The Yale Law Journal


Making the Advice of Counsel Defense Available for Corporate Directors

07 Feb 2007

Imagine that the Department of Justice suspects a hospital and its former CEO of Medicare fraud related to billing practices. Imagine further that the CEO protests that because the hospital’s lawyers assured her that the billing practices were legal, she never had the intent to defraud. If the hospital refuses to waive its attorney-client privilege, as it has the absolute right to do, then the government cannot know whether the CEO really sought the advice of the hospital’s counsel, and cannot know if the advice she received was reasonable. The CEO faces a problem of her own: if the government does indict her, and if the hospital never waives its privilege, how will she defend herself? In a Note recently published in this Journal, I suggest that to avoid this problem corporate directors should insist, as part of their employment contracts, that their employers agree to waive the privilege if necessary to the directors’ defense.

In a case like this, two fundamental rights are at loggerheads: the defendant director’s right to defend herself and the corporation’s right to maintain its attorney-client privilege. There is currently no generally accepted solution to this impasse. In the past two years, federal district courts wrestled with this problem in United States v. W.R. Grace and Ross v. City of Memphis.Both held that a balancing test should be used to determine when the defendant’s right to present exculpatory evidence may trump the corporation’s right to maintain attorney-client privilege. The Sixth Circuit, the only federal appellate court to consider the issue, reversed the Ross court and held that the corporation’s privilege could not be made to yield for the defendant, no matter how much she needed the documents for her defense, because “[a]n uncertain privilege, or one which purports to be certain but results in widely varying applications by the courts, is little better than no privilege at all.”

I propose a contractual solution to this problem. Directors and corporations should contract that the corporation will waive its attorney-client privilege if the director, sued in her individual capacity, needs to raise an advice of counsel defense. Under this solution, courts may continue to enforce strictly the law of corporate attorney-client privilege—namely, that attorney-corporation communications are presumptively held privileged by the corporation. When parties have contracted for conditional waiver of the privilege, however, courts should enforce such contracts.

The waiver agreement should carefully describe the circumstances that would require waiver. In order to identify in advance what types of documents would be subject to waiver, the parties could identify proxies tied to the business practice of the corporation that indicate which opinions of counsel are most critical. For example, corporations could agree to make documents subject to waiver if they are opinions solicited from outside counsel, or if the decision is one that requires two or more high-level executives’ approval.

Courts should encourage these contracts by enforcing a mandatory exclusionary rule. This exclusionary rule would be that a government plaintiff or prosecutor, 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. This exclusionary rule would allow the parties to contract around the current, uncertain state of the law and to anticipate how the litigation would proceed. It would also require little change of the existing legal framework.

The contractual solution can be economically justified when we understand the litigation impasse as a manifestation of agency costs arising between the director and corporate shareholders. Agency costs arise in the corporate decision-making context because the director faces a greater risk of liability than the corporation for choosing a course of action that, in hindsight, proves to be illegal. Because the director faces greater exposure, she is likely to avoid risks more than the shareholders would like.

Seen in this context, the contractual waiver of privilege may be understood as a bonding cost that helps re-align the interests of the director and the shareholders. Secure in the knowledge that if necessary, corporations will waive privilege for the relevant legal opinions, directors will take on the optimal level of risk.

Although contractual waiver does present a cost to the corporation, three factors should incentivize the corporation to “invest” in a contractual waiver or privilege. First, this contractual solution allows shareholders to ensure that the business risks taken by the director are commensurate with the risk level shareholders desire for their investment. This improves the likelihood that returns will meet (or surpass) shareholder expectations. Second, because firms generally believe there is a tight market for high-quality directors, firms are likely to bear the cost of contractual waiver in order to recruit the most talented. Recent history has already proven that firms will make investments that limit directors’ personal liability, either by amending their charters or by purchasing director and officer (“D&O”) insurance. Because would-be directors pay close attention to the benefits packages offered by employers, we can expect a contractual waiver will quickly become a popular request as the problem becomes salient. Third, D&O insurers will realize that contractual waivers lead to better corporate governance and reduce the uncertainties associated with defending individual directors in litigation. These insurers might raise premiums for corporations that refuse to agree to waive privilege.

Ideally, such contracting would take place at the time a director’s employment contract is first negotiated. However, a contractual waiver provision could also be renegotiated into the employment agreements of current directors. No matter when the provision is incorporated, this contractual solution allows directors and corporations to head off an otherwise unsolvable litigation impasse and encourage directors to meet shareholder expectations.

Mark A. Kressel is a third-year student at Yale Law School.

Preferred Citation: Mark A. Kressel, Making the Advice of Counsel Defense Available for Corporate Directors, 116 Yale L.J. Pocket Part 258 (2007),