Canada : Lawyers Must Tread Carefully To Prevent Conflicts Of Interest When Acting For Competitors

In a ruling that has singular implications for lawyers acting in areas of specialized law such as intellectual property, the Supreme Court of Canada ruled that law firms may represent companies who are commercial competitors, but must be wary about breaching fiduciary and contractual obligations they owe to their clients (Davis & Co. et al. v. 3463920 Canada Inc. et al., 2007 SCC 24, June 1, 2007). The decision represents an important clarification for lawyers in fields with a paucity of practitioners such as certain sub-specialties of intellectual property law, where a single firm or practitioner may represent multiple commercial competitors.

Davis & Co. involved a lawyer who specialized in tax law relating to a certain type of income tax shelter. The lawyer and his firm were sued by a former client (Monarch). A previous written retainer with Monarch had stated that the law firm would not represent any competing companies in respect of similar tax shelters for a defined period. After this period, the lawyer was retained by a competing company (Sentinel) founded by a former employee of Monarch. The lawyer also received a significant financial stake in Sentinel, but he failed to fully inform his law partners of this fact. The lawyer eventually left his firm to work with Sentinel. Both companies were pursuing a similar business: film production based upon certain tax shelter schemes. Due to changes in the tax laws, the tax shelter relied upon by both companies ended. However, Sentinel later obtained a favorable tax ruling on a similar tax shelter that would have been of considerable importance to Monarch, had they been aware of it in time. Potentially, the ruling would have allowed them to revive their business, which by then had significantly diminished. However, the lawyer did not inform Monarch of the tax ruling. Monarch then sued the lawyer and his firm (who had by then parted ways) for failing to inform them of the change in the law and breach of fiduciary duty.

It was established that there was no misuse of confidential information by the lawyer or his firm.

The Supreme Court, in a 5-4 split decision, stated that in general, a lawyer’s obligation to a client extends beyond the scope of the retainer agreement (which is contractual in nature) and is overlain by a broader fiduciary duty of trust and confidence. This duty has several aspects; the one breached in this case was that a lawyer must not place himself in a position that aligns his personal financial interests against those of his client.

Importantly, the Court stated that subject to certain limitations, the fiduciary duty owed to a client does not prevent a lawyer from acting for a competitor, even if the competitor benefits financially.

The ruling established the following:

- A lawyer and his firm do not necessarily breach fiduciary or contractual obligations to a client by acting for a competitor. In general, a lawyer must avoid situations where he has, or potentially may, develop a conflict of interest. This is not a universal bar to acting for commercial competitors. The Court identified two “bright line” situations that prevent a lawyer from acting for competitors or which may confine his ability to do so.

The first relates to confidential information: a firm must take suitable steps to prevent release or misuse of confidential information as between clients. A second ‘bright line” is the general rule that a lawyer may not represent one client whose interests are directly adverse to the immediate interests of another current client — even if the two mandates are unrelated — unless both clients consent after receiving full disclosure (and preferably independent legal advice), and the lawyer reasonably believes that he is able to represent each client without adversely affecting the other. The clients’ “interests” that engage the duty of loyalty are legal interests and not adverse commercial interests.

This is not to say that commercial interests can never be relevant. An example would be two competitors who retain the same law firm in respect of competing applications for a single broadcast license which represents a unique business opportunity. Acting for both without disclosure and consent in this situation would be improper since the lawyer’s ability to provide even-handed representation is put in issue. However, commercial conflicts between clients that do not impair a lawyer’s ability to properly represent the legal interests of both clients will not generally present a conflict problem.

The Court did not describe examples of situations in which two clients’ immediate legal interests may be affected. Clearly, a lawyer cannot act on opposing sides of an adversarial matter. As another hypothetical example, a lawyer acting for a first client to defend the validity of a patent could be barred from acting for a second client if success is likely to result in prejudice to the second client, for example by operation of issue estoppel. It must be noted that examples such as this are speculative unless and until the courts have the opportunity to consider such situations.

The Court noted that a client cannot be taken to have consented to conflicts of which it is ignorant. The prudent practice for the lawyer is to obtain informed consent. However, consent may in some cases be implied in the case of sophisticated clients involved in highly specialized areas where it is assumed that lawyers act for multiple clients involved the same type of business.

- There is no duty to “update” a legal opinion, but there may be a duty to provide ongoing advice to current clients even if not specifically requested. A relationship of trust and confidence distinguishes professional advisors from others (the Court’s example consisted of car salesmen and pawnbrokers) whom the public may expect to operate on the basis of “didn’t ask, didn’t tell.”

In general, if an opinion was correct on the date on which it was given but subsequently becomes erroneous due to a change in the law or in the facts upon which the opinion was based, the opining lawyer is not liable for failing to inform the client of the change. The rationale behind the general rule is that a legal opinion speaks as of its date, and thus a lawyer is only obligated to exercise due care in rendering an opinion based on the legal and factual circumstances existing at that time. A client cannot assume that the lawyer’s opinion has an indefinite shelf life.

The general rule is subject to exceptions, including the ongoing duty of a lawyer to provide candid advice on all matters relevant to the client retainer. While a lawyer is not obligated to alter advice given under a concluded retainer, if the retainer is ongoing, there may be a duty to provide advice even if the effect of this is to update a prior opinion.

In this case, the lawyer’s obligation to advise Monarch about the new tax ruling (even though not asked to do so) arose through a contractual duty under the ongoing general retainer. This duty came into conflict with the lawyer’s personal financial interest when he took a major stake in the second company, who was a competitor in a small market where even limited competition could lead to a rapid erosion of market share.

- A lawyer may not align his personal financial interest with a client’s success, if the impact of this on another client is material and adverse. In this case, by acquiring a substantial and direct financial interest in one client seeking to enter a very restricted market related to film production services in which another client previously had a major presence, the lawyer put his personal financial interest into conflict with his duty to first client. The conflict compromised the lawyer’s duty to “zealously” represent the first client’s interests.

The lawyer’s firm was found to be not itself in breach of any duties to Monarch, but still vicariously liable for the breaches of its former partner.

Davis & Co. has far-reaching implications for IP lawyers and others acting in narrow fields of expertise, and also presents a benchmark for client expectations when retaining a firm. The decision clarifies that law firms may indeed act for competitors, and in some cases they can do so without informing their clients, although it is risky for them to rely on implied consent to do so. The decision also is an important reminder for lawyers to inform their clients about significant legal developments that may affect their business, even if not specifically requested to do so.

For more information on this topic, please contact Adrian Zahl [azahl@ridoutmaybee.com] at Ridout & Maybee LLP [www.ridoutmaybee.com] in Ottawa, Canada.

The information contained in this alert is provided for informational purposes only and does not represent legal advice. Neither the APLF nor the author intends to create an attorney client relationship by providing this information to you through this message.

 

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