Considerations for Officers and Directors in Litigating Disputes Involving Closely-Held
Corporations
Simon Bieber, James Camp, Julia Wilkes
Wardle Daley Bernstein Bieber LLP
Introduction
The basic role of directors and officers in closely-held corporations is well-understood. Often in
closely-held corporations, a small number of individuals each act as director, officer, shareholder
and employee. It is not uncommon for internal corporate disputes to arise among a company’s
directors or shareholders including disputes about the operation, direction, and control of the
corporation. Directors and officers must be aware of the court’s recent decisions which (i) limit
joint representation of the corporation and individual directors (and thus limit a director’s right to
counsel of choice) and (ii) comment on a director’s right to access confidential and privileged
information once a dispute arises.
In Rice v. Smith1, the Ontario Superior Court provided a useful summary for directors of the
duties owed by the corporation’s counsel and the conflicting obligations that may arise in an
internal corporate dispute. One group of directors (usually the majority directors) often seek to
be represented by the same counsel as the corporate entity.
However, in the case of an
oppression action brought by the minority director and shareholder, the Court held that there is
an actual conflict between the lawyer’s duties to the corporation and individual directors and
concluded that joint representation is not appropriate. When parties are jointly represented, there
is no privilege as between clients. A lawyer representing a corporation must disclose the
corporation’s privileged and confidential information to all directors, including the minority
directors. Because there is no privilege between clients, a lawyer who is also representing the
1
Rice v. Smith et al., 2013 ONSC 1200 [“Rice”]
-2majority directors in litigation would be obliged to disclose the majority directors’ privileged and
confidential information to the opposing party.
The Court concluded that lawyers should
represent only the corporation or the majority directors to avoid this conflict.
The Court was not required to determine when the minority directors’ right to access privileged
and confidential corporate information ends.
However, the Delaware Court of Chancery
grappled with this question: when can a corporation withhold documentation from some of its
directors on the basis of solicitor-client privilege or litigation privilege.2 The Court held that this
information may be withheld in limited circumstances, when actual adversity between a director
and the corporation is established. At least in Delaware, a director retains his/her unfettered
access to the corporation’s books until it is clear that the interests of the director and the
corporation are “adverse”.
Rice v. Smith
In Rice, there was a typical closely-held corporation in which three individuals were each
officers, directors, shareholders and employees. A dispute arose over about how to operate the
corporation and the future direction of the corporation. Two individuals shared one vision for
the corporation while the third disagreed. The divergence in views caused a breakdown in the
individuals’ relationships and, inevitably, the minority director/shareholder pursued an
oppression action against the majority directors/shareholders and the corporation. The core
dispute was one amongst individuals; however, the corporation was named a defendant because
the plaintiff sought remedies that would affect the corporation (such as winding up). A single
lawyer was appointed to act for the corporation and individual defendants. The plaintiff brought
a motion to remove the lawyer and disqualify him from acting on conflict of interest grounds.
2
Kalisman et al. v. Freedman et al., CA No. 8447-VCL [“Kalisman”]
-3The Court began its determination of whether actual or potential conflicts exist by considering
the nature of the relationships between the parties. The law is settled that a lawyer acting for a
director or group of directors owes duties to that individual or group, including a duty of
confidentiality and obligation to protect privileged information. Amongst a group of directors
who are jointly represented, there is no privilege.
Determining what duties are owed to the corporation is more complicated. A corporation has a
separate legal identity from its officers, directors, and shareholders; however, the corporation can
only act through its directors and officers. While a lawyer acting for a corporation owes its
duties to the corporation, the lawyer receives instructions from the officers or directors. The
Court stressed that a lawyer acting for the corporation owes a duty to, must report to, and must
seek instructions from the entire board - not from the directors that form the majority. In fact,
the Court stated that it is a “fundamental error for a lawyer to regard a corporation as being
synonymous with its majority directors and shareholders”3. Thus all directors have an equal
right of access to confidential and privileged corporate information.
This information is
necessary for all directors, including minority directors, to fulfill their fiduciary duties to the
corporation.
To favour a particular corporate faction is a disregard of a lawyer’s duties owed to the
corporation. Thus, the majority directors must understand that a lawyer cannot choose to share
privileged and confidential information and seek instructions from that majority. In Rice, the
lawyer fell into this trap, and the Court held that this lawyer had an actual conflict.
This problem is a simple illustration of the basic agreement in a joint retainer: there is no
privilege among clients and information cannot be kept confidential as among clients. On the
3
at para. 26.
