Beachcomber Mgmt. Crystal Cove, LLC v. Superior Court of Orange Cnty.

(2) Kohut previously represented the Company concerning some of the issues raised in this suit, and a substantial relationship therefore exists between that representation and Kohut's representation of Defendants in this lawsuit.

We conclude the trial court erred because it failed to apply a more specific line of cases that governs an attorney's successive representation of clients in

filed entitled Salisbury v. Ruby's Diner (Super. Ct. Orange County, 2011, No. 30-2011-00510153).

In 2011, Management hired Kohut to represent it regarding Salisbury's requests for information and challenges to Cavanaugh's management of the Company. Since 2011, Kohut regularly corresponded with Salisbury and his counsel about Cavanaugh's management of the Company.

It is undisputed Kohut also has represented the Company twice. First, between April 2010 and November 2011, Kohut represented the Company, Management, and some investors when served with subpoenas in an unrelated lawsuit entitled DeCinces v. Ruby's Diner, Inc. (Super. Ct. Orange County, 2009, No. 30-2009-00124231). Second, during September and October 2010, Kohut advised the Company about a former employee's wrongful termination lawsuit, but the Company's insurance carrier hired a different counsel to represent the Company in that lawsuit.

Defendants assert these are the only occasions Kohut represented the Company, and those representations ended by late 2011. The trial court, however, found Kohut also represented the Company along with Defendants relating to Salisbury's inquiries and objections to Cavanaugh's management of the Company before Plaintiffs filed this lawsuit.

In March 2016, Plaintiffs filed this lawsuit on the Company's behalf as a shareholder derivative action against Defendants. The complaint named the Company as a nominal defendant and alleged claims for fraud, breach of fiduciary duty, abuse of control, gross negligence and mismanagement, breach of duty of honest services, unjust enrichment, declaratory relief, and accounting. Plaintiffs allege Defendants abused their position as the Company's managers by diverting Company funds to other Cavanaugh entities, paying themselves unauthorized management fees, misallocating expenses the Company shares with other entities, and refusing to provide Plaintiffs complete access to the Company's books and records. Defendants hired Kohut to represent them in this lawsuit, and the Company hired independent counsel, the law firm of Corbin, Steelman & Specter, to represent it in this lawsuit.

lawsuit; and (4) the Company waived any potential or actual conflict of interest arising from Kohut's previous or current representation of any party to this action.

The trial court granted the motion in August 2016. The court found the conflict of interest arising from Kohut's successive representation of the Company and Defendants required the firm's disqualification. The court explained a substantial relationship existed between Kohut's prior representation of the Company and its current representation of Defendants because the two representations involved many of the same issues concerning the Company's management raised by Plaintiffs in this lawsuit. According to the court, two letters Kohut sent to Salisbury's counsel in October 2015 showed the firm represented both the Company and Defendants regarding Plaintiffs' complaints. Moreover, a declaration Defendants submitted from Tad Belshe, the Company's Vice President of Operations, confirmed Kohut had jointly represented the Company and Defendants. The court also found the conflict waiver the Defendants submitted was ineffective because Defendants failed to show a disinterested decision maker authorized the waiver. In granting the motion, the court exclusively relied on Kohut's successive representation of the Company and Defendants; the court did not address Plaintiffs' arguments based on the concurrent representation or witness-advocate rules.

"Disqualification motions implicate competing considerations. On the one hand, these include clients' rights to be represented by their preferred counsel and deterring costly and time-consuming gamesmanship by the other side. '[T]he client has an interest in competent representation by an attorney of his or her choice [citations] and perhaps, the interest in avoiding inconvenience and duplicative expense in replacing counsel already thoroughly familiar with the case.' " ( Banning Ranch Conservancy v. Superior Court (2011) 193 Cal.App.4th 903 , 911, 123 Cal.Rptr.3d 348 ( Banning Ranch ); see SpeeDee Oil , supra , 20 Cal.4th at pp. 1144-1145, 86 Cal.Rptr.2d 816 , 980 P.2d 371 .)

disqualify counsel from representing a successive client in current litigation adverse to the former client's interest, the former client must 'demonstrate a " substantial relationship " between the subjects of the antecedent and current

general prohibition against successive representations when the two representations are substantially related. According to Defendants, the court failed to apply controlling authority that allows an attorney who previously represented both a closely held company and its insiders to continue representing the insiders in a derivative lawsuit brought on the company's behalf against the insiders. We agree.

