Clarity brought to conflicts of interest but grey areas remain

The topic of law firm conflicts of interest is far from glamorous. Yet the issues engaged are real, equally as far as one could imagine from arcane academics and pure theory. Indeed, conflicts of interest are flashpoints, capable of derailing strategy by obstructing mergers and lateral transfers, and – probably worse – setting partners and entire practice groups one against the other. So much so that even the regional dynamics of Canada's tightly knit legal markets could be affected.

From a law firm's perspective, conflicts approach their nadir when they go public in the form of litigation. The potential embarrassment and damage to client relations is so great that law firms must carefully assess whether continued representation is worth fighting over except in the clearest of cases, usually where an adversary brings a motion for disqualification as a tactical manoeuvre.

But there's also the client's perspective. Conflicts issues affect a wide range of clients, from large companies that must rely on the limited number of major firms in Canada's legal market for representation in significant transactions and litigation, to consumers from rural and remote areas that are served by only a few lawyers.

No surprise, then, that the profession eagerly awaited the Supreme Court of Canada's decision in Canadian National Railway Co. v. McKercher LLP, which was released in mid-2013 (see “McKercher v. CNR: A Refresher,” below). McKercher rounded out the high court's “conflicts trilogy” that spanned more than a decade and included R. v. Neil and Strother v. 3464920 Canada Inc.

McKercher's impact cannot be underestimated. The principles enunciated in the reasons informed the conflict rules in the Federation of Law Societies of Canada's current Model Code of Professional Conduct. Substantially identical conflict rules have now been adopted in British Columbia, Alberta, Saskatchewan, Manitoba, Nova Scotia, and Newfoundland and Labrador. Quebec is in the process of implementing the rules and Ontario's version comes into effect in October 2014.

The upshot is that most of Canada will have uniform conflict rules in place in the near future. While the rules are comprehensive and contain illuminating commentary, McKercher and the rest of the trilogy are at their core.

But however eagerly they awaited McKercher, Canada's law firms were for the most part prepared to implement the decision and the rules that followed.

Law firms' local, regional and national expansion in the '90s and beyond, as well as the domestic and cross-border consolidation in many industries, had significantly increased the potential for conflicts. For some 20 years at least, conflicts committees at major firms have been de rigueur, though the formality of their structure and process have varied considerably.

The complexities that emerged, however, led to greater sophistication in conflict management. Many firms started vetting new matters through centralized clearance systems after Clifford Chance became the first to do so in 2000. As technology evolved, so did the systems. Where grey areas or diverging internal interests arose, the conflicts committees, frequently chaired by managing partners and usually including practice group heads, had the final call. Perhaps the most difficult decisions related to mandates that might potentially conflict, or to business conflicts that did not amount to legal conflicts.

Apart from the evolution of technology, which for the most part has kept up with the numeric growth and geographical reach of law firms, and an increasing understanding of the damage caused by mishandled conflicts, not much has changed as far as process is concerned.

What has changed are the questions that firms must ask themselves and the increasing emphasis on practical business considerations. But the answers arrived at, especially in the grey areas, continue to be the products of lawyers' stock-in-trade: the exercise of judgment.

In its 2002 reasons in Neil, the SCC for the first time spoke to the parameters of the duty of loyalty, a duty it recognized as distinct from the duty of confidentiality. Indeed, the duty of loyalty became the foundation of a bright-line rule that prohibits law firms from concurrently representing clients adverse in interest without first obtaining their consent. Arguably, that didn't change much as far as legal conflicts were concerned. The sea change, however, was that the decision suggested that the rule applied to business conflicts as well as legal conflicts: that impacted everything from client development strategies to the reach of conflict-checking systems.

Neil definitely changed the way we and other law firms populated our conflict databases,” says Harvey Morrison of McInnes Cooper's Halifax office.

The core problem Neil created for the country's major law firms was in its sweeping dismissal of the dilemmas the decision posed for them. The SCC suggested that strategic considerations were “interests” that could be directly adverse to the immediate interests of existing clients. In doing so, the SCC formulated a broadly cast duty of loyalty that made the notion that “business development strategies must adapt to legal principles” into a rule of law liberated from the constraints surrounding the existence of confidential information and an assessment of the extent to which breach of that confidentiality might affect the client.

“It's been a rocky, uncertain road ever since Neil came out,” says Michael Charles of intellectual property boutique Bereskin & Parr LLP's Toronto office.

Making matters worse, Neil left open as many questions as it answered. The decision's overriding principle was that lawyers could not represent clients, “whose interests were directly adverse to the immediate interests of another current client — even if the two mandates were unrelated.”

