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Article: February 2020: When the Deal Goes Bad: Thinking Twice About Using Deal Counsel as Litigation Counsel

Business Litigation Reports

We trust our intuitions even when they are wrong.”

- Nobel Laureate Daniel Kahneman

 

Your corporate attorney may be a great deal lawyer—the lead on dozens of major transactions, head of a talented team, and attentive to your every business need.  And the terms of the deal are exactly what you wanted.  But even the most carefully crafted deal can end up in litigation.  One 2018 study found that 85 percent of merger deals struck in 2017 attracted litigation; 73 percent in 2016; and 89 percent in 2015.  Matthew D. Cain, et al., The Shifting Tides of Merger Litigation, 71 U. PA.  Rev. 603 (2018).  Private equity firms, which take on a myriad of roles as shareholders, directors, buyers, bidders, sellers, and lenders, are all too often seen as deep pocket targets, making expensive litigation an unavoidable cost of doing business.

            If the deal ends up in litigation, should a client hire the deal firm to represent it?  Or is the client better served with a separate firm as litigation counsel?  The initial reaction may be that litigation counsel should be from the same firm as the deal lawyer, under the theory that the firm is already on the scene and the intuition that there will be a shorter learning curve, easier coordination between deal lawyers and litigation counsel, and the firm will have a greater investment in defending the client’s position. 

            There are, however, multiple pitfalls inherent in this “one firm” approach.  Using the same firm for deal litigation can constrain the strategies adopted for the litigation and for any possible settlement.  Using one firm also raises a thicket of potential ethical problems that can lead to expensive and time-consuming side disputes.  The acts or omissions of the deal firm itself can be the focus of the litigation.  At worst, litigation counsel may be tainted or disqualified, resulting in the client’s forced restart with new counsel after the litigation has been long underway.  

          Below we give specific examples of why using litigation counsel from your deal firm should not be a “given” and why an independent firm merits serious consideration.

I.  The Strategic Benefits of Independent Litigation Counsel

            When a dispute erupts over a transaction, the person who ultimately has to determine which side prevails, and on what terms and conditions, is someone who had nothing to do with the deal:  a neutral decision-maker, such as an arbitrator, a panel of arbitrators, or a judge.  A client may be better served by a lawyer who, like the judge, has some distance from the deal and can make an experienced judgment about the best strategy, witnesses, and approaches to meet the client’s business goals and positioning of the case.  In all cases, choosing litigation counsel, like choosing a surgeon, should be an intentional choice designed to ensure that the client is employing the best one for the job, not merely the closest at hand.

A.  Deal Lawyers and Their Firm May—Likely Will—Be Affected by Unconscious Bias

            All of us use mental shortcuts or “heuristics” to make critical decisions.  Nobel-prize winning psychologists Daniel Kahneman and his colleague Amos Tversky developed the term “framing effect” to describe how seemingly rational choices may be in fact distorted or “framed” through subjective presentation. The Framing of Decisions and the Psychology of Choice, 211 Science 453 (1981).  Another heuristic they identify is “anchoring bias,” that is, a cognitive bias towards an initial estimate or starting point, which ultimately weighs heavily in the outcome of a decision.  Judgment and Uncertainty: Heuristic and Biases, 185 Science 1124 (1974).  These types of heuristics affect everyday decisions, including decisions made in business and law.  As Daniel Kahneman noted: “By their very nature, heuristic shortcuts will produce biases.”

            Deal lawyers, in particular, tend to have “confirmation bias”:  strong views, which are not objective, about what documents mean and why they did a good job.  Oxbow Carbon LLC Unitholder Litigation, 2017 WL 3207155, at *6 (Del. Ch. July 28, 2017) (“Motivated reasoning, motivated remembering, and confirmation bias are part of the human condition.”).  Confirmation bias can mean favoring a position early on and giving undue weight to evidence that supports that early conclusion.  Raymond S. Nickerson, Confirmation Bias: A Ubiquitous Phenomenon in Many Guises, 2 Rev. of Gen. Psychol. 175 (1998).  That is why judges admonish the trier of fact to “keep an open mind.”  Id.  The same concept applies to the attorneys preparing the strategies and approaches for a courtroom dispute.

