When management damages the corporation, minority shareholders may file a derivative action, i.e. an action on behalf of the corporation to address management’s injury to the corporation. In these cases, the plaintiff stands in the shoes of the corporation and seeks compensation for the corporation. Nevertheless, the corporation is still named as a nominal defendant and is represented by counsel. Although the corporation’s lawyers cannot concurrently represent the individual defendants in the derivative lawsuit, plaintiffs are often frustrated to have corporate counsel involved at all since they usually side with management and oppose the plaintiffs suing on the corporation’s behalf.
In Sarkis v. Angels Gun Club, the Court of Appeal acknowledged this tension and held that corporate counsel cannot represent the corporation in the derivative suit while simultaneously representing an individual defendant in a separate lawsuit.
Sarkis field a direct action against Angels Gun Club and one of its directors, David VerHalen. He alleged the club wrongfully expelled him, that the club’s directors violated their fiduciary duties by not investigating his suspension and taking corrective action on his allegations, and that certain directors had a conflict of interest when they considered his expulsion. The club’s corporate counsel jointly represented VerHalen and the club in this case.
Later, Sarkis and additional members filed a derivative action against VerHalen and other directors. The club’s corporate counsel did not represent VerHalen in the derivative lawsuit, but it did appear as counsel for the club. Sarkis sought to disqualify the corporate attorneys from representing the club in the derivative case because of their concurrent representation in the direct action. The Court of Appeal agreed, and upheld the trial court’s disqualification order.
Even though the individual directors are represented by independent counsel, [corporate counsel] has a bias in favor of the individual directors with whom the firm meets to discuss the club’s affairs in the direct action. The firm may also fear that taking aggressive action in the derivative suit against the directors’ interests may impair its future relationship with the club as its client. By representing the club in the derivative action, the firm has an adverse interest against one of its current clients, VerHalen, and it will inevitably favor VerHalen and the other directors at the expense of the duty of loyalty it owes the club. This adverse interest required the trial court to disqualify [corporate counsel] in the derivative action.
Although this case is unpublished, it still represents an important development in the law governing shareholder derivative lawsuits.
