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ABA Section of Business Law


Business Law Today

Turning Away Clients
A look at problematic representations
By Marty Robins
In today's legal profession where practice development — bringing in business — is so highly prized and endlessly discussed, it may seem heretical to be discussing when transactional lawyers need to turn away clients or matters However, survival in the field requires exactly such guidance. The corporate scandals that have affected so many companies, investors, customers, suppliers and employees have introduced another type of pressure on the business bar, namely pressure to prevent such problems.

For example, witness Section 307 of the Sarbanes-Oxley Act (SOX 307), requiring corporate lawyers to report certain serious management wrongdoing to the client's board of directors, as an indication of the public demand for the bar to prevent scandals. While this statute on its face applies only to public-company lawyers, it does not take much imagination to envision its application to private companies by counsel for disgruntled minority shareholders, lenders, etc.

One of the best ways to prevent such problems (or at least for counsel to avoid entanglement in them) is to avoid dealing with clients who are likely to place counsel in compromising positions. The well-chronicled demise of Arthur Andersen and the precarious situation of KPMG under its deferred prosecution agreement are examples of what can happen when an entrepreneurial culture, emphasizing client development, goes too far.

It must be emphasized that the considerations discussed below are not applicable to litigation. By definition, litigation involves the consequences of events that have already happened. Litigation is not usually a situation where counsel can be held responsible (or even seriously criticized) for failing to prevent client actions that harmed third parties.

Let there be no misunderstanding: Turning away business is likely to hit lawyers in the pocketbook, at least in the short run. This topic should only be addressed in particular cases by seasoned lawyers who can distinguish disreputable behavior from everyday business risk taking by virtue of their experience in commercial practice. It is a topic that needs to be discussed and a policy that needs to be implemented at the firm or bar association level or even the state regulatory level. Otherwise, there may be a "race to the bottom" where lawyers temporarily serve their own interest by taking or retaining clients who are not wanted elsewhere.

Why, then should we consider such action? The lawyers who served Enron, Tyco, Adelphia, HealthSouth, etc., before their problems came to light might be able to tell us about numerous problems from their involvement with scandal-ridden companies. Testimony in criminal and civil litigation or before the SEC or congressional panels inquiring about the causes of a business collapse is not likely to attract new business. Payment of settlements to aggrieved investors or responding to unfavorable publicity in the news media will not be beneficial either. See, McKay, Mollenkamp, "Refco Suits Spotlight White-Shoe Law Firm's Role," Wall Street Journal , April 10, 2006, p. C-3.

Various lawyers who have been sued for alleged violations of tax or securities laws when their clients encountered serious problems can also tell us about the downside of excessive deference to client prerogatives. The immediately preceding issue of this publication makes the point: "When a big scandal occurs, the trend now is for board directors to see whether some big law firm handling its legal work may be to blame." Brewer, Business Law Today , May/June 2006 at p.6, quoting Stephen van Wert, who was originally quoted in the Chicago Tribune.

Even apart from avoidance of direct involvement in legal problems, life will be more pleasant when dealing with clients who are not always operating "on the edge." A declared emphasis on identifying such responsible clients is likely to ultimately induce many of them to work with such firms, especially today where compliance is a key business function. Malpractice insurers are also likely to prefer firms that have in place meaningful mechanisms to stay out of dangerous situations.

Finally, while it may be a quaint notion to some, bolstering the public standing of the profession is likely to be gratifying for many of its members. Simply put, avoiding disreputable clients and transactions will make for a more sustainable (not to mention gratifying) practice. And, it's the right thing to do.

The ideas expressed in this article must be sharply distinguished from the formal obligations to disassociate oneself from clients who are engaged in criminal activity that are found in Sections 1.2(d) and 1.16 of the Model Rules of Professional Conduct, or report up under SOX 307. These recommendations are intended to help counsel avoid reaching that point by identifying at an early stage situations that appear to portend significant problems before they require withdrawal or declination.

One could say that these thoughts are in the nature of best practices, or at least aspirational practices, for the transactional bar. Unfortunately, in the author's experience, they can not be said to be common practice today. As the bench and bar become more familiar with the required changes in approach wrought by Sarbanes-Oxley and common law, it is likely that there will be increased pressure on the profession to adopt such practices.