A corporate shareholder or member in a limited liability company may bring a derivative lawsuit on the company's behalf when the insiders who control the company refuse to do so. The shareholder or member bringing the derivative lawsuit is the plaintiff in name only because the lawsuit seeks redress for injury the company suffered and any recovery belongs to the company. Hence, although the company is named as a nominal defendant based on the insiders' refusal to bring the lawsuit on the company's behalf, the company is the true plaintiff. ( Patrick v. Alacer Corp. (2008) 167 Cal.App.4th 995 , 1003-1004, 84 Cal.Rptr.3d 642 ; see Blue Water Sunset, LLC v. Markowitz (2011) 192 Cal.App.4th 477 , 489, 122 Cal.Rptr.3d 641 ( Blue Water ) [applying corporate derivative action principles to limited liability company].)

The company's status as the true plaintiff prevents an attorney from representing both the company and its insiders in a derivative lawsuit that alleges the insiders breached their duties owed to the company or otherwise injured the company. Such representation would be an impermissible concurrent representation of clients with conflicting interests. ( Ontiveros , supra , 245 Cal.App.4th at p. 696, 199 Cal.Rptr.3d 836 [" 'Current case law clearly forbids dual representation of a corporation and directors in a shareholder derivative suit, at least where, as here, the directors are alleged to have committed fraud' "]; see Forrest , supra , 58 Cal.App.4th at p. 74, 67 Cal.Rptr.2d 857 .)

Successive representation rules, however, generally do not prevent an attorney from continuing to represent insiders in a derivative lawsuit even though a substantial relationship exists between the attorney's previous representation of the company and the attorney's current representation of insiders in the company's lawsuit against them. ( Forrest , supra , 58 Cal.App.4th at pp. 80, 82, 67 Cal.Rptr.2d 857 ; see Ontiveros , supra , 245 Cal.App.4th at pp. 699-700, 199 Cal.Rptr.3d 836 ; Blue Water , supra , 192 Cal.App.4th at pp. 490-491, 122 Cal.Rptr.3d 641 ; Gong v. RFG Oil, Inc. (2008) 166 Cal.App.4th 209 , 217, 82 Cal.Rptr.3d 416 ( Gong ).) This separate rule derives from a recognition that insiders are the

to prove what is in the mind of the attorney. Nor should the attorney have to 'engage in a subtle evaluation of the extent to which he acquired relevant information in the first representation and of the actual use of that knowledge and information in the subsequent representation.' " ' " ( Forrest , at p. 82, 67 Cal.Rptr.2d 857 .)

In a small or closely held company, the company's operations and its insiders typically are so intertwined that any distinction between the two is entirely fictional. The insiders often are the repositories and source of all confidential information an attorney may receive in representing the company. In a larger company confidential information may be divided among many different people with no individual or small group possessing it all, but in a closely held company the few insiders responsible for operating a small company often know all of the company's confidential information. In that situation, it would be meaningless to apply the successive representation rules to prevent an attorney who previously represented the company from representing the company's insiders. ( Forrest , supra , 58 Cal.App.4th at p. 82, 67 Cal.Rptr.2d 857 ; see Ontiveros , supra , 245 Cal.App.4th at pp. 699-700, 199 Cal.Rptr.3d 836 ; Blue Water , supra , 192 Cal.App.4th at p. 491, 122 Cal.Rptr.3d 641 ; Gong , supra , 166 Cal.App.4th at p. 217, 82 Cal.Rptr.3d 416 .) As the repositories and source of the company's confidential information, insiders could provide their new attorney with the same information their previous attorney had, and therefore disqualifying the original attorney would serve no purpose and needlessly generate attorney fees as the new attorney gets up to speed. ( Gong , at p. 217, 82 Cal.Rptr.3d 416 .) Indeed, in this scenario, "[c]ounsel's continued representation of the [insiders] poses no threat to [c]ounsel's continuing duty of confidentiality to [the company]" because the insiders already know all of the Company's confidential information. ( Ontiveros , supra , 245 Cal.App.4th at p. 700, 199 Cal.Rptr.3d 836 , italics omitted.)

