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Analytica, Inc. v. NPD Research Inc.

decided: May 31, 1983.


Appeals from the United States District Court for the Northern District of Illinois, Eastern Division. No. 79 C 2248 -- John F. Grady, Judge.

Posner and Coffey, Circuit Judges, and Campbell, Senior District Judge.*fn* Coffey, Circuit Judge, dissenting.

Author: Posner

POSNER, Circuit Judge.

Two law firms, Schwartz & Freeman and Pressman and Hartunian, appeal from orders disqualifying them from representing Analytica, Inc. in an antitrust suit against NPD, Inc. Schwartz & Freeman also appeals from an order directing it to pay NPD some $25,000 in fees and expenses incurred in prosecuting the disqualification motion; and NPD cross-appeals from this order, contending it should have got more.

John Malec went to work for NPD, a closely held corporation engaged in market research, in 1972. His employment agreement allowed him to, and he did, buy two shares of NPD stock, which made him a 10 percent owner. It also gave him an option to buy two more shares. He allowed the option to expire in 1975, but his two co-owners, in recognition of Malec's substantial contributions to the firm (as executive vice-president and manager of the firm's Chicago office), decided to give him the two additional shares -- another 10 percent of the company -- anyway and they told Malec to find a lawyer who would structure the transaction in the least costly way. He turned to Richard Fine, a partner in Schwartz & Freeman. Fine devised a plan whereby the other co-owners would each transfer one share of stock back to the corporation, which would then issue the stock to Malec together with a cash bonus. Because the stock and the cash bonus were to be deemed compensation for Malec's services to the corporation, the value of the stock, plus the cash, would be taxable income to Malec (the purpose of the cash bonus was to help him pay the income tax that would be due on the value of the stock), and a deductible business expense to the corporation. A value had therefore to be put on the stock. NPD gave Fine the information he needed to estimate that value -- information on NPD's financial condition, sales trends, and management -- and Fine fixed a value which the corporation adopted. Fine billed NPD for his services and NPD paid the bill, which came to about $850, for 11 1/2 hours of Fine's time plus minor expenses.

While the negotiations over the stock transfer were proceeding, relations between Malec and his co-owners were deteriorating, and in May 1977 he left the company and sold his stock to them. His wife, who also had been working for NPD since 1972, left NPD at the same time and within a month had incorporated Analytica to compete with NPD in the market-research business. She has since left Analytica; Mr. Malec apparently never had a position with it.

In October 1977, several months after the Malecs had left NPD and Analytica had been formed, Analytica retained Schwartz & Freeman as its counsel. Schwartz & Freeman forthwith complained on Analytica's behalf to the Federal Trade Commission, charging that NPD was engaged in anticompetitive behavior that was preventing Analytica from establishing itself in the market. When the FTC would do nothing, Analytica decided to bring its own suit against NPD, and it authorized Schwartz & Freeman to engage Pressman and Hartunian as trial counsel. The suit was filed in June 1979 and charges NPD with various antitrust offenses, including abuse of a monopoly position that NPD is alleged to have obtained before June 1977.

In January 1980 NPD moved to disqualify both of Analytica's law firms. Evidentiary hearings on the motion were held intermittently between April 1980 and May 1981. At one stage the law firms voluntarily withdrew, but when the judge told them that he was minded to make them pay the fees and expenses that NPD had incurred in prosecuting the motion they moved to vacate the order granting their motion to withdraw. The motion to vacate was granted and the hearings resumed. In June 1981 the judge disqualified both firms and ordered Schwartz & Freeman to pay NPD's fees and expenses. Analytica has not appealed the orders of disqualification, having retained substitute counsel to prosecute its suit against NPD.

We first consider, on our own initiative as we must, whether Pressman and Hartunian has standing to appeal the order disqualifying it. Orders disqualifying counsel usually are appealed by clients upset by the prospect of losing the services of the lawyer of their choice and by the added expense of bringing substitute counsel up to speed. The client's standing to appeal is plain enough and an order disqualifying counsel, though interlocutory, is appealable, at least in this circuit. Freeman v. Chicago Musical Instrument Co., 689 F.2d 715, 717-20 (7th Cir. 1982). If the client wants to keep the lawyer, the lawyer's standing also seems plain, since if the disqualification order stands he will lose the fees he would have made from the case. But in this case the client has not appealed. Analytica appears content with whatever substitute counsel it has procured. We therefore cannot see what tangible object Pressman and Hartunian has in seeking reversal of the order disqualifying it. It has presented no evidence that it will be rehired and we have no reason to assume it will be, since that would require Analytica to replace the trial counsel it has hired in place of Pressman and Hartunian.

