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Journal of the Institute for the Study of Legal Ethics

Publication Date

10-1-1996

Introduction

The last two decades have witnessed an increasing number of mergers, spin-offs, purchases and sales of corporations and parts of corporations. All this activity has resulted in corporate families with everchanging members. The corporate subsidiary of one corporation on any given day may be a member of a different corporate family on the next day. To this complex mixture we must add another ingredient: law firms themselves are increasing subject to mergers. The newly created firm may find that it is now representing a corporate client in one matter that is adverse to the interests of another corporation, and, while that other corporation is not a client, it is the parent, or subsidiary, or sister corporation of a client.

Under the law of corporations, each of the incorporeal beings of a corporate family are typically treated as separate entities - unless the corporate veil is pierced. However, under the law of ethics and attorney conflict of interests, courts are often assuming that piercing the corporate veil is the rule and not the exception. Attorneys have increasingly found themselves charged with unintended conflicts of interest when the law firm represents a client that becomes a member of a different corporate family.

Should separate corporations that are affiliated with each other be treated the same when a court is deciding whether to disqualify a law firm? Or should courts treat the corporate veil as something that is not easily pierced?

Consider, first, a simple case. Assume that a lawyer (let us call her "Lawyer") represents a client called Corporation Alpha. This Lawyer has never represented another corporation, called Corporation Beta. May Lawyer represent Corporation Alpha, in the case of Alpha v. Defendant, while simultaneously representing another client suing Corporation Beta in a completely unrelated case, the case of Plaintiff v. Beta? Given these facts, the normal rules of ethics would find no conflict. The answer is, in fact, obvious. The Lawyer would be violating no ethics rules, would not be subject to discipline, and the judge in either the Alpha case or the Beta case would find no reason to disqualify the lawyer.

Now, we shall add one more fact: Corporation Beta is the parent, or subsidiary of Corporation Alpha. Or, Beta and Alpha are sister corporations - that is, they are separate corporate entities each owned by a third corporation. The question, more precisely restated, is whether a lawyer may represent a corporation in one matter while undertaking representation adverse to an affiliate of that corporation in a different, unrelated matter. The cases or representations still have no relation to each other; that is, there is no confidential information that the Law Firm learned from Corporation Alpha that would be relevant in representing Plaintiff in the case of Plaintiff v. Beta. The Law Firm does not acquire, by its representation of Corporation Alpha, any improper advantage in representing Plaintiff against Corporation Beta. If, in fact, Corporation Alpha were not affiliated with Corporation Beta, there would be no conflict of interest.

All of these references to Greek letters may remind lawyers too much of high school Algebra, so permit me to substitute a more concrete example. Assume that a law firm does some title work for Taco Bell, as it opens a few more restaurants. The same firm also decides to represent plaintiff, who is suing Kentucky Fried Chicken, because a KFC delivery truck ran into the plaintiff's car. Taco Bell and KFC are each separate corporations, so normally, there would be no ethical question involved. However, both are owned by Pepsico. Does that fact create a per se conflict of interests for the lawyer? Should large parent corporations that create separately-incorporated subsidiaries be able to treat themselves as separate corporations when it suits their purposes while still being able to treat themselves as a single entity for strategic purposes, that is, for purposes of disqualifying opposing counsel?

We should assume that the law firm, while representing Taco Bell, acquired no confidential information that would be at all relevant in the tort action involving the KFC truck. Given the facts of this case, that assumption is certainly a reasonable one to make. Let us also assume that Taco Bell, KFC, and Pepsico are run as separate corporations, and that it cannot be said that one corporation is the alter ego of any of the others.

KFC and Taco Bell both are wholly owned subsidiaries of Pepsico. To some commentators, it is of great moment whether the subsidiaries are wholly owned or only partially owned. To these people, it appears that there would be a per se conflict of interest if the parent wholly owns the two subsidiaries but no such conflict if the parent owned 99 and 44 one-hundredth percent of the two subsidiaries. I find such a distinction unusually formalistic, reminiscent of nineteenth century jurisprudence to conclude that the existence of a per se conflict automatically disappears if the parent owns some small fraction less than 100% of the subsidiary. I will argue that there is no per se conflict even if two subsidiaries are wholly owned by a third corporation. But, in those specific cases where courts should find a conflict, if, in short, there is a conflict, it does not disappear simply because the parent has sold a small fraction of one of its subsidiaries to a third party.

