A Lawyer’s Participation in Intentional Fiduciary Breaches Triggers the Crime Fraud Exception to the Attorney Client Privilege

“The focus of the crime fraud exception is on the intent of the client (citation omitted), not the legitimacy of the services provided by the attorney. An attorney may be completely innocent of wrongdoing, yet the privilege will give way if the client sought the attorney’s assistance for illegal ends.” People v. Radojcic, 2013 IL 114197, ¶ 49.

A lawyer’s participation in intentional breaches of fiduciary duty triggers the crime-fraud exception even though a fiduciary breach is no necessarily a crime or act of common law fraud. Intentional fiduciary breaches are regularly called constructive fraud however and give rise to the crime fraud exception. See Mueller Indus., Inc. v. Berkman, 399 Ill.App.3d 456, 469-73 (2d Dist. 2010) abrogated by People v. Radojcic, 2013 IL 114197 on other grounds (“In concluding that an intentional breach of fiduciary duty may serve as the fraud necessary to establish the crime-fraud exception, we take note of Steelvest, Inc. v. Scansteel Service Center, Inc., 807 S.W.2d 476 (Ky.1991). … The Kentucky Supreme Court held that the breach of fiduciary duty was ‘on an equal par with fraud and deceit.”’) Lawyers who aid and abet fiduciary breaches and other torts are subject to suit. As Thornwood, Inc. v. Jenner & Block, 344 Ill. App. 3d 15, 28–29 (1st Dist. 2003), as modified on denial of reh’g (Nov. 10, 2003) recognized, a lawyer may not “escap[e] liability for knowingly and substantially assisting a client in the commission of a tort.”

Owners in closely held companies have a common law fiduciary duty to act with the utmost good faith and loyalty and this duty includes “prohibiting enhancement of personal interests at the expense of the interests of the enterprise.” Hagshenas v. Gaylord, 199 Ill. App. 3d 60, 71 (2d Dist. 1990). “Perhaps the clearest case for judicial intervention into a close corporation’s dividend policy involves the majority shareholder’s receipt of ‘de facto’ dividends to the exclusion of the minority shareholder.  … [T]he investors surely would not have agreed to an arrangement where the majority, solely at its whim and without any valid reason, could exclude a minority shareholder from distributions of profit that other shareholders (including the majority) are continuing to receive. Such an arrangement would give the majority the unfettered right to freeze a minority investor out of the company’s business returns for so long as the majority desires.” Moll, Shareholder Oppression and Dividend Policy in the Close Corporation, 60 Wash. and Lee L. Rev. 841, 876, 879-880 (2003).

“Majority fault” de facto dividends in this context are defined as the receipt of excessive compensation by the majority owner in a closely held company, initiated by the majority owner in order to deny the minority owner its legal entitlement to a proportionate share of the profits based on its ownership percentage. Id.

If a lawyer assists an owner of a closely held company in “looting” it through phony de facto distributions then the lawyer has arguably aided a fiduciary breach and his or her communications in furtherance of the breach may not be protected by the attorney-client privilege due to the crime-fraud exception. See C.O.A.L., Inc. v. Dana Hotel, LLC, 2017 IL App (1st) 161048, ¶ 73 (managing member of LLC owes duties of loyalty and due care); Kovac v. Barron, 2014 IL App (2d) 121100, ¶ 65 (“Barron breached his fiduciary duty because he acted in his own interest and not in the interests of the Operating Companies and Kovac when he caused the Operating Companies to pay him and Sandra millions in excessive compensation over the years.”); Gidwitz v. Lanzit Corrugated Box Co., 20 Ill. 2d 208, 219 (1960) (“A director or officer of a corporation is forbidden to administer the affairs of the corporation for his private emolument.”); Hagshenas, 199 Ill. App. 3d at 71 (owners of closely held companies owe each other the fiduciary duties of utmost good faith and loyalty); Litle v. Waters, CIV. A. 12155, 1992 WL 25758, at *5 (Del. Ch. Feb. 11, 1992) (policy of failing to declare dividends and using company profits to enrich the majority owner at the expense of the minority owner states a claim for breach of fiduciary duty.)