Nor need we decide whether an interest in reputation alone could give a lawyer standing to appeal a disqualification. Pressman and Hartunian was disqualified not for anything it did or failed to do but simply because as Schwartz & Freeman's co-counsel it had access, actual or potential, to whatever confidential information Schwartz & Freeman had obtained while representing NPD. It appears that Pressman and Hartunian did not even know about that prior representation and so was innocent in thought as well as deed. That is why the district judge did not require it to pay any of the fees or expenses incurred by NPD in prosecuting the motion to disqualify. The judge thought Pressman and Hartunian had to be disqualified to protect NPD but since the firm's conduct was not blameworthy it need not fear for its reputation.

Although Schwartz & Freeman has a stronger argument that it has an interest in reputation at stake in this appeal, we need not decide whether that interest is enough to confer standing either. Since Schwartz & Freeman has standing to appeal from the order directing it to pay $25,000 to NPD for resisting the order of disqualification, and since the order to pay is invalid if Schwartz & Freeman should not have been disqualified, the appeal from that order requires us to consider the validity of the disqualification order in any event.

For rather obvious reasons a lawyer is prohibited from using confidential information that he has obtained from a client against that client on behalf of another one. But this prohibition has not seemed enough by itself to make clients feel secure about reposing confidences in lawyers, so a further prohibition has evolved: a lawyer may not represent an adversary of his former client if the subject matter of the two representations is "substantially related," which means: if the lawyer could have obtained confidential information in the first representation that would have been relevant in the second. It is irrelevant whether he actually obtained such information and used it against his former client, or whether -- if the lawyer is a firm rather than an individual practitioner -- different people in the firm handled the two matters and scrupulously avoided discussing them. See, e.g., Emle Industries, Inc. v. Patentex, Inc., 478 F.2d 562, 570-71 (2d Cir. 1973); Cinema 5, Ltd. v. Cinerama, Inc., 528 F.2d 1384, 1386 (2d Cir. 1976); Trone v. Smith, 621 F.2d 994, 998 (9th Cir. 1980); Duncan v. Merrill Lynch, Pierce, Fenner & Smith, 646 F.2d 1020, 1028 (5th Cir. 1981), and in this circuit Cannon v. U.S. Acoustics Corp., 532 F.2d 1118, 1119 (7th Cir. 1976) (per curiam), aff'g 398 F. Supp. 209, 223-24 (N.D. Ill. 1975); Schloetter v. Railoc of Indiana, Inc., 546 F.2d 706, 710 (7th Cir. 1976); Westinghouse Elec. Corp. v. Gulf Oil Corp., 588 F.2d 221, 223-25 (7th Cir. 1978).

There is an exception for the case where a member or associate of a law firm (or government legal department) changes jobs, and later he or his new firm is retained by an adversary of a client of his former firm. In such a case, even if there is a substantial relationship between the two matters, the lawyer can avoid disqualification by showing that effective measures were taken to prevent confidences from being received by whichever lawyers in the new firm are handling the new matter. See Novo Terapeutisk Laboratorium A/S v. Baxter Travenol Laboratories, Inc., 607 F.2d 186, 197 (7th Cir. 1979) (en banc); Freeman v. Chicago Musical Instrument Co., supra, 689 F.2d at 722-23; LaSalle Nat'l Bank v. County of Lake, 703 F.2d 252 (7th Cir. 1983). The exception is inapplicable here; the firm itself changed sides.

Schwartz & Freeman's Mr. Fine not only had access to but received confidential financial and operating data of NPD in 1976 and early 1977 when he was putting together the deal to transfer stock to Mr. Malec. Within a few months, Schwartz & Freeman popped up as counsel to an adversary of NPD's before the FTC, and in that proceeding and later in the antitrust lawsuit advanced contentions to which the data Fine received might have been relevant. Those data concerned NPD's profitability, sales prospects, and general market strength -- all matters potentially germane to both the liability and damage phases of an antitrust suit charging NPD with monopolization. The two representations are thus substantially related, even though we do not know whether any of the information Fine received would be useful in Analytica's lawsuit (it might just duplicate information in Malec's possession, but we do not know his role in Analytica's suit), or if so whether he conveyed any of it to his partners and associates who were actually handling the suit. If the "substantial relationship" test applies, however, "it is not appropriate for the court to inquire into whether actual confidences were disclosed," Westinghouse Elec. Corp. v. Gulf Oil Corp., supra, 588 F.2d at 224, unless the exception noted above for cases where the law firm itself did not switch sides is applicable, as it is not here. LaSalle Nat'l Bank v. County of Lake, supra, 703 F.2d at 257-58.

