Organization as client (Rule 1.13)

Special Coverage

PROPOSED RULES OF PROFESSIONAL CONDUCT

The Board of Trustees of the State Bar of California has approved, and submitted to the California Supreme Court, a complete set of new and amended proposed Rules of Professional Conduct that will become effective if and when approved by the court.

Included in the proposed rules is Rule 1.13, "Organization as Client." Rule 1.13 would replace our current Rule 3-600. Like many of the other proposed rules, Rule 1.13 conforms to the numbering system of the American Bar Association's Model Rules of Professional Conduct, which serve as models for the ethics rules in all states other than California.

Both Rule 3-600 and Rule 1.13 make clear that, in representing an organization, it is the organization itself - and not its directors, officers, employees or other constituents - that is the client of the lawyer. As an entity, the organization can only act through its authorized officers, employees and other individuals, and such individuals are not the client even though the lawyer may take direction from such persons. Rule 1.13, however, makes the following substantive changes to Rule 3-600:

First, Rule 3-600 permits a lawyer to refer a matter to a higher authority within the organization under certain circumstances, including when the lawyer becomes aware that a constituent of the organization is acting, or intends to act, in a manner that either may be a violation of law imputable to the organization or is likely to result in substantial injury to the organization. (Such an action by the lawyer is often referred to as "reporting up the corporate ladder.") Rule 1.13 would mandate reporting up in certain circumstances. This mandate is consistent with the ABA Model Rule and the rules of many other states, but it diverges from Rule 3-600 which permits, but does not require, a lawyer to take such action.

Second, while the circumstances which trigger reporting up the corporate ladder under Rule 3-600 are based on the lawyer's actual knowledge, a lawyer's duty to report under Rule 1.13 would be triggered by two separate scienter standards: (1) a subjective standard that would require actual knowledge by the lawyer that a constituent is acting, intends to act, or refuses to act; and (2) an objective standard that asks whether the lawyer knows or reasonably should know that the constituent's actions would be (a) a violation of either a legal duty to the organization or law reasonably imputable to the organization, and (b) likely to result in substantial injury to the organization.

Third, unlike Rule 3-600 which permits a lawyer to take corrective action if there is either a violation of law or likely to be substantial injury to the organization, Rule 1.13 would require that both be present before a lawyer's duty to report up the corporate ladder is triggered.

Fourth, under Rule 1.13, a lawyer would be required to notify the highest authority in the organization if the lawyer has been discharged or forced to withdraw as a result of his or her reporting up obligation. No such notification is required by Rule 3-600.

Rule 1.13 would also replace the phrase "In representing an organization" in Rule 3-600 with the phrase "A lawyer employed or retained by an organization." While the rule presumably extends to in-house counsel employed by the organization, this change makes expressly clear that the proposed rule would apply to both in-house and outside counsel.

Rule 1.13 would carry forward some of the other key concepts contained in Rule 3-600, including the requirement that a lawyer must maintain his or her duty of confidentiality when taking action pursuant to the rule. In particular, it is important to note that, while lawyers may be permitted or obligated to report misconduct up the corporate ladder, they are generally precluded by their duty of confidentiality from "reporting out" such misconduct (e.g., to a regulatory body or prosecutor).

Rule 1.13 would carry forward the duty imposed by Rule 3-600 requiring a lawyer for the organization to explain who the client is when it is apparent that the organization's interests are, or may become, adverse to those of a constituent with whom the lawyer is dealing. Rule 1.13 would also carry forward the concept in Rule 3-600 which expressly recognizes that, despite such adversity, a lawyer may jointly represent the organization and a constituent so long as the requirements of the rules addressing actual or potential conflicts of interest are satisfied.

Rule 1.13 would also carry forward the concept in Rule 3-600 that if the highest authority in the organization insists on the course of conduct that triggered the reporting up obligation, the lawyer's response may include discussion of the lawyer's duties regarding mandatory withdrawal from the representation.

Finally, the comments appended to Rule 1.13 provide some clarity on its application. The comments make clear that a lawyer may refer to an organization's highest authority even when not mandated by the proposed rule. The comments discuss a lawyer's duty to defer to constituents' decisions on behalf of the organization, and explain that a lawyer should not generally substitute the lawyer's judgment for that of the organization's highest authority. The comments also make clear that it may be appropriate, before taking action pursuant to Rule 1.13, to urge reconsideration of a constituent's proposed course of action.

Rule 1.13 Organization as Client

(Proposed rule adopted by the board March 9, 2017)

(a) A lawyer employed or retained by an organization shall conform his or her representation to the concept that the client is the organization itself, acting through its duly authorized directors, officers, employees, members, shareholders, or other constituents overseeing the particular engagement.

(b) If a lawyer representing an organization knows* that a constituent is acting, intends to act or refuses to act in a matter related to the representation in a manner that the lawyer knows* or reasonably should know* is (i) a violation of a legal obligation to the organization or a violation of law reasonably* imputable to the organization, and (ii) likely to result in substantial* injury to the organization, the lawyer shall proceed as is reasonably* necessary in the best lawful interest of the organization. Unless the lawyer reasonably believes* that it is not necessary in the best lawful interest of the organization to do so, the lawyer shall refer the matter to higher authority in the organization, including, if warranted by the circumstances, to the highest authority that can act on behalf of the organization as determined by applicable law.

