"AvoidAClaim" Blog

It is easy to understand why a corporate client might ask her lawyer to sit on the board of directors. The lawyer may have worked closely with the corporation’s founders to create the company, and will have a solid understanding of the corporation’s objectives, its relationships with industry partners, suppliers, customers and others, and the challenges it faces in the marketplace. It is also easy to understand why a lawyer might be honoured by, and readily accept, such an invitation.

However, sitting on a client’s board can be problematic for a number of reasons – from both the lawyer’s and the corporate client’s perspective. The following is a very brief introduction to a few of the problems that can flow from a lawyer’s decision to sit on a client board, and some suggestions for avoiding them.

Insurance coverage gaps

Problem: From an insurance perspective, a Ontario lawyers considering sitting on a client’s board need to be aware that LAWPRO’s mandatory insurance program extends coverage only to the provision of “professional services” as defined in the policy (lawyers outside Ontario should check with their own insurer). Acting as a corporate director does not fall within the definition of professional services.

Prevention: A lawyer who sits on a corporate board should ensure that he or she is
covered under a Directors’ and Officers’ liability coverage policy, and/ or an Outside Directors’ Liability policy.

Potential for conflicts of interest

A common source of claims against lawyer-directors is conflicts of interest. A lawyer who advises not only the corporation but also another party – for example, an individual corporate officer whose interests may diverge from those of the corporation – is in a conflict position. The following scenarios may help to highlight some of the
possible conflicts that arise in these situations:

• lawyer acts for individual founders of the corporation, then later the corporation;
• lawyer advises more than one shareholder in a closely-held corporation (for example, family members);
• lawyer sits on the board of a merged corporation after having acted for one half of the corporation so formed;
• lawyer advises both the corporation and individuals within the corporation, when these parties’ interests do not match; or
• lawyer sits on the board of a corporation while having a financial or other interest in a party with which the corporation does business.

Prevention: Conflicts problems tend to creep up on the unaware. A lawyer’s best
defence is to continually ask him or herself the question “who is my client?” If the answer is ambiguous – or there is more than one right answer – the lawyer cannot afford to ignore his or her instincts, and must terminate the working relationship with one (or both) clients. Unfortunately, it may then be too late to undo the damage. Conflict problems can arise at any point in a working relationship, making this issue fairly intractable (and thus dangerous) from a liability perspective.

Potential for loss of solicitor/client privilege

Problem: Sometimes a lawyer is invited to sit on a client’s board so that he or she will be available to provide legal advice about company matters. While this arrangement is convenient, it does not reflect the traditional context for the provision of professional legal services. The duties and role of a corporate director and the director’s responsibility to the shareholders do not overlap neatly with the duties of a lawyer to a client. A lawyer sitting on a corporate board will be expected to consider non-legal issues and to comment
on business (non-legal) directions and decisions.

Where an individual provides legal advice, business advice, and mixed legal-andbusiness advice to a board or to its members, the statements made may NOT meet the established legal tests for solicitor-client privilege. While a lawyer can attempt to set up the conditions for the client’s later assertion of privilege (for example by saying, on the record, something like “speaking, now, in my capacity as legal counsel”), that attempt may not always be determinative, and the client may lose the benefit of privilege for certain communications.

Prevention: A lawyer who chooses to act as a director can attempt to distinguish legal advice from business discussions by causing the record of meetings to reflect the distinction. The lawyer might also, if asked for legal advice during board proceedings, advise that he or she “will get back to” the asker, and then do so in a context more consistent with lawyer-client communications. Neither option is foolproof, and the lawyer would do well to formally advise the client of the risk of loss of solicitor-client privilege that board participation poses.

Potential for loss of ability to represent client

Problem: Related to the foregoing discussion of communications during board meetings is a separate risk: the risk that being a party to those discussions might trigger the eventual termination of the lawyer-client relationship. Consider the scenario in which board proceedings – observed by a lawyer – lead to eventual litigation. If the lawyerdirector is called as a witness in those proceedings, he or she could easily become a party adverse in interest to either the company as a whole or to other individual directors. As a
result, the lawyer would lose the right to represent the corporate client (and the corporation would lose its counsel).

Prevention: Though rare, this contingency is likely not preventable.

In conclusion: lawyers who choose to sit on clients’ boards may be motivated to do so for very generous and practical reasons; however, the risks may outweigh the benefits so provided to the client. These risks are not only risks to the lawyer, but in many cases, to the client as well. Our advice: think carefully, considering the interests of all parties, before agreeing to sit on a client’s board of directors.

