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A divided Pennsylvania Supreme Court has ruled that, in derivative litigation, communications between a corporation's current management and legal counsel are protected by attorney-client privilege, which cannot be overcome by a showing of “good cause” by plaintiffs seeking access to those communications.

The justices ruled 5-2 in Pittsburgh History and Landmarks Foundation v. Ziegler to reverse a Commonwealth Court decision adopting the qualified attorney-client privilege originally set forth in the U.S. Court of Appeals for the Fifth Circuit's 1970 ruling in Garner v. Wolfinbarger.

The Garner court established a mechanism by which plaintiffs in derivative litigation could pierce attorney-client privilege by demonstrating good cause. Garner laid out nine factors for courts to determine whether good cause was shown.

But Justice Max Baer, writing for the majority in Pittsburgh History, said the Garner good cause test ”is inconsistent with the attorney-client privilege under Pennsylvania jurisprudence because it eliminates the necessary predictability of the privilege.”

“Rather than providing clarity and certainty, the Garner test requires attorneys and clients to speculate how a court in the future will weigh the nine subjective and amorphous factors in an attempt to discern whether a derivative plaintiff has brought a sufficient claim to allow the abrogation of the current management's  assertion of the attorney-client privilege in regard to legal advice provided by the corporation's lawyers,” Baer said in the majority's Jan. 23 opinion.

The majority likewise rejected Section 85 of the Restatement (Third) of the Law Governing Lawyers, reasoning that, similar to Garner, it “utilizes a nebulous analysis of whether the plaintiffs' needs are 'sufficiently compelling and the threat to confidentiality sufficiently confined to justify setting the privilege aside.'”

Baer, joined by Chief Justice Thomas Saylor and Justices Kevin Dougherty, Christine Donohue and David Wecht, said allowing a good cause exception to attorney-client privilege in derivative litigation would have unwanted real-world consequences.

“The reality is that this weighing of the factors would result in current managers and the corporation's attorneys having no meaningful way of determining whether their otherwise privileged communications would be later divulged in derivative litigation discovery,” Baer said. ”As a result, corporate management would be less willing to discuss issues with corporate counsel, and corporate counsel would caution corporate management not to speak with her candidly. As a matter of simple logic, this will result in corporate managers being forced to act without necessary legal guidance in an already complicated legal environment.”

The appeal in Pittsburgh History arose after an en banc Commonwealth Court panel in April 2017 determined that the trial court handling the underlying derivative action issued an improperly broad discovery order.

According to court documents, the derivative action dates back to conduct that occurred between 2009 and 2013. The plaintiffs were members of the board of trustees of the Pittsburgh History and Landmarks Foundation and the related Landmarks Financial Corp. Questions began arising about the board's management and efforts to reconstitute the board, court documents said.

In October 2013, the plaintiffs formally demanded the nonprofit corporations secure enforcement of their claims on behalf of the companies. The board then appointed a joint investigating committee to determine whether to proceed with the derivative action. The investigative committee, which was composed of sitting members of the board with advice from independent counsel, ultimately determined not to proceed with the derivative action, and the board adopted that recommendation, according to court documents.

Based on the committee's report, the board filed a motion with the lower court to dismiss the derivative action. The plaintiffs, however, also filed a motion to compel all information that had been provided to the investigating committee.

Relying on the state Supreme Court's 1997 decision in Cuker v. Mikalauskas and the American Law Institute Principles of Corporate Governance, the lower court said the defendants needed to provide the requested materials, including all related legal opinions and communications between the board and the investigating committee.

While the Commonwealth Court said the lower court should not have applied the fiduciary duty or common-interest exceptions to the case, it did find that the court should have looked for potential exceptions to the privilege based on Garner.

But Baer said that while the Cuker ruling adopted several sections of the ALI Principles, it did not specifically discuss the comments to Section 7.13(e) of the ALI Principles, which invoke Garner's good cause analysis.

What the Cuker court did do is officially adopt the “business judgment rule,” Baer explained, which generally requires courts to refrain from interfering with business management decisions “'in the absence of fraud or self-dealing or other misconduct or malfeasance.'”

Under Cuker, the process for bringing derivative litigation is set up as follows: Plaintiffs who believe current management are acting against the interests of the corporation can demand that the corporation pursue litigation or some other action against the current management. In response, the corporation, acting through its current management, can form an independent committee to decide whether such action should be taken. If it declines to take action, the derivative plaintiffs can pursue a derivative action in court and the corporation's current management can file a motion to dismiss the case, citing the independent committee's determination. According to Cuker, the court considering a motion to dismiss in a derivative action must give significant deference to the current management under the business judgment rule.

Baer said the process adopted under Cuker renders the Garner good cause test “unnecessary.”

“This framework provides the derivative plaintiff with a path to challenge the validity of an independent committee's decision not to pursue derivative litigation and allows limited discovery, including some privileged material which would otherwise not be permissible in standard litigation,” Baer said. “Nevertheless, as noted, the ALI Principles protect the current management team through application of the business judgment rule, which has long been a part of Pennsylvania jurisprudence.”

Justice Sallie Updyke Mundy penned a concurring and dissenting opinion, joined by Justice Debra Todd, arguing that the Pittsburgh History case was not the correct vehicle to determine whether to adopt the Garner good cause exception in Pennsylvania.

“In my view, the majority's consideration of Garner is premature, and it is not necessary to resolve the issue of whether Garner permits derivative plaintiffs to obtain discovery related to the underlying claims in responding to a motion to dismiss based on the corporation's decision to follow the recommendation of an independent investigating committee,” Mundy said. “Instead, I would apply Cuker and hold that discovery into the underlying merits of the derivative claim is precluded at the motion to dismiss stage of derivative litigation.”

Gary Hunt of Tucker Arensberg, who represents the defendants, did not return a call seeking comment, nor did counsel for the plaintiffs, Walter DeForest of DeForest Koscelnik Yokitis & Berardinelli.

(Copies of the 53-page opinion in Pittsburgh History and Landmarks Foundation v. Ziegler, PICS No. 19-0115, are available at http://at.law.com/PICS.)