Attorneys are generally aware that they are not permitted to represent more than one party in a matter in which the parties’ interests may be, or may become, adverse without first obtaining the informed consent, in writing, from each party. Indeed, California, like most (if not all) American jurisdictions, specifically prohibits the practice. (California Rules of Professional Conduct, Rule 3-310). Litigators routinely prepare conflict waiver letters for multiple clients on the same side of lawsuits. Transactional and corporate counsel often – but not invariably – provide conflict waiver letters when they know they will, or think they might, find themselves in a potential conflict situation. In the latter case, they generally use forms of conflict waiver letter that are tried and true and that impose upon the attorney the obligation to advise all potentially affected clients if there is any change in the attorney’s judgment that he or she may properly continue to represent potentially adverse parties (i.e., if a non-waivable conflict surfaces, or if the attorney feels, for whatever reason, no longer able to represent one or more parties as vigorously as he or she represents one or more other parties). The clients sign off on the letter and the attorney files it away.

Over the past several years we have seen variations of the following scenario give rise to litigation, avoidable expense, and severely weakened negotiating positions: Law firm (“LF”) undertakes the representation of a corporation, partnership or LLC (“Company”) in which there is a small number of significant equity holders. Letters are prepared by LF to the equity holders pointing out that LF represents Company, not the individual equity holders. Everybody signs off. Smith and Jones, the two principle equity holders, later have a falling out. Smith controls or influences a sufficient number of smaller equity holders to determine Company’s actions. Smith consults with LF regarding his problems with Jones and LF provides advice on how to remove Jones from the board, from his officer position, from his employment, or all three. No one advises Jones of the problem (or at least no one advises Jones of the plan to remove him) until Company’s action is complete or virtually complete.

Prior to the falling out, LF has provided all sorts of counsel not only to Company but to its principal equity holders. It has specifically advised Jones with respect to the establishment of a trust into which to pour his interest in Company if something happens to him. It has given him advice with respect to a relative who has gotten into trouble over a DUI or drug bust. It has advised him in connection with his concerns about personal liability for his actions in connection with Company’s business. It may have provided counsel to him (as well as provided counsel to Smith and the entity) in connection with the modification of his contractual relationships with Company. Whether or not LF or any of its lawyers have thought about it, the provision of such legal services on matters of individual concern create a personal attorney-client relationship between LF and Jones.

Now Jones is clearly adverse to Smith, the minor equity holders and, though it may not yet have sunk in for Jones, Company. He seeks advice from LF. LF reminds him that it represents Company and not Jones personally. LF tells Jones (in the nicest way possible) to get his own counsel. Jones’s new counsel sends LF a demand letter including the demand that LF withdraw from representing anyone (including Company), and the charge that Jones, personally, had been LF’s client and that in advising Smith and Company in connection with the process of removing Jones (without first notifying Jones), LF has violated the rules of professional conduct and its fiduciary duties to Jones.

Our experience in these sorts of matters teaches that if LF fails to withdraw voluntarily (and this is generally the law firm’s initial reaction), Jones’s new counsel will be successful in having LF disqualified. The absence of a written engagement letter with Jones is irrelevant. The fact that Company may have paid for the time LF spent advising Jones on his personal matters is irrelevant (and, indeed, even if LF never billed for that time, that fact is irrelevant). If LF rendered legal advice to Jones, despite its prior letter, it has entered into an attorney-client relationship with Jones and owes the same duties it would owe if it had an engagement letter with Jones and/or if it had never represented the entity or anyone else associated with the entity. Whether Jones could prevail against LF on a claim for breach of fiduciary duty or malpractice depends upon many factors including whether Jones can prove damages and prove that LF’s actions or inactions were the proximate cause of those damages (a tough issue under California law). But LF will be unable to represent anyone against Jones and may well find itself a defendant in Jones’s case.

The principal victim of LF’s failure is Jones. He may not have thought a great deal about the ethical issues, but he almost certainly regarded LF as his lawyer no less than Smith’s lawyer. He almost certainly thought that if there were a dispute between Smith and himself (however that dispute played out as a technical matter), LF would represent neither side. Instead, LF participated in a secret (at least as to Jones) process to disadvantage Jones to the advantage of Smith. But LF and the entity will also suffer. Not only will LF have to withdraw (or get disqualified) in the event of litigation (and the entity will not be enthusiastic about paying attorney’s fees to oppose the disqualification motion), but Company will bear significant attorney’s fees in getting a new law firm up to speed. If Company tries to settle with Jones – and uses LF to represent it in settlement discussions – LF will have its own interests to consider as it conducts such settlement discussions. Indeed, LF may well have a conflict between its own interests (which are to reach a comprehensive agreement with Jones) and Company’s interests (which will be to minimize the cost of getting rid of Jones).

In other words, this is a happy situation for no one. The responsibility for avoiding it is principally that of the company’s law firm. When the law firm says it represents the entity and not any of the individual equity holders, it should mean what it says. It should avoid offering any advice (other than a referral) to individual equity holders, officers or directors on any issue that is not exclusively the company’s issue. E.g., don’t help them set up wills or trusts, don’t counsel them when they or their family members get picked up for criminal or administrative infractions, don’t counsel them on other business ventures. If the company’s lawyers become involved in such matters, they have established attorney-client relationships with the individuals.

On the flip side, the sophisticated partner/shareholder/founder/unit holder will be best served by having his or her own counsel at every critical juncture in the process of establishing the entity and the individual’s rights and responsibilities. This process is not simply adopting (or adapting) some sort of neutral boilerplate set of agreements. Starting (or joining) a business that requires a commitment of money, sweat, blood and/or time with the expectation of equity and/or control rather than simply payment for labor is a complicated business transaction in which the participants have adverse interests – regardless of how much they love each other at the moment. If you have to ask the question in the title above, chances are the answer is, “Not you.”