Lines of communication: Attorney-client privilege in close corporations

By Julie E. Green

Attorneys routinely communicate with clients by email, relying on the assumption that their communications are cloaked with the attorney-client privilege and the work product protection.

But that can be a dangerous assumption in the close corporation context, where shareholders owe duties to each other, and disagreements among owners are always a possibility. What my client might call a business necessity, your client might call a freeze-out.

With e-discovery now the norm, communications with corporate counsel are routinely swept up in document discovery. For corporate counsel, it is crucial to know when your emails may be discoverable in litigation. For litigators, emails with corporate counsel can be critical evidence that makes or breaks a case.

The attorney-client relationship runs between corporate counsel and the corporation itself, not the individual directors or shareholders who actually control the corporation. In close corporation litigation, however, those very directors and shareholders are pitted against each other, raising a dilemma: Who is the “client” in the “attorney-client” privilege?

Communications with corporate counsel can be crucial evidence. Courts addressing whether such communications must be disclosed have generally adopted one of two approaches.

One approach makes a bright-line distinction between the corporation and its directors, and permits corporations to withhold privileged communications even from directors.

The other approach recognizes directors as the governing authority in a corporation and gives all directors automatic access to attorney-client privileged material by virtue of their position.

The Supreme Judicial Court (SJC) of Massachusetts fashioned a new approach in Chambers v. Gold Medal Bakery, Inc., 464 Mass. 383 (2013), that strikes a thoughtful balance between the two traditional approaches by establishing the right of all directors to access attorney-client communications, while shielding those communications made when there is specific adversity between the plaintiffs and the corporation.

The dispute in Chambers involved a classic constellation of issues in close corporation litigation.

A century-old family-owned baking business was owned 50-50 by descendants of two branches of the family. The plaintiffs were 50 percent of the shareholders and directors but not executives in day-to-day management. They asserted both direct and derivative claims, including for freeze-out and breach of fiduciary duty to the corporation, and named as defendants the corporation derivatively and two individual officers (one of whom was also a director and 25 percent shareholder).

In discovery, the plaintiffs sought all communications between the defendants and corporate counsel, reasoning that they (the plaintiffs), as 50 percent of the directors, were just as much the “client” as the defendants.

The SJC held that a director of a corporation is entitled to corporate information protected by the attorney-client privilege and the work product doctrine — unless the interests of the director are adverse to those of the corporation regarding the specific matter at issue.

This resolution serves two vital but competing interests.

On the one hand, corporations should be encouraged to seek advice of counsel in confidence before taking actions of questionable legality.

On the other hand, there is a need to prevent strategic use of the attorney-client privilege by a control group to shield breaches of fiduciary duty, particularly in the close corporation context where the non-control group may be particularly vulnerable to freeze-out.

What is adversity?

Not all “adversity” shields attorney-client communications in litigation. The adversity must be toward the corporation itself, not the other directors and shareholders.

The SJC stressed that adversity is fact-specific and depends on the circumstances of each case.

In an important footnote, it recognized that derivative claims, in particular, require careful analysis. While such claims are ostensibly intended to vindicate the interests of the corporation, they “often arise out of a mix of interests, some of which may be adverse to interests of the corporation.” Chambers, 464 Mass. at 398 n.31.

One important factor is the specter of litigation and the retention of separate counsel by the plaintiffs. In Chambers, the court carefully circumscribed the scope of the communications that were shielded by the privilege to communications created in anticipation of litigation with the plaintiffs.

The litigation alone, however, might not have been sufficient. The court also analyzed the motives underlying the litigation, concluding that they were at least partially related to an anticipated buyout of the plaintiffs by the corporation, creating opposing interests in either maximizing or minimizing price.

Another key factor is whether the party seeking to shield the communications has acted in secret against the interests of the non-control group. Communications with corporate counsel in furtherance of clandestine action are more likely to be ordered produced in discovery.

This principle emerges from the Delaware law relied on by the court in Chambers, and is consistent with the court’s concern for preventing use of the privilege to shield breaches of fiduciary duty from vulnerable minorities.

How can corporate parties protect the confidentiality of their communications? Directors wishing to keep communications confidential from other directors should retain separate counsel. A board of directors can also form a special committee with authority to retain its own counsel.

What about shareholders?

The Supreme Court of Delaware recently adopted the Garner doctrine, which permits shareholders in derivative actions to pierce the corporate attorney-client privilege on a showing of good cause. Wal-Mart Stores, Inc. v. Indiana Electrical Workers, 95 A.3d 1264 (Del. 2014).

This showing is highly fact-specific and requires an analysis of nine factors relating to, among other things, the nature of the shareholders’ claims, the shareholders’ need for the information, and the nature of the information sought.

The SJC has yet to address shareholder access to corporate attorney-client communications, and the issue remains an open question.