Opinion
No. HHD-CV-09-4045755-S
May 18, 2010
MEMORANDUM OF DECISION ON PLAINTIFFS' MOTION TO DISQUALIFY (#109)
In this shareholder derivative action, the motion to disqualify currently before the court raises the important question of whether a law firm that simultaneously represented a corporation and certain of its officers and board of directors, while investigating a shareholders' demand on the board of directors and advising the board to reject the demand, may subsequently represent all of those clients in the resulting derivative action where allegations of fraud and self-dealing are leveled against the individual officers and directors.
The plaintiffs, Jugal Taneja, [REDACTED], Mandeep Taneja, William LaGamba, Michele LaGamba, Anthony LaGamba, Courtney Lagamba, Nicholl Lagamba and Steven Waters, commenced this derivative action on July 27, 2009, against the defendants Familymeds Group, Inc. ("Familymeds"), Drugmax, Inc. ("Drugmax"), Philip Gerbino, Peter Grua, Mark Majeske, Edgardo Mercadante, James Searson, Allison Kiene and Laura Witt. Presently, before the court is the plaintiffs' motion to disqualify the defendants' counsel, Robinson Cole, LLP ("Robinson Cole"). Because the plaintiff's have demonstrated that a disqualifying conflict exists regarding Robinson Cole's representation of the defendants, the court grants their motion to disqualify.
FACTS
The plaintiffs' July 23, 2009 complaint alleges the following facts, which are supplemented by facts submitted by the defendants through affidavits and attached exhibits. The defendants Familymeds and Drugmax are corporations organized under Nevada law with their principal place of business in Farmington, Connecticut. (Complaint, ¶¶ 1-2.) These corporations merged in December 2004. (Complaint, ¶ 19.) After the merger, Drugmax was the surviving business entity. (Complaint, ¶ 20.) In October 2006, following a stock reversal, the surviving entity became known as Familymeds. (Complaint, ¶ 26.) For the sake of simplicity, Drugmax and Familymeds will be referred to as the "corporation."
The plaintiffs, Jugal Taneja, [REDACTED], Mandeep Taneja, William LaGamba, Michele LaGamba, Anthony LaGamba, Courtney Lagamba, Nicholl Lagamba and Steven Waters, were shareholders of the corporation. (Complaint, ¶¶ 11-13.) Additionally, Jugal Taneja was and still is a member of the corporation's board of directors. (Complaint, ¶ 11.)
The defendants Philip Gerbino, Peter Grua, Mark Majeske, James Searson, Laura Witt, and Allison Kiene were members of the board of directors. (Complaint, ¶¶ 3-8, 23.) The defendant Edgardo Mercadante was the chairman of the board of directors and the president and chief executive officer of the corporation. (Complaint, ¶ 6.) In addition to being a director, the defendant James Searson was the corporation's chief operating officer, chief financial officer and treasurer. (Complaint, ¶ 7.) The defendant Allison Kiene was a director and the corporation's senior vice president, secretary and general counsel. (Complaint, ¶¶ 9, 23.)
The plaintiffs brought a prior derivative action in Superior Court against the same defendants on the same grounds on May 1, 2008. (Complaint, ¶ 16.) On January 16, 2009, the court, Domnarski, J., dismissed that complaint for lack of subject matter jurisdiction because the plaintiffs had failed to make a formal demand upon the defendant corporation's board of directors. (Complaint, ¶ 16.) Robinson Cole represented the defendants in that action. (Complaint, ¶ 38.)
The allegations of the present complaint relate to acts and omissions that began in April 2005, and continued until the corporation's dissolution on or about July 31, 2007. (Complaint, ¶ 17.) The complaint alleges that, at the time of the December 2004 merger, Mercadante and Jugal Taneja were co-chairs of the surviving entity. (Complaint, ¶ 22.) Shortly thereafter, Mercadante assumed the roles of president, chief executive officer and chairman of the corporation. (Complaint, ¶ 22.) Through an executive committee that he controlled, Mercadante attempted but failed to remove Jugal Taneja as co-chairman. (Complaint, ¶ 22.)
