directors, and officers.  As a result, Company Counsel becomes keenly aware not only of how each company decision affects or may affect the company's owners and personnel, but also how such actions may have a different and unique effect on the company's requirements, needs, and obligations.  In a number of transactions (including the sale or expansion of, or equity financing for, the company; personnel decisions of the company; or investigations by or of the company), the tax, liability, and other consequences to the owners may be starkly different from the consequences to the company itself.  Often, an action that helps one will disadvantage the other.  While Company Counsel may become a friend and confidant to a company's owners and personnel, Company Counsel always must comply with and obey the conflict of interest rules imposed on attorneys. 

This article outlines common occurrences where the interests of a company and its owners or management personnel are different, and for which separate legal counsel should be sought. 

Sale of a Company

The sale of a company represents the classic example of a situation where the needs and interests of a company and its owners may not match.  A sale's tax effects for one owner can be very different from those of the company and other owners, especially with respect to the characterization of income or loss in the transaction.  Moreover, in the case of multiple owners, each may be asked to make joint and several representations and warranties about the company in the sale documents.  However, the joint and several liability arising from these representations and warranties may be disproportionate to the economic interests of individual owners.  For example, should a 10% owner of a company be equally liable with a 90%, 50%, 25%, or even 15% owner of the company for a breach of the company's representations and warranties?

Additionally, in a sale transaction, some owners may sign post-closing employment agreements, while others may not.  In such a situation, each owner needs to negotiate employment, non-competition, and benefit packages separately from each other owner and from the sale negotiations for the company.  It is not at all uncommon to find friends and colleagues who slaved together to build a successful company bidding against one another, whether intentionally or not, to land the best post-sale deal.  As a result, such negotiations require each owner to have legal representation separate from that of the company and other such owners in order for each owner to enjoy full and unfettered advocacy for that owner's (and the company's) best interests.

"Firing" the Founder

In most situations, lawyers, accountants, and other service providers communicate with only a handful of individuals within a company.  In a small company or start-up entity, the only point of contact may be the founder or founders of the company who still own, individually or collectively, a majority ownership interest and who actively work in the company's business.  Often, a very personal relationship is developed between advisors and founders because they work so closely together on all matters with respect to the company.  But what happens when it is time to "fire" one or more of the founders? 

If circumstances within a company (or the personal circumstances of a founder) change so much that it makes sense for the company to "fire" the founder, or if an investment group comes in and wants to install its own management, the affected founder often does not understand why the advisors to the company, including Company Counsel, will no longer give advice to the founder with respect to the termination of employment or lend an ear to the founder's views of the situation.  But obviously, the interests of the founder and the company now have diverged and the company's advisors must cease to advise the founder, regardless of any personal bond or friendship that has developed.

Investigation of the Company or Its Management

If a company or its owners, board of directors, managers, or general partners come under investigation or scrutiny for fraud, violations of law or governmental regulations, or other possible misfeasance, the individual owners, directors, managers, or partners will be well-served to understand the relationship the company has with its Company Counsel and the rights and obligations associated with that relationship.  As is always the case, the Company Counsel must represent only the company which, in fact, may be the victim, and cannot represent the owner(s), director(s), manager(s), or partner(s) who may be the wrongdoer(s). 

The attorney-client privilege is a privilege whereby communications between an attorney and the attorney's client made in connection with the rendering of professional advice are privileged and cannot be used against the client in litigation.  In an investigation or inquiry into the actions of a company's owners, directors, managers, or partners, it is the company, as the client, that enjoys the attorney-client privilege with Company Counsel and not the owners, directors, managers, or partners in their individual capacities.  As a result, any statement made by the latter to the Company Counsel regarding possible wrongdoing creates a dilemma.  The attorney-client privilege, like most privileges, can be waived by the beneficiary of the privilege.  A company may well consider it to be in its best interest to disclose statements made by a perceived "renegade" owner, director, manager, or partner in order to deflect blame away from the company itself.  If it waives the privilege, the company, like any client protected by the attorney-client privilege, ordinarily would be entitled to expose communications between Company Counsel and the individual owners, directors, managers, or partners.  However, the owner, director, manager, or partner under suspicion may attempt to assert the attorney-client privilege in order to keep incriminating statements made to the Company Counsel from being disclosed to that individual's detriment. 

It is unclear whether an owner, director, manager, or partner can validly assert the privilege (despite the company's decision to waive it) when the problematic communication was made while the owner, director, manager, or partner was acting as an agent for the company.  Some courts have allowed, and some courts have not allowed, the owner, director, manager, or partner to assert the privilege in such a situation.  The lack of certainty puts companies, their management, and Company Counsel in a very difficult position which should be avoided if at all possible.   

Individual owners, directors, managers, and partners should seek separate counsel for any issues which arise, or reasonably could arise, with respect to the appropriateness of their actions.  In such case, the interests of, and strategies implemented by, the individuals may differ from those of the company they serve.

Conclusion

Advisors to small companies want the company and its owners and officers to succeed.  If a company is successful, the interests of the company and its owners and officers usually remain aligned.  The parties stay focused on one goal – making the company a success.  However, when the company is not doing well, when a structural change such as a sale is afoot, or when a claim of improper action is raised, interests inevitably will diverge, and understanding the roles of each advisor to the company is critical.  In any event, Company Counsel's obligations will remain with the company, and those individual owners, directors, managers, and partners seeking to protect their individual rights should consult separate counsel to ensure those rights stay protected.

© 2010, Ward and Smith, P.A.

For further information regarding the issues described above, please contact Deana A. Labriola.

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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.

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