A corporate director’s right of access to corporate books and records, including legal advice from corporate counsel, has been described by courts as “absolute” and “unqualified,” consistent with the fulfillment of a director’s fiduciary duty to monitor and promote the corporation’s business interests.
In contrast, under statute and common law, a shareholder’s right of access may be limited to basic information concerning corporate finance and ownership. In addition, the shareholder has no attorney-client relationship with corporate counsel that would enable access to privileged communications between counsel and the corporation’s directors and executives.
The distinction between director and shareholder rights of access to communications with corporate counsel gets blurred in closely held corporations — especially smaller ones — where the directors and shareholders often are one and the same. When dissension and litigation erupt between antagonistic shareholder/director factions, courts have the difficult task of deciding whether communications with corporate counsel containing legal advice concerning the dispute must be disclosed to a shareholder/director asserting, for example, appraisal rights following a merger and/or derivative claims for breach of fiduciary duty.
A pair of appellate decisions by courts in New York and Massachusetts recently addressed the issue. In both cases, the appellate courts reversed lower court orders requiring disclosure of otherwise-privileged communications with corporate counsel in suits brought by dissident shareholder/directors. In both cases, the appellate courts determined that the plaintiffs were not entitled to the disclosure sought because their interests were “adverse” to the corporation in regard to the subject communications with counsel. Let’s take a closer look.
Barasch v. Williams Real Estate Co.
In Barasch v. Williams Real Estate Co., 2013 NY Slip Op 01613 (1st Dept Mar. 14, 2013), the Manhattan-based Appellate Division, First Department, held that a minority shareholder and director, who brought a contested dissenting shareholder proceeding to compel the appraisal and buy-out of her shares following a merger, was not entitled to access certain emails from the company’s outside transaction counsel in the period between (a) her initial voicing of opposition to the proposed transaction and retention of personal counsel and (b) the date she formally dissented from the transaction and demanded a buy-out.
Barasch concerns a closely held real estate company (“Williams”) that, through a highly complex series of transactions in Fall 2008, sold a 65% interest in the company to a large, Canadian real estate brokerage firm. Candace Barasch, a 10% shareholder and director, brought a dissenting shareholder proceeding seeking to be paid the appraised fair value of her shares. Williams took the position that the transaction was not structured as a merger triggering dissenting shareholder rights. In a November 2011 decision that I wrote about here, and which the appellate court subsequently affirmed, the trial court agreed with Barasch that the transaction triggered her statutory appraisal rights.
In the course of the proceeding Barasch demanded, and the trial court ordered, disclosure of all Williams documents regarding the merger transaction. At a later deposition of in-house counsel, Barasch’s attorney attempted to examine the witness concerning certain September 2008 emails included in Williams’ document production, from its outside transaction counsel, that described Barasch as “hostile” and seemingly confirmed her dissenter’s rights. Williams’ counsel asserted that the emails were produced inadvertently and directed the witness not to answer questions concerning the documents based on the attorney-client privilege.
Barasch thereafter filed a motion to compel testimony concerning the emails. Williams cross-moved for a protective order, contending that Barasch was “adverse” to the company at the time of the contested communications. (Read here Barasch’s legal brief in support of her motion to compel, and here Williams’ legal brief in support of its motion for protective order.) The trial court’s order (read here) sided with Barasch, finding that a corporate director’s “absolute right to inspect corporate books and records, including attorney-client communications” was not displaced based on the facts that she opposed the transaction and threatened to block it. “Because Barasch was and is a director of Williams,” the court wrote, “she is and has been a corporate insider by definition, and therefore not adverse to Williams during the relevant times.”
Williams appealed to the First Department which, earlier this month, over a one-judge dissent on procedural grounds, reversed the lower court’s order on the ground that Barasch was adverse to Williams at the time of the contested communications concerning her with outside transaction counsel. As the court explained:
[T]his case involves a party who is both a corporate director and a shareholder, suing in her capacity as a shareholder, and seeking to invade the corporation’s attorney-client privileged communications about her, which took place at a time when she was adverse to the corporation, in order to advance her own interests as a shareholder. It is evident from the September emails that Williams’s transaction counsel believed petitioner to be hostile to the transaction and that it was advising Williams on how to handle petitioner. Furthermore, that petitioner retained separate counsel to represent her interests demonstrates that she did not believe that Williams’s in-house counsel or transaction counsel were representing her interests as a shareholder. Thus, it is clear that as of September 8, 2008, petitioner was in an adversarial position with Williams, and the attorney-client communications between Williams and its counsel regarding how to deal with petitioner are privileged.
