A recent decision by a Commercial Division judge in New York County has caused shivers of anticipation among New York's professional responsibility community. In an Interim Order in Stock v. Schnader Harrison Segal & Lewis LLP [Index No. 651250/13, 2014 NY Slip Op. 33171U (Sup. Ct. N.Y. Co. 12/5/2014)], Justice Melvin L. Schweitzer held that communications between the law firm's general counsel and a firm lawyer about ethical and malpractice issues in an ongoing case were not privileged, and thus had to be disclosed to the firm's client in a later malpractice action. [Id. at *1.] The law firm has already filed a Notice of Appeal, setting up the first opportunity for a New York appeals court to address whether law firms in this state are entitled to assert what is known as the "law firm in-house privilege" — an issue which has roiled courts across the country for more than 25 years.
This is an issue of huge importance to lawyers in private practice in New York and around the country. It raises a fundamental question: are law firms like ordinary businesses, which may protect as privileged communications between employees and in-house lawyers seeking legal advice, or does lawyers' status as fiduciaries for their clients mean those communications should be treated differently? Finding the correct answer requires courts to parse both ethical issues and the law of fiduciary duty. More important, it requires them to weigh the practicalities of day-to-day law practice against basic ethical principles, and the rights of lawyers against the rights of clients.
The Stock Decision
In Stock, the plaintiff had retained the law firm Schnader, Harrison, Segal & Lewis (Schnader Harrison) to represent him in connection with his departure from MasterCard International Inc. (MasterCard). [Id.] The plaintiff claimed that a Schnader Harrison partner had failed to advise him that his departure would accelerate the expiration date of his stock options, worth $5 million, from 10 years to 90–120 days. [Id.] The options expired worthless and the plaintiff, on Schnader Harrison's advice, brought an arbitration against MasterCard and its plan administrator to recover the value of the lost options. [Id. at *2.] In preparation for her testimony, the Schnader Harrison partner spoke to the firm's General Counsel and other firm lawyers about that testimony and possible ethical issues. [Id.]
When the lawsuit against MasterCard was unsuccessful, the plaintiff sued Schnader Harrison and the relationship partner for malpractice. [Id. at *3.] He claimed, among other things, that the partner had failed to attempt to negotiate an extension of the option expiration, and had covered up the firm's own potential liability in order to induce him to keep the firm as his counsel in the arbitration. [Id.] In the course of discovery, the plaintiff sought 24 documents reflecting communications the partner had with other Schnader Harrison lawyers, including the firm's General Counsel, in advance of her testimony. [Id at *1.]
In ordering the production of these documents, Justice Schweitzer rejected Schnader Harrison's claim that the partner's communications with the firm's General Counsel were covered by the firm's in-house privilege. [Id.] He likened Schnader Harrison's relationship with its client to the relationship between a trustee and a beneficiary, finding that the law firm was a fiduciary with special obligations to its client. [Id. at *2.] Citing Hoopes v. Carotta, [142 A.D.2d 906, 909-10 (3rd Dept.), aff'd, 74 N.Y.2d 716 (1989)], the first case in New York to apply the "fiduciary exception" to the attorney-client privilege, Justice Schweitzer held that "Stock *** has a right to disclosure from his fiduciaries of communications that directly correlate to his claims of self-dealing and conflict of interest." [Stock, Slip Op. at *2.] Reviewing the facts, the Court held that the plaintiff's claim that the law firm had a conflict was "colorable," the lawyers should have realized there was a conflict, and the lawyers, as fiduciaries, "were *** obligated to inform him of the facts underlying [MasterCard's] claim that his attorneys' 'failures' might have caused his losses, the existence of a potential conflict, and that he should seek independent counsel for advice." [Id. at *3.] Because the lawyers were the client's fiduciaries at the time they had the internal communications about the case, Justice Schweitzer suggested, they could not assert the privilege. [Id. at *1-3.]
