I don’t frequent beauty salons and I’m not much of a drinker, so I did a double take when I read a recent court decision involving a falling out among co-owners of a start-up business known as a “beauty bar” offering alcoholic beverages and beauty salon services. I don’t know about you, but getting tipsy before having your hair done seems like a bad idea, unless you have no fear of walking out with a mohawk.  

The case, Big Brows LLC v. Devitt, 32 Misc 3d 1231(A) (Sup Ct Kings County Aug. 12, 2011), presents an interesting issue of attorney ethics with great practical significance in disputes between co-owners of closely held business entities: Can the same lawyer represent multiple owners, including both managers and non-managers, when the managers are accused of acting against the interests of the business?

The facts in Big Brows are straightforward. In April 2009, a group of eight individuals, three of whom were designated the managers, formed a limited liability company called Big Brows LLC to open a beauty bar at a Brooklyn location formerly operated as the Black Bean Café. Simultaneously Big Brows entered into an agreement with the Café’s owner to purchase its assets for $125,000. The agreement required a $15,000 up-front payment, another $80,000 conditioned upon the approval of a temporary liquor license from the State Liquor Authority (SLA), and thereafter the balance in installment payments.

In May 2009, the SLA denied Big Brows’ application for a temporary liquor license. The plaintiff members of Big Brows, including two of the managing members (Keating and Stewart) and the five non-managing members, alleged that the defendant managing member, Devitt, failed to notify them of the SLA’s license denial and improperly paid the Café’s owner $80,000 so as to continue construction on the business, thus wasting their investment. In May 2010, the SLA denied Big Brows’ application for a liquor license in its entirety. The plaintiffs alleged that the liquor license was denied due to Devitt’s prior involvement with another bar. The complaint asserted derivative claims against Devitt for fraud, breach of fiduciary duty and breach of contract.

Devitt claimed that, after the SLA denied the temporary license and after consulting with legal counsel, all three managers decided to continue with construction of the project and to pay the $80,000, believing that the liquor license would ultimately be issued. In his answer to the complaint, Devitt asserted a counterclaim for contribution against his co-managers, Keating and Stewart, alleging that they must share any liability in the event the derivative claims are upheld against Devitt for continuing the project and paying the $80,000.

Devitt then moved to disqualify the plaintiffs’ lawyer under Rule 1.7 of New York’s Rules of Professional Conduct dealing with conflicts of interest. Devitt argued that the same lawyer cannot properly represent the conflicting interests, on the one hand, of the plaintiff non-managing members who indirectly would benefit from a determination that the managing members wasted company assets by proceeding with construction and paying the Café notwithstanding denial of the liquor license and, on the other hand, the two managing member plaintiffs accused in the counterclaims of participating along with defendant Devitt in the decision to do so.

In pertinent part, Rule 1.7 prohibits a lawyer from concurrently representing multiple clients with “differing interests” unless the following four conditions are satisfied:

  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 other proceeding before a tribunal; and
  4. each affected client gives informed consent, confirmed in writing.

Plaintiffs’ counsel submitted an opposing affidavit in which she maintained her compliance with the four, requisite conditions accompanied by affidavits from each plaintiff consenting to her continued representation and acknowledging that they had been advised as to any potential conflict.

In her decision, Kings County Commercial Division Justice Carolyn E. Demarest notes that “the right to be represented by counsel of one’s choice is not to be lightly abridged by disqualification.” She nonetheless concludes that Devitt’s counterclaims against Keating and Stewart place the latter pair in a non-waivable conflict with the other plaintiffs. In the court’s own words:

. . . Devitt has alleged that Keating and Stewart were made aware of the denial of the temporary liquor license in May of 2009, approved Devitt’s decision to continue construction of the premises and advised the other LLC Members of such decision. . . . Although plaintiffs dispute Devitt’s allegations, Devitt’s counterclaim has raised a direct conflict and created adverse interests among plaintiffs. Like Devitt, Keating and Stewart are also fiduciaries to the remaining plaintiffs. If it is determined that Devitt breached his fiduciary duty, it is possible that Stewart and Keating have also breached their fiduciary duties and will ultimately be liable to their fellow plaintiffs as well, placing them in an untenably adverse relationship with the remaining plaintiffs. The same attorney cannot both prosecute and defend.

Plaintiffs’ counsel also argued that her disqualification would severely prejudice the plaintiffs, but Justice Demarest found otherwise primarily because the case was at an early stage in the litigation with discovery barely underway.

The decision’s above-quoted statement, that the “same attorney cannot both prosecute and defend,” implies that plaintiffs’ lawyer could continue her representation with independent, new counsel retained to defend the counterclaim against Keating and Stewart. Not so. “Because [plaintiffs’ counsel] has been privy to the confidential information of all plaintiffs,” Justice Demarest writes, “she will not be able to represent any of them.”

In situations like the one presented in the Big Brows case, i.e. involving a mix of company owners owing fiduciary duties and others not, careful attention must be paid to legal representation to avoid what otherwise could end up with a potentially expensive and time consuming disqualification battle.