The Appeals Court issued its decision last Friday in Baker v. Wilmer Cutler Pickering Hale and Dorr, LLP and reinstated (at the pleading stage) claims asserted by minority members of a Massachusetts limited liability company for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, civil conspiracy and violation of General Laws chapter 93A against the LLC’s lawyers.
Representing family-owned and other closely-held businesses can be thorny.
Identifying the client, determining who among the many stakeholders may be within the attorney-client privilege and navigating potential conflicts all require careful consideration. The Appeals Court in Baker just highlighted another tricky issue entity lawyers must wade through: to whom does the attorney owe duties and will their advice and actions potentially violate any duties to non-clients.
It is well settled in Massachusetts that directors and shareholders in closely held companies owe fiduciary duties of utmost good faith and loyalty to their fellow shareholders. The Supreme Judicial Court’s decision earlier this year in Int’l Brotherhood of Electrical Workers Loc. No. 129 Benefit Fund v. Tucci underscored this long history by making clear that while strict fiduciary duty standards may be relaxed in larger public companies, in closely held companies, the fiduciary duty standard remains stringent, and that shareholders ignore this at their own risk.
While the entity lawyer represents the entity, because the entity only acts through people, there are often disputes about who really is the client and whether the lawyer owes duties to any non-clients. The Supreme Judicial Court in Schaeffer v.. Cohen, Rosenthal, Price, Mirkin, Jennings & Berg, P.C., has previously commented that “there is logic in the proposition that, even though counsel for a closely held corporation does not by virtue of that relationship alone have an attorney-client relationship with the individual shareholders, counsel nevertheless owes each shareholder a fiduciary duty.”
The Appeals Court in Baker takes the next step and finds, at least as a matter of pleading a claim, a lawyer or law firm representing a closely held business can have a fiduciary duty to all owners and puts itself at risk when it chooses sides with the majority owners and acts to the detriment of a minority.
In Baker, minority members of a Massachusetts limited liability company (Company) sued the Company’s outside counsel for their alleged involvement in a “freeze out” orchestrated by and on behalf of the majority members.
The minority members alleged the following; the Company was organized in 2000 by W. Robert Allison and Elof Eriksson as a Massachusetts LLC. By the time of the events at issue in the lawsuit, the minority members were Allison and family trusts Allison created and they held a 24.5% combined interest in the LLC; the majority members were Eriksson and his family trusts, which together held 75.5%. The Company’s Operating Agreement (OA) included significant protections for the minority members, including:
- All members participated in management of the Company by pro rata vote equal to the percentage of ownership interest
- The OA could only be amended by unanimous written consent
- The OA could not be amended to alter the percentage interest of any member without consent of each member adversely affected
- Members had a right to review books and records
- No member could be required to make capital contributions or loans beyond the initial contribution
- If any member contributed additional capital, it was to be treated as a loan and did not dilute the other members’ interest
- Each member owed a duty of utmost good faith and loyalty in the conduct of the Company’s affairs
It was against this backdrop and in the context of the Company’s financial shortfall that the majority owner offered to contribute additional funds, but only in exchange for additional equity (not as a loan as the OA provided). When the minority members rejected this, the majority members secretly hired Eriksson’s daughter and her law firm (Gunderson) and later another law firm (WilmerHale) to which one of the Gunderson lawyers moved to represent the Company to help the majority members take control and get rid of the minority members.
The minority owners further alleged that the lawyers knew that the Company was closely held, were familiar with the OA and the minority protections in it and nevertheless went about to devise, present and carry out a plan to circumvent those protections and dilute or eliminate the minority members. The lawyers allegedly worked behind the scenes to help the majority owners form a new Delaware LLC with a new operating agreement that elimination all minority protections, and then to merge the Company with it. By the time the minority owners learned of the lawyers’ involvement and of the merger, the majority already had “unfettered control” of the new entity with the new operating agreement.
The minority members sued the majority owners in one case and separately sued the Company’s lawyers at Gunderson and WilmerHale for breach of fiduciary duty, aiding and abetting breach of fiduciary duty and civil conspiracy, and unfair and deceptive acts in violation of General Laws chapter 93A section 11.
