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Navigating Ethics Minefields As In-House Counsel

When an attorney works as in-house counsel for a company for some time, it is neither unusual nor surprising that a type of cultural immersion develops whereby the attorneys comes to identify deeply with the organization that is both the employer and client.

It is a well-established principle that in the case of corporate counsel –– whether in-house or not –– an attorney’s allegiance is owed to the organization itself. That is, the client is the corporation alone and not any of the individual constituents associated with that entity.

The difficulty arises, however, in that although a corporation is considered to be a “person” under the law, this is nonetheless a legal fiction — unlike a true person, it cannot act of its own accord. Rather, corporations and other entities may, by definition, act only through their agents, who may on occasion act in ways that are not always in furtherance of the best interests of the corporate client.

In the case of in-house counsel, the complexities of corporate representation are further complicated in light of the dominance of the law firm model reflected in the Model Rules of Professional Conduct (the Rules), which most U.S. jurisdictions have adopted in some form.

Despite the fact that the Rules are often far more compatible with traditional private practice models and rather ill-suited to address in-house practice, they are intended to cover all attorneys, regardless of where they practice. There is no separate code of conduct for in-house attorneys. The result is that in-house attorneys and legal departments are left attempting to figure out how to adapt inapt Rules to a corporate environment with little or no guidance from bar committees.

When an attorney works as in-house counsel for a company for some time, it is neither unusual nor surprising that a type of cultural immersion develops whereby the attorneys comes to identify deeply with the organization that is both the employer and client. This identification, however, poses significant challenges to an attorney’s ability to fulfill the ethical obligations of his or her profession.

One of the duties so implicated is that of independent judgment. This duty of independence manifests itself in a number of different ways throughout the Rules. For example, under the Rules, all attorneys are required to provide candid and independent advice to their clients –– regardless of how unwelcomed that advice may be by the client.

Indeed, it is often the role of an attorney to provide a client with advice that may ultimately delay or otherwise frustrate certain business objectives. Unlike their private-practice counterparts, however, in-house counsel are not simply attorneys — they are also employees and often hold other positions within their employer organization. Given the multiple roles often played by in-house counsel, ethical issues surrounding independence develop in a host of circumstances.

Attorneys As Board Members

Amidst the increasingly risky regulatory environment facing business today, it is not surprising that more and more corporations seek to invite attorneys to join their boards of directors. Indeed, since 2008, the number of U.S. publicly traded companies with lawyers on their boards has increased by roughly 20% and studies show that having an attorney-directors positively impacts a company’s litigation management and alignment of executive compensation with shareholder interests.

Notwithstanding the potential benefits of having lawyer-directors, boards and attorneys themselves should proceed with caution when considering a lawyer that provides legal services to the corporation, especially when that attorney is in-house counsel to the corporation.

While no explicit prohibition exists barring an attorney from serving as a member of his or her client’s board of directors, independence once again becomes an issue, since an attorney who serves both as attorney and director of a corporation is not only an employee of the corporation, but also has become both a client and attorney. This means that the lawyer may be called on to advise the corporation in matters involving actions of the directors. If there is a material risk that the dual role will compromise the lawyer’s independence of professional judgment, the lawyer should not serve as director.

Similarly, the presence of an attorney on the board of directors increases the risk that communications with that attorney will not be protected by the attorney-client privilege. It is therefore critical that attorney-directors make a clear distinction as to when they are acting or advising in their capacity as a board member and when they are acting as legal counsel.

Lawyer-directors should also be aware that their status as a board member for a client could be construed to make them a “control person” under Section 20(a) of the Securities Exchange Act of 1934. As a “control person,” an attorney-director may be held jointly and severally liable for the actions of the corporation’s employees and agents, based on the premise that, as a director, the attorney-director had ultimate control over such actions.

Conflicts Relating to Joint Representation

Likewise, although in-house counsel has traditionally had a single client — his or her employer –– in-house attorneys are increasingly becoming embroiled in impermissible conflicts involving the simultaneous representation of both the company itself and individual constituents of the company, such as officers, directors, or employees. Often this joint representation is quite inadvertent, arising from misunderstandings regarding the lawyer’s role in dealing with an individual and courts’ willingness to find an attorney-client relationship on the basis of the reasonable expectations of the client.

Under Model Rule 1.7, a potentially impermissible conflict of interest exists if representation of a client “may be materially limited by the lawyer’s responsibilities to another client or to a third person, or by the lawyer’s own interests.” Whenever an attorney represents both an organization and an individual constituent in the same matter, it will nearly always be the case that the representation of one may be “materially limited” by the attorney’s responsibilities to the other.

This is so even if the organization has agreed to indemnify the constituent, as that individual will often have interests different from those of the organization. While conflicts that arise in joint representation may certainly sometimes be waived upon proper disclosure and consent, not all conflicts are waivable.

Again under Model Rule 1.7, joint representation is lawful only if, in addition to the client’s informed consent, the attorney reasonably believes the representation will not be adversely affected. Accordingly, in cases of investigations or litigation, joint representation is often non-consentable when the best interests of one client may reasonably result in taking a position adverse to the other client.

For example, in the case of litigation against both the company and an individually named officer, it might be beneficial for the company to argue that an officer acted beyond the scope of his authority. To allow the joint representation to proceed despite being non-waivable is therefore to risk disqualification.

This prospect is especially problematic in the case of in-house counsel since generally, principles of imputation apply to a corporate legal department in precisely the same manner as they do in the context of a traditional law firm. Thus, if one lawyer is disqualified because of a conflict of interest, so too is the entire legal department.

