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'Serving two masters…': existing client conflicts

November 2006 - Conflicts of interest. Legal Developments by Lewis Silkin LLP.

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In this article, we deal with existing client conflicts. This briefing gives a quick refresher on the common law position and the new Law Society rules. We then turn to some real-life examples by considering two important cases in this area: Marks & Spencer Group Plc and another v Freshfields Bruckhaus Deringer and Hilton v Barker Booth and Eastwood (a firm). We conclude with a consideration of the special position of in-house lawyers and the situations where they may be in conflict with their existing client (ie their employer).

Why is this briefing relevant?

These cases offer interesting, if very different, examples of how solicitors can find themselves in a conflict of interest situation when acting for or against existing clients. By being aware of the key issues, the in-house lawyer (as the client) can assess:

  • whether their own solicitor or an opposing solicitor has an actual or potential conflict;
  • whether the solicitor can act in such a situation;
  • whether the client's consent is required;
  • what the consequences of a breach are; and
  • what remedies the client may have.

A quick refresher on the law

Previously, we gave an overview of the common law principles that apply in this area  and a summary of the new Law Society rules, which came into effect on 25 April 2006. By way of a quick reminder:

Common law

Under the common law, a solicitor owes (save in so far as the obligations can and have been expressly limited by the solicitor's retainer) the following fiduciary duties:

  • a duty of loyalty (ie to defend and advance the interests of their client);
  • a duty of trust and confidence;
  • a duty to disclose relevant information obtained in the course of the retainer to their client; and
  • a duty not to profit from their position at the expense of their client.

A solicitor should not act for two or more clients:

  • who have potentially conflicting interests without both clients' informed consent - the ‘double employment rule';
  • where the solicitor will be inhibited from serving the interests of one client by reason of duties owed to the other client, notwithstanding that both clients may have given their informed consent - the ‘no inhibition principle'; or
  • where an actual conflict of interest arises, again notwithstanding that both clients have given their informed consent - the ‘actual conflict rule'.
Rules

New Law Society rules (the Rules) relating to conflicts came into effect on 25 April 2006. Unlike the old conduct rules, the Rules have the force of law and will be enforced by the courts, together with the case law. Where the common law is more onerous, the courts will enforce the common law. Where the Rules are more onerous, the courts will enforce the Rules.

Rule 16D - conflicts

Rule 16D(2)(a) states that a solicitor ‘must not act if there is a conflict of interests'. Rule 16D(2)(b) describes a conflict as:

  • Where a solicitor/their practice owes separate duties to act in the best interests of two or more clients in relation to the same or related matters and those duties conflict, or there is a significant risk that those duties may conflict. As to the meaning of ‘same or related matters', there has to be ‘some reasonable degree of relationship' for conflict to arise. Where the subject matter involves a single asset or liability, the rules provide that they will always be related (Rule 16D(2)(c)).
  • Where there is a conflict, or significant risk of conflict, between the solicitor's own interests and their duty to act in the best interests of their client.

Exceptions to Rule 16D(2)(a)

There are two exceptions to Rule 16D(2)(a) where a solicitor can act with informed consent. The rules specifically state that the exceptions are intended to operate for the client's benefit (eg saving costs or avoiding disruption by having to instruct new lawyers), not the solicitor's benefit. The client should never be pressurised into giving consent. The exceptions1 are as follows:

  • A solicitor/firm can act for two or more clients who have a substantially common interest in the matter and who have all given their informed consent in writing. ‘Common interest' requires a clear common purpose and a strong consensus between the clients on how matters are to be achieved. Any potential conflict must be peripheral to the shared objective. The differences must, however, be kept under review.
  • A firm can act for two or more clients who are competing for the same asset, provided that there is no other conflict and they have both given their informed consent in writing. The ‘same asset' provision is intended only to apply to specialised areas of legal services where the clients are sophisticated users of those services.

