Nic Miller / Digital Vision
Once upon a time in a land called Corporate America worked a type of lawyer known as an in-house attorney. These attorneys made their living toiling for the entities they served. Until one day, the world began to change around them, and they saw events occurring to others in their field that they never knew could happen -- regulatory investigations, fines and even incarceration. They asked: Could this happen to me?
Because for now, it all seemed a mere fairy tale.
In-house counsel are warned of their exposures with respect to regulatory compliance, legal opinions, SEC work, shareholder class actions, §307 of the Sarbanes-Oxley Act[FOOTNOTE 1], outside third-party lawsuits, confidentiality/privilege, intellectual property, conflicts of interest, stock options backdating, multijurisdictional practice, whistleblower and employee issues, and advice given to boards, among others. Certain of these exposures have been the subject of high-profile cases involving in-house counsel, particularly those involving the Securities and Exchange Commission and investigations or enforcement actions; shareholder class actions; misbranding or marketing misstatements regarding pharmaceuticals; and of course the backdating of stock options.
These cases, however, continue to be in the minority and may not necessarily be representative of the typical claims set forth against in-house counsel. Still, although the volume of claims brought against in-house counsel is low in comparison to other corporate characters, it continues to increase at a slow but steady pace. In the end, the majority of these claims settle and never make the "front pages."
This article will provide a sampling of recent and typical real-life claims made against in-house counsel. Certain facts have been modified to maintain anonymity, as all were actual cases handled by various insurance carriers and brokers. The claim scenarios also address the manner in which insurance coverage factored into their respective resolutions vis-à-vis contributions from directors and officers liability insurance, employment practices insurance, and related professional liability insurance as well as employed lawyers professional liability insurance which is specifically designed to protect in-house counsel from claims alleging negligent acts, errors or omissions in the performance of their duties.
DIFFERENCES BY INDUSTRY
Although no single industry sector is a target for claims against in-house counsel, financial institutions, technology/telecommunications, and the energy/environmental sectors seem to experience more losses than other industry groups.
Oftentimes claims against in-house counsel of financial institutions come in the form of lawsuits involving directors and officers coupled with allegations against in-house counsel for negligence in rendering legal advice. The claims against in-house counsel in the technology/telecommunications sector most often involve conflicts of interest.
Health care and the non-profit sector are viewed as a slightly higher hazard class than wholesaling or manufacturing, but not as high as technology or financial institutions. Claims experienced in health care and the non-profit world often revolve around transactional work or regulatory matters with allegations of fraud, misrepresentation, failure to disclose, negligence and breaches of fiduciary duties.
The real estate industry, as compared to service industries, hospitality, and manufacturing, also seems to represent a higher exposure sector, with claims involving the failure to disclose and conflicts of interest.
HEALTH CARE ENTITY
In an action against a health care entity in the U.S. District Court for the Southern District of New York, the plaintiffs were hospitals and doctors who sought payment for the services they provided to participating members of the health care entity. The action named the health care entity and certain board directors and officers, including the general counsel, as defendants. The plaintiffs alleged breach of contract, fraud, misrepresentation, negligence, conflict of interest, deceit, conversion, and related allegations. In addition, the state insurance department commenced a simultaneous action making similar allegations including breach of fiduciary duty.
The general counsel was accused of legal malpractice and breaching his fiduciary duties by making misrepresentations to all of the plaintiffs including the regulatory body. He was also accused of negligently rendering legal opinions with regard to the business affairs of the health care entity.
All of the outstanding actions were eventually consolidated after a two-year period. Approximately four years after the initial action was commenced, and following substantial negotiations with all parties, a global settlement was effectuated and the claims were resolved in their entirety for $30 million. The entity and its directors and officers liability insurer both contributed to the settlement. In addition, the employed lawyers professional liability insurer paid for the claims alleging legal malpractice against the general counsel.
SHAREHOLDER CLASS ACTIONS
Several shareholder class actions were commenced against a financial institution alleging breach of fiduciary duties, violations of Rule 10b-5 of the Securities Exchange Act of 1934[FOOTNOTE 2] inclusive of fraud and insider trading, misrepresentation, negligence, and legal malpractice. These actions were ultimately consolidated. The consolidated plaintiff class named all of the board directors and certain senior level officers as defendants, including the general counsel and two associate general counsels.
The plaintiffs claimed that the general counsel and associate general counsels were negligent in their performance of legal research regarding financial reporting. In the factual allegations, the plaintiffs asserted that the general counsel delegated a research assignment to the associate general counsels who completed it incorrectly, but the general counsel did not review their work. Rather, she forwarded their work directly to the board of directors who in part acted on the inaccurate information.
