This article first appeared in the 2008 Lexpert®/American Lawyer Media Guide to the Leading 500 Lawyers in Canada.
In the past 10 years we have seen a dramatic increase in the number of lawsuits against all professionals, including lawyers, directors and officers. Ten years ago it was unusual for a director to be sued in any context and rare for there to be coverage disputes under directors and officers insurance policies. In today’s world it is a very different story. Since the collapse of Enron, it is almost a matter-of-course for directors and officers to be included as defendants when a company is sued.
There have been similar developments with respect to the liability of lawyers, both in private practice and in-house, in Canada and the United States. In recent years in Canada we have seen a number of significant settlements of claims involving law firms. Torys recently settled the Hollinger claim, involving allegations of failure to act in the company’s best interests, for US$30.25 million, Goodmans was involved in the settlement of the Dylex case, where the total settlement was C$32 million, and the YBM class action settled for C$110 million. In addition, in 3464920 Canada Inc. v. Strothers1, a majority of the Supreme Court of Canada found Davis & Company to be vicariously liable for breaches of fiduciary duty committed by one of its former partners.2
It is the subject of debate as to whether the increase in claims against professionals relates to a general deterioration of practice standards, or rather to an increased scrutiny of the activities of lawyers, directors and officers by both courts and activist shareholders. Irrespective of the answer, it is unreasonable for inhouse counsel to believe that they will avoid the increasingly hostile claims-environment facing all lawyers. Potential liability exposure mounts as more legal work is being brought in-house3 and employed lawyers are increasingly forced to deal with complex legal questions.4
This paper will explore the potential liability of in-house counsel, both in their roles as directors and officers, as well as employed lawyers for companies, with a particular focus on the unique ethical concerns that face lawyers acting in this dual capacity. The final section of the paper will provide a brief consideration of the sources of indemnity that may be available to in-house counsel from various types of insurance policies.
II. Liability of Lawyers Acting as In-House Counsel and as Corporate Directors
A comprehensive discussion of the liability of directors is beyond the scope of this paper. Instead, we will focus on some of the liability issues facing in-house counsel when acting as a director of their employing corporation. Lawyers who are also directors or officers of a corporation may have duties to various entities: first and foremost, to the corporation, including its board of directors and its shareholders, but also to the corporation’s employees, to outside third parties, and to regulatory bodies, such as the relevant Securities Commission that governs the corporation. There are also obligations to the Law Society to which corporate counsel are members.
(a) Lawyer as Director: The Existence of a Higher Standard
While relatively few cases address this issue, two decisions rendered by the Alberta Securities Commission and the Ontario Securities Commission (OSC) suggest that a higher standard of scrutiny will be applied to a lawyer when acting as a director of a corporation, though in both cases the defendant lawyer was found to have not acted improperly.
In Cartaway Resources Corp.,5 the Alberta Securities Commission prosecuted a number of directors, officers and employees of Cartaway for failing to disclose a material change in the affairs of the company and for issuing press releases containing misrepresentations. One such respondent was William DeJong, a director of Cartaway and legal counsel to the company since 1994.
In assessing the relative responsibility of DeJong, the Alberta Securities Commission commented:
In order to determine what an individual director’s obligations are under any circumstances, it is necessary to consider a number of factors that will vary with each director, including: the director’s role with the company; the director’s individual experience, skills and expertise; and the information available to the director.6
DeJong’s role in Cartaway as both a director and legal counsel gave him access to more information than an outside director would normally have. Thus, he assumed a higher degree of responsibility. Nevertheless, the Commission concluded that DeJong had not acted unreasonably in failing to disclose the material change, because he had in fact been deliberately misinformed and misled by another officer and director of Cartaway.
In YBM Magnex International Inc.,7 the OSC investigated 10 former directors of YBM for allegedly acting improperly in failing to disclose a report prepared by a special committee of the company into an investigation being conducted by the U.S. Attorney’s office concerning possible illegal activities of the company. One of the former directors investigated by the OSC was Mr. David Peterson, a lawyer and former Premier of Ontario, who was a partner of a leading law firm that acted as YBM’s Canadian counsel.8 Mr. Peterson was an experienced corporate director who served on many public boards and on many special committees, but not YBM’s. He did, however, attend all board meetings where disclosure was discussed and was fully aware of the mandate of the special committee.