This article by Nora Rock, corporate writer & policy analyst at LAWPRO, appeared in the January 2012 corporate-commercial issue of LAWPRO Webzine. All LAWPRO Magazie and Webzine articles can be found at www.lawpro.ca/magazinearchives

I have a songwriter friend who reports that the hardest part of writing a song is finishing it. She finds that her enthusiasm for writing means that she loves the initial burst of creative energy, but she has trouble keeping herself on task for the polishing process: When a song is nearly finished, she finds herself eager to begin a new one.

Luckily for my friend, she’s often the only person who feels her work is unfinished – everyone else just hears a great song, not a work in progress. Unfortunately for lawyers, a client matter 90 per cent completed is not good enough. Legal work is often about managing a myriad of details, many of which are very important. We at LAWPRO are reminded of this whenever we see a claim come in that is based on a lawyer failing to complete a crucial step – like ensuring that a title insurance policy is in place when a real estate deal is closed. See Kathleen Waters’ recent article on this very topic here.

Do ever find yourself just missing the finish line on a file? This is a very dangerous mistake, and it’s important to take the time to correct it.

Consider scheduling a appointment (it could be with your office staff, with the client, or even just a date with yourself) to formally close every file. Use a checklist (for example, our Commercial Transactions Checklist or our Domestic Contract Matter Toolkit) to review your work and ensure that no steps have been missed; go back and review your original notes with respect to the client; and follow up to confirm the status of registrations, applications, and execution of documents. Write a reporting letter to the client and send a final bill. Not only will you feel a greater sense of accomplishment with respect to the work, but you’ll avoid “loose ends”-type claims.

Many commercial matters involve the preparation of one or more documents. These documents are drafted based on communications between the parties to the document and/or their respective lawyers, the specific circumstances of the matter and applicable substantive law.

While the majority of commercial deals in Ontario are concluded without difficulties, all too often LAWPRO sees claims arising due to various real – or alleged – problems with the documents that lawyers have prepared for clients on commercial matters (see this earlier post on the dangers of drafting errors on commercial documents) These problems frequently arise due to communications problems between the lawyer and client.

Our checklist for commercial transactions contains a series of questions lawyers should ask themselves to help ensure that the commercial documents they are drafting correctly reflect the client’s instructions and expected
results. By following the steps in this checklist, you will be taking steps to proactively manage your file and address the areas where communication problems most commonly occur. You will also be creating a paper trail that could be invaluable in the event your client sues you for negligence.

Given the complexity and the number of commercial agreements drafted each year in Ontario, it is surprising that corporate and commercial claims account for only 13 to 15 per cent of the number of claims reported against lawyers in Ontario annually. Although commercial leasing errors represent a small percentage of those claims, they illustrate where drafting errors occur – and how they can be avoided. Even a simple drafting error could be a costly mistake that leads to protracted litigation. So making an effort to catch and avoid errors is a worthwhile investment of your time.

Proofread, proofread, proofread

One of the issues involved in drafting commercial leases, and indeed many other types of agreements, is the number of changes that aremade between the initial draft and the final version. Lease transactions for example, often involve lengthy negotiations, with several drafts being circulated before the final agreement is executed. During such a tiring process, it is not surprising that, for example, a draft agreement which stipulates that the lease of the premises would be on a “triple-net basis” (so that the landlord would not be responsible for any payments under the lease) is mistakenly changed so that the final agreement stipulates that the lease is on a “net-net basis” (creating additional obligations on the landlord). Similarly, a practitioner drafting a lease for a commercial unit may forget to include a right to use of the parking lot for the unit.

To avoid these types of drafting errors, have someone not involved in the transaction proofread each draft, with an eye to finding inconsistencies between the drafts and the final version of the document.

A significant drafting error can result in a substantial claim for liability. One such LAWPRO case involved a solicitor who failed to recognize that a draft lease treated the calculation of an administration fee obligation differently than the final executed lease agreement.

The agreement to lease stipulated that the tenant would pay for various items including an administrative fee of four per cent of the operating costs, taxes and utilities.

However, the final executed lease agreement stated that the operating costs for the commercial condominium included an administration andmanagement fee of four per cent of the rents received or receivable by the landlord from the tenants of the commercial condominium. The four per cent fee concept contained in both versions of the lease may have lulled the drafter into overlooking the change. However, the difference in wording between the two versions resulted in the tenant owing substantially more over the full term of the lease.

