Trone v. SmithTrone v. Smith
Alan D. Croll, Los Angeles, Cal., argued for appellees; Wyman, Bautzer, Rothman & Kuchel, Los Angeles, Cal., on brief.
Appeal from the United States District Court for the Southern District of California.
GOODWIN, Circuit Judge:
We review1 the district court‘s refusal to grant a motion to disqualify plaintiff‘s counsel. Whether the refusal was correct on the facts of this case turns upon the effect of the rule against suing a former client.
This appeal is one aspect of the complex litigation filed by the trustees in bankruptcy for Westgate-California Corporation (Westgate) and other entities, against a large number of individuals and entities, seeking compensatory damages of at least $500,000,000 and punitive damages of not less than $1,000,000,000. The 110-page complaint, incorporating 194 counts, alleges numerous violations by defendants of provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, the National Banking Act, and the Federal Reserve Act, as well as breaches of duties under state law.
Defendant C. Arnholt Smith was chairman of the board and chief executive officer of Westgate from its date of incorporation until November 2, 1973. Until May 24, 1973, Smith was also the principal shareholder, chairman of the board, president, and chief executive officer of the United States National Bank (USNB). Defendant C. Hugh Friedman was former counsel for Smith, Westgate, and USNB. The remaining defendants are former officers or directors of USNB or of related entities more or less controlled by Smith.
Plaintiffs are represented in this litigation by the firm of Wyman, Bautzer, Rothman & Kuchel (Wyman). Wyman‘s representation began with its appointment as special counsel for Westgate pursuant to an equitable consent judgment entered in Securities Exchange Comm‘n v. Westgate-California Corp., No. 73-217-N (S.D.Cal., Oct. 31, 1973). Wyman was thereby empowered to conduct an investigation into the financial affairs of Westgate and to take appropriate action in connection with that investigation, including the prosecution of actions for the benefit of Westgate or its shareholders to recover wasted or misappropriated assets. In February 1974, Westgate went into Chapter X reorganization proceedings, and Wyman assumed the capacity of general counsel to the trustees, pursuant to court order.
The motion was based upon Wyman‘s legal services in 1972, at the request of Smith, in connection with a proposed secondary offering of 400,000 shares of Smith‘s personally-owned or controlled USNB stock. Salomon Brothers, a firm of underwriters, agreed to assist in the public offering. In connection with preparation of the offering, Salomon Brothers asked Smith to obtain a legal opinion letter from a law firm independent of Smith, USNB, and Friedman, who then represented both Smith and USNB. Smith accordingly retained Wyman, initially contacting Frank Rothman, a senior partner in the firm.
The Wyman firm then began evaluating the circumstances of the offering for the preparation of a legal opinion letter to Salomon Brothers for inclusion in the offering circular. An interoffice memorandum prepared by Jerold Sherman, the Wyman attorney primarily responsible for the case, detailed the matters the firm believed required investigation in order to evaluate the need for disclosure in the circular. These matters included the following:
“11. * * * all sales and purchases of bank stock by Mr. Smith, Westgate, etc. to determine possible 16b violations or problems * * *.
“12. * * * how the bank approves all loans, * * *. We should determine what procedures they follow when the loan is to Mr. Smith, Westgate, etc. Is Mr. Smith‘s involvement disclosed at the time of the loans?
“14. * * * all sales of assets owned personally by Mr. Smith or owned by Westgate or its subsidiaries, etc. to third parties whereby the purchaser finances the purchases through the bank, etc. (e. g. sale of Golden West Airlines).
“34. Apparently the bank leases most of its offices from Westgate. We should determine if the bank financed the construction of the buildings owned by Westgate.
“45. We should determine if there are any presently existing contractual arrangements between the bank and Westgate, US Holding, etc.”
In carrying out the proposed investigation, Sherman reviewed major news stories involving the participants in the offering, examined the financial statements of relevant corporations, and inspected other public documents. He also participated in meetings with USNB employees, which were attended by at least one member of the Friedman firm, as well as by Smith and often by a representative of Salomon Brothers. Believing that information with respect to “sensitive” areas was not being provided, Sherman requested Rothman‘s assistance in convincing Smith that further disclosure was required. At a meeting between Sherman, Rothman, Friedman, and Smith in August 1972, Smith indicated that he had decided not to go ahead with the offering at that time because the timing was not right.
In October 1972, Wyman billed Smith for its efforts in the amount of $15,000 plus costs, as follows:
“SERVICES RENDERED through August 27, 1972 in connection with proposed registration, including meetings with principals, counsel and underwriters, review of corporate structure and preliminary review of various material contracts and transactions to determine scope of disclosures required under federal securities laws.”
At the time of billing, Wyman contemplated that the matter might resume in the early part of 1973 and deferred a portion of its bill with that in mind. Wyman was paid in November 1972 by a cashier‘s check from USNB.