While the OSC concluded that Mr. Peterson had acted reasonably based on his involvement in the matter, his skill and his access to information in the circumstances, it expressed its disappointment regarding Mr. Peterson’s lack of insight and leadership to the board.9 Accordingly, a due diligence defense was available to Mr. Peterson, “but just barely.”10
(b) Ethical Concerns for Lawyers Acting as General Counsel and Director
Lawyers serving in the dual capacity of general counsel and director of a company are faced with unique ethical concerns. It may be a difficult position replete with risks. The American Bar Association’s Model Rules of Professional Conduct11 permit a counsel to act as a director, but set forth concerns regarding potential conflicts when general counsel act both as lawyer and director of a corporation.12
Counsel and clients should be aware of the risks involved:
- Attorney-client privilege may not be applicable depending on whether the attorney/director was acting as legal counsel or as a director. Only the advice offered by in-house counsel in his or her capacity as a lawyer will be privileged. Communications made in a non-legal framework are not protected;
- A potential conflict exists when acting as a “team player” while at the same time striving to render dispassionate legal advice;
- There are potential problems with malpractice insurance since coverage could be denied on the basis that the counsel/director’s alleged improper conduct did not involve the practice of law. The corporation needs adequate director and officer insurance coverage;
- When counsel acts as a director, because of his or her expertise, his or her exposure to personal liability is increased since courts are more likely to apply an enhanced standard to analyze the propriety of the attorney/director’s conduct.13
Significant risks arise from the dual role played by corporate counsel, as officer or director on the one hand, and as legal professional on the other. The most sensible solution is for independent professionals to be retained, so that the professional on the board may solely act as a director. Retaining outside counsel would also allow for prudent use of in-house counsel, who face a particularly delicate situation created by the need to remain a “team player” while giving dispassionate legal advice.
III. Liability as a Corporate Officer
The traditional test in Canada to determine whether a duty of care is owed by professionals and others in negligence arises from the English decision of Anns v. Merton London Borough Council,14 which was adopted by the Supreme Court of Canada in Kamloops v. Nielsen (Kamloops).15 In these two seminal cases, the courts concluded that the appropriate duty of care analysis involves a consideration of whether there is a sufficiently close relationship between the parties such that, in the reasonable contemplation of the defendant, carelessness on its part might cause damage to the plaintiff. If the answer to that question is yes, the second step of the analysis is to determine whether there are any considerations that ought to negate or limit the scope of the duty.
In ADGA Systems International Limited v. Valcom Limited (ADGA),16 the Ontario Court of Appeal addressed the issue of whether a corporate officer is personally liable for corporate conduct that he or she engages in on behalf of the corporation, even when that conduct is carried out solely for the benefit of the corporation and in pursuit of the individual’s employment with the corporation.
In considering the relative dangers that unlimited liability on the part of corporate officers and employers would pose, the Court where the plaintiff has to establish personal tortious conduct on behalf of an officer or director and not simply liability as a corporate agent. As such, personal liability of corporate officers can co-exist with the corporate veil principle.
In effect, the Court’s holding in ADGA allows for any director, officer or employee to be held personally liable for tortious conduct that they engage in where personal liability can be established, even if the activity is pursued on behalf of the corporation.
ADGA was applied shortly thereafter by the Ontario Court of Appeal in NBD Bank, Canada v. Dofasco Inc.17 In that case, the Chief Financial Officer of Dofasco, James Melville, engaged in negotiations with NDB Bank for an enhanced credit facility. During the negotiations, Melville made misrepresentations about the company’s financial state. In applying the principles set out by the Supreme Court in Kamloops, the Court of Appeal found a sufficient relationship of proximity between Melville and the Bank existed to justify a finding of liability.
IV. Liability of In-House Counsel as Company Employee
(a) Liability to the Corporation
Clearly, one of the most obvious sources of liability is to the corporation itself. In-house counsel’s corporate employer is his or her client, so just as personal clients bring actions in negligence against their lawyers, so too may corporate entities bring such claims.
This situation was recently examined by a US court in Pereira, as Trustee of Trace International Holdings Inc. v. Cogan et al.18 In that case, Trace International, a privately held company, went bankrupt. A Trustee in Bankruptcy was appointed who filed an action against a number of company directors and officers, including Philip Smith, the former General Counsel and Vice President. The claim involved allegations that the company had been operated in the best interests of the controlling shareholder, Cogan. Cogan had apparently received millions in unapproved loans from the company while the company was technically bankrupt.
The allegations against Smith included a failure to properly advise the Board of Directors of its responsibility to approve loans and a failure to take action to prevent the company from improperly paying out dividends. At trial, Smith was found liable for damages in excess of US$21 million. While the lower court’s decision was overturned on appeal by the Second Circuit Court of Appeal, this case illustrates the potential liability faced by in-house counsel at the hands of their corporate employers.