Both exceptions are subject to an overriding requirement that it must be reasonable in all the circumstances for the firm to act for all of the clients (Rule 16D(3)(c)). The solicitor must be satisfied that unfettered advice can be given without ‘fear or favour'.

 

Rule 16E - confidentiality and disclosure

Rule 16E deals with the duties of confidentiality and disclosure. In summary, a solicitor must:

  • keep the affairs of their client confidential unless disclosure is required or permitted by law or the client consents to disclosure;
  • disclose all material information to a client, regardless of the source, unless there is a conflicting duty of confidence; and
  • not risk breaching the duty of confidentiality by acting or continuing to act for a second client where another (whether existing or former) client's information may be material to the second client's retainer and the other client is, or is likely to become, an opposing party on the matter (whether a negotiation or dispute).

Exceptions to Rule 16(E)

There are express exceptions to the Rule 16E duty not to act where:

  • both clients give the informed consent and certain other conditions are met, including the erection of any necessary information barriers (or ‘Chinese Walls'); or
  • only the existing client is able to give informed consent and does so (knowing that the solicitor may possess material information which cannot be disclosed) and where other necessary conditions are met, including the erection of any necessary information barriers.

Marks & Spencer

This case was widely reported in 2004, not least because of the high-profile names involved. It focused on the world of City takeover work - where acting for and against clients had been quite common, given the relatively limited number of firms that regularly undertake such work. Many City lawyers at that time felt that the law on conflicts (or, at the very least, the old Law Society rules) needed to be revised to reflect the commercial realities of City work. 2

Facts

In summary, the case concerned Philip Green's bid to take over Marks & Spencer. Philip Green instructed Freshfields Bruckhaus Deringer on the bid. However, Freshfields had been widely engaged by Marks & Spencer on litigation matters and was seemingly still engaged (technically, if not actively) on non-contentious advice to Marks & Spencer concerning arrangements with George Brown and the Per Una brand. Marks & Spencer did not consent to Freshfields acting and immediately sought an injunction to restrain the firm from acting.

Arguments

In relation to existing client conflict, Freshfields robustly argued that, even if Marks & Spencer was an existing client in relation to the Per Una work3, it was not conflicted for various reasons:

  • The risk of a potential conflict was theoretical only. It was not possible to identify a clear conflict which would arise. In particular, the takeover need not necessarily be hostile if the offer was recommended by the Marks & Spencer board. Further, any confidential information that Freshfields possessed by having advised on the Per Una contract was not obtained in the course of acting for Philip Green and therefore it was under no duty to disclose that information to Philip Green.
  • Its retainer with Marks & Spencer in relation to the Per Una brand was wholly unconnected to the Philip Green bid and the conflict/double employment rules were only triggered where the solicitor was instructed on the ‘same transaction'.
  • There were a limited number of firms that were experienced enough to advise on such a corporate takeover, and it would be unfair to Philip Green (and generally detrimental to the market) not to be able to instruct preferred advisers in such a case. Accordingly, such matters as takeover work should be treated differently to other, less exclusive, work.

In relation to former client conflict, Freshfields offered to erect an elaborate information barrier (including relocating staff to physically separate premises) and to provide supporting undertakings to ensure that the Philip Green team had no access to information gained by Freshfields when advising Marks & Spencer on other matters.

Decision

These submissions did not find favour with either the High Court or Court of Appeal.

On the existing client conflict issues, the courts found that:

  • While it was expressly accepted that Freshfields had acted entirely in good faith in deciding that there was no conflict, both Courts decided that the risk of a conflict was real. It was not appropriate to wait to see if the takeover bid went hostile before deciding whether to act. There was, in both Courts' view, the potential for conflict. In particular, the Per Una brand was very important to Marks & Spencer's business and the takeover bid was likely to focus on the brand as an issue. Indeed, the issue had already come into focus and it was possible that the bid report (to which Freshfields would be a signatory) might make some criticism of Marks & Spencer's management at the time. Further, Philip Green's lawyers would have to advise on tactics and Marks & Spencer was entitled to know that such advice was not influenced by the bidder's lawyers having a prior knowledge of Marks & Spencer's business.
  • The conflict rules were not limited to ‘same transaction' cases. There simply had to be a reasonable or sufficient degree of relationship between the two matters. The Courts decided there was in this case.
  • They also rejected the argument that takeover work was to be treated differently.