Mercadante picked a board of directors, composed of the individual defendants, that would "rubber stamp" his proposals. (Complaint, ¶ 23.) As the majority of the board, the defendants took actions that caused irreparable harm to the corporation, including discontinuing the corporation's wholesale pharmaceutical business, retaining unnecessary and expensive consultants, and putting individuals whose interests conflicted with the corporation's on the board of directors. (Complaint, ¶ 24.) The defendants also "wasted over 80 million dollars in corporate assets" through excesses such as leasing "overly extravagant office facilities," engaging in unnecessary and "lavish" business travel and awarding themselves "unjustified increases and salary and bonuses." (Complaint, ¶ 25.)
On or about January 20, 2007, another company, Geo Pharma, offered to purchase fifty-one percent of the corporation's stock at four dollars per share, which was an "excellent price at that point in time," and to invest significant sums in the corporation to stem the decline of its share price and ensure its continued viability. (Complaint, ¶ 27.) The defendants would not accept the offer unless Geo Pharma promised to "maintain its employment relationship" with each of them. (Complaint, ¶ 27.) Ultimately, they voted to refuse the offer. (Complaint, ¶ 27.)
On or about February 10, 2007, the plaintiff Jugal Taneja offered to purchase all of the corporation's stock at two dollars and twenty-five cents per share. (Complaint, ¶ 28.) The defendants refused the offer, and the stock price continued to decline. (Complaint, ¶ 28.) By July 2007, the stock price was sixty cents per share, which reflected a ninety percent decrease from late 2004. (Complaint, ¶ 30.)
In early 2007, the defendants decided to dissolve the corporation and award themselves "unjustifiably extravagant severance packages." (Complaint, ¶ 29.)
In June 2007, the defendant James Searson resigned from the board of directors and became the corporation's chief financial officer. (Complaint, ¶ 31.) Then, Searson and Mercadante, with board approval, caused the corporation to sell its remaining assets to them at a fraction of the fair market value. (Complaint, ¶ 31.) To purchase the corporation's assets, the defendants caused the corporation to give them an unsecured loan of $600,000. (Complaint, ¶ 31.)
The complaint alleges that defendants purposefully refused the prior buyout offers from Geo Pharma and Taneja "in anticipation that the assets of [the corporation] would continue to decline in value due to their own misconduct." (Complaint, ¶ 32.) Once the stock price had dropped, the defendants were able to "take advantage of their own misconduct" by buying the corporation's assets at a fraction of their former value. (Complaint, ¶ 32.)
The plaintiffs served a demand on the defendants on March 25, 2009, and Robinson Cole investigated the demand's allegations. (Complaint, ¶¶ 37, 39.) On July 15, 2009, the board of directors conducted a special meeting by telephone conference. (Complaint, ¶ 38.) The only directors in attendance were Mercadante, Searson, Gerbino, Majeske and Taneja. (Complaint, ¶ 38.) Attorneys Bradford Babbitt and Elizabeth Leong of Robinson Cole, simultaneously serving as counsel for the corporation and certain of the board of directors, also joined this call. (Complaint, ¶ 38.)
The key facts concerning Robinson Cole's participation are not materially in dispute. Attorneys Babbitt and Leong had represented the corporation and the individual defendants in the prior derivative suit that was dismissed in January 2009. (Complaint, ¶ 38.) On May 12, 2008, James Searson, in his role as chief financial officer, signed an engagement letter on behalf of the corporation. In that letter, Robinson Cole obtained a conflict waiver from the corporation. In particular, paragraph 8 of the engagement letter provides in relevant part that Robinson Cole "will be representing the Company and each of the Directors in this matter. At present, the interests of all of the Directors appear to be aligned with each other and with those of the Company. There exists the possibility, however, that conflicts of interest could arise between and among one or more of the Directors and/or the Company. You acknowledge and agree that Robinson Cole LLP may represent all parties to this action but that my firm may withdraw from its representation of all parties if an actual conflict arises in the future that any party does not waive . . ."
The defendants submitted Familymeds' engagement letter with Robinson Cole at the court's request on March 16, 2010.
The other defendants, acting in their individual capacities, signed engagement letters with similar waiver language. The defendants have attached these letters to affidavits that are marked exhibits 15 through 21 to their memorandum of law in objection to the motion to disqualify counsel.
During the July 15, 2009 meeting, Attorney Babbitt summarized the results of his law firm's investigation of the plaintiffs' demand. (Complaint, ¶ 39.) Babbitt stated that he interviewed Searson, Mercadante and Kiene. (Complaint, ¶ 39.) The other defendants and the plaintiffs were not interviewed in the course of the investigation. (Complaint, ¶ 46.) In addition to these three interviews, Babbitt later testified in an affidavit dated February 19, 2010, that Robinson Cole reviewed 14,000 pages of documents related to the demand and composed a twenty-page report that cited to 3,400 pages of original source material. (Def.'s Mem. Law. Obj. Mot. Disqualify Counsel, Exh. 23, ¶¶ 14, 18.) In this report, Robinson Cole concluded that the shareholders' allegations lacked merit. (Complaint, ¶ 39.)
