Typical contractual relationships on a construction project
A construction project typically involves several contractual relationships. The Owner may contract with a Lender as well as a Contractor; the Contractor with Sub-contractors and maybe even a Surety.
Opportunities for joint representation of these parties on the same construction project do occur. The Contractor may have joined with the Owner or with its Sub-contractors in a joint venture to do the project. The same economics underlying the joint venture may lead the parties to use the services of the same law firm on the project. But, even then, the parties have probably used different counsel to negotiate the joint venture.
Given the need to negotiate contracts and the probability of at least routine disputes and litigation during the project, joint representation of the typical contracting parties seems unlikely to work ethically or practically.
Contractor/Lender relationship
What about the contractor and the lender? Unlike the owner and the lender, the contractor and the lender do not necessarily have a direct contractual relationship.
But, the contractor may have to look to the lender to fund pay applications – especially in a project owned by a single purpose entity with limited liability and resources. The principals behind the owning entity may have resources, but they have set up the LLC for the specific purpose of limiting their liability. This fact makes the contractor dependent on the loan disbursements for payment on the construction contract.
Unfortunately, the lender may refuse to fund a pay application for reasons related to the owner’s performance on the loan, not the contractor’s performance on his contract with the owner. The contractor may not get paid even if he has performed. Not surprisingly, the AGC advises: “The lender may (or may not) be your ally.” (AGC Guide to Construction Financing, 2d ed. 2007, p. 15)
This prospect probably means that the lender and the contractor are not typically going to seek out the same counsel. Nor would a construction law firm reasonably seek to represent both on the same project. But, what if the same law firm already represents both the lender and the contractor?
The law firm probably has a strong incentive to represent at least one or the other of its clients on the project. The problem is that either client might not like its law firm representing the other client on the project. The law firm may face the choice of representing neither – a very distasteful decision – or trying to represent both despite the possibility of funding issues.
In this situation the law firm has the ethical and fiduciary obligation to consider whether it can represent both and, if so, how.
The ethical rule
ABA Model Rule 1.7(a) establishes a prohibition “if the representation involves a concurrent conflict of interest.” Under the rule a “concurrent conflict of interest” exists if the clients are “directly adverse” or if there is a “significant risk” that the representation of either client will be materially limited by the law firm’s responsibilities to the other client. Comments 7 and 26 to the rule make clear that both types of conflict can occur in transactional matters, not just litigation. And, Comment 2 makes it the lawyer’s responsibility to determine whether a conflict exists.
“Concurrent conflict of interest”
Certainly, a direct contractual relationship can involve a “concurrent conflict of interest” when the parties are negotiating the contract or if a dispute develops over contract performance. The law firm in our situation may conclude that no concurrent conflict exists because its client the lender will not have an immediate, direct contract with its client the contractor.
But, this conclusion overlooks the reality of the construction project. The lender may require the owner, with which it has a direct contract (the loan), to obtain the contractor’s consent to an assignment of the owner’s interest in the construction contract. The lender may even require the contractor to obtain a completion guaranty from the contractor. Both of these requirements benefit the lender and effectively create a potential obligation by the contractor to the lender. Even though the lender and the contractor may not have an immediate, direct contractual relationship, they may become “directly adverse.”
The loan agreement may also attempt to provide the lender with a priority over any contractor lien on the project. While the validity of the priority may depend on state law, the lien interests of the lender could interfere with the lien interests of the contractor. As noted before, the lender may refuse to fund a pay application. The reality is that there may be a “significant risk” that the law firm’s ability to represent both clients could be materially limited.
“Consentable concurrent conflict of interest”
If a concurrent conflict of interest exists, ABA Model Rule 1.7(b) requires the law firm to determine whether the conflict is “consentable,” meaning can the clients consent to (waive) the conflict. The law firm can only ask the clients to consent to the conflict if it “reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client.”
Presumably, the law firm would have objective difficulty making this determination if the clients were already “directly adverse” or if the law firm’s ability to represent either client were already materially limited by one or the other client. For example, one client insists that the law firm favor its interests over the other client. In other words, the law firm should only be able to make a reasonable determination that a conflict is “consentable” if the conflict is merely potential and even unlikely.
Informed consent
If the conflict is consentable, the law firm must then obtain the clients’ “informed consent, confirmed in writing.” This requires the law firm to consult with the clients, disclose the various ways and risks of adverse effects on the clients from the joint representation and the alternatives and then confirm their consent in writing. The clients’ sophistication is important, but the burden is absolutely on the law firm.
Since most consentable conflicts will be potential, can the client actually provide an informed consent to something in the future? While the rule does not provide a bright line test, it does suggest that a general, open-ended consent to future conflicts is not effective and that the answer depends even more on the sophistication and experience of the client.
Other problems
The law firm in our example may attempt to avoid the conflict by assigning different lawyers to represent its two clients on the project. It cannot. If Rule 1.7 would prohibit one lawyer from representing both clients, it also prohibits two lawyers in the same firm.
Representing two clients on the same construction project or, more generally, on the same transaction runs other risks. One client may require the law firm to keep information confidential from the other client. If that information is potentially prejudicial to the other client, the law firm gets into an untenable position. It cannot disclose the information; yet, it has an ethical responsibility to disclose any information to its clients necessary to represent them.
Independent of the ethical requirements imposed by the rules, a law firm also has fiduciary responsibilities to its clients. In the broadest sense this responsibility means that the law firm must put its clients’ interests ahead of its own and act only in the clients’ interests. In this respect the law firm in our example probably has to tell both of its clients that it cannot represent either on the same project.
If the law firm does not and attempts to obtain consent to the joint representation, it runs the risk that if something goes wrong on the project and one or the other of its clients incurs loss, the client may feel and may even be able to show that the lawyer failed to protect the client’s interest due to the joint representation. This result exposes the law firm to liability for damages.