What should the solicitor in this case have done differently? This type of situation could have been avoided if the solicitor had kept track of the differences between the draft lease and the final version, explained the consequences of the change in wording to the client, and received clear instructions (preferably in writing) from the client to finalize the lease. (more…)

• I will carefully document instructions, advice and steps taken: Sometimes claims against corporate lawyers are a result of an incomplete or improperly drafted document or other mistake by the lawyer, but in many cases there is simply a dispute over what was said and done or not said and done, or confusion over who was to look after which tasks. Taking detailed notes and documenting conversations with the client helps avoid this, as does using LAWPRO’s new “Checklist for Commercial Transactions”.
• I will not dabble in areas outside my expertise: Corporate and commercial law is complex and diverse, so don’t stray outside your area of expertise. If necessary, retain the services of an expert in specialist areas like franchise law, IP or tax if you don’t have thorough knowledge of those fields.
• I will follow the firm’s conflict checking system and take action on conflicts: Most law firms now have rigorous conflicts checking systems in place, and they do a good job of catching potential conflicts. The problem is that often these warnings are ignored because of poor judgement or greed. Listen to your instincts, and ask yourself “who is my client?” You can’t always objectively judge your own conflicts, so get the opinion of someone outside the matter. If there’s a conflict, decline the retainer even if it means turning down work for a good client or turning down substantial fees.
• I will take the time to catch all the details and do the job right: Whether it is misreading (or not reading) information on a corporate document, not doing a title search on a corporate lease matter, or failing to ensure that two merged corporations don’t lose a ‘grandfathered’ exemption, rushing or taking shortcuts can come back to haunt you. Take the time to do the job right, even if it takes a bit longer or involves coming back on another day.

Click here to see the full list of resolutions taken from New Year’s resolutions for a healthier law practice and a new you, which appeared in the December 2012 issue of LAWPRO Magazine.

The following article appeared in the January 2012 edition of LAWPRO Webzine: “Corporate-Commercial Practice: Avoiding Claims”

Here at LAWPRO we take an interest in practice management trends (which means we’re always grateful for your input about the way you practice law today!).

Sometimes, the decline of trends is just as noteworthy as their emergence. One example is the declining use of “shelf corporations” in corporate-commercial practice. A “shelf corporation” is (or was) a business corporation created and registered by a law firm and kept at-the-ready for the convenience of clients who might require incorporation on very short notice.

Prior to the introduction of electronic registration for Ontario and federal corporations, this offered a real advantage: accommodating a client who arrived in the afternoon to request a speedy incorporation meant a scramble to get all the documentation in order and signed before racing to the ministry to stand in line before the 4:30 pm closing time. Having a pre-registered shelf corporation available meant that the lawyer could instead simply amend the necessary corporate information, including addresses and director names.

(In rarer circumstances, explains Violet French of Torkin Manes, a shelf corporation would come in handy for a client who, to appropriately paper a transaction, “needed a company that was of a certain vintage.”)

The practice of “stocking” shelf corporations was not without pitfalls even when it was in fashion. Nicky Huq, a Toronto corporate lawyer, reports that she herself never created shelf corporations: “It just wasn’t necessary,” she explained, “in the context of my particular practice.” But Huq was nevertheless familiar with some of the potential pitfalls. “For example,” she noted, “the Ontario Business Corporations Act (OBCA) has made it challenging to replace a ‘first director.’”

The first directors of shelf corporations were usually, of course, firm lawyers or clerks. Citing the 1991 Tax Court of Canada decision in Zwierschke v. M.N.R. (92 DTC 1003; 1991(2) CTC 2783), Huq pointed out that the OBCA, at the time, contained a provision (s.119(2)) that seemed to preclude the effective resignation of a first director until the first meeting of the shareholders. This created potential exposure, for lawyers, to directors’ liability in the event that the corporate client recipient of the shelf corporation later failed to co-operate in the election of replacement directors. Says Huq, “you can’t force a client to hold a meeting, or to replace a director.”

The current iteration of s. 119(2) seems to contemplate an effective resignation for a first director, prior to a first board meeting, if a substitute director is appointed in the first director’s place; however, the law firm would still presumably have to rely on its corporate client to make that appointment, and to obtain the replacement director’s consent. And of course, the lawyer director would have to actually remember to resign, would have to do it in time to avoid liability, and would have to resign in a manner that is compliant and, therefore, effective.

