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Case Study: Coping with Conflicts of Interest

Although conflict of interest problems have always been an issue for lawyers, they have, in recent years, become something of a plague for the profession.

In litigation or contentious matters, allegations of conflict have become a common tactical device to disqualify lawyers and to impede opponents. Often they are the underpinning for complaints of professional misconduct that can lead to disciplinary proceedings.

In these recessionary times, clients often use allegations of conflicts of interest to shift the blame and burden of a failed transaction to their lawyers and in turn to LAWPRO.

An analysis of LAWPRO's claims statistics revealed that just over 10 per cent of all claims reported in the last seven years had a conflict of interest component as a cause of loss. Moreover, close to 22 per cent of the total incurred value of all claims had a conflict of interest component.

Conflict of interest clearly is an issue that the legal profession needs to take seriously when it comes to reducing claim costs and liability insurance premiums.

The problems surrounding conflict of interest are complicated by the fact that conflicts of interest are subtle: There are no hard-and-fast rules to avoid many problems of conflicts of interest. And those rules that do exist are not absolute, and contain in them conditions, qualifications, exceptions and discretionary factors.

In this loss prevention feature article,we take a look at some of the frequently-cited court cases dealing with conflicts of interest.

Case A: Acting on both sides in a commercial transaction
The law firm of H D&D was retained by both a vendor and a purchaser to put into legal language a verbal agreement that the two parties had reached that would see the purchaser buy the vendor's business. Their agreement included an option to purchase which could be assigned (and was) to a company controlled by the purchaser. That company was also a client of the law firm and one in which a senior partner in the law firm had a financial interest.

Before the transaction closed, the law firm arranged for the vendor to sign an acknowledgement that the firm was acting for both sides of the transaction, and that the senior solicitor had a personal financial interest in one of the companies. Disputes arose under the agreement and the plaintiff vendor claimed damages for negligence and breach of fiduciary duty against the law firm for its failure to protect his financial interests by not obtaining more adequate security from the purchaser. The action was dismissed at trial, but went to the Court of Appeal.

The court's decision
The Court of Appeal held that the firm had breached its fiduciary duty to the plaintiff. The signed acknowledgement was a case of "too little, too late" the court reasoned, since the lawyer who was primarily responsible for the transaction "failed to take proper stock of the situation when he was first approached by the plaintiff."

The court also cast doubt on the practice of solicitors acting for both the vendor and purchaser, even in a straightforward real estate transaction, saying that "the solicitor unquestionably assumes a dual role at his own risk, the onus being on him in any lawsuit that ensues to establish that the client has had the best professional assistance which, if he had been engaged in a transaction with a third party, he could possibly have afforded."

Even on simple real estate transactions, the court said, "the consequences of a conflict can manifest themselves in a failure to make the requisition that . . . would have been made if the solicitor had been motivated solely by a concern for the plaintiff."

Case B: Duty of disclosure
A solicitor sold a half share in a new restaurant venture to his neighbours, for whom he had performed some minor legal services in the past. The neighbours invested $100,000 50% of the $200,000 that the solicitor told them he had invested; in fact, the solicitor had invested considerably less than $200,000.

The solicitor prepared the partnership agreement. He did not recommend independent legal advice, nor did he disclose that the leasehold improvements they purchased were subject to a mortgage with the Federal Business Development Bank. He also did not disclose the existence of a chattel mortgage which was collateral to the realty mortgage on the partnership property. The neighbours subsequently invested an additional $70,000.

When the restaurant failed, the neighbours sued on the basis that the solicitor had failed to make complete disclosure to them.

The solicitor responded that he was not the neighbours' solicitor with respect to the partnership transaction, and that he did not owe them a fiduciary duty. He also argued that the neighbours would have invested even if they had known about the chattel mortgage, and that their losses were caused by the failure of the business, not by the financing arrangements.

The court's decision
The trial judge found that there was a solicitor-client relationship between the solicitor and the neighbours at the time when the partnership agreement was entered into, and accepted the neighbours' position that they would not have invested in the restaurant if they had known about the chattel mortgage and the leasehold improvements.

The trial judge awarded damages equal to the neighbours' entire lost investment.