In the Canadian case of Schwartz v. Chao,19 a corporate employer pursued a breach of fiduciary duty claim against its general counsel. The claim was unsuccessful at trial. The Ontario Divisional Court affirmed the trial judgment and held that the company’s lawyer, who was also a corporate officer, did not owe fiduciary duties to the company in all situations. Here there was no fiduciary duty between Mr. Schwartz and the company that operated to preclude him from depositing a cheque he received in-trust, in a dormant company account pursuant to an oral agreement with a principal of the company. The court concluded that this was “a simple case of contract.”20
(b) Liability to Shareholders
As was noted at the beginning of this paper, Torys has settled a claim by the shareholders of Hollinger International for US$30.25 million, involving allegations of failure to act in the best interests of the company as its legal advisor.
Of more recent note, however, is the jury decision rendered in a Chicago courtroom against several formal officers and directors of Hollinger in July of this year. While the allegations against Conrad Black took center media stage, charges were also laid against the Vice-President and General Counsel of Hollinger, Peter Atkinson, and the Corporate Secretary and Chief Legal Officer at Hollinger, Mark Kipnis.
Atkinson, a Toronto lawyer who helped finalize the deals in question, was charged with six counts of mail and wire fraud and two counts of tax fraud. Kipnis, an Illinois lawyer who, according to prosecutors, did most of the paperwork for the transactions at issue, was charged with nine counts of mail fraud and two counts of tax fraud. The indictment against the defendants alleged that the defendants fraudulently diverted approximately US$80 million from Hollinger. Both men pleaded not guilty to the charges.
At the end of a 16-week long trial, the jury found that both Atkinson and Kipnis were guilty of fraud. Sentencing has yet to be determined. In addition, both are facing a variety of class action lawsuits by Hollinger shareholders.
(c) Liability to Members of the Public
The conventional wisdom that a lawyer only owes a duty of care to his or her client has proven false in numerous instances. Courts have shown little reluctance in expanding the duty of care owed by a lawyer to persons other than his or her own client. In the case of Pollon v. American Home Assurance Co.,21 for example, the Ontario Court of Appeal found that a solicitor was liable to pay taxes to the Ministry of Revenue where he had previously given a personal undertaking on behalf of a client to pay such taxes and then failed to do so. More recently, the Ontario Superior Court found that a lawyer may owe duties to take reasonable care in dealing with unrepresented parties adverse in interest to their clients. In Windstar Equities Ltd. v. Sentinel Hill Sales Corp.,22 the plaintiffs alleged that the defendant had made negligent misrepresentations to them about the settlement of a claim. In the context of a summary judgment motion, the Ontario Superior Court of Justice found that it was tenable that the defendant lawyer ought to have foreseen that the claimants would rely on his representations and that this reliance was reasonable.
While courts have yet to extend this principle strictly to inhouse counsel, there is reason to believe that the same principles would apply in that context. Just as third parties may reasonably rely on the information presented by counsel employed in law firms, corporate clients and other members of the public may rely upon the statements and opinions of in-house counsel. As reliance may ground the existence of a duty, there is no reason to expect that in-house counsel will be immune from suits of this nature.
(d) Liability to Securities’ Regulators
Following the collapse of several major public corporations, securities regulators in Canada and the United States reconsidered the legal obligations of corporate officers and directors in this context. Sweeping changes were made to legislation which greatly expanded the scope for lawyers’ liability. In-house counsel have faced charges and have been exposed to liability in these types of situations.23 Lawyers, even without knowledge of the proposed wrongs, are facing liability for failures to report material information to securities regulators or for failing to sufficiently confirm the accuracy of the reporting.
Lawyers must, therefore, be familiar with the reporting obligations contained in the Sarbanes-Oxley Act24 in the United States and in the revisions to the Securities Act25 in Ontario, pursuant to Bill 198, which took effect December 31, 2005. These revisions allow for the imposition of civil liability on certain groups of individuals for inaccurate or incomplete corporate disclosure in the secondary market. Accordingly, the Securities Act serves as a new source of liability for in-house counsel, who may be found to be ‘influential persons’ or who may themselves be directors or officers.
In October of 2006, the California Attorney General brought multiple criminal charges against five people involved in the Hewlett-Packard (HP) “pretexting” scandal (in an effort to ‘spy’ on board members suspected of leaking company information, investigators were hired to contact phone companies and impersonate HP directors seeking their own records), including former in-house counsel Kevin Hunsaker. Hunsaker was given the task of investigating boardroom leaks within HP, which he pursued zealously.
In fact, according to an e-mail exchange between Hunsaker and an investigator hired by HP, Hunsaker asked how the company’s outside investigator obtained telephone records of individuals who were suspects in the leak investigation. Hunsaker was informed, “the methodology is social engineering. He has investigators call operators under some ruse… I think it is on edge but above board.” To which Hunsaker replied, “I shouldn’t have asked.”
