While the establishment of Chinese walls is becoming more common, law firms should not assume that in-house lawyers will accept their use without question, writes Lara Oyesanya

The potent issue of conflicts of interest is firmly rooted in the preservation of confidentiality – a key professional rule for solicitors and one that is always flagged by them any time the independence of the solicitor's profession is threatened. In any event, it is generally accepted that matters between clients and solicitors are confidential and should remain confidential. Hence, the recognition that legal professional privilege should, in certain circumstances, be attached to the advice that solicitors give to their clients.

This includes legal advice privilege which covers letters and other forms of communication between a client and its lawyers. This is an area of great interest to in-house lawyers as their core activity is to advise their employer clients. This legal advice privilege in recent times appears to be under a great threat. The Three Rivers Case is an example. In Three Rivers District Council v Bank of England (No.10) [2004], the Court of Appeal's decision further limits the circumstances in which solicitors are able to claim legal advice privilege.

The courts have, in case law, recognised that, it is possible for solicitors to act and still protect client confidentiality – Prince Jefri of Bolkiah v KPMG [1999] refers. This case heralded the use of information barriers otherwise known as 'Chinese walls', notably, by City law firms.

There is a big caveat attached to the use of Chinese walls which is that a client must have given their consent. There should be no risk of disclosure or misuse of relevant confidential information. This envisages adequate safeguards to be put in place when Chinese walls are erected. Examples include the isolation of personnel holding the confidential information, and the written confirmation from the isolated group that they understand the information barrier and will comply with it.

The courts have clearly stated that they would interfere where the information barriers put in place are not satisfactory or where there is a risk of disclosure or misuse of relevant confidential information. The Court of Appeal in Koch Shipping [2002] recognised that while client confidentiality should be preserved, there was a danger of the courts being persuaded that there was a risk of disclosure when the uncontroverted evidence did not support such a risk.

It is now more prevalent for private practice law firms, especially the commercial law firms, to act for clients where there is a potential or real risk of conflict through the use of information barriers such as Chinese walls. The reaction over the years of in-house lawyers, who are the largest purchasers of external legal advice, other than the Government, has been rather interesting.

In-house lawyers appeared to have readily embraced the use of Chinese walls – probably because the large law firms, which are capable of handling big matters, are in short supply. In some cases, in-house lawyers have been known to have given consent to law firms that have acted for their clients in the past, to advise their competitors or others who might be in a conflict position, so as to further build up their expertise in a particular field. This position appears to be changing and changing fast.

In-house lawyers and their clients do not appear, however, to be convinced about the effectiveness of Chinese walls and have in some cases, come to distrust it – probably due to the prevalence of its use. This could also be due to the fact that in recent times there has been an explosion of the 'partnering' relationships where law firms position themselves as working 'in partnership with their clients' in the provision of legal services and, in some cases, law firms have described themselves as "an extension of the clients' in-house legal department".

In these circumstances, law firms regularly second their lawyers to in-house legal departments to learn more about the business of their clients. This is so that they become familiar with the work carried out by the department so that the law firms could provide proactive legal advice which they have have promoted as a way of adding value in the 'partnering' arrangement. This means law firms now, more than ever before, have access to a great deal more client information, including potentially sensitive business information. Furthermore, as a result of the uncertainty around legal advice privilege, law firms are called upon to advise on matters that in-house lawyers would have ordinarily advised upon to ensure that privilege is attached to such advice.

It is therefore no surprise that in-house lawyers as 'gatekeepers' for their employer clients, are, from anecdotal evidence, now more often than not, rejecting the use of Chinese walls. The in-house lawyer recognises their responsibilities, particularly since some of them are increasingly involved in the strategic decision-making process of their employer clients and protecting the competitiveness advantage and confidentiality of their employers.

The sound reasoning of in-house lawyers appears to be that the law firms they instruct should never act directly against them even where the law firms seek to assure them that effective barriers are in place. In-house lawyers in such circumstances expect, and demand, that the confidentiality of their employer clients should be protected at all times. Some in-house lawyers have been known to disinstruct their law firms as a result of the law firms acting against them. The balance of power has shifted to in-house lawyers and law firms are now aware, or should be aware, that they ignore the wishes of in-house lawyers at their peril.

It has been interesting (though not for Freshfields) to read about the court battle that followed when Marks & Spencer's (M&S') in-house head of legal, Robert Ivens, instructed Slaughter & May to apply for an injunction restraining Freshfields from acting for the Phillip Green consortium on its takeover bid for M&S. Mr Justice Collins, who granted the injunction in the first instance, concluded that a real risk of conflict existed and rejected Freshfields' claim that it did not. The judge considered the risk to be so serious that he further commented that he could not see that a firm of Freshfields' size would be able to put in place effective information barriers that would eliminate such a risk. This was upheld by the two judges of the Court of Appeal who were very clear that a potential conflict of interest existed.

It is noteworthy that while Freshfields took steps to determine whether a potential conflict existed, and it came up with the George Davies contract it handled for M&S, Freshfields concluded that the Davies contract was not material to the bid and it could therefore accept the instructions from Phillip Green consortium.

Freshfields later set up Chinese walls when it became apparent that the Davies contract would indeed be relevant but it did not consider it necessary to obtain M&S' consent. This would appear to have added to Freshfields' predicament and it paid heavily for this by putting itself under the public gaze. The moral of this debacle is clear from the in-house lawyer's perspective – never ignore or take the in-house lawyer for granted.

In conclusion, does this spell the end of the use of Chinese walls? Probably not, but it further emphasises the relevance and importance of the issues that concern in-house lawyers which centre very much around the effectiveness of Chinese walls. I have no doubt that in-house lawyers will become more aware, more than they have done before, of the issue of Chinese walls, as a result of the significant focus brought about by the 'M&S day in court.'

Perhaps the Law Society would feel justified in considering rejecting the pressure from City law firms for a major liberalisation of the conflict of interest rules. The Law Society recently published its own consultation paper on the review of all the rules and principles governing the professional conduct of solicitors. It would appear from the proposed rules that there are clear instances when information barriers should be used and the message seems to be that these should be to protect confidentiality, and not potential conflicts.

It remains to be seen whether City law firms consider the new rules on conflicts to be far reaching enough for them to change their processes to ensure that they comply. The law firms generally accept that the processes they have in place to deal with the ever-increasing number of conflicts they are faced with do breach the Law Society current rules on conflicts.

As far as the in-house lawyers are concerned, I have no doubt that, regardless of the law firms' response to the new rules on conflicts or whatever additional steps they take to give assurances around the use of Chinese walls, the in-house lawyer will remain wary and alert.

Lara Oyesanya is director of professional standards for the Commerce & Industry Group.