(c) In taking any action pursuant to paragraph (b), the lawyer shall not reveal information protected by Business and Professions Code § 6068(e).

(d) If, despite the lawyer's actions in accordance with paragraph (b), the highest authority that can act on behalf of the organization insists upon action, or fails to act, in a manner that is a violation of a legal obligation to the organization or a violation of law reasonably* imputable to the organization, and is likely to result in substantial* injury to the organization, the lawyer shall continue to proceed as is reasonably* necessary in the best lawful interests of the organization. The lawyer's response may include the lawyer's right and, where appropriate, duty to resign or withdraw in accordance with rule 1.16.

(e) A lawyer who reasonably believes* that he or she has been discharged because of the lawyer's actions taken pursuant to paragraph (b), or who resigns or withdraws under circumstances described in paragraph (d), shall proceed as the lawyer reasonably believes* necessary to assure that the organization's highest authority is informed of the lawyer's discharge or withdrawal.

(f) In dealing with an organization's constituents, a lawyer representing the organization shall explain the identity of the lawyer's client whenever the lawyer knows* or reasonably should know* that the organization's interests are adverse to those of the constituent(s) with whom the lawyer is dealing.

(g) A lawyer representing an organization may also represent any of its constituents, subject to the provisions of rules 1.7, 1.8.2, 1.8.6, and 1.8.7. If the organization's consent to the dual representation is required by any of these rules, the consent shall be given by an appropriate official, constituent, or body of the organization other than the individual who is to be represented, or by the shareholders.

Comment

The Entity as the Client

[1] This rule applies to all forms of private, public and governmental organizations. See Comment [6]. An organizational client can only act through individuals who are authorized to conduct its affairs. The identity of an organization's constituents will depend on its form, structure, and chosen terminology. For example, in the case of a corporation, constituents include officers, directors, employees and shareholders. In the case of other organizational forms, constituents include the equivalents of officers, directors, employees, and shareholders. For purposes of this rule, any agent or fiduciary authorized to act on behalf of an organization is a constituent of the organization.

[2] A lawyer ordinarily must accept decisions an organization's constituents make on behalf of the organization, even if the lawyer questions their utility or prudence. It is not within the lawyer's province to make decisions on behalf of the organization concerning policy and operations, including ones entailing serious risk. A lawyer, however, has a duty to inform the client of significant developments related to the representation under Business and Professions Code § 6068(m) and rule 1.4. Even when a lawyer is not obligated to proceed in accordance with paragraph (b), the lawyer may refer to higher authority, including the organization's highest authority, matters that the lawyer reasonably believes* are sufficiently important to refer in the best interest of the organization subject to Business and Professions Code § 6068(e) and rule 1.6.

[3] Paragraph (b) distinguishes between knowledge of the conduct and knowledge of the consequences of that conduct. When a lawyer knows* of the conduct, the lawyer's obligations under paragraph (b) are triggered when the lawyer knows* or reasonably should know* that the conduct is (i) a violation of a legal obligation to the organization, or a violation of law reasonably* imputable to the organization, and (ii) likely to result in substantial* injury to the organization.

[4] In determining how to proceed under paragraph (b), the lawyer should consider the seriousness of the violation and its potential consequences, the responsibility in the organization and the apparent motivation of the person* involved, the policies of the organization concerning such matters, and any other relevant considerations. Ordinarily, referral to a higher authority would be necessary. In some circumstances, however, the lawyer may ask the constituent to reconsider the matter. For example, if the circumstances involve a constituent's innocent misunderstanding of law and subsequent acceptance of the lawyer's advice, the lawyer may reasonably* conclude that the best interest of the organization does not require that the matter be referred to higher authority. If a constituent persists in conduct contrary to the lawyer's advice, it will be necessary for the lawyer to take steps to have the matter reviewed by a higher authority in the organization. If the matter is of sufficient seriousness and importance or urgency to the organization, referral to higher authority in the organization may be necessary even if the lawyer has not communicated with the constituent. For the responsibility of a subordinate lawyer in representing an organization, see rule 5.2.

[5] In determining how to proceed in the best lawful interests of the organization, a lawyer should consider the extent to which the organization should be informed of the circumstances, the actions taken by the organization with respect to the matter and the direction the lawyer has received from the organizational client.

Governmental Organizations

[6] It is beyond the scope of this rule to define precisely the identity of the client and the lawyer's obligations when representing a governmental agency. Although in some circumstances the client may be a specific agency, it may also be a branch of government or the government as a whole. In a matter involving the conduct of government officials, a government lawyer may have authority under applicable law to question such conduct more extensively than that of a lawyer for a private organization in similar circumstances. Duties of lawyers employed by the government or lawyers in military service may be defined by statutes and regulations. In addition, a governmental organization may establish internal organizational rules and procedures that identify an official, agency, organization, or other person* to serve as the designated recipient of whistle-blower reports from the organization's lawyers, consistent with Business and Professions Code § 6068(e) and rule 1.6. This rule is not intended to limit that authority.