Articles are provided regularly by LACBA’s longstanding Professional Responsibility and Ethics Committee.
By Robert L. Kehr
It is well known that a corporation’s “corporate powers, rights and privileges” can be suspended for failing to pay taxes or failing to file a required tax return.[1] The pertinent statute says: “Suspension of a corporation provides an opposing party with an affirmative defense that, when timely raised, prevents the corporation from prosecuting or defending an action in a California court.”[2] There are multiple consequences to the suspension of corporate powers,[3] but this article focuses only on the ethical aspect of a lawyer’s representation of a suspended company.
The suspension’s effect is read broadly,[4] as one might expect from the fact that a person who attempts to exercise the powers, rights, and privileges of a suspended corporation can be criminally punished under Rev. & Taxation C. § 19719. As a result, the disability applies not just to suing and defending but, for example, also to appealing from an adverse judgment and seeking a writ of mandate,[5] and, as we will see below, to participating in discovery. A foreign corporation suspended in its home state for tax nonpayment also lacks capacity to sue in California.[6]
A parallel set of statutes applies to limited liability companies.[7] The same concept applies to suspension based on a failure to file required information with the Secretary of State.[8] "The purpose of Revenue and Taxation Code section 23301 is to prohibit the delinquent corporation from enjoying the ordinary privileges of a going concern [citation], and to pressure it to pay its taxes [citation]."[9]
What are the ethical consequences for a lawyer asked to represent a suspended corporation or limited liability company? The starting point in answering this question is a line of case law that begins with the opinion in Palm Valley Homeowners Ass'n, Inc. v. Design MTC.[10] The trial court there initially issued a sanctions award of $89,490 against the suspended corporation's counsel. The court reasoned that it was sanctionable bad faith when the "firm chose to conceal its knowledge of the suspension … from both the court and opposing counsel."[11] After ordered by the Court of Appeal to give counsel the opportunity to oppose the sanctions request, the trial court finally imposed sanctions under C.C.P. § 128.5 on the suspended corporation’s law firm; the sanctions totaled $14,241.35, and the Court of Appeal affirmed. The trial court also cited C.C.P. § 2023 regarding discovery abuse, finding that “participating in discovery on behalf of a suspended corporation” was discovery abuse.[12] A parallel standard exists in federal court litigation under Fed. R. Civ. P. 11(b).[13]
Later cases have relied on Palm Valley without questioning its reasoning or effect. See, e.g., City of San Diego v. San Diegans for Open Government, 3 Cal. App. 5th 568 (2016); Sanai v. Saltz, 170 Cal. App. 4th 746 (2009); and Galvez v. All Seasons Transp., 2019 Cal. App. Unpub. LEXIS 7364 (2019).
Does the court's disclosure demand create a conflict between the lawyer's duty to the court and the lawyer's confidentiality duty to the client under Bus. & Prof. Code § 6068(e)? The firm targeted in Palm Valley made this argument, and the Court of Appeal quickly rejected it.[14] The court did not bother to cite the bases for a lawyer's confidentiality duty, and this is not surprising given that a lawyer's duty to the courts and the legal system prevails over the lawyer’s duties to a client.[15]
The prudent lawyer asked to represent a corporation or LLC in litigation always will assume that a "should have known" standard will be used to measure the lawyer’s knowledge and automatically and promptly will check the on-line Secretary of State’s records to confirm that the organization is in good standing.[16] Doing so should satisfy the lawyer's obligation to the court and permit the lawyer to satisfy the duty of competence to the client by advising of the suspension, of the reasonably foreseeable consequences of that suspension, and of the reasonably available alternative courses of action.[17]
No authority in the Palm Valley line of cases addresses professional discipline, but the disciplinary risk is evident. Palm Valley concluded that the law firm's conduct amounted to the "concealment of material facts."[18] The concealing lawyer’s conduct could amount to a violation of the Rules of Professional Conduct, rule 3.3, and of Bus. & Prof. Code § 6068(d). The former is titled “Candor Toward the Tribunal.” The latter obligates a lawyer: “To employ, for the purpose of maintaining the causes confided to him or her those means only as are consistent with trust, and never to seek to mislead the judge or any judicial officer by an artifice or false statement of fact or law.” At least for this reason, a lawyer who violates the standards of the Palm Valley line of cases therefore would face possible disciplinary consequences in addition to the civil consequences discussed in this article.”[19]
[1] Cal. Corp. Code §§ 23301 and 23301.5.