Babbitt advised the board of directors that only Gerbino and Majerske could vote on whether to pursue the derivative action because Taneja was a plaintiff in that action. (Complaint, ¶ 39.) Taneja objected, but the board voted to approve that voting procedure. (Complaint, ¶ 39.) Mercadante and Searson were also directed by Attorney Babbitt to recuse themselves because they were "specifically identified" as committing misconduct in the demand letter. (Internal quotation marks omitted.) (Complaint, ¶ 41.) Subsequently, Gerbino moved to accept Robinson Cole's report and refuse the demand, and Majeske seconded the motion. (Complaint, ¶ 39.)
Presently before the court is the question of whether Robinson Cole may continue to represent both the corporation and the defendant officers and directors in this derivative action. For the following reasons, the court holds that the firm cannot continue its dual representation in the course of this litigation and, in fact, must be disqualified from representing any of the parties in this action.
DISCUSSION
At the outset, a brief discussion of the nature of a shareholder derivative suit is necessary. "The derivative suit is an action brought on behalf of a corporation by some percentage of its shareholders . . . The corporation is in an anomalous position of being both a defendant and a plaintiff in the same action. This unusual posture for the corporation is the result of the historical evolution of the derivative suit. At common law, there was no action in law permitting a shareholder to call corporate managers to account . . . In equity, there were two actions that evolved into a single derivative action: in one action the corporation was named as a defendant in order to compel it to take action against its controlling officers; in the second, the shareholder maintained an action against the officers and directors of the corporation, on behalf of the corporation. The dual actions were cumbersome and evolved into the present day unitary derivative action.
"The shareholder is often only a nominal plaintiff in a derivative action. The purpose of the derivative action is to compel assertion of a corporate right of action against a corporation's directors or officers when the corporation, usually under the control of the defendant officers and directors, refuses to sue on its own behalf . . .
"In a derivative suit, the role of counsel for the corporation who is also counsel for the defendant directors can, under certain circumstances, be hampered by a conflict of interest. Because the determination of whether joint representation of a corporation and its directors creates a conflict requiring separate counsel inevitably turns on the facts of a particular case, that determination is left to the discretion of the trial court. The propriety of dual representation in a derivative action must be determined in light of the particular facts attending each such case." (Citations omitted; internal quotation marks omitted.) Rosenfield v. Metals Selling Corp., 229 Conn. 771, 790-92, 643 A.2d 1253 (1994).
The parties agree that the substantive law of Nevada and the procedural law of Connecticut governs this action. In particular, Connecticut's Rules of Professional Conduct 1.7 and 1.13 and their commentary apply to the question of whether dual representation is permissible under these circumstances.
"The commentary accompanying each Rule explains and illustrates the meaning and purpose of the Rule . . . The Commentaries are intended as guides to interpretation, but the text of each Rule is authoritative. Commentaries do not add obligations to the Rules but provide guidance for practicing in compliance with the Rules . . ." Rules of Professional Conduct, Scope, pp. 3-4.
Rules of Professional Conduct 1.13 provides in relevant part: "(a) A lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents . . . (g) A lawyer representing an organization may also represent any of its directors, officers, members, shareholders or other constituents, subject to the provisions of Rule 1.7. If the organization's consent to the dual representation is required by Rule 1.7, the consent shall be given by an appropriate official of the organization other than the individual who is to be represented, or by the shareholders."
The commentary to rule 1.13 of the Rules of Professional Conduct addresses when dual representation is permissible in a derivative action: "Under generally prevailing law, the shareholders or members of a corporation may bring suit to compel the directors to perform their legal obligations in the supervision of the organization . . . Such an action may be brought nominally by the organization, but usually is, in fact, a legal controversy over management of the organization. The question can arise whether counsel for the organization may defend such an action. The proposition that the organization is the lawyer's client does not alone resolve the issue. Most derivative actions are a normal incident of an organization's affairs, to be defended by the organization's lawyer like any other suit. However, if the claim involves serious charges of wrongdoing by those in control of the organization, a conflict may arise between the lawyer's duty to the organization and the lawyer's relationship with the board. In those circumstances, Rule 1.7 governs who should represent the directors and the organization." (Emphasis added.)