Obviously, a substantial amount of legal work had been done by the time the magistrate considered the disqualification motion. The magistrate recommended that the motion be denied on the grounds that there was no substantial relationship between Wyman‘s representation of Smith in 1972 with respect to the scope of disclosure required under Rule 10b-5 for the stock offering and Wyman‘s role in bringing this action against Smith and others charging breach of fiduciary duty while serving as officers and directors of Westgate and USNB.
The district court reviewed de novo the magistrate‘s conclusions and denied the motion for disqualification of the Wyman firm, making the following findings of fact and conclusions of law:
” * * * (T)he law firm of Wyman, Bautzer, Rothman & Kuchel represented only C. Arnholt Smith, and not United States National Bank (U.S.N.B.) or its directors, in the proposed secondary offering of U.S.N.B. securities in June 1972; that the representation was with respect to the stock offering only and continued for approximately one month; and that members of the Wyman firm gathered public information pursuant to that representation but were denied access to any confidential information by Mr. Smith.
“Accordingly, the court concludes that counsel for plaintiffs did not obtain any confidential information in their prior representation of Smith, and that the legal services rendered in the stock offering were not so related to the instant litigation to justify disqualification of counsel.”
The relevant test for disqualification is whether the former representation is “substantially related” to the current representation. See Gas-A-Tron of Arizona v. Union Oil Co. of California, 534 F.2d 1322, 1325 (9th Cir.), cert. denied, 429 U.S. 861, 97 S.Ct. 164, 50 L.Ed.2d 139 (1976); Westinghouse Electric Co. v. Gulf Oil Corp., 588 F.2d 221, 223 (7th Cir. 1978); Government of India v. Cook Industries, Inc., 569 F.2d 737, 739 (2d Cir. 1978). The interest to be preserved by preventing attorneys from accepting representation adverse to a former client is the protection and enhancement of the professional relationship in all its dimensions. It is necessary to preserve the value attached to the relationship both by the attorney and by the client. These objectives require a rule that prevents attorneys from accepting representation adverse to a former client if the later case bears a substantial connection to the earlier one. NCK Org‘n Ltd. v. Bergman, 542 F.2d 128 (2nd Cir. 1976). Substantiality is present if the factual contexts of the two representations are similar or related.
Perhaps the most important facet of the professional relationship served by this rule of disqualification is the preservation of secrets and confidences communicated to the lawyer by the client. If there is a reasonable probability that confidences were disclosed which could be used against the client in later, adverse representation, a substantial relation between the two cases is presumed.3 Confidentiality, however, is not the only aspect of the professional tie preserved by the disqualification rule.
The rule we state is necessary to implement the following canons of professional ethics: Canon 1 (maintaining integrity and confidence in the legal profession); Canon 4 (preserving confidences and secrets of a client); Canon 5 (exercise of independent professional judgment); Canon 6 (representing a client competently); Canon 7 (representing a client zealously within bounds of the law); Canon 9 (avoiding even the appearance of professional impropriety).
As we have stated, the underlying concern is the possibility, or appearance of the possibility, that the attorney may have received confidential information during the prior representation that would be relevant to the subsequent matter in which disqualification is sought. The test does not require the former client to show that actual confidences were disclosed. That inquiry would be improper as requiring the very disclosure the rule is intended to protect. See Westinghouse Electric Corp. v. Gulf Oil Corp., 588 F.2d at 224 and n.3. The inquiry is for this reason restricted to the scope of the representation engaged in by the attorney. It is the possibility of the breach of confidence, not the fact of the breach, that triggers disqualification.
Once the attorney is found to be disqualified, both the attorney and the attorney‘s firm are disqualified from suing the former client. See Government of India v. Cook Industries, Inc., 569 F.2d at 739-40; NCK Org‘n Ltd. v. Bergman, 542 F.2d 128, 132-34 (2d Cir. 1976). Canon 4 applies not only to the individual attorney. Confidential information possessed by one attorney may or may not have been shared with other members of the firm, but the firm as a whole is disqualified whether or not its other members were actually exposed to the information. See Westinghouse Electric Corp. v. Kerr-McGee Corp., 580 F.2d 1311, 1318 (7th Cir. 1978); Schloetter v. Railoc of Indiana, Inc., 546 F.2d 706, at 710 (7th Cir. 1976).4
The district court‘s order denying disqualification of the Wyman firm was inconsistent with strict standards of professional conduct. The primary responsibility for controlling the conduct of lawyers practicing before the district court rests with that court. See Richardson v. Hamilton International Corp., 469 F.2d 1382, 1385-86 (3d Cir. 1972), cert. denied, 411 U.S. 986, 93 S.Ct. 2271, 36 L.Ed.2d 964 (1973). And where the matter is discretionary, we will not reverse the district court unless it abused its discretion in this area. See Gas-A-Tron of Arizona v. Union Oil Co. of California, 534 F.2d at 1325.