Perhaps someone might think that the law firm representing a plaintiff against KFC might pull its punches in that lawsuit (in the hope of currying favor with Pepsico and thereby secure more business), so we should also assume that the law firm tells the tort plaintiff of its relation- ship with Taco Bell and also advises the tort plaintiff that it believes that it will vigorously sue KFC notwithstanding the fact that KFC is a sister corporation of Taco Bell. The tort plaintiff, after learning these facts, consents to his continued representation by the law firm. In other words, he decides to stay with the law firm, does not hire another lawyer, authorizes the law suit, and waives any right that he may have to object to any alleged conflict involving his lawyer. But what about KFC? Must the law firm also secure consent from KFC, its adversary in the litigation? Does KFC have the right to object to plaintiff hiring a law firm that does work for Taco Bell, if both Taco Bell and KFC are owned by Pepsico? Does Pepsico also have a right to insist on the disqualification of the law firm?

My hypothetical case is just that: hypothetical. I have in mind no specific case involving Pepsico. But the fact pattern I have described is hardly hypothetical. It happens every day, has spawned a great deal of conflicts of interest litigation, and sometimes results in the disqualification of the law firm.

Consider Stratagem Development Corp. v. Heron International N. V., a federal court decision that answered the question that I have posed. Stratagem found a per se conflict. It ruled that, under New York law, a lawyer cannot sue its present client, and therefore cannot sue a subsidiary or affiliate of its present client. The court broadly announced that the duty with regard to suing a present client "applies with equal force where the client is a subsidiary of the entity to be sued."

In Stratagem, the law firm represented the plaintiff, who claimed an alleged breach of a joint venture agreement to develop certain properties. During this same period the law firm also represented a wholly-owned subsidiary of the defendant ("FSC") involving an unrelated lawsuit. The court found that FSC was a present client of the law firm when it was investigating and drafting the complaint against FSC's parent company. Therefore, the court disqualified the law firm by using a test that was sweepingly broad in its implication: a lawyer cannot take a case adverse to the interests of a corporation affiliated with a law firm's client because the "liabilities of a subsidiary corporation affect the bottom line of the corporate parent." Nor can the law firm avoid the problem by dropping the disfavored client: the law firm "may not undertake to represent two potentially adverse clients and then, when the potential conflict becomes actuality, pick and chose between them."

At first glance, the fact situation posed in Stratagem may appear to be unusually narrow, arcane, or esoteric. Indeed, one must understand several other important rules of ethics before even approaching the Stratagem issue. Yet the practical consequences of the Stratagem rule are far from obscure. Nor is Stratagem alone in the case law. A significant number of cases appear to adopt the principle that a law firm may not represent a party adverse to a corporate affiliate of a client, without consent of all parties, even though the matters are completely unrelated, even though one of the parties is the adverse party in litigation (who is therefore unlikely to give consent), and even though the court may also require consent by the corporate parent, which is not even a party to the litigation.

The Stratagem test - whether the "liabilities of a subsidiary corporation affect the bottom line of the corporate parent" - has enormous implications. A law firm could have trouble suing a corporation (such as General Motors) if any one of the law firm's clients owned any stock in General Motors, because the liabilities (and even the potential liabilities) of General Motors "affect the bottom line" of GM.

If a law firm represents clients who used electricity or water (i.e. any client), then it could not also represent an electrical or water utility in the same geographic area urging a rate increase, because an increase in electrical or water rates will adversely "affect the bottom line" of the other clients. Indeed, Stratagem argued that if a law firm represented a trade association, it could not represent any other client in an unrelated law suit brought against any member of the trade association. Should it be the law that if a law firm represents the American Bar Association, it can never represent a client injured in a car driven by a member of the ABA? And if that is the rule, what interests does it protect, and what do those interests have to do with ethics?

In order to analyze the Sister Corporation issue, we must first lay some preliminary groundwork and briefly look at the basic ethical rules that are not in dispute. Then, with this foundation in place, we will apply those rules to analyze an issue that it very much in dispute as we take a closer look at the question involved in the Stratagem decision and others like it.

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