Corporations and Their Affiliates—Who Owns the Privilege?

Corporations and Their Affiliates—Who Owns the Privilege? Anthony E. Davis

This article examines an aspect of the law of attorney-client privilege that is often of critical importance to corporate and transactional lawyers, as well as their litigation brothers and sisters: Who owns the privilege when a dispute arises between a parent and a former subsidiary? The article will examine a trio of cases and draw from them some important lessons for both in-house and outside counsel representing entity clients.

The first case chronologically, and the leading case in New York, is Tekni-Plex v. Meyner and Landis, 89 N.Y.2d 123, 674 N.E.2d 663, a New York Court of Appeals decision from 1996. The case involved the sale in 1994 of Tekni-Plex, a manufacturer and packager of products for the pharmaceutical and other industries. The sale of the company, incorporated under the laws of Delaware in 1967, was by way of a merger agreement, to TP Acquisition Company (Acquisition), whereby the sole shareholder of Tekni-Plex, Tom Y.C. Tang, sold the company to Acquisition for $43 million.

From 1971 and for the next 23 years, Meyner and Landis (M&L), a New Jersey law firm, had represented Tekni-Plex on various legal matters, including environmental compliance, and during this period M&L also represented Tang individually on several personal matters. Under the agreement, Tekni-Plex merged into Acquisition, with Acquisition the surviving corporation, and Tekni-Plex ceased its separate existence. Tekni-Plex conveyed to Acquisition all of its tangible and intangible assets, rights and liabilities. Acquisition in return paid Tang the purchase price “in complete liquidation of Tekni-Plex,” and all of Tang’s shares in Tekni-Plex—the only shares outstanding—were canceled.

The merger agreement contained representations and warranties by Tang concerning environmental matters, including that Tekni-Plex was in full compliance with all applicable environmental laws and possessed all requisite environmental permits. It further provided for indemnification of Acquisition by Tang for any losses incurred by Acquisition as the result of misrepresentation or breach of warranty by either Tang or Tekni-Plex. Acquisition, in turn, agreed to indemnify Tang and Tekni-Plex for any similar losses suffered by them.

Following the transaction, Acquisition changed its name back to “Tekni-Plex, Inc.” (new Tekni-Plex). In June 1994, new Tekni-Plex commenced an arbitration against Tang, alleging breach of representations and warranties contained in the Merger Agreement regarding the former Tekni-Plex’s (old Tekni-Plex) compliance with environmental laws. Tang retained M&L to represent him in the arbitration. In resolving a variety of cross-motions, the New York Supreme Court held that M&L should be disqualified from representing Tang in the arbitration; it further enjoined M&L from disclosing to Tang any information obtained from old Tekni-Plex, and directed M&L to return to new Tekni-Plex all of the files in M&L’s possession concerning its prior representation of old Tekni-Plex. The Appellate Division affirmed.

The New York Court of Appeals upheld the lower courts’ decisions. The important element of the decision for purposes of the present discussion is that with respect to confidential communications between old Tekni-Plex and M&L generated during the law firm’s prior representation of the corporation on environmental compliance matters, the court held that “authority to assert the attorney-client privilege passed to the corporation’s successor management,” that on the facts of the case “the exception to the privilege for co-clients who subsequently become adversaries in litigation is inapplicable”…so that “M&L should be enjoined from disclosing the substance of these communications to Tang and directed…to return the files relating to this representation to new Tekni-Plex.”

Notably, however, the court held that new Tekni-Plex did not “control the attorney-client privilege with regard to discrete communications made by either old Tekni-Plex or Tang individually to M&L concerning the acquisition—a time when old Tekni-Plex and Tang were joined in an adversarial relationship vis-à-vis Acquisition. Consequently, new Tekni-Plex [could not] assert the privilege in order to prevent M&L from disclosing the contents of such communications to Tang. Nor [was] new Tekni-Plex entitled to the law firm’s confidential communications concerning its representation of old Tekni-Plex with regard to the acquisition.”