            “False consensus” bias is another risk, where deal lawyers believe that their interpretation of an agreement based on what they intended and what they thought they accomplished is the only sensible interpretation, even if the cold words on the page are susceptible to different meanings.  Lawrence Solan, et al., False Consensus Bias in Contract Interpretation, 108 Colum. L. Rev. 1268 (2008). 

            Another level of bias is that a litigation partner may be inclined to believe that his or her corporate partner did a good job.  A client deserves a litigation team that is unconstrained from asking the hard questions about the deal lawyer’s work:  What is the plain meaning of the contractual language?  Is it arguably ambiguous?  Would the client’s interests be best advanced by relying on parol evidence or commercial context?  Are the right arguments being made?  Is the client being well served in discussions about whether to litigate the dispute or is the client being steered towards settlement to avoid throwing deal counsel’s work into the crucible of litigation?  Is an attractive solution being avoided because the deal firm would have to admit its own potential liability?

            An additional risk with the “one firm” approach is that the corporate partners may have too much influence about key litigation decisions, such as who from the deal team should testify, whose opinion is most important, whether the other side’s positions have merit, and what is the best approach for presenting the client’s case to a mediator, arbitrator, or judge.  A client may be better served with an independent litigator who can more easily say, “No offense, but that construction of the wording makes no sense,” or “Your position goes against current law and we need to find a way to resolve this quickly.”  Reframing the work of the deal lawyers is a delicate conversation to have under the best of circumstances, and is more likely to proceed well with lawyers from a separate firm.  Ultimately, the natural tendency to engage in framing raises the potential for biased decisions—the opposite of what a client needs when defending a lawsuit.  In the words of Professor Kahneman, the ideal advisor is “a person who likes you and doesn’t care about your feelings.”

B.  Deal Lawyers and Their Firm May Be Motivated by Self-Protection

            When engaging litigation attorneys from the same firm as the deal lawyers, there is an almost inevitable tendency to offer litigation theories and strategies that protect the firm as much as the client—and it is possible that those theories and strategies may not be entirely consistent.  Litigation counsel can face internal pressure to justify the deal language, the negotiations, the documents, and the advice given by their deal partners.  Particularly when the deal lawyer is the firm’s main client contact (the partner who literally puts work on the litigator’s desk for this client and others), it may be difficult, if not impossible, for the litigator to tell the deal partner that the contract has flaws, or that the strategy has to be repositioned, or that a term is ambiguous and that it is important to rethink what the parties meant. 

            In disputes over deals gone bad, the deal lawyers can end up as witnesses about what they did and why.  An independent firm can more easily send the message:  “It’s important that you testify despite the fact that you don’t want to.”  Or, “No offense but you are not the best person to testify about that topic.”  Of course, this concept is not only limited to deal litigation.  For example, it is a well-accepted norm that patent lawyers who prosecute a patent should not litigate it.  

            Independent outside counsel is better suited to do the “tough preparation” with a witness before they testify.  Independent counsel will enhance the deal witness’s (and hence the client’s) credibility because, at the very least, the difference in firms gives the appearance that someone who is removed from the deal is asking the hard questions.  This is a critical, if often overlooked, factor which we expect is at play in many cases where the nature of the “team” advising a client can make a difference to the finder of fact.  The long-term business interests of the client can also favor employing a different litigation firm.  Even though parties are in litigation, the opposing deal lawyers may be working together sooner or later, whether on redoing the same deal in dispute or other deals for the same or other clients.  By using litigation counsel from a firm that is not the usual deal counsel, a client can take an aggressive, no holds barred approach during the litigation and reduce the level of ill will directed against the client or its outside deal counsel.

