50% Member of LLC Did Not Have Standing to Sue LLC’s Attorney For Malpractice and Breach of Fiduciary Duties, and Did Not Have An Attorney-Client Relationship With LLC’s Attorney
In a malpractice action brought by a 50% member of an LLC against the LLC’s outside legal counsel, the California Court of Appeal, Second Appellate District, confirmed a lower court’s holding that the member did not have standing to pursue her claims of (among other things) malpractice and breach of fiduciary duties for services provided by such legal counsel. Additionally, the court held that the member had no basis for claiming an attorney-client relationship with her, which might otherwise have precluded the attorneys from advising the company in a manner adverse to her personal interests. Click here for the court’s opinion in Jean Sprengel v. Gregory Zbylut, et al., certified for publication on October 7, 2019.
Background. Jean Sprengel and her business partner Lanette Mohr held equal interests in an LLC. Mohr was the LLC’s manager in accordance with the operating agreement, which also provided that neither member could bind the LLC without the consent of the other. This created some ambiguity concerning whether Mohr needed Sprengel’s approval for actions taken exclusively in her role as manager When disputes arose between Mohr and Sprengel, Sprengel filed a dissolution action and a separate claim of copyright infringement by the LLC. Mohr and Sprengel each retained legal counsel. In her capacity as manager of the LLC, Mohr caused the LLC to retain separate counsel to represent it in connection with the dissolution and copyright claims. In her malpractice action against the company’s attorneys, Sprengel alleged that they had violated their professional duties by undertaking representation of the LLC without her consent, and by rendering legal advice to the LLC adverse to her interests as a member.
Ruling. The appellate court upheld the lower court’s summary judgment in favor of the defendant attorneys, who argued that Sprengel’s claims failed as a matter of law for two reasons. First, her claims for, among other things, disgorgement of legal fees had to be brought as a derivative action rather than a direct action, because Sprengel was effectively seeking recovery of the LLC’s assets, in which she, as a member of the LLC, had no direct ownership interest. (On appeal, Sprengel conceded this point.) Second, Sprengel claimed she was harmed by the defendant attorneys’ actions on behalf of the LLC because she was forced to expend funds in the copyright dispute between her and the LLC.
The court cited the general principle that, when representing a business entity, the attorney’s client is the entity, not the entity’s individual shareholders or members. However, an attorney-client relationship can be implied under certain circumstances, e.g., where the “totality of the circumstances” implies an agreement that the attorney will not act adversely to the individual shareholder or member’s interest, or where the parties have conducted themselves in a way that would reasonably cause the shareholder or member to believe that the attorney would represent their individual interests. In this case, Sprengel could not identify any such agreement or circumstances. In fact, the defendants had made clear to Sprengel in written correspondence that their representation of the company was adverse to her interests.
The court noted that California’s Rules of Professional Conduct provide that when an attorney is dealing with an entity’s directors, officers, members, shareholders, etc., and it becomes apparent that the entity’s interests are or may become adverse to those individuals, the attorney must identify for those individuals who the attorney’s client is.
The Takeaway: The court’s decision in Sprengel comes as no surprise, but the case is a cautionary tale and useful reminder to attorneys of the importance of being very clear with owners, directors, and officers of client entities that the attorney does not represent them. Sending “I am not your attorney” letters at the beginning of representation can help avoid confusion (or worse) later in the relationship, but circumstances can arise (as they did in Sprengel) to merit repeating that communication at a later point.
Analysis set forth in the decision also provides an important reminder on a topic not directly at issue in this case. That can be particularly relevant to attorneys representing closely-held business entities if they also serve as legal counsel to one of the owners. Such legal counsel may over time — and possibly inadvertently or even unknowingly – find that the shareholder/member/owner has interests in connection with operations of the entity that are not uniform to all of them and is potentially adverse to some of them. The court in Sprengel specifically notes the absence of that factor, which highlights the potential difference its presence could have made to the outcome.
This e-Bulletin was prepared by Emily J. Yukich, Managing Partner of the Los Angeles office of Fox Rothschild LLP. Ms. Yukich is a member of the Corporations Committee of the Business Law Section of the California Lawyers Association.