-4one hand, the entire board is the lawyer’s client; on the other, the majority directors are the
lawyer’s client. The latter group will share information with their counsel including litigation
strategy. Counsel is obliged to communicate this privileged information to the entire board,
including the opposing, minority directors.
The Court provided three other examples of actual conflicts4 that may arise in dealing with
internal corporate disputes:
1.
The corporation pays the legal fees of the lawyer acting for the majority of the
directors.
2.
Legal opinions are provided to the majority directors only.
3.
Litigation-related documents, reports and information are provided only to the
majority directors.
Each of these actual conflicts arises from the erred belief that the corporation can be equated
with the majority of its directors or shareholders. If the majority directors/shareholders’ lawyer
is paid for by the company, there is a conflict - the minority shareholders would pay a portion of
the legal fees of the opposing party.
Since the minority directors and shareholders are entitled to access privileged corporate
information, there is a clear problem highlighted by the final two examples. In litigation, no
lawyer would want to (or could) provide its opinions and litigation-privileged documents to the
opposing parties, namely the minority directors.
In Rice, the Court determined that it could not permit this type of joint representation and
disqualified the lawyer from acting for any of the defendants. If there is an internal corporate
4
adopted from Mottershead v. Burdwood Bay Settlement Co., [1991] BCJ No. 2554 (BCSC).
-5dispute and the corporation requires representation, it must be independent. The opposing
parties must agree on a corporate lawyer or, if they cannot agree, they can apply to the Court and
request that a judge appoint counsel. If the appointed lawyer is unable to obtain instructions
from a board at an impasse, the lawyer must seek instructions from the Court.
In this motion to remove the corporate solicitor as counsel of record, the minority
director/shareholder did not demand access to corporate information.
The Court was not
required to determine the limits on the director’s right to access the corporation’s confidential
and privileged information. However, the Delaware Court of Chancery recently addressed this
issue which may inform a decision reached by the Ontario courts if this issue arises.
Kalisman et al. v. Freedman et al.
The Delaware Court of Chancery was asked to determine whether and when a director’s right to
access privileged corporate information ends (or when a corporation can withhold documentation
from a director on the basis of solicitor-client privilege or litigation privilege).
Directors of corporations are entitled to nearly unfettered access to the corporation’s books,
records and any other information that may be privileged until such time as the director and
corporation are “adverse”. The Court gave little guidance on when there is sufficient “adversity”
such that a director would no longer be entitled to privileged information; however, even as the
interests of a director and the company began to diverge, the Court found that the director was
still entitled to sensitive privileged information.
-6The plaintiff, Kalisman, was a director of the defendant Morgans, a large public company. He
was a founding member of OTK Associates, the co-plaintiff and Morgans’ largest shareholder.
The co-defendants were the other members of Morgans’ Board of Directors.
The company formed a Special Committee to evaluate strategic alternatives for Morgans. The
members of the committee (including Kalisman) developed a range of alternatives, but the
process stalled without recommending any transactions to the Board.
After OTK Associates announced that it would nominate a slate of replacement directors and
make a number of business proposals at the AGM, the Committee resumed its consideration of
strategic alternatives - but Kalisman was excluded from these deliberations. When he asked,
Kalisman was told by counsel that no transactions were being considered.
However, Kalisman was soon invited to attend special meetings of the Board and the Committee
to review, consider and approve a recapitalization. The proposal involved a transaction with
investors who were linked to another Morgans’ director. Both the Committee and Board voted
in favour of the recapitalization. Kalisman filed a complaint with the Court to challenge the
approved recapitalization.
Kalisman requested documentary production from Morgans. Ten days after his initial request,
Morgans refused to provide the privileged information asserting both solicitor-client and
litigation privilege. Kalisman brought a motion asserting that the defendants could not invoke
those privileges as he is a director.
The Court held that a director’s right to information, including privileged materials, is essentially
unfettered. It reasoned that the law imposes fiduciary duties on directors, and they must have
access to the corporate books and records, in order to discharge those duties.
-7The Court stated that directors are joint clients of the Company’s counsel, each with equal rights
to access documents and information. Thus, directors cannot assert privilege against one another
if they subsequently become adversaries.5
The Court noted three recognized limitations to disclosure of privilege materials to a director:
1.
where there was an agreement among parties respecting future events (an ex ante
agreement);
2.
where a special committee has separate counsel, the full board is not entitled to access
solicitor-client privileged documents (at least while the Committee’s work is ongoing); and
3.
where sufficient adversities exist between the director and the corporation. The director
would then no longer have a reasonable expectation that he was a client of the Company’s
counsel.