II.  The Deal Firm May Be “Materially Limited” in Representing the Client 

            ABA Model Rule 1.7—which along with the other ABA Model Rules has been adopted by many states and is a staple of federal court ethics rulings—prevents lawyers from taking a representation that “involves a concurrent conflict of interest.”  A concurrent conflict of interest exists if “there is a significant risk that the representation of one or more clients will be materially limited by the lawyer’s responsibilities to another client, a former client or a third person or by a personal interest of the lawyer.”  Id. (emphasis added).  A competing “personal interest of the lawyer” includes risks to the lawyer’s partners or his or her firm.  Such conflicts may extend to the firm as a whole.  ABA Model Rule 1.10.  When litigation and deal counsel are from one firm, there are multiple ways in which representation of a client may be “materially limited.”

A.  Pursuing Litigation Theories that Favor the Deal Lawyer

            Concern by litigators about the reputation of their firm’s corporate lawyers can “materially constrain” the representation.  Many deals, especially those involving private equity, raise complicated legal and regulatory issues.  If the litigation firm is also the deal firm, the client runs the risk of not receiving unfettered advice about what went wrong with the deal and whether the advice and actions of the deal firm itself may have been a factor. 

            In one case, recently shared by a major private equity firm, the deal firm’s litigators deliberately decided not to seek production of emails from the other side’s lawyers because they did not want to subject their own email communications to scrutiny under a reciprocal request.   Similarly, in Veras Inv. Partners, LLC v. Akin Gump Strauss Hauer & Feld LLP, 52 A.D.3d 370, 372 (1st Dep’t 2008), the law firm did not assert an advice-of-counsel defense when its hedge fund clients were investigated by regulatory authorities about their market timing and late trading practices—allegedly because the law firm placed its own interest in defending its deal advice above the interests of representing the clients before the regulators.  See also Ultrapak, LLC v. Laninver USA, Inc., 2019 WL 244492, at *19-21 (W.D.N.Y. Jan. 17, 2019)(disqualifying deal lawyer who had “direct personal interest” in choosing interpretations of the governing agreement that minimized his personal responsibility for the alleged damage); Milan Markovic, The Sophisticates: Conflicted Representation and The Lehman Bankruptcy, 2 Utah L. Rev. 903 (2012) (a law firm’s interest in preserving its reputation with key government agencies undermined its legal representation of an investment bank and may have contributed to Lehman’s bankruptcy).  Ultimately, where the deal firm’s interest is to minimize its own role in the challenged deal, it may point the finger at others—including, potentially, its own client.  

B.  Deal Lawyer as Witness

            The possibility that a deal lawyer will appear as a fact witness is another basis for disqualification of the deal firm as litigation counsel.  See ABA Model Rule 3.7 (referring to the “lawyer as witness” rule); see also Domain Prot., LLC v. Sea Wasp, LLC, 2019 WL 3219939, at *7-8 (E.D. Tex. Nov. 19, 2019) (discussing Model Rule 3.7 and the “unseemly and ineffective position” of an attorney in a dual role as witness and trial counsel).  There are any number of specific facts about the background and negotiation of the deal that could be the basis of testimony, although they may be hard to anticipate at the beginning of the case.  The actions that the deal firm took—or failed to take—can easily become a focus of discovery and testimony, and can lead to disqualification of the deal firm.  See, e.g., Eurocom, S. A. v. Mahoney, Cohen & Co., 522 F. Supp. 1179, 1180 (S.D.N.Y 1981).

            In the same vein, when the deal lawyer is a witness and the litigation attorney is from the same firm, the other side can dispute whether their conversations are covered by attorney-client privilege, given that the deal lawyer was a “participant in the underlying events.”  See, e.g., Hertzog, Calamari & Gleason v. Prudential Ins. Co., 850 F. Supp. 255, 255 (S.D.N.Y. 1994) (communications remain privileged if the individual in question is acting as an attorney rather than someone who participated in the underlying events). 

            The bottom line is this: your opponent may demand that the deal lawyers give evidence about their underlying work.  A dispute about such evidence can be a costly and time consuming issue to litigate, and can result in disqualification of the litigators.