Following the completion of discovery and on the eve of trial, the parties engaged in settlement negotiations and agreed to resolve this matter for $40 million. The insurer for directors and officers liability contributed $25 million to the settlement and the employed lawyers professional liability insurer contributed $2.25 million for the legal malpractice claims. The remainder of the loss was borne by the financial institution.
EMPLOYMENT PRACTICES
A director of human resources sought the legal advice of the associate general counsel responsible for internal employment practice matters of a large financial institution. The associate general counsel was asked to coordinate an investigation regarding complaints of sexual harassment set forth against a supervisor in a brokerage unit of the company. After interviewing the supervisor and the employees involved, the associate general counsel recommended that the supervisor be terminated.
Thereafter, the supervisor commenced an action for wrongful termination, retaliatory firing, negligence, misrepresentation and conflict of interest naming the financial institution and the associate general counsel, among others, as defendants. The matter was settled with contributions from the employment practices insurer and the employed lawyers professional liability insurer.
In another case involving employment practices insurance, a deputy general counsel of a designer clothing manufacturer and distributor who served predominantly as employment counsel was asked to provide a reference for a former employee in middle management. The deputy general counsel provided a negative reference and as a result the former employee was denied the position for which he applied. The former employee commenced an action against the deputy general counsel for negligent misrepresentation and slander. The matter was settled for $250,000. An employment practices liability policy and an employed lawyers professional liability policy made contributions toward the settlement.
WHISTLEBLOWER
A senior attorney from a food store chain commenced an action in the Supreme Court of New York, New York County, naming the chief legal officer and the human resources labor relations legal counsel as defendants. The plaintiff claimed that she was terminated in retaliation for notifying senior management of potential insider trading violations as well as trademark infringement by the food store chain. The plaintiff sought compensatory damages, punitive damages, and reinstatement.
The plaintiff was reinstated to her position and received back pay as damages. An employment practices liability policy and an employed lawyers professional liability policy both made contributions toward the costs in this matter.
UNAUTHORIZED PRACTICE CLAIM
A general counsel and associate general counsel of a publicly traded technology/telecommunications company, both admitted to practice law in New York, drafted and reviewed legal documents for a transaction of a subsidiary in Hawaii. The documents were relied upon by an outside third party who subsequently consummated the deal with the company. Thereafter, the documents turned out to have inaccuracies and misrepresentations. As a result of the errors related to the transaction, the outside third party lost substantial sums of money.
The outside third party commenced an action for negligence in the rendering of legal advice and legal malpractice in Hawaii naming both the general counsel and the associate general counsel as defendants. In addition, the outside third party notified the Office of Disciplinary Counsel to report the potential for the unauthorized practice of law and sought an investigation since the attorneys were not licensed to practice law in Hawaii.
This matter settled for several millions of dollars. Contributions toward the settlement were made by both the directors and officers liability insurer, the employed lawyers professional liability insurer, and the company. A disciplinary proceeding was initiated against the general counsel and associate general counsel who ultimately incurred certain fines and penalties for the unauthorized practice of law.
Note on Multijurisdictional Practice. In 2002 the American Bar Association (ABA) modified Rule 5.5 of the Model Rules of Professional Conduct and adopted Model Rule 5.5(d) which permits in-house counsel to provide legal services across the United States on behalf of their employers regardless of the state in which they are licensed to practice law.[FOOTNOTE 3] Approximately 26 states require some form of special license for in-house lawyers practicing across state lines. In addition, approximately 32 U.S. jurisdictions via their highest courts have amended their rules of professional conduct to provide for multijurisdictional practice.
Only about a dozen states have adopted a mirror image of the ABA rule. As such, in-house attorneys must be particularly vigilant in investigating exactly what types of legal services they may provide in the various jurisdictions in which they do business as well as what types of registration requirements exist for in-house counsel in those jurisdictions.
Although state bar disciplinary counsel generally do not pursue these issues unless a complaint is brought, in-house counsel may expose themselves to reputational damage and humiliation if they are not properly authorized to practice law. Further, these attorneys may jeopardize attorney-client privilege and confidentiality which certainly would have an impact on their corporate employers.
TRADEMARK AND LANHAM ACT
An action was commenced against the general counsel of a consumer products company specializing in health and beauty aids. The plaintiff company alleged trademark infringement, violations of the Lanham Act,[FOOTNOTE 4] unfair competition, and violations of state common law trademark. The general counsel was asked to approve the use of a certain mark in advertising materials published and publicly disseminated by the company.
