“Hey, It’s My Lawyer Too!” The Massachusetts SJC Addresses the Attorney-Client Privilege in Closely Held Corporate Disputes

Disputes between shareholders and directors of small businesses have become common in Massachusetts courts. These are often high stakes cases with the fate of a business determined by the outcome. A recent SJC decision,Chambers v. Gold Medal Bakery, Inc., addresses key issues with respect to who may access communications protected by the attorney-client privilege in a business dispute. Specifically, the case addresses whether directors of a corporation are entitled to review privileged communications after those directors have sued the corporation. As described in this article, the SJC determined that privileged communications between corporate counsel and directors need not be disclosed to directors whose interests are adverse to the interests of the corporation.

First, some background. The attorney-client privilege is the cornerstone of any relationship between a lawyer and his or her client. It allows the attorney and the client to refuse to disclose private communications made in furtherance of the legal representation. Among other things, the privilege allows an attorney and his or her client to speak candidly about legal issues, and without fear that those communications will be made public as part of a lawsuit or otherwise. The privilege even extends beyond the grave; only an executor or other fiduciary of an estate can waive the decedent-client’s privilege.

With few exceptions, only the client may waive the attorney-client privilege. This presents unique legal issues when the client is a corporation or other entity. For example, if a corporation interacts with its lawyers through its directors, are all directors automatically entitled to access privileged documents – even when the directors are in a dispute with each other? This was at issue in Gold Medal Bakery. Normally, all directors are entitled to access privileged information as the corporation’s representative. However, where there is a dispute among shareholders and directors of a closely held corporation, the directors’ interests may no longer be aligned. In those situations, disclosing privileged communications to directors would mean disclosing privileged communications to direct adversaries, which in turn would undermine the very basis of the attorney-client privilege.

Gold Medal Bakery‘s import is lost without a full understanding of the type of dispute involved in that case. Closely held corporations typically have the following characteristics: (1) a small number of shareholders; (2) no ready market for the corporation’s stock; and (3) significant participation by the majority shareholder in the management, direction, and operations of the corporation. Shareholders of closely held corporations face unique challenges. For example, because there is no readily available market for their shares, minority shareholders are often subject to “freeze out” tactics whereby a majority shareholder uses economic pressure to coerce the minority shareholder to sell his or her stock at a deeply discounted price. To curtail these tactics, courts have ruled that shareholders in a closely held corporation owe each other heightened fiduciary duties, akin to a partnership, such that fellow shareholders are barred from depriving each other the reasonable expectations of stock ownership.

Gold Medal Bakery involved a situation common to many disputes involving family owned businesses. Two directors-shareholders (the plaintiffs) sought an exit strategy from the company, ultimately hoping to obtain a favorable buyout. Two brothers started the company several generations ago and, over its hundred-year history, it had expanded significantly. Four of the founders’ descendants inherited the company and broke off into two competing factions. The two plaintiffs collectively owned fifty percent of the company’s equity (and occupied two of the four directors’ seats), and claimed that the other two shareholder-directors were squeezing them out of managing the company.

In a related but separate lawsuit, the same plaintiffs had sued the corporation, as well as their fellow directors, claiming that they had been deprived access to corporate documents as part of a freeze out scheme. After that matter settled, the plaintiffs filed yet another lawsuit, claiming that the defendants breached the settlement agreement and that they were again engaged in a scheme to freeze the plaintiffs out of participating in the company’s affairs. After the plaintiffs demanded corporate documents as part of the lawsuit, the corporation filed a motion for a protective order to avoid producing the documents to the plaintiffs. The documents at issue included privileged communications both from the earlier litigation and the new lawsuit. The trial court rejected the motion and ordered the corporation to turn over the documents, including privileged documents. The court reasoned that, as directors, the plaintiffs were an “integral and essential part” of the company’s management.

The SJC disagreed and reversed the trial court’s decision, concluding that the plaintiffs should not be entitled to review documents that were protected by the attorney-client privilege (where the corporation was the client) because the plaintiffs’ interests were adverse to the corporation’s interests. The Court balanced multiple competing interests. On one hand, a director of a corporation must have access to corporate documents, including documents that may be privileged, in order to carry out his or her duties as a director. In addition, because the plaintiffs were also shareholders, they had a statutory right to access several categories of corporate records. On the other hand, there was evidence that the plaintiffs’ interests were adverse to the interests of the corporation. For example, the corporation had been named a defendant in the ongoing lawsuit and in prior disputes. Also, the plaintiffs’ self-interest in pursuing the litigation – namely, to obtain a higher buyout price – evidenced that their interests were adverse to the corporation’s interests. Thus, the SJC held that where the corporation itself was the client with respect to privileged documents, an adverse director should not be entitled to review those privileged materials. The Court summed it up as follows: “A director advancing interests shared with the corporation should be entitled to the associated privilege of access to legal advice furnished to a corporation. A director motivated by adverse interests is not so entitled.”

The SJC also distinguished protected attorney-client communications from the facts underlying those communications. The plaintiffs were entitled to most corporate records, such as financial statements, but were not entitled to privileged communications discussing the information contained in those records. In short, the SJC concluded that “A fact is one thing and a communication concerning that fact is an entirely different thing.”

Gold Medal Bakery demonstrates that, although the attorney-client privilege is powerful, it has limits and must be analyzed on a case by case basis. The decision also provides important guidance and key practical lessons in navigating the attorney-client privilege. First, attorneys and clients must know exactly who owns the privilege in any particular circumstance. Second, unless a director’s interests are adverse to a corporation, directors are entitled to review communications even where a corporation asserts the attorney-client privilege. Last, it is the confidential communication itself – rather than the underlying facts contained therein – that is shielded from the light of day.

Gold Medal Bakery also leaves questions unanswered. For example, the SJC remanded the case back to the trial court to determine, in light of the SJC’s ruling, which specific documents should be provided to the plaintiffs. Of course, the plaintiffs are entitled to corporate records that were not privileged. But are all communications between corporate counsel and the defendant directors barred from disclosure? Are the directors’ “adverse” interests to be considered retroactively? In other words, will Gold Medal Bakery prevent an “adverse” director from obtaining privileged documents that were created prior to the genesis of the underlying dispute? These unanswered questions highlight the attorney-client privilege’s intricacy in the context of a small business dispute – and underscore the importance of seeking the assistance of independent counsel when faced with these issues.