Disclosing Confidential Information of an Insolvent Entity
by Frank L. Broyles
There are a variety of circumstances in which a lawyer can be forced to resolve a conflict between the duty to preserve a client’s confidential information and the duty to disclose such information to third parties to prevent either a crime or fraud or participation in a crime or fraud, a conflict Maryland’s highest court termed a “legal ethics nightmare.”Attorney Grievance Commission of Maryland v. Rohrback, 591 A.2d 488, 489 (Md. 1991).
The issue is significant because lawyers who mishandle such situations can suffer both ethics sanctions and direct or derivative liability under various theories including conspiracy and aiding and abetting management’s breaches of fiduciary duty. This significance, as well as attorney risk, rises when the client is insolvent since the duties owed to creditors increase. See e.g., Milbank v. Holmes (In re TOCFHBI, Inc.), 413 B.R. 523, 533-534 (Bankr. N.D. Tex. 2009).
Recently this “legal ethics nightmare” was tackled by the Professional Ethics Committee for the State Bar of Texas in the context of the insolvent, closely held corporation. Tex. Comm. on Prof’l Ethics, Op. 603 (2010), 74 Tex. B.J. 74 (2011). The specific question addressed by the Committee was:
Do the Texas Disciplinary Rules of Professional Conduct require or permit a lawyer to reveal to a[n insolvent] corporation’s creditors the lawyer’s advice to the corporation that the person who owns and manages the corporation has engaged in conduct that constitutes a breach of the person’s fiduciary duties to the corporation?
Material facts identified by the Committee were:
(1) a single individual owns and manages the corporation,
(2) the corporation is insolvent,
(3) the lawyer representing the corporation has concluded that the managing individual is breaching the manager’s fiduciary duties to the client corporation which is likely to cause significant harm to the corporation’s creditors,
(4) the attorney has advised the manager that offensive conduct constitutes a breach of fiduciary duties owed to the corporation and should be stopped, and
(5) the manager has disregarded the advice and specifically instructed the attorney not to make disclosure to the corporation’s creditors.
The Committee began its analysis by emphasizing what it considered the paramount obligation of an attorney: the obligation to preserve “confidential information” under Disciplinary Rule 1.05(b). The Committee then considered the exceptions provided in Rule 1.05 and focused on the permissive disclosure exception to confidentiality provided in Rule 1.05(c)(7). That exception permits a lawyer to reveal a client’s confidential information “[w]hen the lawyer has reason to believe it is necessary to do so in order to prevent the client from committing a criminal or [actual] fraudulent act.”
It ultimately concluded that, under the particular facts and assumptions of the opinion, an attorney is never required to disclose confidential information to creditors but may make such disclosure if:
(1) management’s breaches of fiduciary duty would cause the corporation to engage in actual fraud which would likely result in substantial financial harm to the creditors,
(2) the lawyer has unsuccessfully attempted to dissuade management from committing the fraud,
(3) the lawyer believes disclosure to one or more of the corporation’s creditors will prevent the fraud, and
(4) the lawyer believes no less drastic action will prevent the fraud.
The Committee limited the scope of its opinion by two critical assumptions. First, it assumed that the insolvency of the corporation prevented the corporation from suffering any “corporate harm” as a result of the manager’s breaches of fiduciary duty. Second, it assumed that the lawyer was not a participant to the crime or fraud.
Although the impact of these assumptions on the Committee’s conclusions is beyond the scope of article, they are quite significant because they removed from the Committee’s consideration the mandatory disclosure requirements of Rules 1.05(f) and 1.12(b). A contextual discussion of these mandatory disclosure obligations, under both the Texas Disciplinary Rules of Profession Conduct and the ABA Model Rules, appears in my article, “Duty of Lawyers Representing Insolvent Debtors to Disclose Confidential Information to Creditors,” which appears in the April 2011 ABI Journal.
Although Opinion 603 dealt with the insolvent entity, its guidance is not that limited. Where management of any client entity is breaching duties owed to that entity—or its customers, creditors or equity owners—the conclusions provided in Opinion 603 might well apply.
Frank L. Broyles is a partner in the Dallas law firm of Goins, Underkofler, Crawford & Langdon, LLP and has been board certified in business bankruptcy law by the Texas Board of Legal Specialization since 1990. He can be reached at email@example.com.