[2] Cal. Prac. Guide Corps. ¶ 6:564 (The Rutter Group).
[3] These include that the “the taxpayer shall not be entitled to sell, transfer, or exchange real property in California during the period of forfeiture or suspension”, and that a contract made by a suspended taxpayer is “voidable at the request of any party to the contract other than the taxpayer.” Cal. Rev. & Taxation Code §§ 23302 and 23304.1.
[4] The Rutter Guide cites authority that extends the rule to include appealing an adverse judgment, petitioning for a writ of mandate, and renewing a judgment obtained prior to suspension. The opinion in Palm Valley Homeowners Ass'n, Inc. v. Design MTC, 85 Cal. App. 4th 553 (2000), applied this to "participating in discovery" and "participating in litigation." Id. at 559. These disabilities would flow through to the suspended organization's insurers. See Travelers Prop. Cas. Co. of Am. v. Liberty Surplus Ins. Corp., 806 F. App'x 526, 528 (9th Cir. 2020). The insurer's problem is discussed in Julia A. Molander, Suspended Corporations: The Dilemma Of The Defending Insurer, 48 No. 5 DRI For Def. 14 (2006).
[5] Grell v Laci Le Beau Corp., 73 Cal. App4th 1200, 1306 (1997).
[6] CM Record Corp. v MCA Records, Inc., 168 Cal. App.3d 965, 968-69 (1985).
[7] Cal. Corp. Code § 1502. The Revenue & Taxation Code sections cited above refer to a “taxpayer” and not just a corporation, so they apply equally to LLCs. The same is true under Corp. C. § 15502 for a corporation that fails to file information statements required by Corp. C. § 15501.
[8] Scott v. Gino Morena Enter. L.L.C., 2015 WL 847160, at *2 (C.D. Cal. 2015).
[9] Cal-W. Bus. Servs., Inc. v. Corning Cap. Grp., 221 Cal. App. 4th 304, 310 (2013) (internal quotations and cite omitted).
[10] 85 Cal. App. 4th 553 (2000).
[13] Michael Levine, Inc. v. Connect Apparel, LLC, 2021 WL 4734636, at *3 (C.D. Cal. 2021). This extends to bankruptcy proceedings. In re W. Coast Interventional Pain Med., Inc., 435 B.R. 569, 577 (Bankr. N.D. Ind. 2010) (based on California law).
[15] See Hawk v. Superior Court, 42 Cal. App.3d 108, 126 n. 17 (1974).
[16] The trial court applied a "should have known" standard in Adly Enterprises, LLC v. Action A Parent & Teen Support Program, Inc., 2018 WL 4075912, at *3 (Cal. Ct. App. 2018) (affirming $4,095.40 sanctions against the party and its counsel).
[17] See Los Angeles County Bar Ass'n Form. Op. 408 (1982) ("We conclude that it would not be unethical to represent the suspended corporation if the attorney does not mislead the tribunal or the parties as to the status of the corporation."). Regarding a lawyer’s obligation to give the client the information and ideas needed to make informed decisions, see, e,.g., Cal. Rules of Prof. Conduct, rule 1.4; Considine Co. v. Shadle, Hunt & Hagar, 187 Cal. App. 3d 760, 765 (1986) and Farrar v. Mortimer, 2005 Cal. App. Unpub. LEXIS 7653 (2005).
[18] 85 Cal. App. 4th, supra at 562.
[19] These overlapping standards are discussed in Kehr, A Trial Lawyer’s Guide to Rule 3.3, California Litigation, Vol. 33, No 1 (2020).
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