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Duty of LLC’s attorneys reaches non-client minority

Case vs. Boston law firms survives motion to dismiss

The Massachusetts Appeals Court has found that lawyers for a limited liability company could be sued for breaching a fiduciary duty to the LLC’s minority members despite the lack of an attorney-client relationship.

Counsel for the LLC were accused of working surreptitiously to eliminate protections afforded the minority members in the LLC’s operating agreement. In a companion suit to one filed against majority members of their LLC, the plaintiff minority members sought to hold the company’s attorneys liable for their alleged role in a “freeze-out” scheme.

The minority members claimed that the majority members secretly retained the lawyers, including the daughter of a majority member.

The defendant attorneys successfully argued in the Superior Court’s Business Litigation Session that the plaintiffs had neither an express nor implied attorney-client relationship with the lawyers, and thus they owed them no fiduciary duty.

But the plaintiffs contended that the fiduciary duty had arisen from the defendants’ engagement as counsel for the closely held company, “in which, by law, the shareholders owed each other a fiduciary duty of utmost good faith and loyalty,” Chief Justice Scott L. Kafker wrote on behalf of the Appeals Court panel.

The Supreme Judicial Court, “albeit in dictum,” had left open the possibility that such a duty might exist in its 1989 decision in Schaeffer v. Cohen, Rosenthal, Price, Mirkin, Jennings & Berg, P.C., Kafker added.

The 28-page decision is Baker, et al. v. Wilmer Cutler Pickering Hale and Dorr LLP, et al.

Murky waters

While some attorneys call the ruling a significant expansion of a lawyer’s fiduciary duties, plaintiff W. Robert Allison, an inactive former corporate attorney, said if one simply represents an individual client, “you have nothing to worry about.”

Like all firms, Allison noted, the defendant attorneys in the case issued “elaborate engagement letters,” proclaiming that they represented only the company and could not and would not represent individual stockholders. But even though they were being paid with company funds, the attorneys did the bidding of the majority member.

“Their agenda was his agenda,” he said.

However, Boston attorney Louis M. Ciavarra said leaving the minority owners out of the loop is not necessarily unusual.

“For those of us who regularly represent small companies, we work with the officers and/or the managers, not with the minority owners,” he said.

With the ruling, Ciavarra said, the Appeals Court has taken another step in eroding a lawyer’s ability to zealously and aggressively represent his clients. As long as attorneys avoid conflicts of interest, the client should be able to rely on his lawyer’s advice, “and we should be able to give advice without worrying about getting sued by non-clients,” he added.

While acknowledging those concerns, Boston attorney Stephen D. Riden said Baker ultimately “serves to illustrate what’s always been the case: Attorneys representing close corporations need to tread carefully.”

When there is a conflict within a close corporation, the role of the company’s attorney is generally to step back, be nonpartisan, and not represent one cohort against another, he said. Here, the majority owners could have hired their own counsel to represent their individual interests.

Given the “highly factual analysis” in which the Appeals Court engaged, it was crucial that the minority members had bargained for a significant amount of say in the company’s operating agreement, according to Boston attorney Michael F. Connolly.

“As the company’s lawyers, it is not their job to take those protections away, even if the majority asks them to,” he said.

Allison said he and his attorneys have yet to hear whether the defendants intend to pursue further review of the Appeals Court’s decision. Boston attorney Richard M. Zielinski, who represents one of the attorneys and that lawyer’s firm, declined to comment on the case, while counsel for the other attorney and her firm did not respond to a request for comment.

If further review is sought, it should be welcome news to the bar, given how “murky” the contours of a lawyer’s fiduciary duty in this context are, said Boston attorney John A. Shope.

As it stands now, the test for whether such a duty to a non-client exists seems to be “very factually intensive,” he said, which gives little guidance to the business practitioner.

A wound that wouldn’t heal

On Jan. 28, 2000, Allison and Elof Eriksson formed Applied Tissue Technologies, LLC, to develop and market wound-therapy technologies. Eriksson acquired a 75-percent membership interest in the company, while Allison received the remaining 25 percent.

Applied Tissue Technologies’ operating agreement gave Allison and other minority owners the right to participate in management of the company “by a vote proportionate to their interest.” The agreement also could be amended only if both Eriksson and Allison provided written consent. Further, minority members had to consent before their percentage stakes in the company could be diluted.

