In many business divorce cases involving close corporations (or closely held corporations), a shareholder who brings an action is often also a director of the company. The shareholder/director who brought the lawsuit frequently faces resistance from the other shareholders/directors and company about the limits of his access to the privileged materials. Compared to his rights as a shareholder (who has limited rights of inspection), however, a director has almost unlimited rights to access all company materials, including all privileged materials. With two exceptions limiting a director’s access—a situation involving specific agreements by shareholders (e.g., carve-out provision in the shareholders’ agreement) that limits a shareholder/director’s access or a dispute over the director’s access to the privileged communications between counsel and a special committee formed by the board to deal with the director’s demand or action—the director has unlimited access to all privileged materials. In other words, a dissident director who brings a lawsuit against the controlling shareholders/directors (or the company) has equal access to the privileged materials as the controlling shareholders/directors.

Delaware follows joint client approach for directors.        

Under Delaware law, a corporation cannot assert the attorney-client privilege to deny the former director access to legal advice furnished to the company during the director’s tenure, as in Moore Business Forms v. Cordant Holdings, C.A. No. 13911, (Del. Ch. June 4, 1996). Under Delaware law, all directors should be treated as a “single client” when legal advice is rendered to the corporation. This is because “the directors are all responsible for the proper management of the corporation, and it seems consistent with their joint obligations that they be treated as the ‘joint client’ when legal advice is rendered to the corporation through one of its officers or directors,” as in Kirby v. Kirby, C.A. No. 8604 (Del. Ch. July 29, 1987). “Because the attorney-client privilege belongs to the client, it would be perverse to allow the privilege to be asserted against the client.”

As one court explained, “the rationale for Delaware’s rule is that the board of directors, in its capacity as the governing entity for a corporation, is equivalent to the corporation. Thus, a privilege proper to the corporation cannot be asserted against a person who, at the time, was himself properly representing and, indeed, in some sense, was the corporation,” see Dow Chemical v. Reinhard, (E.D. Mich. May 30, 2008). Compare Schnatter v. Papa John’s International, (Del. Ch. Feb. 25, 2019) (noting a “recognized limitation on a director’s ability to access privileged information” where “a board can act pursuant to 8 Del. C. Section 141(c) and openly with the knowledge of [the excluded director] to appoint a special committee,” in which case “communications with that counsel would be properly protected, at least to the extent necessary for the committee’s ongoing work.”).

Accordingly, for Delaware corporations, with the very limited exceptions as noted above, a director has unfettered access to all privileged materials between the company and counsel during his tenure as a director of the company.

Pennsylvania federal courts follow a similar approach..

In Pennsylvania, too, while not as protective of directors as Delaware law, case law has provided some insight as to the extent of attorney-client privilege where a director seeks the privileged materials of the company in a shareholder dispute. In Gregory v. Correction Connection, (E.D.Pa. Nov. 20, 1990), a shareholder-director, Dick Gregory, brought suit against other shareholders/directors Larry D. Depte and Sandra L. Henderson, for trying to dilute Gregory’s majority share, coercing him to sell his stock back to the company, and attempting to gain and consolidate control of the company. Gregory moved to compel the defendants to disclose the contents of their communications with corporate counsel; while the defendants “did not contest the relevancy of the discovery that Gregory sought,” they argued that the nature of the communications protected them under attorney-client privilege. The court found in favor of Gregory—where inanimate entities, like corporations, were concerned, “the power to waive the corporate attorney-client privilege rests with the corporation’s management and is normally exercised by its officers and directors.” Gregory, as a member of the board of directors, was “entitled to be privy to communications between CCI’s management and CCI’s counsel,” being an “extension of the very ‘client’ that CCI’s attorney-client privilege serves.” Accordingly, the court ordered Depte and Henderson to produce the documents.

Interestingly, the court also said while Gregory may choose to waive the company’s attorney-client privilege by disclosing in public filings the privileged materials, the company and its shareholders would have an action for breach of fiduciary duty if such disclosure is not in the best interest of the company. The statement seems to reinforce the well-known principle that a director owes a fiduciary duty to the company. That is, while the director has access to the privileged materials, the director must still exercise his right to access the privileged materials with a fiduciary duty to the company. Stated another way, while the company may have a claim against a director who abuses his right to access the privileged materials if the company suffers harm, the company may not use the hypothetical harm to prevent the director access in the first place.

Another court in the Eastern District of Pennsylvania reached a similar result in Carnegie Hill Financial v. Krieger, (E.D. Pa. Jan. 5, 2000). In that case, the plaintiffs-companies brought an action against their former shareholders/directors for, among others, breach of fiduciary duty. The defendants-shareholders/directors sought to obtain documents from the companies’ counsel relating to their representation. While the plaintiffs invoked attorney-client privilege on these documents, the defendants argued that “the assertion of attorney-client privilege for documents addressed to defendants Dale Krieger and Richard Ruderman in their capacity as officers and directors of the plaintiff corporations is inappropriate.” In the question of whether former directors had the right to privileged documents in the context of litigation brought by the corporation against these former directors, the court effectively upheld the ruling in Gregory in finding that Krieger and Ruderman, as the directors of the board of the companies, were agents of the companies and entitled to communications between counsel and the companies.

Conclusion

As I noted in my last article, the attorney-client privilege is an exception to the general rule that relevant evidence is admissible. Unfortunately, too many times, some lawyers who represent controlling shareholders/directors improperly assert the attorney-client privilege against a dissident shareholder/director who brings a lawsuit against the controlling shareholders/directors. These lawyers generally side with the shareholders/directors who control the company and forget that the plaintiff shareholder/director remains a director and is entitled to the rights of a director. As the court stated in Krieger, even a former director enjoys the same rights as relates to the privileged materials shared during his tenure as a director. Lawyers representing corporations should be reminded about their ethical duties, especially in a situation where a dissident shareholder/director brings a derivative lawsuit against the controlling shareholders/directors. Before siding with the controlling shareholders/directors immediately, counsel should recognize that a dissident shareholder/director has the equal right to the privileged materials as the controlling shareholders/directors and think before asserting the privilege.

Edward T. Kang is the managing member of Kang Haggerty LLC. He devotes the majority of his practice to business litigation and other litigation involving business entities.