Early 'In-House Privilege' Cases
The Stock holding is consistent with the early cases that addressed the issue, including the one case that has ruled on the law firm in-house privilege under New York law. In that case, Bank Brussels Lambert v. Credit Lyonnais (Suisse) [220 F. Supp.2d 283, 286–88 (S.D.N.Y. 2002)], the District Court rejected the privilege assertion on the ground that the lawyers' internal consultations about potential malpractice created a conflict between the firm's interests and those of its client: the firm was consulting to ascertain and protect its own interests while it still represented the client. Contemporaneous cases in other jurisdictions used the same rationale to reject law firms' assertions of the in-house privilege. [See, e.g., Koen Book Distrib. v. Powell, Trachtman, Logan, Carrle, Bowman & Lombardo, 212 F.R.D. 283, 283-85 (E.D. Pa. 2002); VersusLaw, Inc. v. Stoel Rives, LLP, 111 P.3d 866, 878 (Wash. 2005) (citing cases).] As one court put it, "a law firm's communication with in-house counsel is not protected by the attorney-client privilege if the communication implicates or creates a conflict between the law firm's fiduciary duties to itself and its duties to its client seeking to discover the communication." [In re Sunrise Securities Litigation, 130 F.R.D. 560, 597 (E.D. Pa. 1989); accord, E-Pass Technologies, Inc. v. Moses & Singer, No. C09-5967 (EMC), 2011 U.S. Dist. LEXIS 96231 at *6-7 (N.D. Ca. 8/26/2011).]
Some of these earlier cases, like Stock, also relied on the "fiduciary exception" to the attorney-client privilege, which states that "where a trustee, acting on behalf of his fiduciaries, uses trust funds to obtain legal advice regarding a trust matter, 'the beneficiaries [are] the 'real clients' of the attorney who *** advised the trustee on trust-related matters," and therefore the "attorney-client privilege properly belong[s] to the beneficiaries rather than the trustees.'" [See RFF Partnership, LP v. Burns & Levinson, LLP, 991 N.E.2d 1066, 1074-75 (2013), citing U.S. v. Jicarilla Apache Nation, 131 S.Ct. 2313, 2322 (2011); Garner v. Wolfinbarger, 430 F.2d 1093, 1103-04 (5th Cir. 1970), defining the "fiduciary exception."] These courts applied the fiduciary exception broadly to require disclosure of internal law firm communications about all aspects of the attorney-client relationship. [See, e.g, Sunrise, 130 F.R.D. at 597; In re SonicBlue, Inc., Adv. No. 07-5082, 2008 Bankr. LEXIS 181 at *27–30 (N.D. Cal. 1/18/2008).]
The Tide Begins to Turn
In sum, by about 2005, courts across the country were uniform in rejecting the in-house attorney-client privilege. Law firms which needed advice on ethical or malpractice issues involving existing clients and wanted to protect the privilege had to hire outside counsel. But this situation was viewed as expensive and impractical, and the organized Bar took the lead in taking a different position.
In N.Y. State 789 (10/26/2005), the New York State Bar Association Committee on Professional Ethics questioned the Bank Brussels view that the provision of in-house legal advice to firm lawyers about existing client matters created a conflict of interest. [See, N.Y. Eth. Op. 789 (N.Y.S. Bar. Assn. Comm. Prof. Eth.), 2005 WL 3046319, at *1.] Though it analyzed the problem under the then-existing New York Code of Professional Responsibility, its analysis would be the same under current New York Rule 1.7(a).
The Committee determined that neither the firm lawyer seeking the advice nor the firm General Counsel providing the advice had a conflict. [Id. at *3.] As to the former, the firm lawyer's "interest in carrying out the ethical obligations imposed by the Code is not an interest extraneous to the representation of the client. It is inherent in that representation and a required part of the work in carrying out the representation." [Id.] It is thus "not an interest that 'affects' the lawyer's exercise of independent professional judgment." [Id.]
