provides that a lawyer may not represent multiple clients with adverse interests unless each client consents after full disclosure of the conflicts which might arise in their joint representation. Because a corporation acts only through its board of directors, and, here, all but two of FDI's directors are parties to this litigation, very different issues are presented with respect to each of the two conflicts asserted by PBT.
A. Joint Representation of the Corporation and the Directors.
The propriety of the joint representation of a corporation and the directors in a derivative action is a question on which there is some division of authority. The only decision in this Circuit is Otis & Co. v. Pennsylvania R. Co., 57 F. Supp. 680 (E.D. Pa. 1944), aff'd, 155 F.2d 522 (3rd Cir. 1946) (per curiam). In that case, the corporation shared counsel with directors accused of breach of fiduciary duty. Although dealing only briefly with the issue, the district court held that such an arrangement was proper, at least in the absence of "any allegation of breach of confidence or trust" by a party to the attorney-client relationship. 57 F. Supp. at 684.
More recent decisions appear to have adopted the position that directors accused of fraud may not share counsel with the corporation in a derivative shareholder's action. Thus, in Lewis v. Shaffer Stores Co., 218 F. Supp. 238 (S.D.N.Y. 1963), the court held that the corporation could not share counsel with individual directors accused of defrauding the corporation. The court noted that "[under] all the circumstances, including the nature of the charges . . . it would be wise for the corporation to retain independent counsel, who have had no previous connection with the corporation, to advise it as to the position it should take in this controversy." Id., at 240. In Cannon v. U.S. Acoustics Co., 398 F. Supp. 209 (D. Ill. 1975), aff'd in relevant part, 532 F.2d 1118, 1119 (7th Cir. 1976) (per curiam) the district court disqualified counsel from simultaneously representing the corporation and the individual directors accused of fraud, noting not only the conflicting interests of these defendants, but also the possibility that confidences obtained from one client might be used to the detriment of the other.
The nature of the allegations against the directors is but one factor that has been considered in determining the propriety of the joint representation of the corporation and the directors in a derivative action. The Association of the Bar of New York Committee on Ethics, while recognizing that a conflict of interests is always inherent in such arrangements, has indicated that the corporation should obtain independent counsel whenever the corporation elects to take an active role in the litigation. Op. 842, 15 Record N.Y.C.B.A. (1960). By contrast, commentators appear to have taken the broader view that the corporation should always be separately represented in a derivative action. See, e.g., Henn, Corporations § 370 (2d Ed. 1970); 13 Fletcher, Corporations § 6025 (rev. ed. 1970). Note, Independent Representation for Corporate Defendants in Derivative Suits, 74 Yale L.J. 524 (1965).
This Court perceives no basis for relying upon the nature of the charges against the directors for purposes of determining whether they may share counsel with the corporation. Irrespective of the nature of the charges against the directors -- whether it be fraud or negligence -- the interests of the two groups will almost always be diverse. Nor can we readily perceive the need for independent counsel turning upon the question whether the corporation has already elected to pursue an active or passive stance in the litigation, for that very election may have already been tainted by conflict. Moreover, just as it should be recognized that the corporate entity has a legitimate interest in recovering the fruits of past mismanagement or fraud on the part of its own directors, so too, it has a legitimate interest, and perhaps a role to play, in the defense of actions which have been frivolously or even wrongfully brought against its directors. The initial decision then as to what role if any the corporation should take must in the first instance be made completely free from any actual or apparent conflict.
However, because in the instant case the directors have been accused of fraud and the corporation has elected to take an active stance in the litigation, it is enough for now to decide that, under these combined circumstances, the corporation must retain independent counsel.
Independent counsel for the corporation, unshackeled by any ties to the directors, would be in the unique position of having only the corporation's interest at stake. For example, in this case, serious questions have been raised as to whether the corporation has expended funds on behalf of the directors in violation of law.
Under Delaware law, a corporation may advance monies to the directors for their litigation expenses upon a resolution of the Board of Directors and receipt of an undertaking. § 145(e) Del. Corp. Law. A director is required to repay such expenses in the event that he is ultimately "adjudged to have been liable for negligence or misconduct in the performance of his duty to the corporation." Id., at § 145(b). On oral argument of this motion, Mr. Blackford, present counsel for FDI, conceded that the directors had not posted the undertaking required by Delaware law to ensure repayment of their litigation expenses in the event that it is later determined that they were guilty of misconduct in office. Tr. 9/28/77 at 19. Counsel was also unclear whether FDI had passed the required resolution permitting the corporation to advance the directors' litigation expenses. Tr. 9/28/77 at 34-35. He did indicate that he believed there had been no impropriety, although it was unclear whether he had made that judgment on behalf of his director clients, for whom the funds had been paid to him, or his corporate client, who had paid those fees.
PBT further contends that present counsel for FDI disregarded the corporation's interest by bringing frivolous cross-claims against PBT on FDI's behalf.
However, resolution of this issue, along with the issue of the directors' litigation expenses, will have to await the appointment of new counsel for FDI.
Accordingly, this Court will require FDI to retain independent counsel. This Court is next faced with the question of the manner in which such counsel is to be selected.
PBT urges that this Court itself appoint new counsel for FDI, a procedure with some, but scant, support in the case law.
Present counsel for FDI has indicated to the Court that the corporation has in the interim appointed an ad hoc committee consisting of the two directors who are not parties to this litigation. If so ordered by the Court, he reports, this committee will retain new counsel for the corporation and supervise the corporation's role in the litigation.
This Court, while not necessarily approving the procedure suggested by present counsel for FDI, will at this time direct only that the corporation resolve this problem as it would any other issue as to which the existence of interested directors renders the usual corporate decision-making process unavailable. Of course, the directors may request this or any other court with jurisdiction over the matter to relieve them of this duty. It may well be that there are other ways to fashion a solution to this problem. However, at this time, this Court declines to itself appoint counsel or to prospectively pass on the method proposed by present counsel for FDI. It is the duty of the directors, in this as in other matters, to act in the corporation's best interest. If they are disqualified from acting on this or on any other matter, then it is for them, in the first instance, to devise a method to accommodate the need to continue the corporate enterprise while refraining from participating in any corporate decision in which they might have a personal interest. They act, or fail to act, at their peril.
B. Joint Representation of the Insiders and the Outsiders.
PBT points out a second potential conflict inherent in the representation afforded by the Weston-Sills firms. The outsiders may have an interest in proving that they were deceived by the insiders, an interest disserved by joint representation. This Court agrees that the joint representation of these two groups presents a real potential for conflict. However, in contrast to the question of the joint representation of the directors and the corporation, here there are individuals who are capable of informed consent and who can act independently of each other. Thus, it is this Court's role only to ensure strict compliance with the disclosure requirements of DR5-105, supra.
Accordingly, this Court directs the Weston-Sills firms to submit an affidavit stating that it has disclosed to each of its clients the possible conflicts that might arise in its continued representation, and that each of its clients has consented to this arrangement. Cf. United States v. Garafola, 428 F. Supp. 620 (D. N.J. 1977); Thomas F. Campion and Sharon T. Jacobson, Representation of Multiple Defendants in Criminal Cases, (August 9, 1977) (unpublished address to a panel of the Committee on Complex Crimes Litigation, American Bar Association). Perceiving a similar potential for conflict, this Court also directs Lamb, Hutchinson, Chappell, Ryan & Hartung, counsel for defendants Pearl and the Katten firm, to submit a similar affidavit with respect to defendant Pearl and each of the Katten partners.