THE STATE BAR OF CALIFORNIA STANDING COMMITTEE ON PROFESSIONAL RESPONSIBILITY AND CONDUCT
Formal Opinion No. 2013-189
California Ethics Opinions
ISSUE: Has an attorney engaged in deceitful conduct by not alerting opposing counsel of: (A) an apparent material error made by opposing counsel in contract language; or (B) a material change made by the attorney in contract language?
DIGEST: Where an attorney has engaged in no conduct or activity that induced an apparent material error by opposing counsel, the attorney has no obligation to alert the opposing counsel of the apparent error. However, where the attorney has made a material change in contract language in such a manner that his conduct constitutes deceit, active concealment or fraud, the failure of the attorney to alert opposing counsel of the change would be a violation of his ethical obligations.
INTERPRETED: Rule 3-700(B)(2) of the Rules of Professional Conduct of the State Bar of California.
Business and Professions Code section 6106.
Business and Professions Code section 6128(a).
STATEMENT OF FACTS
Buyer and Seller have been in discussions regarding the sale of the Company from Seller to Buyer, and have agreed in concept to some of the material terms, including total consideration of $5 million to be paid by Buyer and Buyer’s requirement that Seller enter into a covenant not to compete with the Company following the sale. Buyer’s Attorney and Seller’s Attorney are tasked with preparing a Purchase and Sale Agreement to reflect the agreement of the parties.
Buyer’s Attorney prepares an initial draft of the Purchase and Sale Agreement. One section towards the back of the 50-page draft agreement contains the terms of an enforceable covenant not to compete, and includes a provision that Buyer’s sole and exclusive remedy for a breach by Seller of its covenant not to compete is the return of that portion of the total consideration which has been allocated in the Purchase and Sale Agreement for the covenant not to compete. Another section in the front of the draft agreement provides that, of the $5 million to be paid by Buyer, $3 million is to be allocated to the purchase price for the Company and $2 million is to be allocated as consideration for the covenant not to compete.
After soliciting input on the initial draft from Seller and Seller’s tax advisor, Seller’s Attorney provides Buyer’s Attorney with comments on the initial draft, including the observation from Seller’s tax advisor that payments received by Seller with respect to the covenant not to compete are not as favorable, from a tax perspective, as payments with respect to the purchase price for the Company.
Buyer’s Attorney then prepares a revised version of the Purchase and Sale Agreement which, apparently in response to the comments of Seller’s Attorney, provides for an allocation of only $1 as consideration for the covenant not to compete with $4, 999, 999 allocated to the purchase price for the Company. In reviewing the changes made in the revised version, Seller’s Attorney recognizes that the allocation of only $1 as consideration for the covenant not to compete essentially renders the covenant meaningless, because Buyer’s sole and exclusive remedy for breach by Seller of the covenant would be the return by Seller of $1 of the total consideration. Seller’s Attorney notifies Seller about the apparent error with respect to the consequences of the change made by Buyer’s Attorney. Seller instructs Seller’s Attorney to not inform Buyer’s Attorney of this apparent error. Seller’s Attorney says nothing to Buyer’s Attorney and allows the Purchase and Sale Agreement to be entered into by the parties in that form.
After receiving the initial draft from Buyer’s Attorney, Seller’s Attorney prepares a revised version of the Purchase and Sale Agreement which provides for an allocation of only $1 as consideration for the covenant not to compete, with the intent of essentially rendering the covenant not to compete meaningless. Although Seller's Attorney had no intention of keeping this change secret from Buyer's Attorney, Seller's Attorney generates a “redline” of the draft that unintentionally failed to highlight the change, and then tenders the revised version to Buyer's Attorney. Subsequently, Seller’s Attorney discovers the unintended defect in the “redline” and notifies Seller about the change, including the failure to highlight the change, in the revised version. Seller instructs Seller’s Attorney to not inform Buyer’s Attorney of the change. Seller’s Attorney says nothing to Buyer’s Attorney and allows the Purchase and Sale Agreement to be entered into by the parties in that form.
Under either Scenario, has Seller’s Attorney violated any ethical duties?
Following Client’s Instruction to Not Disclose
Attorneys generally must follow the instructions of their clients. See ABA Model Rule 1.2(a) (“ a lawyer shall abide by a client's decisions concerning the objectives of representation and, as required by [ABA Model] Rule 1.4, shall consult with the client as to the means by which they are to be pursued. A lawyer may take such action on behalf of the client as is impliedly authorized to carry out the representation …”).However, if the client insists on certain unethical conduct, the attorney may have an obligation to withdraw from the representation. Rule 3-700(B)(2) provides “[a] member...