As to former client/confidentiality issues, both Courts decided that the implementation of an information barrier and the giving of undertakings was not sufficient and that the risk of inadvertent disclosure was too great.

Accordingly, Marks & Spencer was granted the injunction to restrain Freshfields from acting.

Comment

The Marks & Spencer judgments are an important addition to the law on existing client conflicts and offer some long-awaited guidance on the application of conflict rules to City work.

The case was, of course, heard before the new Rules came into effect and so must now be read in conjunction with them. That said, the result would probably be the same now, given the terms of Rules 16(D) and (E). In fact, the Rules echo the Marks & Spencer decision in adopting the ‘reasonable degree of relationship' test.

The case also shows what is perhaps the primary remedy for a client in this situation - ie an injunction to stop the conflicted solicitor from acting. Indeed, Marks & Spencer applied for an interim injunction and the matter was heard very quickly as a result.4

Hilton

This was a very different case, far removed from the specialised world of corporate takeovers of FTSE100 companies. It was also something of a harrowing personal story for the claimant, Mr Hilton, and the House of Lords was extremely critical of the conduct of the law firm in this case.

Facts

In summary, the firm, BBE, acted for both a seller (Mr Hilton) and a buyer on a property transaction. However, the transaction did not involve ‘run-of-the-mill' conveyancing. Mr Hilton was not just selling land - he was also taking on obligations as developer and builder - and he required a law firm that was looking out solely for his interests. In acting for both parties, BBE failed to have the necessary independence. Further, it failed to disclose to the seller that it knew that the buyer was something of a rogue, with a criminal and prison record for fraud, and was of doubtful financial standing. BBE also failed to disclose that it was lending money to the buyer to complete on part of the transaction. Against that background, and some time after the contract was completed, the buyer defaulted and Mr Hilton was left with a massive loss that eventually led to his bankruptcy. After failed attempts to get redress from the buyer, Mr Hilton sued BBE.

Decision

The House of Lords, overturning the decisions of both the High Court and the Court of Appeal, decided that:

  • BBE owed contractual/fiduciary duties to each client that were inconsistent.
  • The firm should have declined to act for both parties. Having put itself in conflict by acting for both, the firm had to take the consequences. Lord Walker said:

‘... if a solicitor is unwise enough to undertake irreconcilable duties it is his own fault, and he cannot use his discomfiture as a reason why his duty to either client should have been taken to be modified.'

  • BBE was accordingly bound to disclose to the seller what it knew about the buyer's past, which it did not do. Had the firm done so, the buyer would never have entered into the transaction.
  • As a result of BBE's breaches, the seller suffered grave losses and was entitled to substantial damages for those losses.
Comment

This case shows the potentially serious consequences of a solicitor acting under a conflict of interest. In an appropriate case, a client may have a claim in damages for loss suffered by reason of the conflict. Hilton was also decided before the Rules came into force but, again, it is likely that the same result would have been achieved by applying them.

Outstanding questions

The above cases and the introduction of the Rules have certainly clarified this area considerably. However, there are still some unanswered questions. Two such important questions are:

  • Is it possible for a firm to act for client A against client B where the solicitor has an ongoing retainer with client B on a wholly unrelated matter?

This issue is of very real concern given the tendency for firms to have national and international offices and where clients may use firms for discrete specialist areas. In theory, the answer would seem to be yes, and that consent is not required. In practice, of course, it may be wise to get consent.

  • Is it ever possible for a solicitor to act for client A against client B in litigation where the solicitor has an ongoing retainer with client B?