Rules of Professional Conduct 1.7 provides: "(a) Except as provided in subsection (b), a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict of interest exists if: (1) the representation of one client will be directly adverse to another client; or (2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer. (b) Notwithstanding the existence of a concurrent conflict of interest under subsection (a), a lawyer may represent a client if: (1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client; (2) the representation is not prohibited by law; (3) the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or the same proceeding before any tribunal; and (4) each affected client gives informed consent, confirmed in writing."
The defendants argue that the plaintiffs do not have standing to challenge their choice of counsel. Courts have taken competing views regarding whether litigants may challenge their opposing party's choice of counsel; compare, e.g., People's Bank v. 418 Meadow Street Associates, LLC, Superior Court, judicial district of Fairfield, Docket No. CV 07 5007172 (December 7, 2007, Maiocco, J.T.R.), with Kocsis v. Gerencser, Superior Court, judicial district of New Haven, Docket No. CV 95 0375378S (January 3, 1997, Corradino, J.); but under the present circumstances, the plaintiffs may offer such a challenge. Connecticut's commentary to rule 1.7 of the Rules of Professional Conduct, after all, provides that "[w]here the conflict is such as clearly to call in question the fair or efficient administration of justice, opposing counsel may properly raise the question [of conflict of interest]. Such an objection should be viewed with caution, however, for it can be misused as a technique of harassment." In this case, the plaintiffs' motion to disqualify is not a "technique of harassment" instead, it has alerted the court to the unfairness of permitting counsel that represented the defendants, investigated the plaintiffs' demand, and advised the board to reject it, to now defend the corporation and its interested directors and officers despite allegations of their malfeasance.
The defendants next argue that no actual conflict of interest exists between the corporation and the individual defendants because the corporation is being dissolved. They argue that the derivative action cannot benefit the corporation because the suit will deplete its remaining assets: the corporation is not insured for the derivative claims and, therefore, it would have to "pay itself any possible recovery that [the] [p]laintiffs may obtain against the individual defendants." (Def.'s Mem. Law. Obj. Mot. Disqualify Counsel, p. 35.) This argument is factually and legally unavailing. "After dissolution, a corporation no longer enjoys the right to carry on its normal operations. Its business is limited to those transactions necessary for the winding up of its affairs. Under Nevada law, those transactions include disposing of and conveying its property, collecting and discharging its obligations, distributing its assets, and 'prosecuting and defending suits, actions, proceedings, and claims of any kind or character by or against it . . .' Nev. Rev. Stat. § 78.585." Clipper Air Cargo, Inc. v. Aviation Products International, Inc., 981 F.Sup. 956, 958 (D.S.C. 1997). Among these remedies is the corporation's right to pursue an action against individual officers and directors accused of fraud. Ultimately, if the corporation recovers against these individuals, shareholders will enjoy a greater distribution upon dissolution.
Having addressed these initial arguments, the court now turns to the key issue of whether Robinson Cole may continue to represent both the corporation and the individual defendants in this derivative action after previously representing them, investigating the claims of wrongdoing, and finally advising the board to reject the plaintiffs' demand. "Succintly put, the question is this: Can an attorney render truly impartial advice to the corporate client where the interests of his individual clients will inevitably be affected by the character of the corporation's response to the [derivative] suit?" (Internal quotation marks omitted.) Stepak v. Addison, 20 F.3d 398, 404 (11th Cir. 1994).
In the present case, the court holds that such simultaneous representation creates an irreconcilable conflict because the individual defendants are accused of serious wrongdoing. After all, "if the derivative suit is meritorious, the interests of the corporate entity and the interests of the insider defendants are likely to be directly adverse." Stepak v. Addison, supra, 20 F.3d 404.