In the years since Zwierschke, some additional legal protection has emerged for lawyer first directors. First, a 1994 amendment to the OBCA, which introduced the concept of “deemed directors” for corporations with no directors (s. 115(4)) specifically excluded from the list of potential deemed directors, at s. 115(4)(b) “a lawyer, accountant or other professional who participates in the management of the corporation solely for the purposes of providing professional services.” Second, recent case law such as the 2008 decision in Hartrell v. Canada ([2006] T.C.J. No. 386 (Tax Court of Canada) appeal dismissed in [2008] F.C.J. No. 228 (Federal Court of Appeal)) has tended to support the view that a lawyer named as a first director for practical purposes ought not be held liable
for acts of the corporation (for example, the failure to make remittances under employment law statutes).

It seems, however, that these (partial) protections for the creators of shelf corporations arrived just in time to be replaced by a new potential pitfall: earlier tax obligations. Explains Violet French: “…[when a corporation is registered, the Canada Revenue Agency] opens up the Business Number (BN) for income tax automatically which means returns need to be filed. In the ‘old days’ it took a lot longer for CRA to issue a BN number so it was relatively easy to set up some shelf companies and hold onto them
without too much tending and mending.”

It appears then that the hassle of tending and mending, lingering concerns about directors’ liability, the ease of electronic registration – or more likely a convergence of all three factors – have contributed to a significant decline in the practice of creating and “stocking” shelf corporations. If you are one of the few lawyers who continues this practice, have you given recent consideration to the pros and the cons? We’d be happy to hear your thoughts on the issue.

Corporate/commercial law accounts for the third highest number of legal malpractice claims in Ontario, after real estate and civil litigation. An article in the January edition of the LAWPRO Webzine examines the causes of these claims in detail, and what tells lawyers what they can do to reduce their exposure to claim in this area of law.

Over the last ten years, corporate/commercial-related claims (including bankruptcy, tax, and securities-related claims) averaged 14 per cent of LAWPRO’s claims count (279 claims per year), and 23 per cent of our claims costs ($14.9 million per year). While there has been some fluctuation, the number of claims in this area has remained consistent over this time period, while the cost of resolving claims in this area has increased. On average, resolving a corporate/commercial claim cost LAWPRO $53,340 over that period.

As the the above chart shows, the main cause of claims against corporate/commercial lawyers is a breakdown in communications.

These errors fall into three general categories:

• A failure to inform the client or obtain the client’s consent;
• A failure to follow a client’s instructions; and
• Poor communication with the client.

A review of common fact scenarios for each type of error will give you a better understanding of why these errors happen and the steps you can take to avoid a communications-related claim.

Failure to inform client or get consent

The most common type of communications error on corporate/commercial files – 28 per cent of communications-related claims – involves a failure to obtain the client’s consent or to inform the client. Examples of this type of error include:

• Failing to explain to a client the consequences of a personal guarantee in a commercial lease, mortgage or other transaction involving security. Failing to make it clear that the client is personally responsible for the borrower’s debt.
• Failing to specify the limits of the retainer in writing. Failing to specify in writing which services the lawyer will perform and which things the client will do. For example, if you are involved in a transaction that includes the dissolution of a corporation, ensure that the client is aware of – and agrees to undertake – any final-year filings outstanding after the termination of your retainer.
• Failing to state in writing that a client has not provided sufficient information to complete the retainer on an incorporation and organization of a corporation. Do not allow the client to develop the mistaken impression that the incorporation is proceeding when it is stalled.
  Failing to set out in an accompanying letter the limited purpose of a draft document, together with instructions that it is only to be used for the specified purpose and may not be suitable for other purposes.
• Failing to clearly and unambiguously inform a client in writing that you are declining to act on a particular matter, either because of a conflict of interest or because you don’t practise in that area.
• Failing to recommend that the client retain another lawyer to handle that matter. For example, if tax considerations might influence the choice between two different courses of action, but you don’t have enough tax expertise to take these considerations into account, document your recommendation that the client obtain tax advice. If the client wants you to take a course of action without the recommended tax advice, document that instruction.
• Failing to clearly and unambiguously inform a client in writing that you are terminating the retainer and failing to recommend that the client find another lawyer. Failing to clearly and unambiguously spell out any tasks you will not be completing and that the client needs to do or retain another lawyer to do.
• Failing to inform a franchisor client about the disclosure requirements under the Arthur Wishart Act and the severe consequences of inadequate disclosure.
• Failing to inform a franchisee client about the disclosure requirements and rescission remedies under the Arthur Wishart Act.

Failure to follow client’s instructions

A “failure to follow client instructions” is the second most common communications related error and accounts for 35 per cent of communications-related claims. It really amounts to nothing more than a simple failure to follow a client’s specific instructions.

