Ethics Opinion 216

Representation of Closely Held Corporation in Action Against Corporate Shareholder

Applicable Rule

• Rule 1.13(a) (Organization as Client.)

A and B were each 50% shareholders of C, a close corporation organized under Maryland law which did business in the District of Columbia.

C had a banking relationship with U, which also extended personal loans to A and B, individually. A and B have defaulted on their loan payments to U. C has filed an action in the District of Columbia against U, alleging a wrongful termination of the banking relationship.

Following the filing of C's action against U, U obtained a judgment against A and, as the result of a Sheriff's execution sale, U became the owner of A's 50% interest in C. A, however, maintains that he is still President of C, since C's two shareholders, B and U are deadlocked and a majority vote is needed to remove him. U has filed an action in the Maryland courts to dissolve C because of shareholder deadlock. This action is still pending.

B's widow, who has succeeded to B's interest in C, wishes to maintain C's action against U. U, of course, wishes to discontinue the action. The question in this Inquiry is whether C's corporate lawyer, retained when C was controlled by A and B, may continue to represent C in its action against U, now one of its 50% shareholders, and in U's action to dissolve C.

Discussion
The Inquiry is governed by Rule 1.13 of the District of Columbia Rules of Professional Conduct. Under Rule 1.13(a), "[a] lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents." This rule embodies the well-established principle that a lawyer retained by a corporation, or by any other organization recognized as a separate legal entity, represents the entity. As stated in EC 5-18 of the former Code of Professional Responsibility, "[a] lawyer employed or retained by a corporation or similar entity owes his allegiance to the entity and not to a shareholder, director, officer, employee, representative, or other person connected with the entity." See Opinion 159 (1985); Opinion 186 (1987); Egan v. McNamara, 467 A.2d 733, 738 (D.C. Ct. of App. 1983).

The principle that a lawyer representing a corporation represents the entity and not its individual shareholders or other constituents applies even when the shareholders come into conflict with the entity. Courts have generally held, therefore, that a corporation's lawyer is not disqualified from representing the corporation in litigation against its constituents. See, e.g., Bobbitt v. Victorian House, Inc., 545F. Supp. 1124 (N.D. Ill. 1982); Dalrymple v. National Bank and Trust Co. of Traverse City, 615 F. Supp. 979 (W.D. Mich. 1985); U.S. Industries, Inc. v. Goldman, 421 F. Supp. 7 (S.D.N.Y. 1976); Wayland v. Shore Lobster & Shrimp Corp., 537 F. Supp. 1220 (S.D.N.Y. 1982). A different result may sometimes be required where the shareholders of a closely held corporation reasonably might have believed they had a personal lawyer-client relationship with the corporation's lawyer. See, e.g., Rosman v. Shapiro, 653 F. Supp. 1441 (S.D.N.Y. 1987); In re Brownstein, 288 Or. 83, 602 P.2d 655 (1979); In re Banks, 283 Or. 459, 584 P.2d 284 (1978). This is not such a case, however, since under the circumstances U, the bank, could not reasonably believe it has or had a personal lawyer-client relationship with C's lawyer.

Since C's lawyer is not disqualified from continuing to represent C in its litigation with one of its 50% shareholders, the question arises how the lawyer is to carry out his ethical duties in this representation. On the one hand, the corporate lawyer owes a duty of loyalty to the corporation, as distinct from its owners and managers, and he or she must act in the best interests of the corporation as an entity.

On the other hand, the lawyer must normally follow the direction of those duly appointed or elected to act on behalf of the corporation. See, e.g., Financial General Bankshares, Inc. v. Metzger, 523 F. Supp. 744, 764 ( D. D.C. 1981), vacated for lack of jurisdiction, 680 F.2d 768 (D.C. Cir. 1982) (". . . both practically and theoretically, the corporate attorney should consider himself as representing the entity interests articulated by those in current control of the management"); ABA Informal Opinion 1056 (1968); Comment, Conflicts of Law in the Legal Profession, 94 Harv. L. Rev. 1244, 1336 (1981). Rule 1.13 expressly recognizes that a lawyer represents an organization such as a corporation "through its duly authorized constituents." Comment [4] further states that "[w]hen constituents of the organization make decisions for it, the decisions ordinarily must be accepted by the lawyer even if their utility or prudence is doubtful."

The difficulty here is that the corporation's President, A, may continue to hold office only because of the shareholder deadlock; moreover, because of his own dispute with U, A may have reason to disregard the corporation's interest in determining the corporation's course of action in its dispute with U. These difficulties notwithstanding, the corporation's lawyer may continue to take direction from A until the dispute over control of the corporation is resolved by the courts or the parties. If, however, the lawyer should become convinced that A's decisions are clearly in violation of A's own fiduciary duties to the corporation, the lawyer may be forced to seek guidance from the courts as to who is in control of the corporation, there being no higher authority within the corporation to whom the lawyer can turn. Throughout the representation, the lawyer must continue to recognize that the interests of the corporation must be paramount and that he must take care to remain neutral with respect to the disputes between the present shareholders, B and U, and between A and U. See ABA Opinion 86 (1932) ("In acting as the corporation's legal adviser [an attorney] must refrain from taking part in any controversies or factual differences which may exist among stockholders as to its control"), quoted with approval in Financial General Bankshares, Inc. v. Metzger, 523 F. Supp. at 765.

Inquiry 90-1040 
January 15, 1991