"[A]s a general matter, the case law is not uniform on the issue of joint representation of the corporation and individual defendants." Bell Atlantic Corp. v. Bolger, 2 F.3d 1304, 1316 (3rd Cir. 1993). In the past, courts permitted dual representation. See Selama-Dindings Plantations v. Durham, 216 F.Sup. 104 (1963), affd. sub nom. Selama-Dindings Plantations v. Cincinnati Union Stock Yard Co., 337 F.2d 949 (1964); Hausman v. Buckley, 299 F.2d 696, cert. denied, 369 U.S. 885, 82 S.Ct. 1157, 8 L.Ed.2d 286 (1962); Otis Co. v. Pennsylvania Railroad Co., 57 F.Sup. 680 (1944). More recent case law holds, however, that dual representation is improper under these circumstances. Forrest v. Baeza, 58 Cal.App. 4th 65, 74, 67 Cal. Rptr.2d 857 (1997); Musheno v. Gensemer, 897 F.Sup. 833, 837 (M.D. Pa. 1995); In re Oracle Securities Litigation, 829 F.Sup. 1176, 1188-89 (N.D. Cal. 1993); Schwartz v. Guterman, 109 Misc.2d 1004, 1007, 441 N.Y.S.2d 597 (N.Y. Sup.Ct. 1981), aff'd, 86 App. Div.2d 804, 448 N.Y.S.2d 650 (1982).
Because Connecticut law governs this question, the court begins with the applicable Rule of Professional Conduct and its commentary. Connecticut's Rules of Professional Conduct 1.13 provides in relevant part: "(a) A lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents . . . (g) A lawyer representing an organization may also represent any of its directors, officers, members, shareholders or other constituents, subject to the provisions of Rule 1.7. If the organization's consent to the dual representation is required by Rule 1.7, the consent shall be given by an appropriate official of the organization other than the individual who is to be represented, or by the shareholders." The commentary to rule 1.13 provides in relevant part that "if the claim involves serious charges of wrongdoing by those in control of the organization, a conflict may arise between the lawyer's duty to the organization and the lawyer's relationship with the board."
Rule 1.13 and its commentary therefore support the modern trend concerning dual representation in a derivative suit. Indeed, "[i]n the specific context of shareholder derivative actions, courts have consistently recognized that the law clearly forbids dual representation of a corporation and directors in a shareholder derivative suit, at least where, as here, the directors are alleged to have committed fraud . . . In each of these cases, the courts recognized the difficulties created by dual representation in a shareholder derivative suit, including the inability to ensure an attorney's duty of loyalty to his client, preventing conflicts of interest which could prejudice a client, and maintaining client confidentiality. In general, the courts emphasized that to permit such dual representation would unfairly prejudice the shareholder bringing the derivative action on behalf of the corporation." (Citations omitted; internal quotation marks omitted.) Natomas Gardens Investment Group, LLC v. Sinadinos, NO. CIV. S-08-2308 FCD/KJM (E.D. Cal. 9-14-2009), citing Forrest v. Baeza, 58 Cal.App. 4th 65, 74, 67 Cal. Rptr.2d 857 (1997).
In disfavoring dual representation in the context of derivative suits, courts are primarily concerned with an attorney's ability to balance his or her duty of loyalty to each client and avoid the potential for conflicts of interest among clients. "Loyalty and independent judgment are essential elements in the lawyer's relationship to a client." Commentary, Rules of Professional Conduct 1.7. "Our Supreme Court has explained that a conflict of interest is that which impedes [counsel's] paramount duty of loyalty to his client [such that] an attorney may be considered to be laboring under an impaired duty of loyalty, and thereby be subject to conflicting interests, because of interests or factors personal to him that are inconsistent, diverse or otherwise discordant with [the interests] of his client . . . Moreover, counsel's loyalty is impaired when . . . [he] cannot consider, recommend or carry out an appropriate course of action for the client because of . . . [his] other responsibilities or interests . . . While the right to conflict-free representation typically is implicated in cases involving representation of criminal codefendants by a single attorney . . . it is equally applicable in other cases where a conflict of interest may impair an attorney's ability to represent his client effectively . . . Thus, [t]he key here should be the presence of a specific concern that would divide counsel's loyalties." (Citations omitted; internal quotation marks omitted.) State v. Thompson, 118 Conn.App. 140, 148, 983 A.2d 20 (2009), cert. denied, 294 Conn. 932, 986 A.2d 1057 (2010).
One such concern is that an attorney's duty of loyalty to a corporate client may be compromised if the attorney has a "lingering alliance" to that corporation's interested officers and directors. Stepak v. Addison, supra, 20 F.3d 405. Stepak v. Addison was an appeal from a district court's granting of a corporation's motion to dismiss a derivative suit. Id. In that case, the United States Court of Appeals for the Eleventh Circuit held that a board of director's refusal of a shareholder's demand was wrongful where the shareholder had alleged in his complaint that the board's consideration of his demand was dominated by a law firm that had previously represented individual directors and officers in criminal proceedings relating to the subject matter of the demand. Id., 407.