This question overlaps with the one above but raises different issues about whether a conflict is inherent in the nature of litigation. It is our view that, if the subject matter is unrelated and if the nature of the litigation is limited to, say, dry legal/expert issues, there may not be an inherent conflict. Clearly though, such cases will be rare.

Conflicts and the in-house lawyer - special rules

Conflict between the interests of the in-house lawyer and their employer5

Since the employer of an in-house lawyer is effectively their client, wherever the interests of an in-house lawyer do not match those of their employer, there is potential for conflict of interest.

An in-house lawyer advising on a transaction that may affect their own position, such as a merger which may involve redundancies (including their own), has a conflict. However, they are free to act, assuming:

1) the employer knows of the conflicting interest; and

2) it is possible to give objective advice on the legal issues where expertise is required.

Where the in-house adviser feels that their objectivity is impaired, they must ask their employer to seek other advice (whether internally or externally). If the employer does not know of the competing interest, this must be disclosed first. If it is not disclosed, the in-house lawyer must explain that a conflict has arisen which prevents them from advising on the issue and cease acting.

Conflict would also arise where:

  • an employer asks an in-house lawyer to do something that is contrary to their professional obligations - this must always be declined; or
  • contrary to an in-house lawyer's advice, the employer engages in a criminal activity that may require the adviser to take action against the employer (money-laundering or whistle-blowing obligations). Here the position is more complex and the in-house lawyer should consider seeking independent legal advice.
Conflict between clients

Generally, an in-house lawyer's only client is their employer. However, an in-house lawyer is permitted, pursuant to the Employed Solicitors Code 1990, to provide advice to a limited number of bodies other than their employer.

If the employer is a company, the in-house lawyer may also act for a holding, associated or subsidiary company. In-house lawyers in local government can also advise local councillors.

Clearly, there is potential for conflict between the employer and the second ‘client' that is being advised. Careful consideration must be given by the professional to ensure that they are not acting in a situation of conflict. Their position will be similar in this regard to that of a solicitor in private practice and they must observe Rules 16D and 16E.

Conclusion

Changes in the way legal services are sourced (eg through panels where a firm may provide just one specialist service), changes in how firms are structured (eg with mergers to form ‘mega-firms') and the increasing movement of individuals and departments from one firm to another have meant that firms are faced with the possibility of acting for and against existing clients. These trends are likely to ensure that existing client conflicts will remain an important consideration for the profession.

The recent changes introduced by the Law Society are a welcome development. The position for practitioners is now clearer than it has been. However, there are still areas of uncertainty and this area of law looks set to remain dynamic.

Notes

  1. The Law Society has provided ‘Q&A'-style examples to amplify the Rules and these make for interesting reading.
  2. While the new rules have now taken on board many of the City's concerns, a group of Magic Circle and City firms have petitioned the Law Society to change the Rules on the ground that they are too strict in requiring informed consent to act against a former client even where an information barrier can properly and effectively be erected to preserve confidential information - see the Law Society Gazette, 28 September 2006.
  3. It is not clear exactly what the status of the Per Una retainer was and this was somewhat glossed over in the decisions, although it seems to have been accepted that the retainer was technically still open.
  4. It is worth noting that the judgments were given in response to an interim injunction application and at very short notice. As a result, the judgments are perhaps not as fully reasoned as they would otherwise have been. They do not, for example, clearly analyse the issues in terms of the ‘double employment', ‘no inhibition' or ‘no actual conflict' rules.
  5. The Law Society conflict guidance - explanatory notes, para 18.

Case references

Marks & Spencer Plc and another v Freshfields Bruckhaus Deringer [2004] EWCA 1337 and [2004] EWCA Civ 741

Hilton v Barker Booth and Eastwood (a firm) [2005] UKHL 8

 

By Mark Lim, associate, Lewis Silkin LLP.

E-mail: mark.lim@lewissilkin.com.