A paralegal who conducted the search for the trademark at issue advised the general counsel that the trademark was neither registered nor in use in the stream of commerce. The general counsel provided the necessary approval, but the information provided to her by the paralegal was inaccurate as the paralegal had conducted a faulty search. Thereafter, however, the owners of the trademark, having become aware of its unauthorized use, were compelled to initiate legal action to protect their intellectual property.
The court issued a cease and desist order, and the consumer products company had to pay damages for the unauthorized use of the trademark. Portions of the damages were paid for by the professional liability insurer with a contribution from the employed lawyers professional liability insurer.
HOTEL CHAIN
A company affiliated with a hotel chain sought an associate general counsel's advice regarding development of certain real property. The associate general counsel rendered a written legal opinion upon which the affiliate relied. The legal opinion turned out to be wrong and as a result the affiliate incurred close to $1 million in additional costs for development. The affiliate commenced an action against the associate general counsel alleging breach of fiduciary duty, negligence, legal malpractice, and conflict of interest. The matter settled for $500,000, a portion of which was reimbursed by the employed lawyers professional liability insurer.
FAILURE TO DISCLOSE
Inasmuch as courts seem more inclined to impose an attorney-client relationship upon in-house counsel and outside third parties, the duty to disclose defects coupled with the duty to warn have escalated in importance. These issues become particularly acute in the energy/environmental context where in-house counsel may be held liable for failure to warn of the discharge of toxic or poisonous materials or waste. Similarly, this issue may also arise in the pharmaceutical or consumer product context where in-house counsel may become aware of products scheduled for recall by regulators and fail to timely disclose this information to the public.
REAL ESTATE
An in-house attorney who was employed by a real estate developer was reviewing documents relative to the development of a gated residential community. The documents included information suggesting that the general contractor was not building according to the applicable housing code and as a result the residential units may contain defects. Although the in-house attorney raised her concerns to a senior attorney in the legal department, the matter was not pursued. Thereafter, after the buyers took possession of their respective premises weather conditions triggered the defect in housing design and caused significant flooding and water damage.
The buyers retained counsel who set forth claims against the in-house attorney and her employer, among others. The in-house attorney was accused of failure to warn and disclose the defect, misrepresentation, and negligence. The matter in its entirety was settled for several millions of dollars, portions of which were paid by real estate errors & omissions insurance and employed lawyers professional liability insurance.
ENERGY/ENVIRONMENTAL
The treasurer of a publicly traded energy/environmental company sought the guidance of the general counsel with respect to compliance with financial reporting and disclosure pursuant to §404 of SOX.[FOOTNOTE 5] Although the general counsel consulted with outside counsel regarding the issue, his advice was inaccurate and led to the termination of the treasurer. The company also sought to terminate the general counsel who advised that there was a miscommunication on the part of the treasurer, and as such he should bear the loss.
The treasurer commenced an action against the company, the general counsel, and its outside counsel. The allegations against the general counsel included conflict of interest, misrepresentation, negligence, breach of fiduciary duty, and legal malpractice. The general counsel was indemnified by the company, and he was ultimately dismissed out of the action.
CONCLUSION
The claims discussed illustrate all too clearly that the remote exposures and liabilities of yesterday have become the commonplace truths of today. Unfortunately, the giants, ogres, and other creatures hiding in the work closets of Corporate America are escaping and manifesting themselves in a myriad of different types of claims against in-house counsel. Going forward, the new horizon may likely present claims involving electronic discovery, document preservation, international transactions (bribery), whistleblower actions, as well as corporate gatekeeping and reform. Certainly, however, claims against in-house counsel pertaining to multijurisdictional practice, failure to disclose, backdating stock options, and regulatory investigations will continue to dominate headlines. In the end, while there may be no fairies, good queens, nor magic spells to assist in-house counsel, the moral of the story is that a variety of avenues present the right potion for a happy ending.
Susan F. Friedman is a senior vice president, claims advocate and practice leader of the Employed Lawyers Product Practice at Marsh. She can be reached at Susan.F.Friedman@marsh.com. Myra Riggs, an attorney and claims advocate with the practice group, assisted in the preparation of this article.
:::::FOOTNOTES:::::
FN1 Corporate and Criminal Fraud Accountability Act of 2002, 18 USC §1514A et seq. (2002).
FN2 Securities Exchange Act of 1934, 17 CFR §240 Rule 10b-5, as modified.
FN3 American Bar Association, 2004 Edition of Model Rules of Professional Conduct.
FN4 See generally Lanham Act, 15 USC §1051 et seq.
FN5 See supra note 1 at §404 et seq.