The Stepak court explained that these competing loyalties will impact a law firm's ability to decide whether to pursue potential claims against these individuals at the demand stage. Id., 404. "[C]ounsel, who until recently advocated the position of the alleged wrongdoers, is now asked to investigate their conduct objectively and impartially and to advise an alleged victim whether it should seek to recover from them. That asks too much of human nature, given that a fair and thorough review might lead the corporation to sue the former clients. We believe that it is unreasonable for a board of directors to entrust its investigation of a shareholder's demand to conflicted counsel." Id., 406.
Along with the problem of conflicted interests and divided loyalties, courts have noted that "a law firm that had previously defended the alleged wrongdoers would be hampered in its investigation of the shareholder's allegations by its continuing duty to preserve the secrets and confidences of its former clients." Stepak v. Addison, supra, 20 F.3d 406.
In Stepak v. Addison, supra, 20 F.3d 406, the Eleventh Circuit explained how dual representation could jeopardize an attorney's duty of confidentiality: "By definition, the duty [of confidentiality] protects information acquired by means other than privileged communications with the client. Therefore, much of the protected information might have been uncovered by an investigation conducted by truly independent counsel on behalf of the corporation. But counsel who has previously represented the alleged wrongdoers in connection with the very conduct in question, and who is thereby burdened with a confidentiality duty to them, is not truly independent. It would be unrealistic to expect a lawyer or law firm to unlearn that which it had already learned about a case and then to reinvestigate, rediscover, and relearn that same information, all without betraying the interests of either the former or the present client. So long as it is assumed that the conflicted law firm would observe its ethical obligation of confidentiality in the conduct of its investigation, a board's selection of that firm as the primary investigator is tantamount to a decision to forego material information reasonably available." (Internal quotation marks omitted.)
In opposing the motion to disqualify, the defendants rely on the United States Court of Appeals for the Third Circuit's decision in Bell Atlantic Corp. v. Bolger, supra, 2 F.3d 1316. In that case, the court applied rule 1.13 of the American Bar Association's Model Rules of Professional Conduct, which is identical to Connecticut's Rule 1.13, to a shareholder's challenge of dual representation in a derivative suit. The court held that the shareholder had not demonstrated that the dual representation violated Rule 1.13 because "serious charges of wrongdoing" such as "allegations of self-dealing, stealing, fraud, intentional misconduct, conflicts of interest, or usurpation of corporate opportunities" had not been asserted against the individual directors. Id. The court found that the shareholder's allegations pertained to violations of the duty of care, which "requires directors to keep themselves informed and to act with requisite care," rather than the duty of loyalty, "which requires a director to act in good faith and in the honest belief that the action taken is in the corporation's best interests." Id.
In dicta, however, the court suggested "that in cases where the line is blurred between duties of care and loyalty, the better practice is to obtain separate counsel for individual and corporate defendants." Id., 1317. The court noted that a split of authority existed on this issue: Some courts have required independent counsel where directors allegedly defrauded the corporation; Cannon v. U.S. Acoustics Co., 398 F.Sup. 209 (N.D.Ill. 1975), aff'd in relevant part, 532 F.2d 1118 (7th Cir. 1976); while other courts have required independent counsel regardless of whether the complaint sounded in fraud or negligence. Messing v. FDI, Inc., 439 F.Sup. 776, 779 (D.N.J. 1977).
In the present case, the plaintiffs have leveled "serious charges of wrongdoing" against certain officers and directors of the corporation. They allege that over three years, the corporation's stock price dropped from four dollars to less than one dollar as "a proximate result of the misconduct of the individual defendants . . ." (Complaint, ¶ 21.) Some of this alleged misconduct, such as discontinuing the corporation's wholesale business and retaining unnecessary consultants, reflects issues of business judgment and, therefore, falls within the scope of the duty of care. (See complaint, ¶ 24.) Other allegations, however, could demonstrate that the named directors and officers breached their duty of loyalty to the corporation by misappropriating corporate assets and committing fraud. For example, the complaint alleges that the defendants wasted $80 million in corporate assets through self-dealing, such as engaging in unnecessary and "lavish" business travel and awarding themselves "unjustified increases and salary and bonuses." (Complaint, ¶ 25.) It further alleges that the defendants provided themselves with "unjustifiably extravagant severance packages." (Complaint, ¶ 29.)