In reaching this decision, the court decided that “[f]or analytical purposes, the attorney-client communications must be separated into two categories: general business communications and those relating to the merger negotiations.” The court reasoned that since the management of new Tekni-Plex continues the business operations of the pre-merger entity, control of the attorney-client privilege with regard to confidential communications arising out of those operations passed to the management of new Tekni-Plex. By contrast, however, the court held that with respect to “communications between old Tekni-Plex and M&L—those relating to the merger transaction—new Tekni-Plex did not succeed to old Tekni-Plex’s right to control the attorney-client privilege.” In reaching this conclusion, the court reasoned that:

to grant new Tekni-Plex control over the attorney-client privilege as to communications concerning the merger transaction would thwart, rather than promote, the purposes underlying the privilege.… Where the parties to a corporate acquisition agree that in any subsequent dispute arising out of the transaction the interests of the buyer will be pitted against the interests of the sold corporation, corporate actors should not have to worry that their privileged communications with counsel concerning the negotiations might be available to the buyer for use against the sold corporation in any ensuing litigation. Such concern would significantly chill attorney-client communication during the transaction.

Thus, while generally ‘parties who negotiate a corporate acquisition should expect that the privileges of the acquired corporation would be incidents of the sale’ the agreement between the parties here contemplated that, in any dispute arising from the merger transaction, the rights of the acquired corporation, old Tekni-Plex, relating to the transaction would remain independent from and adverse to the rights of new Tekni-Plex.

Notably, while Tekni-Plex is a New York decision, it addresses issues pertaining to a Delaware entity—as do both of the next cases to be considered. However, neither of these other decisions accept the bifurcated approach to the privilege adopted by the New York Court of Appeals.

Joint Representation

The next case chronologically is In re Teleglobe Communications Corporation, 493 F.3d 345, decided by the U.S. Court of Appeals for the Third Circuit in 2007. The case concerned an adversary proceeding brought by debtor subsidiaries alleging breach of contract, breach of fiduciary duties, estoppel, and misrepresentation relating to the manner in which the predecessor controlling corporation had ceased funding the debtors’ corporate parent. For present purposes, the significant issue was the ownership of the privilege regarding transactions between the parent and the subsidiary.

The court delved at length and in depth into three aspects of the law of attorney-client privilege: the disclosure rule, where the disclosure of information to a third party operates as a waiver of the privilege; the co-client (or joint-client) privilege, where the privilege is shared (and can only be waived with the consent of all of the co-clients) unless and until the joint representation terminates; and, the community-of-interest (or common-interest) privilege, which protects all communications shared within a proper ‘community of interest.’

The court determined that despite the district court having referred to the common interest privilege, it was inapplicable to the case as this privilege assumed two clients with separate attorneys, which had not been the case here. After extensive discussion, the court determined that the default position will be that while a parent and its subsidiary entities are judicially separate and distinct, where they share a single lawyer (whether in-house or outside), they will be treated as jointly represented.

Of greatest interest here is how the court suggests that lawyers jointly representing corporations and subsidiaries need to proceed when their interests diverge.

It is inevitable that on occasion parents and subsidiaries will see their interests diverge, particularly in spin-off, sale, and insolvency situations. When this happens, it is wise for the parent to secure for the subsidiary outside representation. Maintaining a joint representation for the spin-off transaction too long risks the outcome [where]…parent companies were forced to turn over documents to their former subsidiaries in adverse litigation—not to mention the attorneys’ potential for running afoul of conflict rules. That the companies should have separate counsel on the matter of the spin-off transaction, however, does not mean that the parent’s in-house counsel must cease representing the subsidiary on all other matters. After all, spin-off transactions can be in the works for months (or even years), and during that time it is proper (and obviously efficient) for in-house counsel to continue to represent the subsidiary (jointly or alone) on other matters.

Once conflicts begin coming to the surface, the question of when to acquire separate counsel is often difficult.…[F]rom the perspective of protecting the privilege the best answer is that once the parties’ interests become sufficiently adverse that the parent does not want future controllers of the subsidiary to be able to invade the parent’s privilege, it should end any joint representation on the matter of the relevant transaction.

…In sum, in-house counsel have available numerous means to protect a parent company’s privilege. By taking care not to begin joint representations except when necessary, to limit the scope of joint representations, and seasonably to separate counsel on matters in which subsidiaries are adverse to the parent, in-house counsel can maintain sufficient control over the parent’s privileged communications.

Ultimately, in Teleglobe the court remanded the case for further fact-finding regarding the nature and extent of the joint representation, and the consequences in the case for the ownership and control of the privilege. But the language quoted above points the way to the manner in which counsel for corporate entities, whether in-house or outside, need to proceed where a divestiture is in the offing.

