NOTE CONTENTS INTRODUCTION I. THE LEGAL FRAMEWORK A. The Advice of Counsel Defense 1. Use of the Defense in Practice 2. The Doctrinal Nature of the Defense B. The Impasse C. Current Federal and State Jurisprudence II. POSSIBLE SOLUTIONS A. The Impasse as Agency Cost B. Ex Post Solutions 1. Piercing the Privilege 2. Motion in Limine 3. Doctrinal Solutions: The Constitutional Right to a Defense C. Ex Ante Solutions 1. Multiple Clients or Multiple Lawyers 2. Contracting for Waiver of Privilege III. CONTRACTING SOLUTIONS IN DEPTH A. Are Contractual Waivers of Privilege Enforceable? B. The Corporation's Incentives C. Default and Mandatory Rules 1. Default Rules 2. Mandatory Rules D. The Terms of the Agreement CONCLUSION INTRODUCTION
The succession of shocking corporate scandals since 2002, coupled with increased scrutiny from Congress, the Department of Justice (DOJ), and the Securities and Exchange Commission (SEC), has increased public interest in holding corporate directors and executives personally liable for corporate malfeasance. (1) The DOJ may initiate a suit as a prosecutor for criminal fraud or as a civil plaintiff under the False Claims Act, (2) and since 2002, the number of federal civil fraud charges has increased by as much as 30%. (3) The Office of the Attorney General created the Corporate Fraud Task Force (CFTF) in July 2002 to prosecute criminal corporate malfeasance and to "restore confidence to the marketplace." (4) By late 2005, the CFTF reported that since its inception it had secured over 700 corporate fraud convictions, including convictions of more than 100 corporate CEOs and presidents, 80 vice presidents, and 30 CFOs. (5)
When a corporate director finds herself under investigation for fraud for corporate actions that she approved or implemented, (6) one defense she may wish to raise is her good faith reliance on the advice of the corporation's counsel that the actions were legal. (7) Generally, when a defendant raises this "advice of counsel defense," the court requires her to waive the attorney-client privilege with respect to the legal opinions upon which she relied. However, the corporate director who hopes to raise this defense faces a unique challenge: she is not actually the holder of the attorney-client privilege, because the corporation was the client who retained the counsel's services. Although society expects and even requires directors to rely on the legal advice of their corporation's counsel, (8) courts have consistently held that the corporation is the sole holder of the attorney-client privilege (9) because to hold otherwise would eviscerate the privilege. (10) Therefore, if a director, sued in her individual capacity, wishes to raise an advice of counsel defense and the corporation refuses to waive its privilege, the legal system reaches an impasse in which two fundamental doctrines are at loggerheads: the defendant director's right to defend herself and the corporation's right to maintain its attorney-client privilege.
This Note examines possible solutions to this impasse and argues that the best solution is to encourage directors and corporations to contract ex ante: the corporation will waive its attorney-client privilege if the director, sued in her individual capacity, needs to raise an advice of counsel defense. The default privilege rule should hold all attorney-corporation communications to be presumptively privileged by the corporation; in other words, the default should preserve the current law on establishing attorney-client privilege. (11) When the parties have contracted for waiver of the privilege, however, courts should enforce such contracts. Furthermore, courts should encourage the director and corporation to contract for waiver by enforcing a mandatory exclusionary rule. A plaintiff, faced with a director who threatens to raise an advice of counsel defense without having access to the relevant legal opinions, should be granted a motion in limine to prevent the defendant from even mentioning at trial that she relied on the advice of counsel. (12) Consistent application of this exclusionary rule and the motion in limine, while remaining within the existing legal framework, would be an improvement over the current, uncertain regime, and would allow the parties to anticipate how litigation would proceed.