For example, Forrest involved a shareholder derivative suit brought by a minority shareholder in two closely held corporations against a husband and

The rule established by Forrest and applied in subsequent cases supplanted the generally applicable successive representation rule and now governs in derivative lawsuits involving a closely held company in which a limited number of insiders are responsible for the company's operations and possess or are privy to its confidential information. Applying a presumption that requires disqualification based solely on the relationship between the attorney's representation of the company and his or her representation of insiders makes little sense in this context because the insiders are the source of the attorney's information, or at least they possess the same information as the attorney, and therefore the attorney's representation of the insiders does not threaten the attorney's duty of confidentiality to the Company.

Although Forrest used the terminology "sole repositories of corporate information to which the attorney has had access" ( Forrest, supra , 58 Cal.App.4th at p. 82, 67 Cal.Rptr.2d 857 ), that terminology describes the factual scenario in

tasks when Defendants were the ones with the exclusive right to manage the Company. Moreover, although we ordinarily infer all findings necessary to support the trial court's decision, we do so only if substantial evidence supports those inferences ( Nellie Gail , supra , 4 Cal.App.5th at p. 996 ), and only when the record shows the court actually performed its factfinding function on the question for which we would infer

(1) vacate its order disqualifying Kohut from representing Defendants in this lawsuit; (2) determine whether Forrest and the other cases applying it allow Kohut to continue representing Defendants in this lawsuit; (3) determine whether Kohut concurrently represented Defendants and the Company so as to require Kohut's disqualification; (4) determine whether Kohut should be disqualified from representing Defendants in this lawsuit because one or more of its attorneys testify as a witness in this lawsuit; and (5) enter a new order deciding Plaintiffs' disqualification motion based on the foregoing determinations. Defendants shall recover their own costs on this writ proceeding.

WE CONCUR:

O'LEARY, P.J.

FYBEL, J.

Defendants Beachcomber Management Crystal Cove, LLC (Management) and Douglas Cavanaugh (collectively, Defendants) challenge the trial court's order disqualifying the law firm of Kohut & Kohut LLP (Kohut) from continuing to represent Defendants in the underlying matter. Plaintiffs Douglas L. Salisbury, as trustee of the DLS Living Trust, Philip de Carion, and Gina de Carion (collectively, Plaintiffs) brought this derivative lawsuit on behalf of Beachcomber at Crystal Cove, LLC (Company) to challenge various actions Defendants took in managing the Company.

The duty of confidentiality generally prevents an attorney from continuing to represent a client if the representation conflicts with the attorney's representation of a previous client in a related matter. Once the previous client establishes a substantial relationship between the successive representations, the court must disqualify the attorney from continuing to represent the second client because the law presumes the attorney received confidential information during the first representation that is relevant to the second.

Here, the trial court concluded disqualification was mandatory based on its findings that (1) Defendants and the Company have conflicting interests because the Company is the true plaintiff in this derivative suit that Plaintiffs brought against Defendants on the Company's behalf, and

a derivative lawsuit brought on a small or closely held company's behalf against the insiders who run the company. Under these cases, an attorney may represent the insiders in a derivative lawsuit by the company despite the attorney's previous representation of the company regarding issues raised in the suit. Unlike the ordinary successive representation case, these cases recognize the attorney's representation of the insiders does not threaten the attorney's duty of confidentiality to the company because the insiders already are privy to all of the company's confidential information. Indeed, any attorney representing the insiders would discover the company's confidential information because the insiders are the source of that information.