This enunciation of the rule raised a number of questions, such as whether acting for a competitor of a client in a proposed merger was prohibited because it might affect a current client's market position adversely; whether a “current client” was one for whom the firm acted regularly on relatively minor matters, or had acted for once on a large transaction fairly recently; and whether a current client was one whose file has not been closed simply because the account had not been paid, or because a trivial matter remained outstanding, or because the firm's file-closing system tended to lag behind events.

The Strother decision in 2007 reinforced Neil in the context of a lawyer's personal adverse interest, but questioned whether the bright-line rule with respect to current clients applied to business conflicts as well as legal conflicts.

In the end, it was left to McKercher to more definitively flesh out the outstanding issues that Neil and Strother had left in their wake.

The McKercher court ruled that a lawyer's duty of loyalty comprised three elements: a duty to avoid conflicting interests; a duty of commitment to the client's cause; and a duty of candour. The general rule was a bright-line rule: lawyers and their law firms could not represent clients adverse in interest without first obtaining their consent. This rule applied where a situation engendered an inescapable conflict of interest, applied to concurrent representation in both related and unrelated matters, and could not be rebutted.

But the bright-line rule was limited in scope: it applied only where the immediate interests of clients were directly adverse to the matters on which the lawyer was acting. It also applied only to legal interests, not to commercial or strategic interests. It could not be raised tactically and did not apply where it was unreasonable for a client to expect that a law firm would refrain from acting against it in unrelated matters.

McKercher, then, brought some much-needed certainty to a pivotal issue in the conflicts debate.

“By clarifying that the bright-line rule applied only to legal interests and not to business interests, the Supreme Court decision should bring more consistency to how different law firms understand their obligations,” says Julia Holland, counsel in Torys LLP's Toronto office.

Still, important questions lingered.

Where the bright-line rule was inapplicable, the SCC stated, the issue became whether the concurrent representation created a substantial risk that the lawyer's representation of the client would be materially and adversely affected by the lawyer's own interests or by the lawyer's duties to another current client, a former client, or a third person.

“The upshot is that the bright-line rule is still very much intact, but it's there to protect clients and still requires lawyers to turn work away in appropriate cases,” says John Hunter of Hunter Litigation Chambers in Vancouver, who intervened on behalf of the Federation of Law Societies of Canada. “On the other hand, the business community can have confidence that existing or former clients cannot just turn around at any time and assert a conflict that will disqualify their opponent's lawyer of choice.”

Perhaps, but the fact remains that the difficult decisions are the ones most likely to arise in the context of commercial or strategic conflicts, rather than legal ones. Ultimately, each such case had to be judged by a “reasonableness” standard — arguably the standard that has promoted more jurisprudence than any other in the history of the common law.

Interestingly, the model professional conduct rules that followed on the trilogy do not distinguish between legal and business interests.

In the case of existing clients, they state that a conflict of interest exists when there is a significant and plausible risk that a lawyer's loyalty to or representation of an existing client would be materially or adversely affected by the lawyer's interest to himself or a third party. While the risk must not be certain or even probable, it must be genuine, serious and more than a mere possibility.

Lawyers can act in a conflict of interest, however, when the client gives express or implied consent, but only where it is reasonable to conclude that the lawyer can act without having a material adverse effect upon representation or loyalty. “Possible material impairment may be waived but actual material impairment cannot be waived,” the Ontario rules state.

The upshot is that Canadian law firms, absent informed consent, will no longer have the luxury of letting their own business considerations be the determinants of whether they can accept retainers against current clients, even where no confidential information is involved and even where the matters in issue are unrelated.

In the case of former clients, the strictures prohibit representation in the same or related matters, or any matter in which a lawyer has relevant confidential information arising from the relationship with the former client and that may prejudice that client. In the latter case, another lawyer in the same firm may act against the former client if the former client consents or if the firm erects appropriate “Chinese walls.”

Seen in overall perspective, then, the trilogy went a long way to clarifying the basic rules regarding conflicts of interest, as do the new rules of conduct. But in no sense has the exercise of judgment diminished as a factor in law firms' consideration of how they should proceed in the grey areas.

Consider, for example, the amorphous nature of “significant and plausible risk” and the complexities of what constitutes a risk that “materially or adversely” affects a client, which come into play when attempting to predict the business outcomes that will likely form the bulk of the disputes about whether a conflict exists.

“The factors limiting the bright-line rule can be difficult to wrestle to the ground,” Morrison says. “Direct legal adversity isn't too bad to deal with, but it can be difficult to get a sense of the tactical side of the rules as they relate to business or strategic interests.”

