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July 26, 2017

Legal Update
William L. Boesch

Operating agreement and alleged “covert” representation held sufficient to support minority shareholders’ claims against corporate lawyers

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The Massachusetts Appeals Court has reinstated a lawsuit brought by minority shareholders in a closely held medical-technology company against lawyers for the company at WilmerHale and another firm, holding that even though the shareholders had no contact with the lawyers and never relied on their advice or services, they could still sue the lawyers for their role in a scheme to alter the company’s structure. In the July 21 decision (Baker v. Wilmer Cutler Pickering Hale & Dorr LLP), the Appeals Court rejected—at least preliminarily—the lower court’s application of a number of established principles that normally limit the scope of an organizational lawyer’s duties to non-clients, suggesting that under the particular circumstances alleged in this case, the limiting principles may not apply.

In simple outline, Robert Allison and Elof Eriksson formed a company to market and sell wound-healing technology that Eriksson had invented. Allison had a 25% interest in the company, which was organized as an LLC, and was made president and CEO; Eriksson had a 75% interest. The LLC’s operating agreement expressly established various fiduciary duties for members and protections for Allison as minority member, including a requirement that he consent to any dilution of his interest.

Over several years beginning in the mid 2000’s, the company’s financial performance declined, and Allison and Eriksson disagreed about how to remedy the situation. Eriksson was willing to invest more money, but only in return for more equity; Allison was unwilling to invest more, but did not want Eriksson’s equity share to increase. In November 2011, Allison resigned as head of the company.

In early 2012, Eriksson and the new CEO engaged two lawyers—one of them Eriksson’s daughter—to help with efforts to resolve the stalemate between Eriksson and Allison. The lawyers arranged for an independent appraisal of the company, and then drafted an offer from Eriksson, based on the valuation, to purchase Allison’s share. Allison rejected the offer.

The lawyers and Eriksson then looked to a Massachusetts statute that generally authorizes majority members in an LLC to decide to merge the entity into another company. They created a new LLC, with a different and less-restrictive operating agreement, and merged the existing company into it—all without Allison’s knowledge or agreement; indeed, he was unaware of the lawyers’ involvement. In the ensuing months, Eriksson invested in the new company and obtained equity, which reduced Allison’s interest.

Allison sued Eriksson, and later filed a separate suit against the lawyers. The case against Eriksson went to a bench trial in April 2016. The trial judge found that Eriksson had breached his fiduciary obligations to Allison under the original LLC operating agreement “when he surreptitiously retained [the lawyers] to represent [the company] and then adopted [their] advice” on the merger, which “effectively unilaterally amend[ed] the operating agreement” and deprived Allison of his rights. On the other hand, the court found, Allison’s position in the negotiations over the company’s future was itself inconsistent with his fiduciary obligations to Eriksson, and put him and the company in an untenable “predicament.”

For this reason, the court rejected Allison’s demand that the merger be undone and his interest restored. Instead, the court was willing only to make a slight adjustment in Allison’s interest and to require Eriksson to make certain revisions to the new company’s operating agreement.

Meanwhile, another superior court judge had granted a motion by the lawyer-defendants in Allison’s other suit to dismiss the case entirely for failing to state a claim. The court held that none of Allison’s claims against the lawyers—for breach of fiduciary duty, for aiding and abetting (and/or conspiring in) Eriksson’s breach of his fiduciary duties, and for unfair or deceptive conduct in violation of Mass. Gen. L. ch. 93A—could survive on the facts alleged. As lawyers for the company, the court agreed, the lawyers could owe no fiduciary duty to a minority member—Allison—who never interacted with or purported to have relied on anything the lawyers did—particularly where that member was in active conflict with the company and the majority member, Eriksson. The aiding-and-abetting and conspiracy claims too were facially invalid, the court held, because the lawyers had done nothing more than advise their client about the legality of the potential merger. Even if that advice turned out to be wrong—because the merger was a breach of Eriksson’s fiduciary duties—that alone would not support a claim that the lawyers were tortious participants in Eriksson’s breach. Finally, the court agreed that there could be no valid Chapter 93A claim against the lawyers in the context of a private intra-company dispute in which the lawyers had no dealings with the plaintiff.

In its July 21 decision, the Appeals Court overturned each of these rulings. It held that under the particular factual circumstances alleged here—especially the existence of an operating agreement explicitly granting protective rights to Allison as minority member, and the “secrecy” under which the lawyers’ work was conducted—none of these ordinary limiting principles applied—or at least, none applied so clearly as to permit dismissal of the complaint at the outset. The Court acknowledged that a lawyer for a closely held company ordinarily owes duties to individual shareholders or members only in circumstances where he knows the latter are personally relying on his advice. Further, such a duty will only be imposed where doing so does not create a conflict with the lawyer’s duties to the entity itself.

Here, the Appeals Court reasoned, the broad minority rights granted under the operating agreement should have entitled Allison to rely on the lawyers to protect those rights—even in the face of an intra-company conflict—and the lawyers should not be able to use the concealment of their role to defeat such a claim. Further, the Court read the complaint to allege a greater level of lawyer participation in Eriksson’s scheme than ordinary advice to a client, and in this view the added role would support claims of aiding-and-abetting and conspiracy. Finally, while the matter of Chapter 93A’s applicability in this context was indeed a “novel and close question,” the alleged role of the attorneys arguably took the matter beyond a purely private dispute into the realm of public “trade or commerce,” thereby implicating the statute.

Notwithstanding the Appeals Court’s efforts to restrict its reasoning to the particular facts and allegations of this case—and to the relatively deferential standard of review appropriate on an initial motion to dismiss a complaint—there is some reason for concern that the decision not lead to an erosion of important principles of Massachusetts law that reasonably limit the obligations and potential liabilities of lawyers representing closely held corporations and similar entities. Further developments in this and other similar cases will bear close observation.