Plaintiffs contend these cases do not apply here because the evidence shows Defendants were neither solely in charge of the Company's operations nor the sole repositories of its confidential information. Plaintiffs, however, misconstrue the underlying rationale of these cases. The critical inquiry is not whether the insiders were solely in charge or the sole repositories of the company's confidential information. Rather, the critical inquiry is whether the insiders possessed or had access to the same confidential information as the attorney who previously represented the company.

The trial court made no findings regarding this critical question, and therefore we grant the petition and issue a writ of mandate directing the court to (1) vacate its order disqualifying Kohut; (2) determine whether the reasoning in these cases permits Kohut to continue representing Defendants in the lawsuit; (3) determine whether the additional grounds Plaintiffs raised in their motion support disqualification; and (4) enter a new order on Plaintiffs' disqualification motion.

FACTS AND PROCEDURAL HISTORY

In 2006, Management founded the Beachcomber Café at Crystal Cove, which the Company owns. The Company is a limited liability company and Management serves as its managing member with the exclusive right to operate its business. The Company has five other members who invested in it, but have no right to participate in the day-to-day operations. These members are Plaintiffs and nonparties Ralph Kosmides, Edward and Janis Carpenter, and Michael Hoopis. Management is a limited liability company and Cavanaugh is its managing member with the exclusive right to manage the Company.

Cavanaugh also operates and owns an interest in several other restaurants and food service entities, including Ruby's Diner, Inc.,

Ruby's Franchise Systems, Inc., Ruby's Management, LLC, Ruby's Retail Brands, LLC, Lighthouse Café, and Malibu Restaurant Group, LLP. Salisbury is an investor in some of these entities, and he has a long history of questioning Cavanaugh's actions in managing the Company and these other entities. In 2009, Cavanaugh hired Kohut to represent him and certain of the Ruby's Diner entities regarding Salisbury's numerous requests for information and challenges to Cavanaugh's management. Kohut's representation included defending some of the Ruby's Diner entities and Cavanaugh in a lawsuit Salisbury

In May 2016, Plaintiffs filed a motion to disqualify Kohut "from any further participation in this case" based on conflicts of interests arising from its past and present representation of the Company and Defendants. Specifically, Plaintiffs based their disqualification motion on conflicts of interest arising from (1) Kohut's concurrent representation of the Company and Defendants; (2) Kohut's successive representation of the Company and Defendants concerning the disputes over the Company's operations; and (3) the need for Kohut to testify in this lawsuit about the services it provided to the Company and Defendants.

Defendants opposed the motion, arguing (1) there is no concurrent representation because Kohut does not represent the Company in this lawsuit and has not represented the Company in any other matter since late 2011; (2) Kohut's successive representation of the Company and Defendants does not require disqualification because no substantial relationship exists between the firm's prior representation of the Company and this lawsuit, and the successive representation rules allow an attorney to continue representing a company's insiders in a derivative lawsuit so long as the attorney does not continue to represent the company; (3) Kohut will not be a witness in this matter on any issue other than the value of its services, and that testimony is an express exception to the rule prohibiting an attorney from being an advocate and a witness in the same

At the same time it granted the disqualification motion, the trial court sustained Defendants' demurrer to the declaratory relief claim with leave to amend because Plaintiffs brought an individual claim regarding Salisbury's voting rights, not a derivative claim alleging injury to the Company. The court overruled the demurrer to all other claims because it found they were derivative claims. Plaintiffs thereafter filed an amended complaint confirming that Salisbury sought declaratory relief as an individual claim and all other claims were brought on the Company's behalf. Based on the amended complaint, Defendants filed a motion asking the court to reconsider its ruling on the disqualification motion, and allow Kohut to remain as counsel on the declaratory relief claim because the Company was not a party to that claim and therefore no conflict of interest existed. The court denied the motion for reconsideration, but stayed the lawsuit to allow Defendants to seek appellate review of the disqualification order.