The complaint also alleges that the individual defendants refused two bona fide offers to sell the corporation with the intent of lowering the stock price. (Complaint, ¶ 32.) Their alleged intent was to obtain personally the corporation's assets at a fraction of their former value. (Complaint, ¶ 32.) Thus, a conflict of interest, grounded in the individual officers and directors' alleged fraud, warrants a conclusion by this court that Robinson Cole may not represent the defendants in the plaintiffs' shareholder derivative action.
Next, the defendants contend that all of the defendants have waived any potential conflict of interest between the corporation, the board and the directors through the engagement letters they signed with Robinson Cole regarding their representation in the derivative action. Under these circumstances, however, this conflict cannot be waived pursuant to the Rules of Professional Conduct. The procedure for waiving the present conflict of interest, which arises under Rules of Professional Conduct 1.7(a) and 1.13, is provided by Rules of Professional Conduct 1.7(b): "Notwithstanding the existence of a concurrent conflict of interest under subsection (a), a lawyer may represent a client if: (1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client; (2) the representation is not prohibited by law; (3) the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or the same proceeding before any tribunal; and (4) each affected client gives informed consent, confirmed in writing."
Robinson Cole and the defendants have not and, given the allegations in the complaint, cannot effectively waive the conflict. First, the engagement letter, which is signed by James Searson, the chief financial officer of Familymeds, and one of the named defendants in this action, does not waive the corporation's conflict. Rules of Professional Conduct 1.13(g) provides in relevant part: "If the organization's consent to the dual representation is required by Rule 1.7, the consent shall be given by an appropriate official of the organization other than the individual who is to be represented, or by the shareholders." As an "individual who is to be represented," Searson cannot be an "appropriate official of the organization" capable of giving written informed consent to a concurrent conflict.
Second, even if Searson were capable of waiving the conflict on behalf of the corporation, the representation involves the assertion of fraud claims by one client — the corporation, through the action of its shareholders — against another client, the individual directors and officers, in the same proceeding. This concurrent conflict of interest cannot be waived by the defendants under Rules of Professional Conduct 1.7(b) because Robinson Cole cannot reasonably believe that it will be able to provide competent and diligent representation to each client when the representation involves "the assertion of a claim by one client against another client represented by [Robinson Cole] in the same litigation . . ." Rules of Professional Conduct 1.7(b)(1) and (3).
The defendants argue that even if a conflict of interest exists between the individual directors and officers and the corporation, Robinson Cole may nonetheless represent all of the defendants because the plaintiffs' claims are "patently frivolous." They draw this rule from Bell Atlantic Corp. v. Bolger, supra, 2 F.3d 1316. Along with considering whether the shareholder had leveled "serious charges of wrongdoing," the Bell Atlantic Corp. court, in dicta, suggested that "independent counsel may not be required if the derivative claim is obviously or patently frivolous." (Internal quotation marks omitted.) Bell Atlantic Corp. v. Bolger, supra, 2 F.3d 1316, citing W. Fletcher, Fletcher Cyclopedia of the Law of Private Corporations § 6025 (1991). See also Musheno v. Gensemer, supra, 897 F.Sup. 837 (finding no evidence that shareholder's claims were patently frivolous).
Other courts, however, have declined to adopt this rule because it effectively requires the shareholder to prove the substantive merits of the claim underlying the conflict at the very beginning of the proceeding. Instead, these courts have "held that whether the interests of the parties are adverse should be determined on the face of the complaint rather than through an examination of the underlying merits of the derivative action." Natomas Gardens Investment Group, LLC v. Sinadinos, supra, NO. CIV. S-08-2308 FCD/KJM, citing Lewis v. Shaffer Stores Co., 218 F.Sup. 238, 239-40 (S.D.N.Y. 1963) ("The interests of the officer, director and majority stockholder defendants in this action are clearly adverse, on the face of the complaint, to the interests of the [plaintiff] stockholders . . . The court cannot and should not attempt to pass upon the merits at this stage.").