Consistently with this distinction, Westinghouse Elec. Corp. v. Kerr-McGee Corp., 580 F.2d 1311, 1321 (7th Cir. 1978) -- like this a case where the same law firm represented adversaries in substantially related matters -- states that it would have made no difference whether "actual confidences were disclosed" even if the law firm had set up a "Chinese wall" between the teams of lawyers working on substantially related matters, though the two teams were in different offices of the firm, located hundreds of miles apart. Now Schwartz & Freeman has never, in this litigation, contended that it created a "Chinese wall" between Fine and the lawyers working for Analytica against NPD. The offer of proof that it made in the district court was an offer to prove that the individuals in Schwartz & Freeman who were handling Analytica's case against NPD had not received any relevant confidential information about NPD from Fine. This proof would not have established the existence of a "Chinese wall." In LaSalle Nat'l Bank, where this court just the other day upheld the disqualification of a law firm that hired a former county lawyer and later was retained to bring a suit against the county, it was not enough that the lawyer "did not disclose to any person associated with the firm any information . . . on any matter relevant to this litigation," for "no specific institutional mechanisms were in place to insure that that information was not shared, even if inadvertently," until the disqualification motion was filed -- months after the lawyer had joined the firm. 703 F.2d at 259. We contrasted the absence of such mechanisms with a case in which the lawyer "was denied access to relevant files and did not share in the profits or fees derived from the representation in question; discussion of the suit was prohibited in his presence and no members of the firm were permitted to show him any documents relating to the case; and both the disqualified attorney and others in his firm affirmed these facts under oath," and with another case where "all other attorneys in the firm were forbidden to discuss the case with the disqualified attorney and instructed to prevent any documents from reaching him; the files were kept in a locked file cabinet, with the keys controlled by two partners and issued to others only on a 'need to know ' basis." Id. at 258-59. Schwartz & Freeman has never offered to prove -- has never so much as intimated -- that any "institutional mechanisms" were in place in this case. But we emphasize that even if they were, this would not help Schwartz & Freeman; a law firm is not permitted to switch sides if its former representation was substantially related to its new representation, no matter what screens it sets up.

Schwartz & Freeman argues, it is true, that Malec rather than NPD retained it to structure the stock transfer, but this is both erroneous and irrelevant. NPD's three co-owners retained Schwartz & Freeman to work out a deal beneficial to all of them. All agreed that Mr. Malec should be given two more shares of the stock; the only question was the cheapest way of doing it; the right answer would benefit them all. Cf. Coase, The Problem of Social Cost, 3 J. Law & Econ. 1 (1960). The principals saw no need to be represented by separate lawyers, each pushing for a bigger slice of a fixed pie and a fee for getting it. Not only did NPD rather than Malec pay Schwartz & Freeman's bills (and there is no proof that it had a practice of paying its officers' legal expenses), but neither NPD nor the co-owners were represented by counsel other than Schwartz & Freeman. Though Millman, an accountant for NPD, did have a law degree and did do some work on the stock-transfer plan, he was not acting as the co-owners' or NPD's lawyer in a negotiation in which Fine was acting as Malec's lawyer. As is common in closely held corporations, Fine was counsel to the firm, as well as to all of its principals, for the transaction. If the position taken by Schwartz & Freeman prevailed, a corporation that used only one lawyer to counsel it on matters of shareholder compensation would run the risk of the lawyer's later being deemed to have represented a single shareholder rather than the whole firm, and the corporation would lose the protection of the lawyer-client relationship. Schwartz & Freeman's position thus could force up the legal expenses of owners of closely held corporations.

But it does not even matter whether NPD or Malec was the client. In Westinghouse's antitrust suit against Kerr-McGee and other uranium producers, Kerr-McGee moved to disqualify Westinghouse's counsel, Kirkland & Ellis, because of a project that the law firm had done for the American Petroleum Institute, of which Kerr-McGee was a member, on competition in the energy industries. Kirkland & Ellis's client had been the Institute rather than Kerr-McGee but we held that this did not matter; what mattered was that Kerr-McGee had furnished confidential information to Kirkland & Ellis in connection with the law firm's work for the Institute. Westinghouse Elec. Corp. v. Kerr-McGee Corp., supra. As in this case, it was not shown that the information had actually been used in the antitrust litigation. The work for the Institute had been done almost entirely by Kirkland & Ellis's Washington office, the antitrust litigation was being handled in the Chicago office, and Kirkland & Ellis is a big firm. The connection between the representation of a trade association of which Kerr-McGee happened to be a member and the representation of its adversary thus was rather tenuous; one may doubt whether Kerr-McGee really thought its confidences had been abused by Kirkland & Ellis. If there is any aspect of the Kerr-McGee decision that is subject to criticism, it is this. The present case is a much stronger one for disqualification. If NPD did not retain Schwartz & Freeman -- though we think it did -- still it supplied Schwartz & Freeman with just the kind of confidential data that it would have furnished a lawyer that it had retained; and it had a right not to see Schwartz & Freeman reappear within months on the opposite side of a litigation to which that data might be highly pertinent.

