State Bar of Arizona Ethics Opinions

02-06: Corporate Representation; Multiple Representation; Lawyer-Client Relationship; Confidentiality; Conflicts of Interest
9/2002

A lawyer may form a business entity for various individuals and be counsel only for the yet-to-be-formed entity, if appropriate disclosures and consents occur. Alternatively, a lawyer may represent all of the incorporators, collectively, with appropriate disclosures.

FACTS[1]

Lawyer is a business law practitioner who currently represents several businessmen in various matters.  The existing clients ask the lawyer to form a new entity corporation for them and to be counsel only for the entity. 

QUESTIONS PRESENTED

  1. May a lawyer represent a yet-to-be-formed entity during formation?
  2. Can a lawyer represent the prospective entity without being deemed to also represent the incorporators?
  3. If so, what disclosures must the lawyer make to the constituents to clarify who is the client?

RELEVANT ETHICAL RULES

ER 1.6.            Confidentiality of Information

(a)        A lawyer shall not reveal information relating to representation of a client unless the client consents after consultation, except for disclosures that are impliedly authorized in order to carry out the representation, and except as stated in paragraphs (b), (c) and (d) or ER 3.3(a)(2).

(b)        A lawyer shall reveal such information to the extent the lawyer reasonably believes necessary to prevent the client from committing a criminal act that the lawyer believes is likely to result in death or substantial bodily harm.

(c)        A lawyer may reveal the intention of his client to commit a crime and the information necessary to prevent the crime.

(d)        A lawyer may reveal such information to the extent the lawyer reasonably believes necessary to establish a claim or defense on behalf of the lawyer in a controversy between the lawyer and the client, to establish a defense to a criminal charge or civil claim against the lawyer based upon conduct in which the client was involved, or to respond to allegations in any proceedings concerning the lawyer's representation of the client.

ER 1.7.            Conflict of Interest:  General Rule

(a)        A lawyer shall not represent a client if the representation of that client will be directly adverse to another client, unless:

(1)            the lawyer reasonably believes the representation will not adversely affect the relationship with the other client; and

(2)            each client consents after consultation. 

(b)        A lawyer shall not represent a client if the representation of that client may be materially limited by the lawyer's responsibilities to another client or to a third person, or by the lawyer's own interests, unless:

(1)            the lawyer reasonably believes the representation will not be adversely affected; and

(2)            the client consents after consultation.  When representation of multiple clients in a single matter is undertaken, the consultation shall include explanation of the implications of the common representation and the advantages and risks involved.

* * * *

ER 1.13.            Organization as Client

(a)        A lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents.

(b)        If a lawyer for an organization knows that an officer, employee or other person associated with the organization is engaged in action, intends to act or refuses to act in a matter related to the representation that is a violation of a legal obligation to the organization, or a violation of law which reasonably might be imputed to the organization, and is likely to result in substantial injury to the organization, the lawyer shall proceed as is reasonably necessary in the best interest of the organization.  In determining how to proceed, the lawyer shall give due consideration to the seriousness of the violation and its consequences, the scope and nature of the lawyer's representation, the responsibility in the organization and the apparent motivation of the person involved, the policies of the organization concerning such matters and any other relevant considerations.  Any measures taken shall be designed to minimize disruption of the organization and the risk of revealing information relating to the representation to persons outside the organization.  Such measures may include among others:

(1)            asking reconsideration of the matter;

(2)            advising that a separate legal opinion on the matter be sought for presentation to appropriate authority in the organization; and

(3)            referring the matter to higher authority in the organization, including, if warranted by the seriousness of the matter, referral to the highest authority that can act in behalf of the organization as determined by applicable law.

(c)        If, despite the lawyer's efforts in accordance with paragraph (b), the highest authority that can act on behalf of the organization insists upon action, or a refusal to act, that is clearly a violation of law and is likely to result in substantial injury to the organization, the lawyer may resign in accordance with ER 1.16.

(d)        In dealing with an organization's directors, officers, employees, members, shareholders, or other constituents, a lawyer shall explain the identity of the client when it is apparent that the organization's interests are adverse to those of the constituents with whom the lawyer is dealing.

(e)        A lawyer representing an organization may also represent any of its directors, officers, employees, members, shareholders or other constituents, subject to the provisions of ER 1.7.  If the organization's consent to the dual representation is required by ER 1.7, the consent shall be given by an appropriate official of the organization other than the individual who is to be represented, or by the shareholders.