By early 2012, the company was facing a financial shortfall. Eriksson had loaned it money in the past and was prepared to do so again but demanded additional equity in return. Allison preferred to hire new management and develop a new business plan. He would only dilute his interest if outside investors who were bringing new management to the company provided the additional capital.

With the company’s CEO privately urging him to gain control of the company, Eriksson reached out to his daughter, Emma Eriksson Broomhead, an attorney at Gunderson, Dettmer, Stough, Villeneuve, Franklin & Hachigian. The firm and Elof Eriksson had a longstanding attorney-client relationship. Broomhead introduced her father to colleague Gary R. Schall, who would later relocate his practice to WilmerHale.

On Feb. 14, 2012, the company’s CEO formally engaged Gunderson Dettmer as counsel, with the engagement agreement specifying that the law firm would not represent any individual members of the company.

Despite being fully aware of the protections for minority members in the organizing agreement, the attorneys “immediately set about devising and presenting a plan to Eriksson to both circumvent those protections and eliminate the minority members,” according to the complaint.

After Allison rejected a buyout offer that Schall had drafted on Eriksson’s behalf, Eriksson and the attorneys moved to their Plan B, according to the complaint.

That plan, outlined in a memo drafted by Schall, relied on G.L.c. 156C, §60, which allows members owning more than 50 percent of Massachusetts LLCs to approve a merger with another business entity, unless the company’s operating agreement provides otherwise. ATT’s operating agreement was silent on the issue of mergers.

By merging with a new entity, Schall explained that Eriksson could convert his outstanding loans and future contributions into preferred stock in the new entity and eliminate Allison’s “ability to interfere with company operations” while decreasing his ownership stake, according to the complaint.

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“As the company’s lawyers, it is not their job to take those protections away, even if the majority asks them to.”
— Michael F. Connolly, Boston

On May 25, 2012, Eriksson and the attorneys set the plan into motion, creating a new Delaware LLC. Eriksson, the CEO and the attorneys executed various documents to effectuate the merger, including a new operating agreement, which eliminated all of the minority members’ previous protections.

Not until May 29, 2012, did Eriksson and the CEO meet with Allison to inform him of the merger and reveal the work the company’s attorneys had been doing, according to the complaint.

Allison first sued Eriksson, his wife and the CEO in May 2013, asserting claims for breach of contract, intentional interference with advantageous business relations, breach of fiduciary duty and civil conspiracy.

After a jury-waived trial in that case, Allison and the Allison Trust were awarded a 5-percent interest in ATT Delaware, not subject to dilution.

Both sides have filed for further review of that decision, which is currently pending before the Appeals Court.

On May 28, 2015, Allison, the Allison Trust and fellow minority member Christian Baker filed the current suit. The defendants’ motions to dismiss were granted on Feb. 23, 2016, and the plaintiffs appealed.

The case now heads back to the BLS unless the defendants seek further appellate review.

‘Trust and confidence’ implied

To reinforce the possibility of a fiduciary duty to a non-client minority member, Kafker pointed to the SJC’s favorable citation in Schaeffer to a Michigan Appeals Court opinion, Fassihi v. Sommers, Schwartz, Silver, Schwartz & Tyler, P.C.

In Fassihi, a claim for breach of fiduciary duty was brought against counsel for the corporation for allegedly assisting one 50-percent shareholder in ousting another from the corporation.

That claim survived summary judgment because the plaintiff was able to show he had placed “trust and confidence” in the defendant attorney.

The defendant attorneys in Baker argued that their situation was different, as the plaintiffs had not even interacted with them, much less placed “trust and confidence” in them. They also suggested that there was an actual or potential conflict between their client, the LLC, and the minority members over how to address the company’s potential financial shortfall.

But noting that determining whether a fiduciary duty exists is “largely fact specific,” Kafker pointed to the allegation that counsel were required to communicate with the minority members, particularly given the strong protections in the company’s organizing agreement. The attorneys also were alleged to have taken “purposeful steps” to conceal their activities undermining that agreement.

“Given the protections contained in the … agreement, the minority members should have been able to repose trust and confidence that counsel hired by the company would have communicated and consulted with them prior to undoing those protections,” Kafker wrote.

The agreement also imposed “consensual decision-making … on important matters despite the obvious potential for conflict,” he added.

“Accordingly, it can plausibly be inferred that the defendants knew, or should have reasonably foreseen, that anyone who served as counsel for the company was constrained by the operating agreement, and the consensual decision-making it imposed on important matters, or at least could not act covertly, in concert with the majority members, for the very purpose of eliminating those protections,” Kafker said.

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