Disqualification in Derivative Actions

On Behalf of | May 26, 2016 | Uncategorized |

Litigation involving members of close corporations may create issues with attorney representation. In Ontiveros v. Constable, 245 Cal. App. 4th 686, 199 Cal. Rptr. 3d 836 (2016), a minority shareholder brought derivative claims against the corporation, the majority shareholder and the majority shareholder’s wife, who all retained the same counsel for representation. The minority shareholder argued disqualification was automatic because the corporation’s interests were adverse to the majority shareholder’s and his wife’s. The minority shareholder also argued that counsel could not withdraw from representing the corporation and continue representing the majority shareholder and his wife because of counsel undoubtedly ” derived sensitive confidential information” regarding the corporation’s position vis-à-vis the corporation’s claims against the majority shareholder and his wife. The trial court disqualified defendants’ counsel.

On appeal, defendants contended the trial court erred by disqualifying counsel as to the corporation. The Court of Appeal disagreed holding that counsel could not represent the corporation because the corporation and the majority shareholder had conflicting interests and the majority shareholder did not have authority to waive the conflict. The Court of Appeal noted the nature of the minority shareholders derivative claims, which sound in fraud, demonstrates that an actual conflict of interest existed.

In light of disqualifying counsel from representing the corporation, the Court of Appeal then analyzed the issue as to representing the majority shareholder as a successive representation problem – where the focus is on confidentiality – and not a concurrent representation problem – where the focus is on loyalty – looking at the corporation as a former client and the majority shareholder as a current client. Applying Forrest v. Baeza, 58 Cal. App. 4th 65, 67 Cal. Rptr. 2d 857 (1997) and Blue Water Sunset, LLC v. Markowitz, 192 Cal. App. 4th 477, 122 Cal. Rptr. 3d 641 (2011), the Court of Appeal concluded that because counsel’s relationship with the corporation was solely based on counsel’s interaction with the majority shareholder, it was “impossible to conceive of confidential information counsel could have received from the corporation that is different from the information he received from” the jointly represented shareholders. Thus, since counsel’s continued representation of the majority shareholder and his wife posed no threat to counsel’s continuing duty of confidentiality to the corporation, the Court of Appeals concluded the trial court wrongly disqualified counsel from representing the majority shareholder.

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