OPINION

1.         Can a lawyer represent an entity that does not yet exist?

Yes, as long as the incorporators understand that they are retaining counsel on behalf of the yet-to-be-formed entity and will need to ratify this corporate action, nunc pro tunc, once the entity is formed.  According to ER 1.13(a), a lawyer may represent an "organization."  The Comments to the Rule explain that an "organizational client is a legal entity, but it cannot act except through its officers, directors, employees, shareholders and other constituents. . . . The duties defined in this comment apply equally to unincorporated associations." 

An "organizational client" or "entity" can be a separate client.  For purposes of the ethical analysis, this Opinion will refer to "corporations" as the entity at issue, but the analysis also is applicable to other legal entities.

To determine whether a lawyer ethically may represent a yet-to-be-formed corporation, the analysis must include a review of Arizona corporate and partnership statutes.  A.R.S. § 10-203 provides:

A.        Unless a delayed effective date is specified in the articles of incorporation, incorporation occurs and the corporate existence begins when the articles of incorporation and certificate of disclosure are delivered to the commission for filing.

Under this statute, a corporation does not exist as a separate legal entity until its articles of incorporation are filed with the Corporation Commission.[2]  Section 10-204 of the Arizona Revised Statutes further cautions that individuals who attempt to transact business as a corporation, knowing that no corporation exists, will be jointly liable for their actions.  Presumably, however, a newly formed corporation may ratify pre-incorporation acts of the corporation, nunc pro tunc.

A decision from Wisconsin specifically holds that a lawyer hired to form an entity can represent the to-be-formed entity, not the incorporators, and the "entity" rule applies retroactively.  Jesse v. Danforth, 485 N.W.2d 63 (Wis. 1992).   This view would be consistent with the "entity" theory of representation, under ER 1.13(a).    The "entity" theory holds that a lawyer may represent the corporation and does not, necessarily, represent any of the constituents that act on behalf of the entity - even if it is a closely held corporation.   See, e.g., Skarbrevik v. Cohen, England & Whitfield, 282 Cal. Rptr. 627 (Cal. App. 1991); Bowen v. Smith, 838 P.2d 186 (Wyo. 1992). 

An alternative view is the "aggregate" theory in which the lawyer is found to represent the incorporators/constituents collectively as joint clients.  See Griva v. Davison, 637 A.2d 830 (D.C. 1994).  Under the aggregate theory, a lawyer represents multiple co-clients during formation of the corporation and then once the entity is formed, the clients must determine whether the lawyer will continue to represent all of the constituents and the entity, or just the entity.  Who a lawyer may represent depends upon whether the lawyer's independent professional judgment would be materially limited because of the lawyer's duties to another client or third person.  See ER 1.7(b); Matter of Shannon, 179 Ariz. 52, 876 P.2d 548 (1994).  As discussed below in Section 3, there are specific disclosures that a lawyer must make to co-clients, in order for them to consent to a joint representation. 

Thus, a lawyer may represent an entity during the formation process, as long as the constituents who are acting on behalf of the yet-to-be-formed entity understand and agree to the entity being the client.

2.         Can a lawyer represent only the yet-to-be-formed entity and not the constituents?

Who a lawyer represents depends upon the reasonable perceptions of those who have consulted with the lawyer.  In re Petrie, 154 Ariz. 295 (1987).  When two or more individuals consult with a lawyer about forming an entity, it is the responsibility of the lawyer at that initial meeting to clarify who the lawyer will represent.   ER 1.13 provides that a lawyer may represent an entity and the Rule suggests that the lawyer will not automatically be considered counsel for the constituents because paragraph (e) of the Rule provides:

A lawyer representing an organization may also represent any of its directors, officers, employees, members, shareholders or other constituents, subject to the provisions of ER 1.7.  If the organization's consent to the dual representation is required by ER 1.7, the consent shall be given by an appropriate official of the organization other than the individual who is to be represented, or by the shareholders.

