Sept. 21, 2022 – Lawyers retained to form a business entity work with the entity’s owners – and may continue to provide legal services to the entity. What happens when there’s a legal action against the owners? Who is the client – the entity, or its owners?

Question

A few years ago, my firm agreed to create a limited liability entity for a group of 23 doctors to acquire and lease medical imaging equipment. My firm has continued to provide general corporate legal services to the entity since then.

I recently was asked to represent a plaintiff in a medical malpractice action in which one of the doctor/owners of the entity is likely to be named as a defendant. The matter is unrelated to the business of the entity.

May I undertake the malpractice action, or does my firm have a conflict of interest?

Answer

Most lawyers are familiar with the “entity theory” of representation, as set forth in SCR 20:1.13, which stands for the proposition that lawyers who represent organizations represent the organization itself and not the human beings associated with the organization, such as employees, owners or shareholders.

Of course, a lawyer for an organization must communicate and interact with the human constituents of the represented organization. But, as stated by ABA Comment [2] to SCR 20:1.13, “(t)his does not mean, however, that constituents of an organizational client are the clients of the lawyer.”

Neither the rule nor its comment address client identity in entity formation, but guidance may be found in Wisconsin case law.

This scenario is based upon the facts of Jesse v. Danforth.¹ In that case, as in the scenario here, the firm in question had formed and provided legal services to the medical imaging entity and was also bringing a malpractice action against two of the owner doctors. The doctors sought disqualification of the plaintiff’s firm, asserting that the firm had a conflict under SCR 20:1.7 because the firm represented the doctors individually. While the firm argued that the entity, and not the individual doctors, was the client, the defendants argued that the firm had to represent the doctors as individuals in forming the entity.

In reversing the disqualification order of the court of appeals, the Supreme Court stated:

We thus provide the following guideline: where (1) a person retains a lawyer for the purpose of organizing an entity and (2) the lawyer's involvement with that person is directly related to that incorporation and (3) such entity is eventually incorporated, the entity rule applies retroactively such that the lawyer's pre-incorporation involvement with the person is deemed to be representation of the entity, not the person.

In essence, the retroactive application of the entity rule simply gives the person who retained the lawyer the status of being a corporate constituent during the period before actual incorporation, as long as actual incorporation eventually occurred.

In also rejecting the defendant doctor’s argument that the firm should also be disqualified because the firm was in possession of information about the doctors’ personal financial finances that was acquired pursuant to formation of the entity and that was protected by SCR 20:1.6, the Court stated:

This standard also applies to privileged communications under SCR 20:1.6. Thus, where the above standard is met, communications between the retroactive constituent and the corporation are protected under SCR 20:1.6. And, it is the corporate entity, not the retroactive constituent that holds the privilege. This tracks the Comment to SCR 20:1.13 which states in part: “When one of the constituents of an organizational client communicates with the organization's lawyer in that person's organizational capacity, the communication isprotected by Rule 1.6.”

***

Because MRIGM, not the physician shareholders, was and is the client of DeWitt, and because the communications between Drs. Danforth and Ullrich were directly related to the purpose of organizing MRIGM, we conclude that Drs. Danforth or Ullrich cannot claim the privilege of confidentiality.

(footnote omitted)

While the Court’s language seems to conflate the evidentiary privilege with the disciplinary rule of confidentiality,² the Court is clear that the duty of confidentiality is owed to the entity and not to the human constituents of the entity who provided the information to the lawyer.³

Finally, the defendants argued that the firm should be disqualified because the representation was “directly adverse” to the entity itself:

Dr. Ullrich asserts that there is also a conflict of interest between DeWitt's undisputed representation of MRIGM and DeWitt's undisputed representation of the plaintiffs. We disagree. For a conflict to exist, the representation of one client must be “directly adverse” to the representation of another client. Defendant Ullrich asserts that DeWitt's representation of plaintiff Jesse is directly adverse to DeWitt's representation of MRIGM by arguing that Drs. Danforth and Ullrich could lose their licenses to practice medicine if plaintiff Jesse prevails and MRIGM would face the loss of two of its shareholders and its president. Defendant Ullrich argues that, in light of plaintiffs' “financial incentive” allegations concerning the use of the CAT scanner, prosecution of this case could “mar” MRIGM's reputation and result in an adverse financial impact. Defendant Ullrich argues that DeWitt possesses information that most persons would consider confidential and, if DeWitt is allowed to continue as plaintiff Jesse's counsel, it may be difficult for MRIGM to secure additional shareholders who fear disclosure of such information.

Such possibilities fall short of “direct” adversity. While “directly adverse” and “indirectly adverse” are somewhat nebulous and factually dependent terms, the possible ramifications of DeWitt's representation of plaintiff Jesse are simply insufficient to be characterized as “directly adverse” to DeWitt's representation of MRIGM.

This is clearly an important case for Wisconsin lawyers who represent businesses, as the retroactive application of the entity representation rule to the formation of the entity is very helpful in managing conflicts – but there are important caveats to the Court’s holding.

First, the Court’s conclusion that the yet-to-be formed entity was the client was based upon a factual analysis of the lawyers’ communications with the doctors. An attorney-client relationship may be formed even when the lawyer does not ​so intend, if the lawyer’s words or actions create a reasonable belief of such a relationship on the part of the person.⁴

Therefore, a lawyer who is retained to form an entity must be explicit in engagement agreements and communications that the lawyer’s client is the yet-to-be formed entity, so that there can be no room for confusion.⁵

The clarity about the lawyer’s role is also important in protecting the confidentiality of information as well as the organization’s evidentiary privilege, as the Court noted that the “privilege” for communications not directly related to the formation of the entity belong to the individual rather than the entity.

Finally, while the Court held that the somewhat speculative reputational risk to the doctors was not directly adverse to the entity, the Court did not elaborate on the directly adverse standard. Nonetheless, Jesse remains an important case for business lawyers.

Endnotes

¹ Jesse v. Danforth, 169 Wis.2d 229, 485 N.W.2d 63 (1992).

² For a discussion of the differences between privilege and confidentiality, see Wisconsin Ethics Op. EF-17-02.

³ For a discussion of whether an entity or a constituent owns the evidentiary privilege, see Lane v. Sharp Packaging Systems.

⁴ See, e.g., Restatement (Third) of the Law Governing Lawyers, sec. 14.

⁵ See also SCR 20:1.3(f).