We acknowledge the growing dissatisfaction, illustrated by Lindgren, Toward a New Standard of Attorney Disqualification, 1982 Am. Bar Foundation Research J. 419, with the use of disqualification as a remedy for unethical conduct by lawyers. The dissatisfaction is based partly on the effect of disqualification proceedings in delaying the underlying litigation and partly on a sense that current conflict of interest standards, in legal representation as in government employment, are too stringent, particularly as applied to large law firms -- though there is no indication that Schwartz & Freeman is a large firm. But we cannot find any authority for withholding the remedy in a case like this, even if we assume contrary to fact that Schwartz & Freeman is as large as Kirkland & Ellis. NPD thought Schwartz & Freeman was its counsel and supplied it without reserve with the sort of data -- data about profits and sales and marketing plans -- that play a key role in a monopolization suit -- and lo and behold, within months Schwartz & Freeman had been hired by a competitor of NPD's to try to get the Federal Trade Commission to sue NPD; and later that competitor, still represented by Schwartz & Freeman, brought its own suit against NPD. We doubt that anyone would argue that Schwartz & Freeman could resist disqualification if it were still representing NPD, even if no confidences were revealed, and we do not think that an interval of a few months ought to make a critical difference.

The "substantial relationship" test has its problems, but conducting a factual inquiry in every case into whether confidences had actually been revealed would not be a satisfactory alternative, particularly in a case such as this where the issue is not just whether they have been revealed but also whether they will be revealed during a pending litigation. Apart from the difficulty of taking evidence on the question without compromising the confidences themselves, the only witnesses would be the very lawyers whose firm was sought to be disqualified (unlike a case where the issue is what confidences a lawyer received while at a former law firm), and their interest not only in retaining a client but in denying a serious breach of professional ethics might outweigh any felt obligation to "come clean." While "appearance of impropriety" as a principle of professional ethics invites and maybe has undergone uncritical expansion because of its vague and open-ended character, in this case it has meaning and weight. For a law firm to represent one client today, and the client's adversary tomorrow in a closely related matter, creates an unsavory appearance of conflict of interest that is difficult to dispel in the eyes of the lay public -- or for that matter the bench and bar -- by the filing of affidavits, difficult to verify objectively, denying that improper communication has taken place or will take place between the lawyers in the firm handling the two sides. Clients will not repose confidences in lawyers whom they distrust and will not trust firms that switch sides as nimbly as Schwartz & Freeman.

Since the order disqualifying Schwartz & Freeman was correct, we must decide whether Schwartz & Freeman's insistence on litigating the question rather than bowing out gracefully was so unreasonable that the district judge could properly find it to be in bad faith; otherwise the order to reimburse NPD's legal fees and expenses was improper. Browning Debenture Holders' Comm. v. DASA Corp., 560 F.2d 1078, 1087-88 (2d Cir. 1977). By bad faith in this context we mean without at least a colorable basis in law -- what in a malicious prosecution case would be called "probable cause." This court had decided the two Westinghouse cases two years before the motion for disqualification was filed in this case, and they were controlling precedents. In its appeal brief Schwartz & Freeman makes a perfunctory effort to distinguish them and then moves on to argue that later decisions in this and other circuits suggest a movement away from those decisions. One would have to move awfully far away to give any solace to Schwartz & Freeman, and we have not found any case that questions the validity of the Westinghouse cases on a point relevant to this case. We disagree that the Westinghouse cases were overruled by Novo or Freeman. Novo and Freeman do not involve a law firm's changing sides -- a distinction also implicit in Judge Mansfield's concurring opinion in Government of India v. Cook Industries, Inc., 569 F.2d 737, 740-41 (2d Cir. 1978), on which Schwartz & Freeman relies, and in Judge Fairchild's dissent from the panel decision (which was reversed en banc) in Novo, where he said, "This is not a case where a party's former attorney is now representing the adverse party," 607 F.2d at 193 (emphasis added). And Novo and Freeman cite the Westinghouse cases approvingly, see 607 F.2d at 196-97; 689 F.2d at 722 and n.10, as does our even more recent decision in LaSalle Nat'l Bank, see 703 F.2d at 255-57.

The fact that Schwartz & Freeman is a law firm makes its stubbornness in resisting disqualification less forgivable than if it were a lay client. Cf. McCandless v. Great Atlantic & Pac. Tea Co., 697 F.2d 198, 201 (7th Cir. 1983). The district judge was entitled to find that Schwartz & Freeman had acted in bad faith in opposing the motion to disqualify, and therefore to award NPD its fees and expenses.

NPD's cross-appeal challenging the level of the award has no merit. The district judge found that NPD's counsel had put in excessive, and excessively remunerated, time on the case and he therefore refused to award the full amount sought. His finding was not clearly erroneous and his determination of the reasonable fee was not an abuse of ...

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