As a technical proposition, there may be justification for applying these practices to a greater extent in the context of publicly held clients or securities transactions. However, the author contends that this distinction is not likely to be helpful if it is used to rationalize reduced attention to the nature of clients and representations elsewhere. If a transaction results in disaster, counsel faces the real possibility of scrutiny and attack whether or not public markets were involved. While the possibility of a favorable outcome for counsel may be greater outside the public or private securities area, the challenge itself will be quite traumatic.

It is prudent for firms to create a panel of senior lawyers, well versed in ethics and professional responsibility as well as commercial norms, to consider whether the circumstances actually exist in particular cases — that is, the burden should not fall on only one person. Withdrawal from or declining representation should be considered when:
  • Don't know enough. This should be obvious ... but we see too many cases where it is not. If the requisite expertise and experience is not possessed by or readily available to the lawyers doing the work, the matter must be declined or referred elsewhere. For larger firms, a searchable "skill bank" indicating the backgrounds of their lawyers is highly desirable so long as it is used for this purpose. A description of such a "bank" and products that may be used to implement it is found in Totty, "A New Way to Keep Track of Talent," Wall Street Journal , May 15, 2006, p. R7.

  • The pain of rejection ... of advice. If the client will not listen to the guidance of experienced lawyers concerning the risk of a given structure or transaction, including the legal risk arising from business terms or structures, problems are likely to result. To be clear: We are not talking about a client insisting on pursuing a deal where it may lose money; it is not our place to dissuade clients from doing that so as long as we apprise them of the material risks.

    We are talking about situations where by its nature a deal appears to be deceptive, overreaching, incomplete, grossly unbalanced or otherwise of the nature that is likely to prompt after-the-fact recriminations. It will not insulate the lawyer from challenge, or perhaps liability, to state that he was simply implementing the client's "business decision" or "accounting-policy" decision where senior-level counsel has discussed serious reservations with the client, explained why he feels the risk is beyond material and the client flatly rejects the advice. That includes situations where counsel feels that his own client is the party being seriously disadvantaged.

    While it is unrealistic, and undesirable, to expect a client to accept counsel's advice in every situation, a pattern of such disregard or disregard of advice labeled as critical is a cause for concern. When things go wrong, there will be plenty of blame to go around and counsel will not be thanked for deference to client prerogatives. Clients who say that all they want is a scrivener to "do the paperwork" have a way of recalling the conversation differently when a deal turns out badly. Even heeding the SOX 307 admonition about reporting up is not necessarily a safe harbor from all challenges or criticism of the lawyer's conduct.

  • See through ... or else! For public clients (and private clients pursuing private placements of securities or who have their financial statements audited at the insistence of lenders or private equity investors), an unwillingness to disclose fully material transactions is a bad sign for counsel. In today's compliance-oriented world, there is a high premium placed on full and prompt disclosure of material events — favorable and otherwise. If a client or potential client is reluctant or unwilling to do so after appropriate advice as to what is required, counsel has reason for concern about the client being embroiled in scandal or violating the law.

    Even assuming that SOX 307 has not yet come into play when counsel learns of the client's position, for example, if review of a potential client's 10-K or annual report suggests an anti-disclosure bias, counsel may well benefit by avoiding the situation. Materiality of proposed disclosures is always a legitimate issue, and competent counsel will often disagree about materiality of any particular matter. However, a continuing reliance on immateriality as a justification for nondisclosure is also ground for serious concern.

  • Doing it in the worst way. When a client rushes into a major deal with strategic implications for its business without wanting to understand its implications, or simply says that "we have no choice," be concerned. It is rare that there truly is no other choice, and a client who is desperate to do something today may very well be desperate to undo it tomorrow. While hasty decisions on one or more minor matters are not usually a problem, in a course of conduct that affects the client's competitive posture (or existence), danger is lurking.

  • Not enough space ... lacking independence. Even clients who want to do the right thing may need objective counsel to help identify it. If you or your firm is too close to the client or transaction because of the volume of business you do with that client, personal relationships with the key actors, a personal stake in the transaction at issue, or otherwise, you may not be able to provide the requisite independent advice in particular cases.

