Derivative suits put the corporation in the odd position of simultaneously occupying the position of a defendant and plaintiff.  When the suit is initiated, the corporation is named as a nominal defendant.  If, however, the suit is allowed to proceed, then the corporation is the “real” plaintiff.  What does this mean for attorneys who seek to represent both the corporation and the “real” defendants in a derivative suit?  In an opinion certified for publication earlier this week, the California Court of Appeal provided an answer.

Ontiveros v. Constable, 2016 Cal. App. LEXIS 188 (Cal. Ct. App. 2016) involved a derivative suit initiated by a minority shareholder against the majority shareholder and his spouse.  After some discovery battles and two amended complaints, the shareholder sought to disqualify the corporation’s counsel from representing both the corporation and the individual defendants.  The trial disqualified the counsel from representing the corporation and the individual defendants.  The Court of Appeal affirmed the disqualification as to the corporation but not the individual defendants.

The Court of Appeal based its holding on Rule 3-310 of the California Rules of Professional Conduct.  That rule prohibits a member, without the informed written consent of each client, from accepting or continuing representation of more than one client in a matter in which the interests of the clients actually conflict.  The rule also prohibits a member, without the consent of the client or former client, from accepting employment adverse to the client or former client when, by reason of the representation of the client or former client, the member has obtained confidential information material to the employment.  The defendants argued that Rule 3-600(E) permits concurrent representation of a corporation and its directors, officers or shareholder subject to Rule 3-310.  If the organization’s consent is required under Rule 3-310, the consent must be given by (i) an appropriate constituent of the organization other than the individual or constituent who is represented; or (ii) by the shareholder(s) or organization members.  The defendants contended that one of the individual defendants, a majority shareholder, had consented to the dual representation.  The Court of Appeal, citing Forrest v. Baeza, 58 Cal. App. 4th 65 (1997), found the majority shareholder’s consent was ineffective.

Although the Court of Appeal’s opinion in Ontiveros doesn’t disclose the state of incorporation of the defendant/plaintiff corporation, a check of the Secretary of State’s online records reveals that it is a California corporation.  This shouldn’t affect the outcome because the Court of Appeal was applying California’s Rules of Professional Conduct, not its corporate law.  Thus, this shouldn’t be viewed as problem arising only with respect to California corporations.

While consistent with precedent, the Court of Appeal’s opinion fails to give effect to the plain language of Rule 3-600(E).  More significantly, one has to ask where disqualifying counsel in these situations leaves the corporation when the controlling shareholder is, as in Ontiveros, a defendant in the derivative suit.  As a party, the corporation should be represented by counsel.  Who will select that counsel? Ultimately, the power to make that decision rests with the majority shareholder who presumably controls a majority of the board of directors.  Rule 3-600(A) provides “In representing an organization, a member shall conform his or her representation to the concept that the client is the organization itself, acting through its highest authorized officer, employee, body, or constituent overseeing the particular engagement.”  If in this circumstance, what is accomplished by disqualification?