Unpacking Bad Faith

A very smart lawyer at a very large firm once told me something very convincing.

All the good stuff lies in the privilege log.

The notion of "bad faith" prompted this comment. And by bad faith, I generally refer to the defense perception that many competition cases simply are motivated by a piling on of litigation costs - usually from an established player onto a start-up or nascent rival. As bad faith is often the standard for fee-shifting - certainly under state trade secrets law - then the concept becomes important for building a defense.

The problem for many defense lawyers (and more importantly, their clients) is proving bad faith. The concept smacks of deception, and by its nature the source of its proof largely is outside the control of the defense. On rare occasions, the defense will uncover a smoking gun - this usually is an e-mail, by the way - or a document that suggests an improper purpose behind the lawsuit. That purpose would be to achieve something other than a victory on the merits or a legitimate settlement of a valid claim.

A problem that has vexed me for some time is how to unpack bad faith through discovery. It's a knotty issue, with proof often a patchwork maze of inferences here and there from poorly conceived claims or simple lack of proof. But even a crummy case on the merits might not equate to "bad faith."

Is there something else? Some other way to prove it?

I have talked before about lawyer involvement in perpetuating bad faith claims as a major issue that underlies competition lawsuits. Lawyers often assume their clients' identities and are complicit in maintaining claims that fill up the courts for no legitimate reason. Because competition disputes are amenable to discovery morasses, this is a serious issue. Another serious issue is incompetence. Competition law is not easy, nor intuitive. And many lawyers simply don't understand the law very well. Add to that the declining market for legal services, and attorneys able to grab a competition case see a source of fee revenue for the taking. It's a toxic brew.

So recalling what my colleague said about privilege, is there a way to circumvent it? There might be. It's called the "crime-fraud" exception. Lawyers and clients labor under a terrible misconception of privilege. It is the exception and not the rule, so it's carefully scrutinized and particularly favored. This is particularly so since it's antithetical to the goal of the adversarial process: to find out the truth when reaching a result.

The essence of the crime-fraud exception is fairly straightforward: a lawyer does not render professional services if she is assisting the client to perpetrate a crime or a fraud. In some places, courts give "fraud" a rather broad interpretation. It follows, then, that if a lawyer is facilitating a frivolous suit, then her discussions with her client about how to achieve this should be discoverable. This may loosely be called a "fraud upon the court" (though I recoil at that term), or something akin to fraud.

The procedural hurdle is that the party seeking discovery must advance a preliminary showing of bad faith. This is no small feat. But if a party can present this, then it may ask the court to review otherwise designated privileged material. This in camera review (likely, of attorney-client e-mails) will enable the court to act as a gatekeeper and ferret out truly privileged materials that don't further the fraud.

But communications where a client seeks counsel's assistance in perpetuating a frivolous claim are not privileged and should be disclosed. This rule makes sense when one considers that counsel have an ethical duty to the court, as well as her client. And it further makes sense when one realizes courts have the inherent authority to control their docket and advance cases towards a speedy, just resolution. If a lawyer is assisting a client perpetuate a nonsense claim, why should this help be immune from disclosure?

Trade Secrets, Litigation Funding, and the Fall of Champtery

The rise of third-party litigation funding presents a quandary of legal, ethical, and economic issues, which commentators have tried to sort through for many years. With the importance of trade secrets to many businesses, it's no surprise that this facet of intellectual property litigation has drawn the interest of litigation financiers.

Yet, despite this reality, very few courts have had the opportunity to examine the legal issues that come into play when a third-party funds a trade secrets plaintiff. One of the more high-profile Chicago-area trade secrets cases, however, deals with this new paradigm. The case is Miller UK v. Caterpillar, Inc. - now several years old. It is a typical business-to-business trade secret case, which features a dispute arising from the fracturing of a long-term business relationship when Caterpillar allegedly began offering a product derived from Miller's confidential information. Most non-employment trade secrets cases feature some variation on this fact pattern.

It turns out Miller had concerns about its capability - financially, that is - to litigate against Caterpillar. And, as everyone knows, trade secrets litigation ain't cheap.

