Cannon v. US Acoustics Corporation
| Decision Date | 26 June 1975 |
| Docket Number | No. 74 C 662.,74 C 662. |
| Citation | 398 F. Supp. 209 |
| Parties | Charles B. CANNON et al., Plaintiffs, v. U. S. ACOUSTICS CORPORATION, a Florida Corporation, et al., Defendants. |
| Court | U.S. District Court — Northern District of Illinois |
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Boodell, Sears, Sugrue, Giambalvo & Crowley, Chicago, Ill., for plaintiffs.
Baker & McKenzie, Chicago, Ill., for defendants.
Charles B. Cannon, Richard L. Davis, John G. Marsh, and Jeffrey Ross brought this derivative shareholder's action, as well as personal claims, against the defendants, U.S. Acoustics Corporation (hereinafter "Acoustics"), a Florida corporation, and National Perlite Products, S.A., (hereinafter "Perlite"), a Panamanian Corporation.1 The six-count complaint alleges violations of the Securities Exchange Act of 1934, 15 U. S.C. § 78a et seq., and the common and statutory laws of Florida and Illinois. Jurisdiction of the federal claims exists under 28 U.S.C. § 1331 (1970), and 15 U.S.C. § 78aa (1970). The state claims which arise from the same transactional nucleus as the federal claims are here under the doctrine of pendent jurisdiction. United Mine Workers of America v. Gibbs, 383 U.S. 715, 86 S.Ct. 1130, 16 L.Ed.2d 218 (1966); Brunswick v. Regent, 463 F.2d 1205, 1206-1207 (5th Cir. 1972). Jurisdiction of Count 4 of the complaint is based on diversity of citizenship, 28 U.S.C. § 1332(a)(1) (1970).
There are pending for decision cross-motions to disqualify counsel and a motion to disqualify Cannon as a party plaintiff. Shortly after Robert J. Gareis, Peter J. Mone and the firm of Baker & McKenzie filed their appearances on behalf of the corporate and individual defendants, plaintiffs moved to disqualify them from representing the corporate defendants and requested that the court appoint independent counsel.2 Plaintiffs base their motion on the theory that dual representation in a shareholder derivative suit creates a conflict of interest that the court can order terminated.
Concomitant with filing their answer to the plaintiffs' motion, defendants moved to strike Cannon as a party plaintiff and to strike the appearances of N. A. Giambalvo and Boodell, Sears, Sugrue, Giambalvo & Crowley as counsel for the plaintiff.
Defendants argue that by virtue of Canon 4 of the American Bar Association's Code of Professional Responsibility (hereinafter "CPR"), Cannon (who is a lawyer), and the lawyers and law firm which represent him, cannot maintain the pending suit because each previously represented the corporate defendants in legal matters that are substantially related to the present litigation.
Plaintiffs' motion to disqualify the lawyers from the firm of Baker & McKenzie from representing the corporate defendants raises fundamental questions of legal ethics and the extent to which a court should interfere with the right of any litigant to be represented by counsel of his own choosing. Furthermore, a motion to disqualify calls to question not only the probity of the individual lawyer, but the legal profession as a whole. See Hull v. Celanese Corp., 513 F.2d 568 (2d Cir. 1975). Mindful of these problems and considerations we have reached the conclusion that independent counsel must be selected for the defendant corporations.
In substance, the plaintiffs' complaint is a shareholder's derivative suit. While no treatise exposition on the nature of these suits is necessary here, a few pertinent observations will be helpful in analyzing the ultimate issue presented by the motion: whether the same counsel can represent both the individual and corporate defendants in a derivative shareholders suit consistent with the ethical standards promulgated by the American Bar Association and adopted by this court. A derivative suit is, in legal effect, a suit brought by the corporation, but conducted by the shareholders. The corporation, although formally aligned as a defendant for historical reasons,3 is in actuality a plaintiff. Ross v. Bernhard, 396 U.S. 531, 538, 90 S.Ct. 733, 24 L.Ed.2d 729 (1969); Swanson v. Traer, 230 F.2d 228 (7th Cir. 1956); 13 W. Fletcher, Encyclopedia of the Law of Private Corporations, § 5939, at 324 (1970) (hereinafter "Fletcher"); see Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541, 548-49, 69 S.Ct. 1221, 93 L.Ed. 1528 (1949). The stockholder is only a nominal plaintiff. 13 Fletcher, supra, § 5941.1, at 328, succinctly states the theoretical basis of the derivative suit:
The stockholder's suit has . . . a double aspect. The stockholders have a right in equity to compel the assertion of a corporate right of action against the directors or other wrongdoers when the corporation wrongfully refuses to sue. The suit is thus an action for specific enforcement of an obligation owed by the corporation to the stockholders to assert its rights of action when the corporation has been put in default by the wrongful refusal of the directors or management to take suitable measures for its protection.