The court also critiqued the lower court’s status-based approach, under which a director “by definition” is an “insider” and not adverse to the corporation, as one that would thwart the purpose of the attorney-client privilege to encourage full and frank communication between attorneys and their clients. “Taken to its logical conclusion,” the court added, “the motion court’s reasoning would prevent a corporation from freely consulting with counsel when dealing with a dispute involving a sitting director, or seeking advice regarding a director’s suspected misconduct.”
Chambers v. Gold Medal Bakery, Inc.
Earlier this year, in Chambers v. Gold Medal Bakery, Inc., 464 Mass. 383, 2013 WL 453143 (Feb. 8, 2013), the Massachusetts Supreme Judicial Court faced a similar dispute over access by shareholder/directors to the records of a close corporation’s outside lawyers.
The Gold Medal Bakery, founded in Fall River, Massachusetts, by Auguste LeComte over 100 years ago, is one of the nation’s largest independent bakers, currently managed by third and fourth generation members of the LeComte family. The company’s ownership is split 50/50 between two family branches, each with two seats on the four-member board of directors, but only one side (“Side A”) active in the company’s day-to-day management.
The inactive side (“Side B”), apparently in furtherance of their desire for a buy-out, brought a lawsuit against the company in 2007 seeking access to books and records. The lawsuit was settled in 2008 with an agreement providing Side B access to corporate records and permitting them to audit the company in anticipation of buy-out negotiations.
In 2009, Side B brought another suit against the members of Side A asserting direct and derivative claims for breach of the 2008 settlement agreement and breach of fiduciary duty in regard to company management. Side B served a discovery subpoena on the company’s outside corporate counsel seeking a broad range of corporate records and communications with the Side A parties.
The law firm objected on grounds of attorney-client privilege and attorney work product. The trial court overruled the objections and ordered disclosure. On interlocutory appeal to the Massachusetts Supreme Judicial Court, the appellate panel reversed the lower court’s order, concluding,
on the narrow facts of this case, that the plaintiffs’ interests are adverse to Gold Medal for purposes of attorney-client privilege and work product protection as concerns documents generated in anticipation of or related to the 2007 and present litigations.
The court’s analysis begins with the general proposition that a corporate director “has fiduciary duties to the corporation irrespective of his involvement in day-to-day operations,” which duties cannot be satisfied “without access to basic information about the company he represents” including legal advice. A corollary principle is the
need to prevent the strategic use of attorney-client privilege and other protections to hinder a codirector’s access to the legal advice, particularly in the close corporation context where shareholders owe fiduciary duties to each other as well as to the corporation, and the minority may be particularly vulnerable to freezeout.
The general proposition, however, “is not a per se guarantee” of director access to legal advice, since such access is “based on the assumption that the interests of the directors are not adverse to the interests of the corporation on a given issue.” As the court explained:
A director advancing interests shared with the corporation should be entitled to the associated privilege of access to legal advice furnished to a corporation. A director motivated by adverse interests is not so entitled.
Stressing that the analysis is “fact specific and necessarily depends upon the circumstances of each case,” the court found that Side B’s interests were adverse to the company based on “the nature and frequency of suit by the plaintiffs against Gold Medal” and “the plaintiffs’ self-interested motive in pursuing both the 2007 and present litigations.” More specifically,
By the terms of their own pleadings, the plaintiffs have been pursuing a global buyout of their Gold Medal shares since approximately late 2006. They brought a direct suit solely against Gold Medal in 2007 for the inspection of corporate records to then use to value their Gold Medal shares. The settlement agreement that ended the 2007 litigation provided for an audit of Gold Medal “for the purpose of facilitating a sale of the [p]laintiffs’ shares to [Gold Medal] and/or [Gold Medal's] other shareholders.” The plaintiffs are interested in maximizing the price in the sale of their stock consistent with their fiduciary obligations as directors and shareholders of a close corporation to the corporation and other shareholders. Gold Medal, as a potential buyer, is interested in minimizing the stock price, consistent with its contractual duty of good faith pursuant to the 2008 settlement agreement described earlier. Thus, the interests of the plaintiffs and Gold Medal are adverse. [Citation omitted.]
Managing the relationship between corporate counsel and the diverse interests of multiple shareholder/directors of a close corporation can be a very challenging task at the best of times, and even more so when hostilities break out between owner factions. The Barasch and Chambers cases show that the courts will not adopt a categorical approach to the problem of access to privileged attorney-client communications, but will closely examine the interests being advanced in factional disputes in deciding whether the party seeking access is doing so predominantly wearing a director’s hat or a shareholder’s hat and, in the latter event, will deny access where the shareholder interest at stake is adverse to the corporation.
Update April 22, 2013: Pileggi’s blog (read here) highlights a recent Delaware Chancery Court ruling by Vice Chancellor Laster in Kalisman v. Friedman with a useful summation of Delaware law explaining the narrow circumstances under which a director may be denied access to corporate counsel’s communications with other board members.