The trial court dismissed the claims against the lawyers on a Rule 12(b)(6) motion and the minority members appealed.
On appeal, the Appeals Court reversed and reinstated the breach of fiduciary duty, aiding and abetting, civil conspiracy and 93A claims against the lawyers and remanded the case for further proceedings.
The Appeals Court ruled:
- Breach of fiduciary duty
Citing Schaeffer, the Appeals Court first observed that “[t]he Supreme Judicial Court has stated that counsel for a close corporation can owe a fiduciary duty to individual shareholders” and noted that the question of whether such a duty exists in a particular case is largely a question of fact.
The Appeals Court concluded that (1) the minority members had alleged enough to “plausibly suggest” that the attorneys, acting as counsel for the LLC governed by the OA which contained significant minority protections, owed the minority members a fiduciary duty; and (2) that by alleging the attorneys secretly worked to eliminate those protections, had also “done enough” to state a claim for breach of fiduciary duty against the attorneys.
The Appeals Court rejected the attorneys’ argument that no duty existed because the minority members had not “reposed trust and confidence” in them. The Court explained that while this is typically a measure used to determine if a fiduciary duty to a non-client exists, there is no one formulation of how such a duty may arise. And further, the Court stated, given the OA’s protections for the minority, those members “should have been able to repose trust and confidence” that the LLC’s counsel would have consulted with them before undoing those protections.
- Aiding and Abetting Breach of Fiduciary Duty & Civil Conspiracy
First noting that the minority members’ claims for aiding and abetting breach of fiduciary duty and civil conspiracy both required knowledge of and substantial assistance with the breach of fiduciary duty or other tortious conduct, the Appeals Court found that the allegations were sufficient to state both claims.
The Court explained that while an attorney cannot be liable merely because a breaching client asserts that it acted on advice of counsel, the minority members’ allegations in Baker that the lawyers knew of the nature of the Company and the protections in the OA and yet devised a plan to allow the majority members to circumvent those protections, knowing this violated the OA and the majority’s fiduciary duty to the minority members, were sufficient to plead aiding and abetting and civil conspiracy.
- Chapter 93A – Unfair and Deceptive Trade Practices
Finally, the Appeals Court rejected the attorneys’ argument that their alleged conduct was not undertaken in “trade or commerce” as required to state a claim under chapter 93A. The Court explained:
- The practice of law generally is considered to be in trade or commerce;
- A client is ordinarily the party who may assert a 93A claim against its lawyer, but the Court concluded that it could not say as a matter of law that the fiduciary duty owed by the attorneys to the minority members in this case was not “sufficiently akin” to an attorney-client relationship for the purposes of satisfying the trade or commerce requirement; and
- While intra-enterprise disputes (governance and other disputes among owners and others inside a closely-held company) are typically considered private grievances outside of 93A’s scope, the attorneys “were not members of the entity…and the fiduciary duty they are alleged to have owed the [minority members] arose from their engagement as counsel to the Company.” In any event, the Court added, it is arguable that the attorneys did not merely inject themselves into a private disputes but “engaged in unfair and deceptive acts or practices in connection with professional services they sold in the marketplace.” This is significant since owner disputes have largely been considered outside of 93A and Baker makes clear that the exception for such disputes is limited.
Of course, the existence of the OA’s minority protections was significant and everything in the case was “colored by” the fact that one of the attorneys was Eriksson’s daughter and the fact that her husband apparently was a beneficiary of the plan as he obtained preferred shares in the new Delaware LLC.
The moral of the story for lawyers representing closely held businesses is nevertheless still significant: Be wary of choosing sides in owner disputes when a lawyer represents an entity.
Oh, and if you (allegedly) secretly help a majority owner freeze out a minority owner you might be on the hook yourself.
Be Careful. Be Wise. Beware.
This article is for informational purposes only and does not constitute legal advice and should not be relied upon for any purpose. Legal Disclaimer