The Court of Appeal upheld the trial judgment and confirmed that the solicitor's failure to reveal that the mortgage also secured the leasehold improvements and chattels was a breach of fiduciary duty.

Although the Court of Appeal found that the solicitor's intentions were not dishonest, it did express the view that the law holds solicitors to a high standard of disclosure even where they do not have a personal interest in the enterprise involved. When they do have a personal interest, they must be meticulous in matters of disclosure.

Loss prevention advice
Because so many conflicts of interest are subtle, lawyers need to be both vigilant and cautious if they are to avoid conflict problems.

Ask yourself if you're acting for conflicting or competing positions
Take for example the situation of a lawyer who is acting for two clients who are, and always have been, strangers to one another on matters that have been, and always will be, factually separate. Where is the potential for conflict? The lawyer could be representing opposing legal positions or claims that directly or indirectly compete for limited resources. The lawyer's success or failure for one client will establish a precedent or a reduction of available resources that will help or harm the interests of the other client. Thus, the lawyer's success for one client will come at the expense of the other, and the lawyer will have had a conflict of interest in trying to serve both clients. Although this type of conflict of interest occurs most often in litigation cases, it can occur in administrative and commercial law matters where clients are directly or indirectly in competition.

Know your firm's other clients
If the same two clients cited in the example above retain two different lawyers from the same law firm, the situation is further complicated. The rules of professional conduct and case-law impute the knowledge of a member of a law firm to all other members of the same firm. So, the two lawyers in this example would be treated as a single entity and the conflict would not be avoided, even though neither lawyer might know, until it was too late, that the firm was working at cross-purposes and that the interests of one of the firm's clients might suffer. The harmed client may not accept the explanation of how very difficult it is for the members of the law firm to know what their associates are doing.

Take care with joint retainers
Joint retainers are, in many ways, a no-win situation for the legal profession. On the one hand, those who refuse joint retainers because of the potential for conflict of interest could be accused of trying to generate needless legal fees.

For example, a couple buying a home or corporate directors acting for a corporation could object to the idea that more than one law firm is needed to provide them with proper and adequate legal services. And clients with in-house professional advisors may not need or want the protection extended to them by the case-law or by the profession's rules of professional conduct.

But those same lawyers also need to be extremely wary that joint retainers could lead to professional negligence claims. Even a lawyer who has carefully followed the rules of professional conduct, who has recommended that both clients obtain independent legal advice and who has obtained consent to the joint retainer in writing from both clients will be more vulnerable to claims of conflict of interest. Why? Because it may be difficult to show that each client received the standard of care s/he would have received if the lawyer was acting for one party alone and did not have any responsibility to the client with the opposing interest. Sometimes, one client may complain that the other was favoured; sometimes both parties complain. And sometimes the complaint may be that the lawyer failed to realize that the opposing interests of the client made a joint retainer inappropriate.

Consider whether or not it's appropriate for your firm to represent the client
Take the example where a real estate transaction has failed and the lawyer who did the conveyancing work decides to either continue the retainer to enforce the agreement, or opts to pass the file on to an associate in the same firm who is a civil litigator. If the transaction may have failed to close because of a mistake by the conveyancing lawyer, the law firm's decision to continue to litigate the file raises conflict of interest problems; the issue of whether or not it is appropriate for members of the firm to appear as both counsel and witnesses at a subsequent trial too poses conflict problems.

In many such cases, the mistake is revealed only after action is well under way, and by this time the defence of the professional negligence claim, and insurance coverage could well be compromised.

Sometimes the rules of conflict may not apply, yet it would still be inappropriate for a lawyer to act. For example, if a litigation lawyer spends a lot of time preparing for a trial with an expert hired by a client, it might be inappropriate for the lawyer to accept a new retainer against the expert even though the matters are unrelated and the expert was never a client of the lawyer.

In this case, the new retainer might offend the spirit, if not the letter of the rules about conflicts of interest. In this case, as with many others, it is difficult to determine if there is a genuine conflict of interest. In the "ever-ever and never-never" world of conflicts of interest, very little is straightforward except the need for caution and vigilance.

Note: This article was prepared with the assistance of Paul M. Perell of Weir and Foulds. Mr. Perell is author of Conflicts of Interest in the Legal Profession, published by Butterworths Toronto, 1995.


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