As to the firm General Counsel providing advice, the Committee focused on whether the General Counsel's actions would "involve the lawyer in representing differing interests." [Id. at *4.] The Committee noted that the Code, like the New York Rules of Professional Conduct (RPC), defines "differing interests" to mean "every interest that will adversely affect either the judgment or loyalty of a lawyer to a client, whether it be conflicting, inconsistent, diverse or other interest." (Emphasis added). [Id.] Calling the italicized phrase "key," the Committee opined that "because the Code requires adherence to its rules in service of the many duties a lawyer owes, a law firm's consideration of its own legal and ethical obligations in connection with its representation of one or more clients cannot be said to implicate a 'differing interest' that will adversely affect the lawyer's exercise of professional judgment nor the loyalty due a client within the meaning of the Code." [Id.] Put another way, because lawyers are obligated to adhere to the ethical rules to protect clients, finding out what their ethical obligations are is "part of what clients and the legal system expect lawyers to do, serves to reinforce ethical behavior, and informs future conduct." [Id. at *5.]
The Committee then determined that while a lawyer had no obligation to inform a client that she was seeking legal advice from the firm's General Counsel, she did have a duty in many cases to disclose "the products" of that advice. [Id.] The Committee cited as examples situations where the lawyer determines she has a conflict of interest, and may need to contact the client to obtain informed consent. [Id.] More on point for most of the court cases in this area, the Committee explained that "whether an attorney has an obligation to disclose a mistake to a client will depend *** on all relevant facts, such as whether the error or omission gives rise to a colorable malpractice claim, is capable of correction or is injurious to a client." [Id. at *6.]
There is much that is troubling here. First off, the notion that a lawyer who may have committed malpractice or an ethical violation and the lawyer's client have the same interest in upholding ethical conduct is, to put it mildly, naïve; law firms have separate interests to protect in those situations that may be very different from the client's. Equally concerning is the suggestion that there can be a situation where a lawyer commits a significant error — even one that can be corrected — but has no obligation to disclose it to the client under RPC 1.4.
Nevertheless, the NYSBA opinion started a trend. Three years later, the ABA Standing Committee on Ethics and Professional Responsibility issued Formal Opinion 08-453, in which it opined, among other things, that (i) lawyers are permitted, under Model Rule 1.6(b)(4), to disclose client confidential information to the law firm's in-house or outside counsel to obtain legal advice; (ii) a lawyer seeking "prophylactic advice" from firm in-house counsel in order to conform her conduct to the Rules or applicable law does not have a conflict of interest under Model Rule 1.7 (though a conflict may exist where the lawyer has already "engaged in misconduct," since "it may be difficult or impossible for that lawyer" or the law firm to give the client "sufficiently detached advice"); and (iii) while the fact of an internal consultation need not be revealed to a client, the result of that consultation might have to be under Model Rule 1.4. [ABA Formal Op. 08-453 (2008).]
New Trend Supporting Privilege
These two ethical opinions, as well as influential scholarly articles supporting the law firm in-house privilege [see, e.g., E. Chambliss, The Scope of the In-firm Privilege, 80 Notre Dame L. Rev. 1721 (2005)], worked a subtle change in the courts' approach to the in-house privilege. Even courts that generally opposed that privilege recognized that "public policy encourages lawyers to consult with in-house counsel to understand and comply with their professional responsibilities and ethical restraints," and began to allow law firms to retain a privilege on consultations until such time as the firm determined that an ethical or malpractice problem existed requiring disclosure; after that, no internal communication remains privileged from the client. [See, SonicBlue, 2008 Bankr. LEXIS 181 at *27; accord, Thelen Reid & Priest LLP v. Marland, No. C 06-2071 (VRW), 2007 U.S. Dist. LEXIS 17482 at *20–21 (N.D. Cal. 2/21/2007).]