The greatest difficulty, as is often the case, may be in the exceptions to the rule. And the big exception that arises from McKercher is what some commentators have called the “professional litigant” exception, one that applies to entities like large corporations and governments having a litigation portfolio that is always extant.

In such cases, the SCC stated, it might not be reasonable for an entity that is a current client of a law firm to object to the law firm acting against it in an unrelated matter where confidential information is not in issue. Factors in determining whether an objection is reasonable, and therefore whether consent might be implied, included the size of the client and the nature of the relationship between lawyer and client.

“The exception that the court created for huge market players is very vague, so there's going to be a problem soon,” says Allan Hutchinson, Distinguished Research Professor at York University's Osgoode Hall Law School in Toronto. “The exception was unnecessary and unsatisfactory, and simply a case of the court trying to have it both ways by sticking to the bright-line rule it enunciated in Neil and making an exception for cases where choice of counsel comes into play.”

What's somewhat confounding is that the McKercher court found that CN, undoubtedly a corporation large enough to fall within the “professional litigant” exception, was reasonable in its objection to McKercher's representation of plaintiffs in a class action against the railway.

“What we don't know is what circumstances will in future give rise to an unreasonable objection by the client,” says Gavin MacKenzie of Davis LLP's Toronto office, a prominent expert on conflicts law and ethics generally, who represented the law firm in McKercher.

That being said, law firms don't seem overly concerned that McKercher and the new rules have changed the playing field much. “McKercher did change the way in which resort to the bright line was limited, but on the more practical side, Neil has been the guiding star for some years, and McKercher affirmed the principles laid down there,” Morrison says. “Unlike Neil, McKercher hasn't changed the way we populate our databases.”

Still, Morrison concedes that dealing with the exception can be challenging in individual cases. “Like the tactical side, it can be hard to get a handle on the reasonable non-objection category,” he says.

Practically speaking, that may not matter. “Client expectations as a feature of implied consent are not relevant to our practice,” Holland says. “Our clients' expectations are that the bright line will apply. In fact, professional litigants and institutions are precisely the kind of client that have guidelines and want us to seek their express consent.”

A sampling of in-house counsel at large corporations suggests that Holland has hit the nail on the head. “McKercher hasn't really impacted our consideration of conflict issues, because the group of core firms whom we tend to work with over and over again and with whom we have developed strong relationships over the years know or expect that we will want the opportunity to decide whether to consent to any situation where the possibility of a conflict arises,” says John Chimienti, Associate General Counsel and Chief Counsel, Retail at Canadian Tire in Toronto.

In determining whether to consent, Canadian Tire takes a more rigid approach to legal conflicts than to business conflicts. “Given the breadth of businesses carried on by the Canadian Tire family of companies, business conflicts are obviously more difficult to avoid,” Chimienti says. “I am sure that some of the firms we use also have some of our competitors as clients.”

IGM Financial Inc. requires knowledge of any actual or potential conflict both at the time of a retainer and throughout. “We try to resolve matters through discussion with outside counsel, and we are amenable to solutions like ethical walls in some situations,” says Geoffrey Creighton, IGM's General Counsel. “But we do require that our usual team of preferred individual lawyers be on our side of the wall.”

Creighton also points out that some transactions don't lend themselves to ethical walls. By way of example, he cites the case of a law firm acting for more than one bidder in an M&A contest where the two clients are “facing off” with one another.

“Generally, however, we recognize that one of the by-products of working with big, sophisticated firms with lots of expertise and bench strength is that there will often be situations where an ethical wall will be necessary,” he says. “After all, one of the reasons you want a firm of that kind is precisely because they do act for everyone, and that is what gives them the experience and insight that benefits you.”

Creighton, like Chimienti, says McKercher has not really affected IGM's policies. “We seldom get down to such fine lines that a rigorous legal analysis is needed,” he explains. “But whether something will be a problem for us is probably a tougher standard than what a law firm would say is the minimum acceptable.”

Ultimately, Creighton concludes, it's a touchy-feely thing. “Discomfort is enough for us to determine the issue in most cases and because we have good two-way trusting relationships with our primary external counsel, that has become a liveable way to proceed on both sides,” he says. “On balance, the relationship tends to be more beneficial to both sides than any particular problematic retainer.”

Bombardier, by contrast, has a somewhat less flexible approach. “McKercher hasn't changed anything,” says Daniel Desjardins, the company's General Counsel. “It's always the case that if you act for us in litigation, you can't act against us in litigation. In commercial transactions, call us and we'll decide.”