In September 2016, Defendants filed this writ petition seeking a writ of mandate compelling the trial court to vacate its order disqualifying Kohut and enter a new order denying the motion to disqualify. Alternatively, Defendants sought a writ of mandate compelling the trial court to vacate its order denying their motion for reconsideration and enter a new order granting reconsideration. We issued an order to show cause why a writ of mandate should not issue.

DISCUSSION

A. Legal Background on Attorney Disqualification

"A trial court's authority to disqualify an attorney derives from the power inherent in every court '[t]o control in furtherance of justice, the conduct of its ministerial officers, and of all other persons in any manner connected with a judicial proceeding before it, in every matter pertaining thereto.' " ( People ex rel. Dept. of Corporations v. SpeeDee Oil Change Systems, Inc. (1999) 20 Cal.4th 1135 , 1145, 86 Cal.Rptr.2d 816 , 980 P.2d 371 ( SpeeDee Oil ); see Code Civ. Proc., § 128, subd. (a)(5).)

representations.' [Citation.] A substantial relationship exists where 'the attorney had a direct professional relationship with the former client in which the attorney personally provided legal advice and services on a legal issue that is closely related to the legal issue in the present representation.' " ( M'Guinness , supra , 243 Cal.App.4th at p. 614, 196 Cal.Rptr.3d 662 .) " 'Where the requisite substantial relationship between the subjects of the prior and the current representations can be demonstrated, access to confidential information by the attorney in the course of the first representation (relevant, by definition, to the second representation) is presumed and disqualification of the attorney's representation of the second client is mandatory....' " ( Ontiveros v. Constable (2016) 245 Cal.App.4th 686 , 696, 199 Cal.Rptr.3d 836 ( Ontiveros ).)

"In instances of concurrent representation, '[b]ecause a conflict involving an attorney's duty of loyalty is "[t]he most egregious" kind of conflict,' a ' "more stringent" ' test is applied. [Citation.] Even if the dual representations 'may have nothing in common, and there is no risk that confidences to which counsel is a party in the one case have any relation to the other matter, disqualification may nevertheless be required . Indeed, in all but a few instances, the rule of disqualification in simultaneous representation cases is a per se or "automatic" one. [Citations.]' [Citations.] This per se rule is appropriate because '[a] client who learns that his or her lawyer is also representing a litigation adversary, even with respect to a matter wholly unrelated to the one for which counsel was retained, cannot long be expected to sustain the level of confidence and trust in counsel that is one of the foundations of the professional relationship.' " ( M'Guinness , supra , 243 Cal.App.4th at pp. 614-615, 196 Cal.Rptr.3d 662 .) "The strict proscription against dual representation of clients with adverse interests thus derives from a concern with protecting the integrity of the attorney-client relationship rather than from concerns with the risk of specific acts of disloyalty or diminution of the quality of the attorney's representation." ( Forrest v. Baeza (1997) 58 Cal.App.4th 65 , 74, 67 Cal.Rptr.2d 857 ( Forrest ).)

"Generally, a trial court's decision on a disqualification motion is reviewed for abuse of discretion. [Citations.] If the trial court resolved disputed factual issues, the reviewing court should not substitute its judgment for the trial court's express or implied findings supported by substantial evidence. [Citations.] When substantial evidence supports the trial court's factual findings, the appellate court reviews the conclusions based on those findings for abuse of discretion. [Citation.] However, the trial court's discretion is limited by the applicable legal principles. [Citation.] Thus, where there are no material disputed factual issues, the appellate court reviews the trial court's determination as a question of law. [Citation.] In any event, a disqualification motion involves concerns that justify careful review of the trial court's exercise of discretion." ( SpeeDee Oil , supra , 20 Cal.4th at pp. 1143-1144, 86 Cal.Rptr.2d 816 , 980 P.2d 371 ; see Ontiveros , supra , 245 Cal.App.4th at p. 696, 199 Cal.Rptr.3d 836 .)