The court adopts the rule in Natomas Gardens Investment Group, LLC v. Sinadinos, supra, NO. CIV. S-08-2308 FCD/KJM, because it would be patently unfair to require shareholders to produce persuasive evidence supporting their allegations before discovery even commences. Indeed, Robinson Cole's duty of confidentiality toward the individual defendants would put the shareholders, acting for the corporation, in the exceedingly difficult position of having to prove the merits of their claims of wrongdoing without conducting discovery and without access to privileged or protected information gathered by Robinson Cole in the course of its investigation of the shareholders' demand, including the law firm's interviews of three of those interested officers and directors. Further, no Connecticut court has held that a law firm can represent both the corporation and individual directors and officers accused of self-dealing if those claims have been deemed at an early stage of the derivative proceeding to be "patently frivolous."
Thus, the court will not presently consider the merits of the underlying derivative action, but, rather, will examine the face of the complaint to determine if the interests of the individual directors and officers and the corporation are adverse. Because the complaint alleges that these individuals committed intentional misconduct and fraud, their interests conflict with the corporation's, and, therefore, simultaneous representation is not permitted.
Based on the foregoing analysis, the court holds that a conflict of interest exists between Robinson Cole, the corporation and its individual officers and directors. This conflict may not be waived. Therefore, the firm is disqualified from representing the corporation in this shareholder derivative suit.
Having made this determination, the court next addresses the question of whether Robinson Cole should be permitted to continue to represent the individual officers and directors. The plaintiffs' motion to disqualify is somewhat schizophrenic on this point and does not analyze whether, having been disqualified from representing the corporation, Robinson Cole may remain as counsel for the individual defendants. At oral argument on March 15, 2010, however, the plaintiffs' attorney, Donald McKillop, stated that if the court finds in the plaintiffs' favor, it should order that the corporation and the individual defendants retain separate counsel, and neither set of defendants may continue to retain Robinson Cole.
The defendants' brief also fails to address this question directly. At oral argument, the court inquired of Attorney Craig Raabe of Robinson Cole whether he was of the view that Robinson Cole, if disqualified from representing some of the defendants, could serve as counsel to the others. Attorney Raabe responded that, in the event of disqualification, Robinson Cole should continue to represent the corporation, and the court should order the appointment of independent counsel to evaluate whether the plaintiffs' claims against the individual defendants are "patently frivolous" pursuant to General Statutes § 33-274(e). The court declines this invitation because this provision appears to apply to the demand stage, and the court concludes, for the reasons set forth below, that Robinson Cole is not permitted to represent either party at this point in the derivative action.
General Statutes § 33-274(e) provides: "Upon motion by the corporation, the court may appoint a panel of one or more individuals to make a determination whether the maintenance of the derivative proceeding is in the best interests of the corporation. In such case, the plaintiff shall have the burden of proving that the requirements of subsection (a) of this section have not been met."
The case law regarding the question of complete disqualification in a shareholder derivative suit is spare. In Forrest v. Baeza, supra, 58 Cal.App. 4th 80-82, the California Appellate Court concluded, after some analysis, that a law firm is not necessarily disqualified from representing all of the defendants in a derivative action even if the firm is disqualified from representing the corporation itself. The court's reasoning, in part, appears to give significant deference to respecting the individual defendants' choice of counsel. Id.
This question if further complicated in this case by the fact that the plaintiffs argue, and the defendants apparently concede, that two attorneys from Robinson Cole may well be necessary witnesses in this action. Robinson Cole, however, argues that even though these attorneys may be required to testify at trial, other attorneys in the firm may continue to participate in the litigation. The court disagrees.
Rule 3.7(b) of the Rules of Professional Conduct governs the question of whether Robinson Cole must be disqualified because two lawyers in that firm are necessary witnesses. Rule 1.7(b) provides: "A lawyer may act as advocate in a trial in which another lawyer in the lawyer's firm is likely to be called as a witness unless precluded from doing so by Rule 1.7 or Rule 1.9."
Rule 1.7 of the Rules of Professional Conduct would not apply to this situation because of the court's conclusion that Robinson Cole cannot represent both the corporation and the individual defendants simultaneously. Rule 1.7 applies only to the concurrent representation of two clients.
Rule 1.9(a) of the Rules of Professional Conduct, however, is applicable. Rule 1.9(a) provides: "A lawyer who has formerly represented a client in a matter shall not thereafter represent another person in the same or a substantially related matter in which that person's interests are materially adverse to the interests of the former client unless the former client gives informed consent, confirmed in writing."
In light of this rule, and under the facts and circumstances of this case, the court concludes that such consent is not obtainable in light of the same or similar problems existing with the corporation's attempt to consent to dual representation. Accordingly, the court concludes that Robinson Cole must be disqualified from representing all of the defendants in this action.