In this case, however, the district court misperceived the rule of law and failed to give adequate consideration to the nature and scope of Wyman‘s prior representation of Smith. The court should have compared the scope of representation undertaken by the attorneys in each case. Here, a reasonable probability existed that in the first case Smith relayed confidential information to the attorneys. Although Wyman was retained for a limited purpose, the scope of its lawyers’ inquiry pursuant to that representation was not as limited as the district court‘s findings would indicate. There was a substantial similarity between the two professional employments in these circumstances.
Wyman argued, and the district court found, that there was no close relationship between the matters involved in the two representations. That finding is plainly wrong. The district court found that Wyman‘s prior representation was with respect to the proposed 1972 stock offering only, lasted but one month, and that no substantial relationship existed because the complaint in the instant case contains no allegation concerning that offering as a basis for liability. This inquiry was insufficient and missed the point. The substantial relationship test does not require that the issues in the two representations be identical.
The relationship is measured by the allegations in the complaint and by the nature of the evidence that would be helpful in establishing those allegations. Among the numerous allegations in the complaint in this case are charges with respect to Westgate‘s purported borrowings for the benefit of others, the purchase and sale of assets by Westgate at other than a fair market value, and Westgate‘s alleged practice of borrowing at excessive interest rates to improve the financial condition of USNB and to finance self-dealing transactions. The information sought in the course of Wyman‘s prior representation of Smith, whether disclosed to Wyman or not, would be of value in establishing the truth of Wyman‘s present allegations.
Although the issues presented in the two representations are not identical, their relationship is strong. It reasonably could be said that during the prior representation the attorneys were trying to acquire information vitally related to the subject matter of the pending litigation. See Westinghouse Electric Corp. v. Gulf Oil Corp., 588 F.2d at 226-27 (information with respect to uranium reserves acquired during course of work on leases and title disputes relevant to charge of conspiracy to fix prices by restricting production); Government of India v. Cook Industries, Inc., 569 F.2d at 739 (information with respect to loading and billing procedures acquired during defense of “short weight” case relevant to prosecution of similar claim for another party); Emle Industries, Inc. v. Patentex, Inc., 478 F.2d 562, 570 (2d Cir. 1973) (information with respect to parent-subsidiary relationship acquired while defending parent relevant to subsequent suit against subsidiary corporation); Richardson v. Hamilton International Corp., 469 F.2d 1382 (3d Cir.) (information acquired while defending against SEC investigation of possible securities laws violations relevant to suit based on allegedly false and misleading proxy statement).
Wyman suggests that disqualification is not required in this case because Rothman fully disclosed to the court the fact of Wyman‘s prior legal work on behalf of Smith before the court appointed the firm special counsel for Westgate. Wyman then argues that the court‘s approval must now be deemed final a sort of res judicata effect.
Our review of the record has revealed only the following testimony by Rothman in this regard:
“I was the partner who was originally contacted by Judge Nielsen (with respect to the appointment). I was aware of the fact that we had represented Mr. Smith. I was aware of the fact that we had handled a sale of a produce business in 1969, and I was aware of the fact that we were in some litigation involving Air California. I met first with Mr. Kuchel and advised him of those facts.
“At that point those were the only potential areas that I felt should be discussed in the interest, not so much of conflict, but just in the interest of objectivity and fairness. I knew of no others. I considered no others that I could conceive of.”
That the above disclosure was made does not alter our determination that disqualification of the Wyman firm is required. Even if the quoted disclosure had dealt specifically with Wyman‘s 1972 work for Smith, which it did not, the court‘s earlier approval of Wyman‘s representation of the trustees in light of that disclosure would not be dispositive of the pending disqualification motion.
Disqualification does not depend upon proof of the abuse of confidential information. Because of the sensitivity of client confidence and the profession‘s institutional need to avoid even the appearance of a breach of confidence, disqualification is required when lawyers change sides in factually related cases. The district court applied too permissive a standard, and thus erred in failing to remove counsel.
There remains the problem of Wyman‘s representation of the trustees against the remaining defendants in the case. Although none of these defendants was ever technically in an attorney-client relationship with the Wyman firm, the multiple and interlocking bonds between all defendants and Smith require us to cut the Gordian knot in this case and disqualify the firm from representing plaintiffs against all defendants.5 While the facts of this case are not as compelling as those described in Westinghouse Electric Corp. v. Kerr-McGee Corp., 580 F.2d 1311 (7th Cir.), cert. denied, 439 U.S. 955, 99 S.Ct. 353, 58 L.Ed.2d 346 (1978), the principles discussed therein are applicable. Fiduciary obligations and professional responsibilities may warrant disqualification of counsel in appropriate cases even in the absence of a strict contractual attorney-client relationship. 580 F.2d at 1316-20. Smith‘s potential liability in this case is inextricably intertwined with that of the other defendants. The interrelation compels the conclusion that the appearance of a fair trial for Smith cannot be guaranteed while Wyman is present in the courtroom on behalf of plaintiffs, even as co-counsel. Accordingly, we hold that the Wyman firm must be disqualified from further representation of plaintiffs against Smith‘s co-defendants so long as all parties remain joined for trial.
Remanded with instructions to order the removal of counsel.