Closely held business disputes frequently trigger complex ethical traps for legal counsel. Conflict issues routinely arise during derivative actions when minority owners allege misconduct against majority controllers. Understanding how to handle dual representation can protect both the clients and the lawyer.
The Pitfalls of Dual Representation in Derivative Actions
A derivative lawsuit creates an inherent conflict of interest for legal representation. In a typical scenario, a minority stakeholder sues the majority controllers for self-dealing or breach of fiduciary duty. Because the minority stakeholder brings the claim on behalf of the entity itself, the business essentially sues the majority owners. When a single law firm attempts to represent both the majority controllers and the entity as co-defendants, ethical issues immediately emerge.
Applying Rule of Professional Conduct 1.7
Washington Rule of Professional Conduct (RPC) 1.7 directly governs these concurrent conflicts. Under RPC 1.7(a), a concurrent conflict exists if representing one client directly opposes another or materially limits your duties. Because the company’s financial recovery aligns against the majority owners, an attorney cannot easily serve both interests simultaneously. Furthermore, obtaining valid informed consent from both the company and the majority controllers under RPC 1.7(b) remains legally questionable in a derivative context.
The Uncertainty of Washington Case Law
Washington courts offer limited guidance on the validity of dual representation in derivative suits. The leading state case, Hicks v. Edwards, addressed Rule 11 sanctions rather than ruling on the legality of joint representation. It contains many references to legal commentators and other jurisdictions regarding the legality of joint representation in a derivative action, but it never addresses the issue head-on.
As a result, Washington practitioners can look to outside jurisdictions for guidance on this issue. For example, in past Washington cases, courts looked to both New York and Delaware for guidance on issues relating to derivative litigation. Here, those two jurisdictions appear to conflict. While New York generally prohibits dual representation in derivative matters, Delaware evaluates these situations using a flexible, case-by-case framework.
Why Separate Counsel Remains the Best Practice
There is not a clear-cut answer in Washington as to whether a firm can jointly represent a company and its controllers in a derivative action. Avoiding dual representation entirely serves as the safest strategy for all parties involved. Retaining independent counsel for the business entity eliminates disqualification risks and helps present impartiality to the court. Moreover, it avoids a scenario where clients pay for motions practice to address potential conflicts. Engaging separate counsel for both the company and its controllers from the outset saves resources and allows everyone to focus on resolving the underlying dispute on its merits.
The lawyers at Beresford Booth have extensive experience in dealing with all types of business matters and disputes. Contact us at info@beresfordlaw.com or (425) 776-4100 to see how we can help.