The Court concluded that the third limitation prevented Kalisman from accessing privileged
materials from the date of the meetings that approved the recapitalization onwards. But before
that time, the Court held that Kalisman’s access to privileged materials should not be restricted.6
While this dispute arose in the context of a large publicly-held company, the facts reflect the
usual circumstances in a closely-held corporation. Kalisman, the minority director seeking
access to information, was also the owner of the corporation which was Morgans’ largest
shareholder. The Court addressed the effect of this dual role on Kalisman’s entitlement to access
privileged corporate information.
Morgans submitted that Kalisman’s access to privileged
information should be limited because he could misuse the sensitive information in his role as a
5
To our knowledge, no Canadian court has concluded that directors are joint clients of the corporate counsel. If this
were true, a corporation’s counsel could not act in litigation brought by a director, as counsel would be
acting against a former client. Nonetheless, the Court’s reasoning that one group of directors cannot assert
privilege over corporate information is supported by Rice v. Smith.
6
This reasoning applied equally to solicitor-client and litigation privilege.
-8shareholder. The Court disagreed. It refused to presume that Kalisman would misuse the
information; instead, it reasoned that a director must have access to the information necessary to
fulfil his fiduciary duties to the corporation. However, the Court noted that it might restrict
access to privileged information from an earlier date if the Company had concrete evidence that
the director would use the privileged information improperly (and in breach of his fiduciary
duties to the corporation).
This decision attempts to clarify the point in time at which directors are – and are not – entitled
to access to corporate information that would otherwise be privileged. There are often instances
when the interests of the corporation and a director begin to diverge, but this case highlights that
a simple/potential divergence of interest is not enough to preclude a director from accessing
privileged material. Rather, the threshold is actual adversity. This distinction is important to
keep in mind for directors in dealing with sensitive corporate matters at a time when directors
have different and, perhaps, competing interests that may not be aligned with the interests of the
corporation.
In Ontario, courts have placed limits on a director’s right to access corporate information once
the director and corporation are engaged in litigation. In Dublin v. Montessori Jewish Day
School of Toronto, the Court stated that:
“Dealing then with the first point of whether board communications with a lawyer
for advice about a member of the board categorically cannot be privileged
because a board member is normally entitled to disclosure of all board
communications, the decision of Ground, J. in Livent Inc., Re, 1999 CarswellOnt
4838 (Ont. S.C.J.) addresses this point. Ground, J. refers to his decision Livent
Inc., Re, and applies it in Hamilton v. Pietrobon, [2005] O.J. No. 5212 (Ont.
S.C.J.).
In Livent Inc., Re, in an reductio ad absurdum argument, Ground, J. points out
that it would lead to a ludicrous result if a director as litigant could negate his or
her corporation's privilege in precisely the circumstances when the privilege is
-9necessary; namely, when the corporation is seeking confidential legal advice
about its legal relationship with the particular director.
I do not dispute that a director is normally entitled to full disclosure of
communications made to and by the board of directors of which he or she is a
member. However, it makes sense to qualify that entitlement in circumstances
where the subject matter of the communication is legal advice about the
relationship between the director and the corporation.”7
In this circumstance, the Court granted a limited exception to the director’s usual unfettered
access to corporate information. This is a clear circumstance where actual adversity existed
between the corporation and the individual director. The factual circumstances of each case will
dictate the point at which actual adversity exists and access to information should cease.
Conclusion
Directors and shareholders must consider that a lawyer representing a corporation has a duty to
share confidential and privileged corporate information with the entire board of directors. It is
thus unacceptable for a lawyer to jointly represent one group of directors and the corporation because clients cannot assert privilege amongst themselves, the lawyer will be obliged to share
privileged information with the minority directors who are the opposing party.
When an internal corporate dispute arises, directors should attend to the Court’s conclusions that,
due to actual conflicts, individual directors (or groups of directors):
1. Should seek independent representation (separate from corporation’s counsel);
2. Should not use corporate funds to pay for their independent counsel; and
3. Maintain some right of access to confidential and privileged corporate information,
including legal opinions and litigation-related documents and reports.
7
2007 CarswellOnt 1663, 85 OR (3d) 511 (SCJ).
- 10 Both Delaware and Ontario courts have concluded that, at some point, a director’s unfettered
access to confidential and privileged corporate information ends. In Delaware, once a minority
director seeking to access privileged information has sufficient adversity with the corporation
such that the director no longer has a reasonable expectation that he is entitled to receive
corporate information or advice from corporate counsel. As directors continue to seek access to
corporate information, Ontario courts will likely be asked to address when this point of
“adversity” has been reached.