Compensation Pitfalls

Another potential ethical minefield for in-house attorneys is compensation — especially given that compensation structures for in-house attorneys are generally quite different from traditional law firm models built around hourly rates and contingency percentages. Rather, in-house attorneys are generally the salaried employees of their clients.

Notably, there is nothing in the Rules expressly prohibiting this structure (indeed, it is akin to what might be considered a flat-fee arrangement in the context of outside counsel). Compensation provided to in-house counsel must nonetheless comport with the Rules relating to fairness of attorney fees and certain restrictions relating to business transactions with clients.

Specifically, Model Rule 1.5 prohibits an attorney from receiving an “unreasonable fee or an unreasonable amount for expenses.” Traditionally, this has meant prohibiting either compensation grossly disproportionate to the work performed or the charging of disbursements to which large additional surcharges have been applied.

In the case of in-house counsel, an attorney’s entire compensation (taking into account any raise, bonus and/or other benefits) must be considered and reviewed under the “unreasonable” standard set forth in Rule 1.5. This evaluation becomes especially important if an attorney receives stock options as part of his or her compensation. Although such options may represent little or no value when originally awarded, if the stock price increases significantly during the exercise period, these options may come to represent substantial value for the attorney holder. In such event, an argument might be made that the total compensation received by the attorney is ultimately too high, and therefore unreasonable (especially if the lawyer also has received a salary in the interim).

The receipt by attorneys of compensation in the form of equity or other business interests is also potentially problematic under Model Rules 1.7 and 1.8. As discussed previously, Model Rule 1.7 applies whenever the lawyer’s financial interest in a client is such that it may materially limit the lawyer’s representation.

In the context of equity compensation, when the lawyer’s interest in a client is significant there is the potential that the lawyer’s investment interest may differ from the company’s long-term interest. Thus for example, in-house counsel who is a large stake-holder in the company may be reluctant to offer advise that, if implemented, may adversely affect the price of the stock –– regardless of how legally proper that advice might be. As previously discussed, personal interest conflicts under Rule 1.7 are often consentable, but there may nonetheless be circumstances in which the lawyer is prohibited from advising the company in a particular matter.

Model Rule 1.8 provides that a lawyer shall not enter into a “business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client” unless that the transaction was fair and reasonable to the client. Additionally, Model Rule 1.8 prescribes several requirements with which an attorney must comply if he or she is to enter into a business transaction with a client. For example, the lawyer must disclose the terms of the transaction in writing, give the client an opportunity to seek advice from independent counsel, and obtain the client’s written consent to the transaction.

In the context of early-stage companies, lawyers sometimes become principals in the business and may be granted equity interests in lieu of cash payment for legal services. To the extent that an in-house lawyer’s receipt of equity-based compensation is merely a component of the general employment relationship and is offered pursuant to a company-wide, long-term incentive plan, the requirements of Model Rule 1.8 are unlikely to prove particularly problematic.

In such instances, the attorney typically participates in neither the setting nor negotiation of the terms of the plan. On the other hand, if the lawyer does participate in setting any terms or drafting the documentation, it may prove more difficult to establish that the transaction was fair and reasonable to the company. In such instances, the company should, at a minimum, be asked to acknowledge in writing that it consents to the transaction after receiving an opportunity to seek independent counsel, and that it believes the terms of the transaction are fair and reasonable.

Employed Lawyers Coverage

While most everyone is familiar with attorney malpractice claims in the context of a client lawsuit against its outside counsel, legal malpractice actions in the in-house context are not unprecedented. Accordingly, just as attorneys in private practice take pains to ensure that they are insured against such claims, so too must in-house counsel.

As an initial matter, in-house attorneys sometimes assume that they are covered under their organization’s directors and officers (D&O) insurance policy. However, the availability and scope of coverage (if any) available to the attorney will depend on nature of the allegations leveled against the attorney.

For example, some D&O policies contain exclusions for “professional services” that may bar coverage for legal malpractice claims. Likewise, other D&O policies may exclude “legal advice” from the definition of “wrongful acts” covered under the policy. In some instances, state statues may also offer some protection for in-house counsel. For example in California, employers are generally required to indemnify employees for all losses incurred in direct consequence of the discharge of their duties unless the employee knew his conduct to be unlawful at the time of his actions.

For in-house counsel looking for additional security, Employed Lawyers Coverage (ELC) may be available and is essentially legal malpractice insurance designed specifically for in-house attorneys. While ELC coverage is not necessary for every in-house attorney, it nonetheless can be a useful extra layer of coverage in a variety of instances; for instance, if there is a possibility that your employer-client might be insolvent (and thus unable to indemnify you) at the time of a malpractice suit.

Conclusion

Far from being a refuge from the Rules of Professional Responsibility, in-house practice is, in fact, an ethics minefield in which practitioners are left attempting to navigate rules often not engineered for their environment. Unfortunately, the focus of the Rules and the attention of most commentators has been fixed on the realm of private practice and the traditional law-firm environment.

As a result, in-house lawyers have received little guidance in detecting and handling the particular conflicts issues that arise in their own practice. Nonetheless, care must be taken by in-house practitioners to ensure compliance with these ill-suited rules as the ramifications are just as grave as for their private-practice colleagues.

The views expressed in the article are those of the authors and not necessarily the views of their clients or other attorneys in their firm.

Originally published on the Law Journal Newsletters. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

Contributing Author

Tamara Kurtzman

Tamara Kurtzman is a shareholder of the Beverly Hills-based corporate law firm TMK Attorneys and has served in the role of general counsel over many...

Bio and more articles

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