While Hunsaker maintained his innocence throughout the proceedings, he resigned in 2006. Ann Baskins, HP’s chief inhouse counsel, also resigned from the company in September of 2006. In December of 2007, HP announced that it had entered into an agreement with the Attorney General to resolve civil claims arising from the investigation into leaks from its board of directors. The agreement, filed in the Santa Clara County Superior Court, called for HP to pay US$14.5 million, and to involve a series of measures designed to ensure that its internal investigations are conducted in accordance with California law.
(e) Law Society Reporting Rules
Law Society regulators have also responded to the challenges posed by corporate wrongdoing throughout North America. The Law Society of Upper Canada’s Rules of Professional Conduct26 have adopted the “report up the ladder” requirement for lawyers in Ontario. Rule 2.02 (5.2) states that when a lawyer is employed by an organization and the lawyer knows that the organization intends to act dishonestly, fraudulently, criminally or illegally with respect to the matter for which the lawyer is employed, the lawyer for the organization shall advise the person from whom the lawyer takes instructions that the actual or proposed conduct would be, or is, dishonest, fraudulent or illegal.27
If this fails to yield any result, then the lawyer should advise the organization’s Chief Legal Officer (CLO), or both the CLO and the Chief Executive Officer that the proposed conduct would be dishonest, fraudulent or illegal. If the organization intends to pursue the course of conduct, then the lawyer must withdraw from acting in the matter.28
V. Responding to the Increased Exposure to Liability
The environment in which in-house counsel practice in North America is changing at a rapid pace. The discussion above demonstrates just some of the ways in which lawyers’ liability is being expanded, particularly in tort. As directors, officers, employees, colleagues and legal professionals, in-house counsel are facing a growing number of lawsuits. Courts are increasingly accepting that in-house counsel are engaged in special relationships with their corporate employers and fellow employees, and with members of the public. Moreover, courts are becoming progressively more willing to accept that there are policy reasons that support imposing liability upon counsel generally, and inhouse counsel more particularly. As a result, new duties of care are being grounded, which will have potentially profound implications for in-house counsel.
In responding to the changing environment, it will be important for in-house counsel to be aware of the protection afforded them under various policies of insurance, which turns us now to a consideration of the insurance coverage that may be provided to inhouse counsel when acting in their various roles in a corporation.
VI. Insurance Options for In-House Counsel
(a) Insurance Protection for In-House Counsel – The D&O Perspective
As highlighted in the discussion above, the role of in-house counsel has expanded over the years and, as a result, so too has the spectrum of potential liability exposure for such professionals. This increased exposure arises in part out of the increased responsibilities of in-house counsel, as well as, in many cases, the increased blurring of the line between the roles of in-house counsel as legal counsel to the corporation and as a director or officer of the corporation. Given this increased exposure to liability, it is imperative that in-house counsel carefully consider what protection, if any, is offered to them under the Directors and Officers (D&O) Insurance policy purchased by the corporation as well as the corporate indemnity.
In addition to the corporate D&O policy, some in-house counsel may be covered by the mandatory errors and omissions programs offered through their Law Society. A recent development has been the introduction of specialty insurance products specifically covering employed lawyers.
(b) Ten Tips to Ensure You Are Protected
The following 10 tips are offered to in-house counsel seeking to determine if they are adequately protected by their employer’s insurance policies:
1. Review the company’s Directors’ and Officers’ Policy carefully. Does it have adequate limits?
2. Does the insurance company provide entity coverage, which could dilute the coverage available to directors and officers? If so, consider a separate Side A policy or priority of payments for Side A.
3. Review the definition of “wrongful act.” Is it broadly worded? Does it cover the broader exposure to security litigation?
4. Does the policy cover “professional services” ? If so, is there a sub-limit?
5. Do the exclusions restrict coverage unduly? Remember to review the endorsements.
6. Are you covered under your provincial Law Society’s policy?
7. Are you covered under the corporate indemnity? Have you considered a separate indemnity agreement?
8. Have you considered purchasing a stand-alone legal liability policy? If so, does it cover moonlighting?
9. Do any of your insurance policies cover claims made against you by your employer, other employees, or shareholders?
10. Do all of your policies provide for severability with respect to both the application and exclusions?
Clearly, the roles, responsibilities and potential liabilities of inhouse counsel are increasing. A stand-alone in-house counsel professional liability policy may cover the specific risks that company lawyers face when acting for the organization in their in-house capacity. Nevertheless, it is important to note that policy wordings of in-house counsel professional liability policies vary and that a careful review of policy language is required to determine the extent of coverage provided.
All things considered, lawyers acting as both in-house counsel and as a director or officer of a corporation must understand the complexities of the legal and ethical obligations facing them when acting in this dual role. Those who fail to do so, may find themselves sharing the less-than-favorable media spotlight with the likes of Peter Atkinson, Mark Kipnis, and Kevin Hunsaker, to name a few. n