Enter the funding company. Caterpillar cried foul. And a discovery dispute arose, raising significant issues that likely will arise time and again. Are discovery disputes interesting? Not really, but this one worked its way in to the Wall Street Journal a few weeks ago.

The dispute presented two significant legal questions that I feel are important to address (many others seemed secondary and aren't worth commenting on).

First, do litigation funding agreements violate laws against champtery? Those ancient statutes generally bar third-parties from stirring up lawsuits by helping others to promote litigation in an officious manner.

The Miller court answered that question with an emphatic "no." In a lengthy opinion by Magistrate Jeffrey Cole (somewhat renowned for his lengthy, well-cited opinions), the court held that Caterpillar couldn't obtain the litigation funding agreements between Miller and its litigation sugar-daddy because they weren't relevant. In particular, those documents couldn't help Caterpillar establish any sort of defense or counterclaim, since the champtery statutes did not apply to litigation funding arrangements.

Second, the attorney-client privilege does not protect documents that the trade secrets plaintiff and its counsel share with the actual or potential funders. Since the privilege does not extend to business arrangements, a plaintiff cannot cloak communications with the privilege even if they somehow relate to the litigation process.

Importantly, this does not preclude a trade secrets plaintiff from precluding disclosure of information under the work-product privilege, which may offer greater protection. Disclosure of mental impressions, internal memos and the like to a third-party does not destroy the privilege, and in Miller's case it at least was able to show that it took some steps to guard against disclosure of its counsel's case memos even though potential funders received them.

Magistrate Judge Cole's opinion is embedded below.

Miller UK v. Caterpillar - Opinion on Litigation Funding (00189411xAF516)

Fee Agreements and Time Sheets Discoverable In Non-Compete Dispute (OfficeMax Inc. v. Sousa)

Key employees who leave one firm to join a rival often have their attorneys' fees paid for by the new employer. Agreements to indemnify an employee for fees are sometimes contained in a negotiated new employment contract as a material inducement for the employee to defect and join a competitor. Indeed, many employees on the fence may not leave without some security that litigation will be financed by the new employer, which - to be sure - is in a better position to provide for and fund a legal defense.

Indemnification arrangements, however, are fully discoverable in litigation. A plaintiff's first discovery request almost always will include a demand for any employment agreements the defendant has signed in connection with his competing job. Also discoverable are facts related to fees paid by the new employer for a new employee. In a case where the employee does not have a written indemnification agreement, a plaintiff may seek and obtain discovery from the new employer about whether it has paid for the employee's legal fees.

This discovery even may extend not just to the fact of payment, but also the amount and the description of legal services performed. As a recent federal district court case held, records revealing "the general nature of legal work performed are not within the attorney-client privilege" because they do not contain confidential communications.

That is not to say all fee sheets are fully discoverable. For attorneys whose time entries are more detailed and may suggest the type of communication between the attorney and the client, a court certainly has the discretion and ability to cloak time entries with a privilege. But it is a mistake for counsel to assume that all fee sheets are privileged. They're not, even if the time entries generally describe the nature of the work performed and suggest what an attorney and a client may be discussing.

Aside from privilege, there is another point attorneys and clients also ought to be aware of regarding indemnity rights. Courts rely on indemnification agreements to support the conclusion that an injunction may issue. In particular, courts reason that if an employee is indemnified by an employer for legal costs, he or she won't suffer tremendous hardship from a temporary restraint on competitive conduct. This finding is more prevalent in cases where the indemnification agreement states that the employee will be paid his or her full salary even if a court-ordered injunction materially limits the prospective job responsibilities that the employee was hired to perform. Though indemnification agreements provide some insurance for competing employees, they also can actually help a plaintiff in seeking equitable relief.

--

Court: United States District Court for the District of Maine
Opinion Date: 9/29/10
Cite: OfficeMax Inc. v. Sousa, 2010 U.S. Dist. LEXIS 103736 (D. Me. Sept. 29, 2010)
Favors: Employer
Law: Federal Rules of Civil Procedure