The most frequent scenarios for this error include:

• Failing to file the requisite notice of change form to remove the old officers and directors when a company is sold. (Failure to do so could, for example, leave the former directors on the hook for tax or other liability.)
• Failing to ensure that all the clauses in a commercial offer to lease are carried over to and appear in the final form of commercial lease.
• Performing additional services for the client that the client did not specifically ask you to do but doing so carelessly, for example, making unsuccessful or incomplete attempts to terminate existing tenancies on behalf of a vendor or purchaser in connection with a commercial lease transaction.

Poor communication with client

Poor communication with the client is the third most common communications-related error and causes 24 per cent of this type of error. Common scenarios for this error include:

• Failing to ensure that the client understands what you are telling him/her and that you understand what he/she is telling you, particularly if there is a language barrier.
• Failing to ensure that the client understands clearly what you will be doing as the lawyer and what the client is responsible for doing.
• Failing to establish clearly who your client is, e.g., where two or more family members have an interest in the transaction.
• Making assumptions about a long-standing corporate client’s intentions and instructions without confirming these in writing. A long-standing relationship is no substitute for clear communication.
• Failing to document in writing that a client instructed you to take a different course of action in a corporate transaction from the one you recommended.
• Failing to include restrictions on the use and applicability of your advice in an opinion letter, including details of any qualifications or limits to the opinion.
• Also, a failure to document the assumptions upon which your advice in the opinion letter is based.

AVOIDING COMMUNICATIONS ERRORS

As a means of avoiding communications-related claim, the value of carefully documenting instructions, advice, and steps completed cannot be overstated. While the failure to have written confirmation of instructions and advice is not negligence in and of itself, such written communication can be extremely helpful in defending you in the unhappy event that a claim is made against you (or you are the target of a law society complaint or you are defending your account before an assessment officer).

Why is having something in writing so helpful? Because more often than not, this type of claim involves the lawyer recalling that one thing was said or done, or not said or not done, and a disappointed or upset client who alleges something different. These claims are very hard for LAWPRO to defend successfully, because they tend to come down to a question of credibility. Judges tend to prefer the client’s evidence, as the client usually has a much better recollection of what transpired and what was said.

Remember, most clients are involved in relatively few corporate/commercial transactions in their lifetimes, and they are more likely to remember specific details about what happened. By contrast, lawyers who have handled hundreds of corporate/commercial matters often have little or no specific recollection about what happened on a specific transaction, especially one in the distant past.

Unfortunately, we frequently find inadequate documentation in the lawyer’s file to back up the lawyer’s version of what occurred. We frequently see files with no notes or correspondence documenting what was said and done, and on occasion, even files with no reporting letters whatsoever.

Communications-related errors are among the easiest to prevent. You can significantly reduce your claims exposure by documenting your work. Confirm the information that your client provided to you, your advice to the client, the client’s instructions to you, and what steps were taken on those instructions. Document the time spent reviewing the file and note what issues were discussed with the client. This documentation can take the form of notes to the file, marginal notes on draft documents, comments in interim or final reporting letters, or even in an email message. Admittedly, you can’t document everything on every file, but taking the time to document unusual things or issues that seemed to concern the client can be very helpful in the event of a claim, especially if you have a difficult or demanding client.

Some corporate-commercial lawyers do not track or docket the time they spend on files. This is a shame, as there are two benefits of doing so. First, by tracking lawyer and staff time, you can determine the actual amount of time you are spending on each file – a critical piece of information for determining the profitability of the transactions you complete. Secondly, even taking just a few seconds to make detailed dockets can be a lifesaver in the event of a claim. “Conference with client re need for more information to complete incorporation and organization of Acme Widgets” is much better than just
“Conference with client re Acme Widgets incorporation”; “Conference with client re consequences of signing personal guarantee in Smith Co. financing” is much better than just “Conference with client re Smith Co. financing.” Weeks, months or even years after a deal is completed, detailed dockets such as these can serve to confirm that particular issues were discussed with the client.

EVEN IF NO ALLEGATIONS ARE MADE…TELL US!

If you become aware of a potential claim, you should immediately report it to LAWPRO, even if no allegations of negligence have been made by your client. This is an obligation under the Rules of Professional Conduct and is required by the terms of the LAWPRO policy. Putting us on notice will help us help you understand what your claims exposure might be and may help reduce the damages on any potential claim. We may retain counsel to assist you and protect your interests and to make any necessary repairs. It is interesting to note that we close about 87 per cent of our corporate/commercial claims without any indemnity payments.

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You can’t totally eliminate the risk of a malpractice claim. However, you can substantially reduce your risk of a claim by improving your lawyer/client communications and documenting your work.