C.  Impact on Credibility of Trial Counsel

            A trial lawyer’s greatest asset with a fact finder is his or her credibility.  To persuade, the trial lawyer must be credible.  To be credible, the trial lawyer must be able to take positions based on the evidence without apparent bias.  If the trial lawyer is seen not only as an advocate for their client, but for his or her partner and their work or work product on the deal at issue, that will affect credibility.  In such circumstances, the trial lawyer may be perceived to have a personal stake in the litigation.

D.  Crossover Roles

            In some instances, a deal lawyer may “cross over” and be deemed litigation counsel—for example, by conducting an investigation well before any litigation is filed.  Disqualification of the entire firm is a possible result, although the issue can take literally years to resolve.  See, e.g., FDIC v. United States Fire Ins. Co., 50 F.3d 1304, 1317 (5th Cir. 1995) (district court disqualified firm whose lawyer conducted pre-dispute investigation along with his firm; four years later, appellate court reversed the disqualification).  This is not to say that disqualification motions are routinely granted, as most federal and state courts have set a high bar for granting them.  See, e.g., Murray v. Metropolitan Life Ins. Co., 583 F.3d 173, 178 (2009).  Nonetheless, such motions are frequently filed, bringing the risk of disqualification and, at best, an unnecessary and costly distraction.

E.  Recommendations About Settlement

            One-firm representation can affect litigation counsel’s advice about the scope of settlement or even the possibility that the case will settle.  The risk is heightened when the deal firm has a financial interest in the outcome as a result of, for example, a success fee or kicker contingent upon closing the challenged transaction.   The litigation attorney’s financial interest as a partner of the deal firm would be affected by the outcome of the dispute, including such factors as when and for how much the dispute is resolved.  As one court put it, “the parties are entitled to advice on that subject from counsel who are entirely uninhibited by any personal involvement of their own in the merits.”  Eurocom, 522 F. Supp. at 1180.

            Equity billing, such as receiving shares of stock, is another way that a firm may have direct financial interest in the client’s business, including any deal negotiated by the law firm.  The consequent financial or reputational risks can trigger potential conflicts such as the bar on business dealings between attorney and client (ABA Model Rule 1.8) and the reasonableness of attorney’s fees (ABA Model Rule 1.5). 

F.  Whether There Is a Meaningful Conflict Waiver

            The foregoing conflicts require a sufficient waiver, which must be specific and in writing.  See Model Rule 1.7(b)(4).  The client must be made aware of the relevant circumstances and of the material and reasonably foreseeable ways that the conflict could have adverse effects on the client’s interests.  And the client must agree to a “proposed course of conduct after the lawyer has communicated adequate information and explanation about the material risks of and reasonably available alternatives to the proposed course of conduct.”  Bd. of Regents of the Univ. of Neb. v. BASF Corp., 2006 WL 2385363, at *7 (D. Neb. August 17, 2006) (quoting the Comments to Rule 1.7).

III.  Final Thoughts

            There are sound legal and practical reasons to consider someone other than your deal lawyer’s firm to handle complex disputes arising from a transaction.  Although it may be tempting to choose those familiar with the deal to handle the matter, the potential conflicts and the impact of biased decision-making can undermine strategies and actions that best serve the client’s interests.  Lawyers who drafted the deal, and their partners, may be unable or reluctant to challenge accepted wisdom or think outside the box, creating an “echo-chamber” effect that can lead to less than desirable outcomes in litigation. 

            Ultimately, if a client chooses to hire the deal firm to litigate a dispute over the transaction, a labyrinth of risks and rules must be navigated.  The risks often outweigh any of the presumed benefits of retaining one firm for both roles.  At best, the client may get a constrained view of the litigation options and potentially an expensive and time-consuming sideshow over which firm will be its trial counsel.  Worse outcomes are possible.  Efficiency and prudence usually favors an independent law firm to help a client develop the most effective litigation defense, try the case, or negotiate a strong settlement.