In Samaritan v. Goodfarb, 176 Ariz. 497, 508, 862 P.2d 870 (1993), the Arizona Supreme Court confirmed that a lawyer representing an entity does not automatically represent the constituents.  Therefore, unless a lawyer wants to be counsel to all of the incorporators and the entity, the lawyer should specify that the lawyer does not represent the constituents collectively - the lawyer only represents the entity.  If an engagement letter or oral representation by the lawyer suggests that the constituents are represented as an aggregate, then the lawyer will have ethical obligations to each constituent.  Aggregate representation also is ethically proper if the disclosure to each client includes an explanation that the lawyer may have to withdraw from representing each client if a conflict arises among the clients.

3.         What disclosures should a lawyer make to the incorporating constituents to obtain their informed consent to the limited representation of the entity?

         The underlying premise of the conflict Rules is loyalty to clients. Where a lawyer's independent professional judgment for a client is materially limited due to anything or anyone, a conflict may exist.  Thus, in order to avoid inadvertent conflicts caused by misunderstandings of constituents in corporate representations, it is crucial for lawyers to specify exactly who they represent, who they do not represent, and how information conveyed to the lawyer by constituents of an entity client will be treated, for confidentiality purposes.   The Restatement Third, The Law Governing Lawyers, Comment b to § 14 provides in part:  "A lawyer may be held to responsibility of representation when the client reasonably relies on the existence of the relationship. . . ." 

See also Comment f:  "[A] lawyer's failure to clarify whom the lawyer represents in circumstances calling for such a result might lead a lawyer to have entered into client-lawyer representations not intended by the lawyer."

Therefore, it is crucial that a lawyer specify in the engagement agreement if the lawyer is not representing the constituents of an entity client.

Even if the engagement letter specifies that the constituents are not clients, lawyers still should regularly caution constituents that they are not clients - particularly when they consult with counsel.  Lawyers who represent entities also must be aware of the entity's potential fiduciary duties to the constituents, so that the lawyer does not run afoul of those statutory or common law obligations.  For instance, there are cases that have held that lawyers may have fiduciary duties to non-clients, depending upon whether the entity represented had fiduciary duties to the third parties.  See Fickett v. Superior Ct. of Pima Cty, 27 Ariz. App. 793, 558 P.2d 988 (1976); Matter of Estate of Shano, 177 Ariz. 550, 869 P.2d 1203 (App. 1993) (lawyer disqualified as counsel to administrator for an estate because of prior representation of one beneficiary and derivative duty of neutrality to all beneficiaries).  Accordingly, lawyers for entities should be mindful of this potential responsibility and that a derivative fiduciary duty to constituents may cause a conflict of interest for the lawyer.

The engagement letter also should explain that once the entity is created, the constituents agree to ratify the lawyer's services, nunc pro tunc on behalf of the entity.

With respect to confidentiality obligations, lawyers should specify how information conveyed to the lawyer will be treated for confidentiality purposes.  If the firm is representing only the entity, constituents must be advised that their communications to the lawyer will be conveyed to the other decision-makers for the entity and are not confidential as to the entity.  The information is confidential, however, according to Rule 1.6(a), to the "outside world."  Similarly, information shared by one co-client that is necessary for the representation of the other joint clients will be shared with the other co-clients because there is no individual confidentiality when a joint representation exists. 

Finally, if the lawyer has chosen to represent multiple clients, including the constituents and the entity, the lawyer should explain, at the beginning of the joint representation, that in the event that a conflict arises among the clients, the lawyer most likely will need to withdraw from representing all of the co-clients.  However, some commentators, including the Restatement Third, note that the engagement agreement may provide that in the event of a conflict, the lawyer may withdraw from representing one of the co-clients and continue to represent the remaining clients.  The usefulness of such provisions was recently demonstrated in In re Rite Aid Corp. Securities Litigation v. Grass, 139 F. Supp. 2d 649 (E.D. Pa. April 17, 2001), where the court permitted the law firm to withdraw as counsel for one of the executives of Rite Aid and continue as counsel for the entity in a class action suit, primarily because the engagement agreement provided for such action. 



[1] Formal Opinions of the Committee on the Rules of Professional Conduct are advisory in nature only and are not binding in any disciplinary or other legal proceedings.  Ó State Bar of Arizona 2002

[2] Partnerships, however, are not required to make a filing to establish their existence; a partnership exists once there is an "association of two or more persons to carry on as co-owners [of] a business for profit. . . whether or not the persons intend to form a partnership."  A.R.S. § 29-1012.A.