Bombardier, however, is somewhat more flexible when a firm it uses in non-litigious matters turns up on the other side in litigation. “But that only applies to firms that we do not regard as primary law firms, but even these firms will not be allowed to represent us in any litigation if they are on the other side in another case involving commercial litigation,” Desjardins says.

Like Bombardier, Air Canada casts its net beyond legal conflicts to business conflicts. “McKercher articulates our policy but it's narrower because we include strategic or business interests,” says David Shapiro, the company's Chief Legal Officer. “The reason we take a broader view is because we regard our relationship firms as partners in various respects, including billing arrangements.”

Shapiro says that he found the law firm's position in McKercher to be an “abomination,” but adds that he tries to accommodate relationship firms where the bright-line test doesn't apply to either the legal or business interests involved. “I want the law firms that act for us to win unless their representation adversely affects Air Canada, but I also want the opportunity to make the decision,” he says.

In the case of non-relationship firms, Air Canada's expectations are lower. “That's particularly so when I'm the one chasing a firm because our relationship firms don't provide the specific expertise or a particular level of service,” he says. “In that case, we both know that it's a one-off so I stick to legal considerations, although I do expect the firm to divulge who they are representing on matters that are strategically or commercially adverse.”

Needless to say, however, disputes over conflicts do arise between lawyers and clients. “That can occur because the lines between strategic counsel and relationship firms are not always that clear,” Shapiro says.

Where disputes do arise and legal analysis is required, McKercher does make a difference. While that difference may not lie in the conclusion a court might reach about a dispute, it does lie in the area of disclosure, which has not been the most frequently discussed aspect of the SCC's decision.

“On the ground, disclosure always mattered but it matters even more now,” says Malcolm Mercer of Toronto, who is McCarthy Tétrault LLP's general counsel as well as a partner. “Any firm that is not being transparent about the decision-making considerations, even when it believes that there is no conflict, is at considerably greater risk of acting improperly.”

Indeed, both McKercher and the new conflicts rules make it clear that lawyers must think about substantial risk even where the bright-line rule does not apply.

“The key consideration is client representation,” Mercer says. “So the question of whether you are putting representation at risk can really be more important than focusing on the bright-line rule.”

Lawyers facing potential conflicts, Mercer suggests, should analyze the situation from the perspective of the existing or new client. “It's better to ask yourself whether you're putting the representation you're taking on at risk because the existing or former client will feel betrayed and challenge that representation,” Mercer says. “Regardless of the extent to which McKercher has changed the law or practice, the fact remains that this area has become convoluted and technical.”

As Mercer sees it, dealing with conflicts is in some ways easier in larger than in medium-sized or smaller firms. “It's central that the person who's making the decision is not the person who's doing the business,” Mercer says. “Even people acting in good faith make mistakes when they want something.”

And, as everyone knows, law firms want as many good clients as they can get.

Julius Melnitzer is a freelance legal-affairs writer in Toronto.


MCKERCHER V. CNR: A REFRESHER

McKercher originated in 2008, when McKercher LLP, one of Saskatchewan's largest law firms, took on a proposed class action for a group of prairie farmers. The claim alleged that CN and others had overcharged the class for grain transportation for more than 25 years. At the time, McKercher was acting for the railway in other matters, but subsequently withdrew from these cases. The first the railway heard of the potential conflict, however, was when it was served with the statement of claim in the class action.

CN sought to disqualify McKercher from acting on the class-action lawsuit.

As the SCC saw it, McKercher's conduct fell squarely within the bright-line rule: CN and the class suing the railway were adverse in legal interest; CN's resistance to McKercher's representation of the class was not tactically abusive; and the expectation that McKercher would not act against CN was reasonable in a lawsuit where the amount claimed was $1.75 billion.

By failing to obtain CN's consent, terminating its retainers with CN, and failing to advise CN of its intention to represent the class, McKercher had breached the bright-line rule.

Still, on the issue of remedy, it was pivotal that McKercher had no confidential information that was prejudicial to CN. Normally, a breach of the bright-line rule attracted disqualification as a remedy that could avoid the improper use of confidential information, avoid the risk of impaired representation, and maintain faith in the administration of justice. Here, however, only the need to maintain faith in the administration of justice came into play and factors that might militate against disqualification had to be considered. These factors, to be considered by the motions judge on a re-hearing to determine whether disqualification was warranted, included delay in seeking disqualification, prejudice to the new client's right to retain counsel of choice, and the law firm's good faith in accepting the new retainer.