Although the principle that a corporation’s lawyer represents the company rather than the individuals who own or run the company is well-established, lawyers for small, closely held companies sometimes face challenges in determining whether they also have any fiduciary obligations to shareholders.

Ennico

Clifford Ennico, a former Wall Street lawyer who now represents small companies, notes that it’s understandable why attorneys sometimes confuse the company with its executives. “Two guys always approach you and say they want to form a corporation. As a practical matter, you’re going to be getting calls from both these guys. Both may view you as their attorney. That problem just exacerbates as company grows,” says Ennico, author of the Small Business Survival Guide.

One case in point is Ahan v. Grammas, currently under appeal in Maryland, where a jury initially awarded $17.2 million to a 50-percent shareholder who claimed he was pushed out of a small satellite communications business with the help of a Chicago law firm hired to represent the company.

A judge threw out the jury’s verdict against the law firm, a decision the plaintiff’s lawyer, Creighton Magid of Dorsey & Whitney, calls “puzzling.” But Magid tells Compliance Week he is hopeful that the award will be reinstated on appeal.

Magid

“This law firm claimed to represent the corporation, but it went beyond its role and sided with one of its shareholders to the detriment of the other,” Magid says. “And all the while, the law firm claimed it was looking out for the interests of both shareholders.”

Magid’s client, Michael Ahan, had been involved in separate litigation with Nader Modanlo, the shareholder who ousted Ahan from the company, called FAI. A Maryland jury had awarded Ahan $103.9 million in that case but the award has been left in limbo because Modanlo subsequently filed for bankruptcy.

Three Theories Of Liability

According to Magid, the issue of whether a lawyer for a closely held corporation can be liable for breach of fiduciary duty to one of the corporation’s shareholders has been gaining attention around the country. For example, courts in Michigan and Massachusetts have held that attorneys have a fiduciary obligation to shareholders because small companies with only a handful of shareholders are similar to partnerships.

Federal judges in New York and Illinois, however, have taken a different view, basing any fiduciary duty owed to a shareholder on the existence of an attorney-client relationship that developed between the lawyer and shareholder. Another theory of liability that found favor in an Oregon case focuses on whether a lawyer has aided and abetted the majority shareholders when they breached a fiduciary duty to an ousted shareholder.

Richard

Patrick Richard, a partner with the law firm Nossaman Guthner Knox & Elliott, notes that the issue of fiduciary duty “is going to be a question of state law,” and that some states—California among them—have conclusively rejected any suggestion that a lawyer for a close corporation owes a fiduciary duty to shareholders.

“California law is as close to crystal clear as you can get,” he says. “You do not have an attorney-client relationship [with shareholders] and thus don’t have a fiduciary duty to shareholders.”

Richard says that as long as a lawyer makes no direct dealings with nor make misrepresentations to a shareholder, there is little risk in California that the lawyer will be held liable for giving advice to a corporation on how to dilute that shareholder’s interests.

A “bright-line rule” is needed in these situations, Richard says. “The rule put forward in the Ahan case would create a potential conflict of interest for the lawyer.”

Lines Not Always Clear

Rave

Michael Rave, a lawyer with the law firm Pitney Hardin, says the nature of closely held companies can lead to the creation of fiduciary obligations to shareholders, even if no such obligations exist at the outset of the representation.

“When you have a very small corporation, you may end up giving an individual shareholder tax advice or personal advice,” Rave says. “If that happens, you can be found to have an obligation to the shareholder—to be representing the shareholder as well as the company.”

Once an attorney-client relationship with a shareholder has been established, Rave says, it is unethical for the lawyer to represent someone adverse to that shareholder. In particular, Rave says, he would worry about representing a group of shareholders trying to squeeze out a minority shareholder. “Any lawyer who is going to do that should be very wary of being sued by the shareholder.”

At a small company, the lines of appropriate behavior often “aren’t clear at all” about when the lawyer is representing the company or its individual shareholders, Rave says. He gives the example of dispensing tax advice—which technically goes to the company, although the shareholders “are reaping the benefits of it.”

Joseph DeMaria, an attorney with the law firm Tew Cardenas, says the perils are greater in a small private company because, while the client may be the company, the lawyer’s relationships are with a handful of individuals.

“The typical small corporation ends up being your client because of a personal relationship,” DeMaria says. “There’s a temptation, when a friend asks you to help out, for you not to want to turn it away and give it to some other lawyer.”

In a typical small company, DeMaria notes, the corporate lawyer is going to possess confidential information about the shareholders that will preclude the attorney from aiding any effort to squeeze out one of those shareholders. “You’re going to have confidential information from those shareholders and you’re going to try to use that against them?” he says. “Nah. That’s not going to work.”

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