Although a plaintiff may sue both current and former directors in their individual capacities in connection with a corporate fraud, the case of current directors is complicated by two factors. First, fiduciary duty constrains a current director's ability to assert defenses in litigation that are not in the corporation's interests. (13) Second, extralegal pressures (such as the desire for a successful ongoing business relationship) may bear on the current director's and corporation's litigation decisions. (14) Therefore, although much of this Note applies to current directors, its analysis focuses on former directors and indicates particular issues relevant to current directors as they arise. It is important to note that my proposed solution--contractual waiver of attorney-client privilege--can assist both former and current directors who, at the time of litigation, have previously negotiated for such a waiver. Thus, while the contours of the legal uncertainty that contributes to the impasse are affected by the current/former distinction, the implementation of the solution ultimately is not.
This Note proceeds in three Parts. Part I describes the legal framework of the advice of counsel defense in the context of corporate directors. Courts have considered the attorney-client privilege to be among the most fundamental testimonial privileges in the legal system. However, a party who raises the advice of counsel defense must waive the attorney-client privilege with respect to the opinions relied upon. (15) If the corporation holds the privilege and refuses to waive, this impasse has implications for both the plaintiff and the defendant. It creates uncertainty as to whether the defendant will be permitted to raise the defense at all during the trial and, if so, whether the plaintiff will be unfairly prejudiced by the inability to cross-examine the defendant on this issue. (16) Part II analyzes this impasse as a form of agency cost and then considers two groups of possible solutions to the problem. Ex post solutions attempt to break the impasse at the time of litigation, while ex ante solutions anticipate the impasse early in the relationship between the director and the corporation. Part II then proposes that the best solution is to encourage directors and corporations to contract ex ante to waive the corporation's privilege under limited circumstances. Part III develops the mechanics of how such a contractual regime would operate. Before concluding, the Note explores how parties could contractually tailor the scope of waiver and the conditions under which waiver would be executed.
THE LEGAL FRAMEWORK
This Part considers how the advice of counsel defense operates in practice and describes its doctrinal framework. The "defense" is actually a category of evidence designed to controvert the scienter element of the plaintiffs prima facie case. Directors are permitted, by courts and in some states by statute, to rely on advice of counsel as a defense to scienter. However, defendants who raise this defense are required to waive their attorney-client privilege so that the opposing party is able to investigate and rebut the defendant's claim. The impasse arises in part because this doctrine of required waiver assumes that the defendant is the holder of the privilege; it does not contemplate that a third party may be the privilege holder. Arrival at this impasse during pretrial litigation creates a high level of uncertainty for both the plaintiff and the defendant because it can create tactical advantages and disadvantages for each party depending on the facts of the case.
The Advice of Counsel Defense
Use of the Defense in Practice
To understand how the advice of counsel may operate in practice, consider the following hypothetical scenario. (17) During an ongoing investigation, the government is deciding whether to press civil and criminal charges against a hospital and its former CEO. It alleges the hospital paid fees to doctors as inducements for patient referrals, in violation of the Medicare Anti-Kickback Act. (18) The government is intent on charging the former CEO individually. The CEO's lawyers tell the government that no jury would ever convict the CEO because he relied on the advice of the hospital's counsel that the transactions, which amounted to paying the doctors for providing medical services, would be structured so as to avoid violating the Act.
The problem, explain the CEO's lawyers, is that the hospital refuses to waive its attorney-client privilege, so the CEO cannot turn over copies of the relevant legal opinions. At this point, the government faces a dilemma: is the government's case against the CEO strong enough to take to trial, or should it decline to file suit? The government has no idea whether the CEO really sought and received the claimed advice, nor does it know if this advice was reasonable. The CEO faces a dilemma of his own: if the hospital never waives privilege, how will he be able to keep himself out of jail?
In such scenarios, the legal community agrees that directors under investigation regularly consider raising an advice of counsel defense. (19) However, it is difficult to discover how frequently directors actually raise the advice of counsel defense in litigation. One reason is that these cases generally settle. The fact that so few cases go to trial in turn creates even more pressure to settle: fewer cases tried leads to fewer definitive rulings, generating more uncertainty about what is permissible in an increasingly complex regulatory system. (20) Settlements are often kept under seal to avoid reputational...