Surviving Corporation

The most recent case addressing these issues was decided by the Delaware Chancery Court. Great Hill Equity Partners IV v. SIG Growth Equity Fund I, 80 A.3d 155 (Del. Ch. 2013) [2013 BL 316872] was a suit between the buyers of Plimus, a subsidiary of the seller defendants, for fraudulent inducement. The facts of the dispute as to the privilege were described by the court.

After the Buyer brought this suit in September 2012—a full year after the merger—it notified the Seller that, among the files on the Plimus computer systems that the Buyer acquired in the merger, it had discovered certain communications between the Seller and Plimus’s then-legal counsel…regarding the transaction. During that year, the Seller had done nothing to get these computer records back, and there is no evidence that the Seller took any steps to segregate these communications before the merger or excise them from the Plimus computer systems, the control over which was passing to the Buyer in the merger. It is also undisputed that the merger agreement lacked any provision excluding pre-merger attorney-client communications from the assets of Plimus that were transferred to the Buyer as a matter of law in the merger, and the merger was intended to have the effects set forth in the Delaware General Corporation Law (“DGCL”). Nonetheless, when the Seller was notified that the Buyer had found pre-merger communications on the Plimus computer system, the Seller asserted the attorney-client privilege over those communications on the ground that it, and not the surviving corporation, retained control of the attorney-client privilege that belonged to Plimus for communications regarding the negotiation of the merger agreement. Before the court is a motion by the Buyer seeking to resolve this privilege dispute and determine, among other things, that the surviving corporation owns and controls any pre-merger privilege of Plimus or, alternatively, that the Seller has waived any privilege otherwise attaching to those pre-merger communications. (Emphasis added.)

The Delaware court, in a succinct decision, first noted that Section 259 of the DGCL provides that following a merger, “all property, rights, privileges, powers and franchises, and all and every other interest shall be thereafter as effectually the property of the surviving or resulting corporation…” Notwithstanding this language, the seller had argued—based largely on the bifurcation of the privilege adopted by the New York Court of Appeals in Tekni-Plex—that the statutory phrase ‘all…privileges’ does not include the attorney-client privilege, and that the Seller still retained control over that particular subset of Plimus’ privileges regarding the merger negotiations.

The Delaware court rejected this position on three grounds. First, it had this to say about Tekni-Plex: “the Court of Appeals innovated and, without citing §259 of the DGCL, concluded that the pre-merger attorney-client communications regarding the merger negotiations did not pass to the surviving corporation for policy reasons related to its analysis of New York attorney-client privilege law.” In other words, if Delaware law applied in Tekni-Plex, then the New York Court of Appeals ignored the plain language of the applicable Delaware statute, presumably for its own policy reasons. Second, it held that the language of the Delaware statute was plain and unambiguous (concluding that the word “all” means “all”).

Third, it cited the U.S. Supreme Court in Commodity Futures Trading Commission v. Weintraub, 471 U.S. 343, 349, 105 S.Ct. 1986, 85 L.Ed.2d 372 (1985): “[W]hen control of a corporation passes to new management the authority to assert and waive the corporation’s attorney-client privilege passes as well. New managers installed as a result of a take-over, merger, loss of confidence by shareholders, or simply normal succession, may waive the attorney-client privilege with respect to communications made by former officers and directors. Displaced managers may not assert the privilege over the wishes of current managers, even as to statements that the former might have made to counsel concerning matters within the scope of their corporate duties.” (Emphasis added.)

Without referring to Teleglobe, but echoing the Third Circuit, the Delaware court noted for the record that “the answer to any parties worried about facing this predicament in the future is to use their contractual freedom in the manner shown in prior deals to exclude from the transferred assets the attorney-client communications they wish to retain as their own.”

Two Clear Lessons

Whether or not a future New York decision as to Delaware (or New York) corporations will apply “public policy” grounds to uphold Tekni-Plex, or whether it will recognize the reasoning in Great Hill Equity, there are two clear lessons to be learned from all three of these cases by lawyers representing entities with subsidiaries in mergers or other situations where disputes may arise with their former parent entities. First, whenever the interests of the parent and subsidiary may begin to diverge, including any negotiation for divestiture, it is critical to limit joint representation going forward to matters other than the divestiture or other divergent interest, and to obtain separate counsel for the subsidiary as to those matters. Second, in the documents relating to the transaction, the privilege of the parent or selling entity should be explicitly reserved as an asset of that entity, and not passed to the subsidiary or its owners either by operation of the agreement or by any statutory default.

Anthony E. Davis is a partner at Hinshaw & Culbertson and a past president of the Association of Professional Responsibility Lawyers.

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