More important, as the years passed, a scattering of lower courts across the country began to recognize an in-house law firm privilege that covered all communications between firm lawyers and law firm General Counsel, or recognized only narrow exceptions. [See, e.g., TattleTale Alarm Sys. v. Calfee, Halter & Griswold, LLP, 2011 WL 382627 at *10 (S.D. Ohio 2/3/2011), applying attorney-client privilege and rejecting client's access to documents for failure to show "good cause;" Garvy v. Seyfarth Shaw LLP, 966 N.E.2d 523, 526-31 (Ill. App. Ct. 2012), applying attorney-client privilege to communications where firm lawyer sought in-house advice regarding malpractice claim while still representing client.] And what began as a trickle became a flood in the past two years as the highest courts of three states — Georgia, Massachusetts, and Oregon — all found a broad in-house law firm privilege.
These three decisions, Crimson Trace Corp. v. Davis Wright Tremaine LLP [326 P.3d 1181, 1190–91 (Or. 2014)], St. Simons Waterfront LLC v. Hunter, Maclean, Exley & Dunn, P.C. [746 S.E.2d 98, 106 (Ga. 2013)], and RFF Family Pship. LP v. Burns & Levinson, LLP [991 N.E.2d 1066, 1073–74 (Mass. 2013)], took different approaches to reach the same result. In St. Simons, for example, the Georgia Supreme Court concluded that although a law firm General Counsel may have a conflict of interest in dispensing advice to another firm lawyer about a current client matter, that is irrelevant to the privilege determination: the ethics rules "are not intended to govern or affect judicial application of either the attorney-client or work-product privilege." [746 S.E.2d at 106 (citing Ga. Rules of Profl. Conduct, Preamble, Para. 19).] Thus, as long as all the requisites of the privilege are met, its protections will apply regardless of any conflict that may exist. [Id.]
In RFF, on the other hand, the Court adopted the conflict analysis found in N.Y. State Op. 789 (2005), along with a sharp dose of practicality. [991 N.E.2d at 1073, 1080.] "We prefer a formulation of the attorney-client privilege," the Court stated, "that encourages attorneys faced with the threat of legal action by a client to seek the legal advice of in-house ethics counsel before deciding whether they must withdraw from the representation to one that would encourage attorneys to withdraw or disclose a poorly-understood conflict before seeking such advice." [Id. at 1080.] Applying conflict of interest rules to this situation "yields a dysfunctional result." [Id.]
In Crimson Trace, the Oregon court took the narrowest approach of all. Noting that the attorney-client privilege in Oregon is defined solely by statute — Oregon Evidence Code §503 — the court looked only at whether the "in-house privilege" fell within the basic requirements for the privilege. [326 P.3d at 1183.] The argument opposing the privilege on the ground that there was a conflict was rejected both because, like in St. Simons, it relied on the ethics rules rather than the applicable statute and because the "argument is essentially one of policy" [Id. at 1189] that had no place in interpreting the words of the Evidence Code. [Id. at 1189, 1191.] As a result, the conflict issue is not addressed.
Importantly, all three cases also rejected application of the "fiduciary exception" to the attorney-client privilege. [326 P.3d at 1193; 746 S.E.2d at 108; 991 N.E.2d at 1075.] In St. Simons and Crimson Trace, the "fiduciary exception" was rejected because it was not one of the statutorily-defined exceptions to the attorney-client privilege. [326 P.3d at 1193; 746 S.E.2d at 108.] In RFF, the Court ruled that an "exception to the exception" applied, since the "legal advice [was being] procured 'at the trustee's own expense and for his own protection," given that the "trustee is defending himself against the threat of litigation brought by the beneficiary." [991 N.E.2d at 1075.] At this point, the Court suggested, the interests of the law firm and its client have become sufficiently adverse that the client may no longer claim that he "owns" the privileged communications — even if the law firm has not yet disclosed the advice. [Id.]