See Ross v. Bernhard, supra, 396 at 334, 90 S.Ct. 733. Finally, a derivative action is appropriate to enforce a cause of action under the Securities Act of 1933, and the Securities Exchange Act of 1934. Fletcher, supra, § 5925, at 312; see Comment, "Shareholder's Derivative Suit to Enforce a Corporate Right of Action Against Directors under SEC Rule 10b-5," 114 U.Penn.L.Rev. 578 (1966).
The preceding paragraph delineates the anomalous position of the corporation; it is both a defendant and a plaintiff. An examination of plaintiffs' complaint amply reveals this position. Count 1 alleges that beginning in 1968 and continuing to the present, the individual defendants committed numerous violations of Rule 10b-5:4 illegal stock options were allegedly granted, stock was issued and purchased upon false representations that the stock was for services, rent, and other expenses, stock was issued for little or no consideration, corporate opportunities were usurped, illegal profits were retained by certain officers and directors, and illegal and excessive compensation was paid to Stedman.5
The remaining derivative counts allege the same misconduct but seek recovery under Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b) (1970), and the common law of Florida and Illinois.
Even a cursory examination of the foregoing allegations demonstrates that should they be established at trial, Acoustics and Perlite will benefit substantially. For this reason plaintiffs argue that Mone, Gareis, and the firm of Baker & McKenzie cannot represent the alleged wrongdoers and the ultimate beneficiaries of any judgment that might be obtained.
Defendants' position is that although there is a theoretical conflict of interest, no real conflict exists. They argue that the corporations are really inactive participants in the lawsuit,6 and that should any conflict arise they will withdraw their representation of the individual defendants and continue their representation of the corporations.7 Defendants further argue that their present position is that all the transactions complained of are legal and should be upheld.
The conduct of attorneys practicing before the court is governed by the American Bar Association's CPR. General Rules of the District Court for the Northern District of Illinois, Rule 8(a) & (d).8 Jurisdiction to enforce the CPR exists by reason of the court's regulatory power over the members of its Bar. Cord v. Smith, 338 F.2d 516, 524 (9th Cir. 1964); Richardson v. Hamilton International Corp., 333 F.Supp. 1049, 1052 (E.D.Pa.1971), aff'd, 469 F.2d 1382 (1972), cert. denied, 411 U.S. 986, 93 S.Ct. 2271, 36 L.Ed.2d 964 (1973); see United States v. Ott, 489 F.2d 872, 874 (7th Cir. 1973); Handelman v. Weiss, 368 F.Supp. 258, 263 (S. D.N.Y.1972).
When a single lawyer or law firm undertakes to represent both the individual and corporate defendants in a derivative action, at least two potential ethical problems arise. First, there exists, as previously discussed, a potential conflict of interest between the individual and corporate defendants, and second, there is the threat that confidences and secrets obtained from each client may be jeopardized because of the dual nature of the representation. The CPR addresses each of these problems in varying degrees of particularity. No code of ethics could establish unalterable rules governing all possible eventualities. Ultimately, therefore, the resolution of these problems rests in the reasoned discretion of the court.
Canon 5 of the CPR addresses the ethics of representing conflicting interests.9 It provides that a lawyer "Should Exercise Independent Professional Judgment on Behalf of a Client." Ethical consideration (hereinafter EC) 5-1 sets the Canon's overall objective:
The professional judgment of a lawyer should be exercised solely for the benefit of his client and free from compromising influences and loyalties. . . . The interest of other clients . . . should not be permitted to dilute his loyalty to his client.
In the instant case Gareis, Mone and their firm represent two clients with, at a minimum, potentially conflicting interests. The pleadings charge the individual defendants with serious corporate misconduct, and although counsel has in good faith represented there is no present conflict between the two sets of defendants, the subtle influences emanating from the representation of the individual defendants that might lead counsel to reach this position on behalf of the corporations are troubling.
Fortunately there are several other ethical considerations that deal more specifically with multiple clients. EC5-18 provides:
A lawyer employed or retained by a corporation or similar entity owes his allegiance to the entity and not to a stockholder, director, officer, employee, representative, or other person connected with the...
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