B. The Trial Court Failed to Apply the Proper Legal Standards for Evaluating Successive Representations Involving a Shareholder Derivative Lawsuit

Defendants contend the trial court erred in disqualifying Kohut based on the

source of a closely held company's confidential information. ( Forrest , at p. 82, 67 Cal.Rptr.2d 857 ; see Ontiveros , at pp. 699-700, 199 Cal.Rptr.3d 836 ; Blue Water , at p. 491, 122 Cal.Rptr.3d 641 ; Gong , at p. 217, 82 Cal.Rptr.3d 416 .)

As explained above, client confidentiality is the fiduciary value threatened by an attorney's successive representation of separate clients in substantially related matters. ( M'Guinness , supra , 243 Cal.App.4th at p. 613, 196 Cal.Rptr.3d 662 ; Forrest , supra , 58 Cal.App.4th at p. 73, 67 Cal.Rptr.2d 857 .) Once a substantial relationship between the two representations is shown, courts must presume the attorney received confidential information during the first representation and therefore the attorney's disqualification in the second representation is mandatory. ( Ontiveros , supra , 245 Cal.App.4th at pp. 695-696, 199 Cal.Rptr.3d 836 .) This rule "is based on the need to protect scrupulously against the improper use of confidential information[.] ' "This is the rule by necessity, for it is not within the power of the former client

wife who were the majority shareholders and ran the corporations. The minority shareholder brought a motion to disqualify the attorney who represented both the corporations and the majority shareholders in the lawsuit. The Court of Appeal affirmed the trial court's order granting the motion to disqualify the attorney from representing the corporations, but denying the motion to disqualify the attorney from representing the majority shareholders. ( Forrest , supra , 58 Cal.App.4th at pp. 68-72, 67 Cal.Rptr.2d 857 .)

The Forrest court explained the prohibition on concurrent representation of clients with conflicting interests prohibited the attorney from continuing to represent both the corporations and the majority shareholders because the lawsuit essentially was brought by the corporations against the majority shareholders. ( Forrest , supra , 58 Cal.App.4th at p. 74, 67 Cal.Rptr.2d 857 .) But the appellate court also concluded the prohibition on successive representations in substantially related matters did not require the attorney's disqualification from representing the majority shareholders because the continued representation of those shareholders posed no threat that the attorney would use confidential information he received from the corporations: "[I]n the factual circumstances of this case, where [the attorney] has been representing a corporation comprised of three shareholders solely by virtue of his relationship with ... the majority directors/shareholders, it is impossible to conceive of confidential information [the attorney] could have received from the

the Company has hired independent counsel to represent it. These undisputed facts about this lawsuit and the relationship among the parties and Kohut support Defendants' argument Kohut may continue representing Defendants despite the trial court's finding a substantial relationship existed between the firm's previous representation of the Company and its current representation of Defendants.

Defendants brought these facts to the trial court's attention and relied on the rule established in Forrest and its progeny. Nonetheless, the court disqualified Kohut from representing Defendants in this lawsuit based on the general successive representation rule requiring a court to presume confidential information was disclosed during a prior representation if the two representations are substantially related. Although the court issued a lengthy written order explaining its ruling, the court neither acknowledged nor distinguished Forrest or any of the foregoing cases.

Plaintiffs argue the Forrest line of cases establish a narrow rule inapplicable here because Defendants were not solely in charge of the Company's operations and they are not the sole repositories of the Company's records. According to Plaintiffs, an attorney who previously represented a corporation may represent a corporate insider in a derivative lawsuit against the insider only "where it is shown that the nature of the relationship between the corporation and the insider is so intertwined that there is no possibility that confidential information of the corporation would be jeopardized." Plaintiffs misconstrue Forrest and the basis for its decision.

DISPOSITION

The petition is granted. Let a writ of mandate issue directing the trial court to