Lower courts have increasingly followed this trend. [See, e.g., Moore v. Grau, 2014 N.H. Super. LEXIS 20, at *20–27 (N.H. Super. Ct. 12/15/2014), law firm may assert privilege for internal communications during a representation; Edwards Wildman Palmer v. Superior Court (Mireskandari), 180 Cal. Rptr. 3d 620, 629-32 (11/25/2014), recognizing in-firm privilege for legal discussions with law firms about problems with current client's representation.] Moreover, just weeks after St. Simons and RFF were decided, the ABA House of Delegates passed a resolution urging all "federal, state, tribal, territorial and local legislative, judicial and other governmental bodies" to support applying the attorney-client privilege to protect from disclosure "confidential communications between law firm personnel and their firms' designated in-house counsel made for the purpose of the rendition of professional legal services to the law firm" and to reject any claim that conflict of interest principles or the "fiduciary exception" undermine that claim of privilege. As they say in football and politics, momentum has truly shifted.
In any event, the RFF court set forth a four-part test for application of the law firm in-house privilege that provides excellent guidance for New York attorneys wishing to build a record for invoking that privilege:
1. "[T[he law firm must designate, formally or informally, an attorney or attorneys within the firm to represent the firm as in-house or ethics counsel," so as to create a clear attorney-client relationship between the inquiring lawyer and the law firm;
2. The in-house counsel providing the advice "must not have performed any work on the particular client matter at issue or a substantially related matter;"
3. "[T]he time spent by the attorneys in these communications with in-house counsel may not be billed or charged to any outside client;" and
4. The law firm's internal attorney-client communications "must be made in confidence and kept confidential." [991 N.E.2d at 1080–81.]
Moreover, the RFF court also made clear that the in-house privilege is not absolute. [Id.] While the client is not entitled to the internal law firm communications regarding legal advice, she is entitled to "'full and fair disclosure of facts material to [her] interests.'" [Id. at 1076 (emphasis in original; citation omitted).] The lawyer also remains obligated to "provide the client with appropriate legal advice," even if that advice was informed by an otherwise privileged consultation. [Id.] This too is excellent advice for New York lawyers.
But we must not get ahead of ourselves. The only two New York cases that have addressed this issue — Bank Brussels and Stock — both take a completely opposite view, eschewing any law firm in-house privilege. Analytically, they may even have the stronger position, for several reasons. First, the fiduciary exception, well recognized in New York law as applied to trustees and other fiduciaries, should apply here as well. Lawyers are more than happy to be called fiduciaries when it serves their interests: two obvious examples are restrictive covenants, which the Court of Appeals has declared unenforceable for lawyers because of their fiduciary status [Cohen v. Lord Day & Lord, 550 N.E.2d 410 (1989)], and the unfinished business doctrine, where lawyers' fiduciary relationship with clients was deemed to trump their obligations to their former partners. [In re Thelen, 20 N.E.3d 264, 270 (N.Y. 2014).] Lawyers can't have it both ways, and eschew their fiduciary status only when it is bad for business.
Second, there really is a conflict of interest when a lawyer, while representing a client, seeks legal advice about the client's matter without telling the client. The client is entitled to full disclosure, as in any situation where a conflict waiver is needed — indeed RPC 1.4(b)(a)(i) mandates it. But the in-house privilege encourages secrecy while the firm "lawyers up" and pursues its own strategy.
Nevertheless, all this should mean little in the face of the practical need for lawyers to obtain quick in-house legal advice on client matters to help ensure compliance with their ethical and legal obligations. Law firms should have the same rights as other businesses to obtain the confidential advice they need. We hope this more practical approach ultimately prevails. But any ruling upholding the in-house privilege should emphasize the firm's fiduciary obligation to notify clients as quickly as possible about potential malpractice or malfeasance, or any other situation that may create differing interests between lawyers and their clients. The privilege should be used to assist firm lawyers to comply with their obligations, not to hide the ball indefinitely from clients.
Ronald C. Minkoff is Chairman of the Legal Ethics and Professional Responsibility Group at Frankfurt Kurnit Klein & Selz, P.C. and is Co-Editor of the New York Legal Ethics Reporter. He thanks Tyler Maulsby, an associate at Frankfurt Kurnit, for his assistance in the preparation of this article.
This article originally appeared in the New York Legal Ethics
Reporter, April 2015
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