    For example, a firm acting as longtime principal outside counsel to a large company being asked to investigate its senior officers for possible wrongdoing is in a very awkward position and should probably defer to someone else, at least for that particular matter.

    The Enron episode is a case in point. When allegations of wrongdoing began to surface, Enron's regular counsel, Vinson & Elkins, which had been receiving $35-40 million in fees each year, was asked to investigate the conduct of management. While a partner of the firm advised its general counsel (apparently orally) that its ties prevented it from doing a "full-blown, independent investigation," it took on the matter and provided "a clean bill of health." This conclusion was based on interviews with at least four employees who later pleaded guilty to various crimes. McWilliams, Emshwiller, "Skilling Testimony May Come Today," Wall Street Journal April 6, 2006, p.C3.

    The fact that this testimony was elicited in the criminal trial of Enron's former president and chairman indicates why the engagement should have been declined altogether. A much higher degree of skepticism and inquiry at the time the review was requested and while it was performed would have well served V& E and the marketplace.

    Similarly, if counsel has a personal financial stake (directly or through family members) in a deal getting done, she probably can not take a hard look at whether the deal makes sense, is properly documented for the client, or might have an incentive to overreach the other party.

    Many would suggest that, as contemplated in Rules 1.7 and 1.8 of the Model Rules, written disclosure of the factor(s) that impair counsel's independence is sufficient if the client consents. In some situations, this is true. However, counsel still must be able to separate his interest from the client's when rendering advice or other services and there are occasions where this simply can not be done. See, for example, Comment 5 to Model Rule 1.7. Even if the disclosure cures the problem in some theoretical sense, the conflict is still likely to prompt challenges to counsel's actions if anyone is unhappy with the outcome. Such challenges may come from third parties who are not privy to the disclosures or from the client, claiming that she did not understand them or that they were deceptive.

  • Knock! Knock! Nobody answers. If counsel can not obtain from the client coherent (or any) answers to queries about the structure of or rationale for key points in a deal or the deal itself, that is a red flag. While the parties' relative bargaining strengths are certainly relevant if a deal is being arbitrarily imposed on someone or which does not seem to the client to have a rational basis for some or all key terms, it suggests something is wrong.

    Hearing "that's just the way it is" does not indicate a meeting of the minds with benefit to both parties. That is especially true in the case of public clients, where public disclosure of material transactions is required. If no one can identify plausible, genuine commercial rationales for all parties, the deal invites claims for misleading public disclosures, no matter what is eventually included in the 10-K's, 10-Q's, etc.

    Similarly, language with an illusory meaning such as a benefit that becomes available only if a nonfinancial asset declines in value by 90 percent within six months or if the prime interest rate goes to 30 percent within the next year, may be an indication of a dispute waiting to happen.

  • Haunted by the past. If a client has a history of problematic behavior — for example, failed deals spawning disputes, litigation, regulatory challenges, bankruptcies and the like — there needs to be serious discussion with him about whether and why things are likely to be different going forward. Strong documentation of the explanation and its viability is necessary if the representation is accepted. That is true whether the problems involved other counsel or your own firm.

    Knowing that a client has been cutting corners will place counsel under a greater burden than if this is not the case. It has to be emphasized that discretion must be used in evaluating information about prior client behavior. It is hard to justify new transactional work for a client under indictment for (or convicted of) bank fraud. However, that is not necessarily the case for a client who was a party to a civil lawsuit over a business venture or filed for bankruptcy five years ago.

    This begs the question of whether counsel has a duty of inquiry with respect to new clients or expanded relationships. There does not appear to be any formal authority on the point. However, some sort of good-faith inquiry with appropriate action in response is likely to go a long way in avoiding bad situations, or in mitigating the consequences of those that can not be avoided.

    What sort of inquiry? If nothing else, asking the client orally — or where warranted, through a D&O-style questionnaire — about recent litigation, bankruptcies, regulatory or criminal proceedings, is likely to be helpful. If such a query turns up nothing concrete, but the situation still seems troublesome — for example, inconsistent or incomplete answers — formal background checking with an outside service, such as that done with many new employees, may be desirable if the firm is still interested in pursuing the representation.

    Given the widespread use of the technique in other contexts, an Internet search through any of the major search engines is also advisable. Where applicable, special attention should be paid to disciplinary databases in specialized fields such as securities broker-dealers, CPAs, medical professionals, mortgage bankers and the like.

  • In our opinion ... There is debate in the literature (such as in The Business Lawyer) about whether corporate counsel is customarily required to act as a "gatekeeper" with respect to the M&A and securities markets by affirmatively screening out undesirable participants. However, there is no debate that, as a result of the misuse of tax and securities opinions in many recent scandals, rendering formal opinions to be relied on by third parties substantially increases counsel's responsibility.

    While provision of opinions has been and always will be a key part of a transactional counsel's job, beware of situations where a client is unduly interested in the topic and appears to be essentially "buying" an opinion to use in marketing its transaction, or has unrealistic expectations of what work is required to support the requested opinions.

    There is no shortage of literature governing how firms are to go about determining what opinions can be given. Even compliance with such procedures does not excuse participation in a wrongful scheme in which the opinion is an integral part.

    Such situations are often indicated when an opinion is the client's primary or only concern. Use of express language in engagement letters to disavow any commitment to provide an opinion is recommended where counsel is not agreeable to committing to provide it. Such disclaimers may "smoke out" clients with an inordinate interest in the topic.

  • Something for nothing. Be wary of cases where the client is counting on getting something that seems too good to be true, such as tax benefits without economic risk or substance, and simply wants you to quickly "review the documents." The various exotic tax shelters that were in vogue in the late 1980s and the 1990s, such as the well-publicized Sprint management transaction involving transfer of stock options to controlled entities and the infamous KPMG BLIPs and FLIPs, which featured tax losses with little or no money changing hands and no real business purpose, should have put counsel on notice.

    Also be wary of cases where the client believes that her opposite number will do something irrational simply because they like your client or the ever-popular "they value the personal relationship so much." Unrealistic expectations have a way of causing unrealistic, but all too real, hostility toward all concerned when they are not attained.

  • Taking it too personally. The multitude of scandals involving improper disclosure of executive compensation (such as backdated stock options or obtuse supplemental retirement plans) illustrate another sign of trouble for counsel for a corporation: management that exhibits a very high degree of emphasis on their own remuneration at the expense of looking out for the company. When discussion of a proposed transaction frequently shifts to addressing its direct benefits to management, the interest of the company may be jeopardized.

    Executives focused on "what's in it for me?" may not be very interested in seeing that their employer gets what it bargains for or running the business at a profit, which may lead to challenges from shareholders, regulators, etc. Such challenges may address whether counsel properly advised the board of directors of all relevant facts in accordance with SOX 307 or otherwise fulfilled their obligation under Model Rule 1.13 to represent the organization as opposed to any of its officers.
So, what can we do?

If a problematic situation does arise, the manner in which counsel should extricate himself depends on the stage at which the problem comes to light. If it involves a proposed new client where no work has been done, all that is required is a declination and nonrepresentation letter. When dealing with a new matter for an existing client where no work has been done, a similar letter with respect to the particular matter (or the entire representation if desired by the firm) should suffice. There is no need to identify the reasons for the action.

If work has already been done, client consent to the withdrawal is needed under Rule 1.16 of the Model Rules unless it is clear that the lawyer is being used to perpetrate a crime or fraud — a higher standard than simply being uncomfortable with the situation.

There is no question that the business law field has dramatically changed in recent years as we all rightly become much more focused on revenue generation. However, we must see to it that our zeal for client development remains tempered with prudence. Maybe this article should be retitled "A dose of broccoli for the barristers" because it addresses an unpalatable topic. The good tasting but sometimes dangerously fattening activity of client development has the usual hazards of rich food. Hopefully, the readers will use the ideas contained here to formulate their own "diet."
Robins is a sole practitioner in Buffalo Grove, Ill. His e-mail is mrobins@mr-laws.com.

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