Moreover, failures to disclose a CEO compensation agreement is, standing alone, a separate breach of fiduciary duty. Halperin v. Halperin, 750 F.3d 668, 671 (7th Cir. 2014). And it makes no difference if the company lawyer participated knowingly or in ignorance. The crime-fraud exception applies either way.

After a plaintiff makes a showing that a lawyer aided and abetted a manager or controlling owner in breaching his fiduciary duties, the plaintiff is then entitled to all of the documents because they fall within the crime-fraud exception. “Where one party asserts that a communication is protected by attorney-client privilege and the opposing party makes a sufficient showing that an exception to the privilege applies, the trial court should hold an evidentiary hearing on the matter.” In re Marriage of Stinauer, 2021 IL App (3d) 190692, ¶ 18; see also DeHart v. DeHart, 2013 IL 114137 ¶ 73; People v. Hart, 194 Ill. App. 3d 997, 1003 (2nd Dist. 1990) (whether exceptions to physician-patient privilege applied could only be determined by trial court upon facts adduced at a hearing).

In re Marriage of Stinauer, quoted above, dealt with the crime-fraud exception. In the underlying divorce case, the wife “alleged in her petition that Jesse misrepresented his income during the dissolution proceedings and alleged that Jesse’s actions constituted a ‘possible concealment of assets.’ In the e-mail communication at issue, Jesse’s counsel referenced Jesse possibly receiving an additional $350,000 in income in 2017, which Jesse never disclosed during the dissolution proceedings.” Id. at ¶ 25. That single episode of counsel making a material misrepresentation was all that was required to warrant an evidentiary hearing for the crime-fraud exception. When the trial court declined to hold an evidentiary hearing after the showing was made, it was reversed on appeal by the 3rd District based on the following reasons:

  • DeHart v. DeHart, 2013 IL 114137, ¶ 73 stands for the proposition that once a party makes a prima facie case that the privilege does not apply (because of an exception—in DeHart it was a will contest exception, but the crime fraud exception would be treated the same way), the proponent of privilege has to rebut the prima facie If the proponent fails to do that then the party making the prima facie case that privilege does not apply is entitled to discovery, which includes deposing the attorney: “Thus, it appears that plaintiff will be able to make out a prima facie case on remand that the attorney-client privilege does not apply because it is subject to the will-contest exception. It would then be up to defendant to rebut plaintiff’s prima facie case on remand. If she is unable to do so, the trial court should compel the deposition of attorney Peters.”
  • “This evidentiary burden has been described as both a prima facie showing and a probable cause showing.” People v. Radojcic, 2013 IL 114197, ¶ 44; Decker, 153 Ill.2d at 322, 180 Ill.Dec. 17, 606 N.E.2d 1094.[2]
  • The evidentiary burden can be met by the contents of the communication itself, or if the court in its discretion deems it necessary, through information uncovered in the course of an in camera People v. Radojcic, 2013 IL 114197, ¶ 45-46.

The Supreme Court in Radojcic held that the evidentiary showing required for an in camera review of the documents with narrowly targeted questioning of the attorney on those same documents in camera is lower than the probable cause showing that is required to trigger a full blown hearing on the applicability of the crime-fraud exception. Id. At ¶ 45. It concluded that the in camera document review and related narrowly tailored questioning of the attorney “should be conducted by a judge other than the judge presiding over the matter at which the communications would be introduced.” Id. See United States v. Al-Shahin, 474 F.3d 941, 946 (7th Cir. 2007) (“’In order for the crime/fraud exception “[t]o drive the privilege away, there must be ‘something to give colour to the charge;’ there must be ‘prima facie evidence that it has some foundation in fact.’ ” Clark v. United States, 289 U.S. 1, 15, 53 S.Ct. 465, 77 L.Ed. 993 (1933) (quoting O’Rourke v. Darbishire, [1920] A.C. 581, 604 (P.C.)); see also Davis, 1 F.3d at 609; In re Feldberg, 862 F.2d 622, 625 (7th Cir.1988). If such evidence of a crime or fraud exists, then ‘the seal of secrecy is broken” and the privilege is inapplicable. Clark, 289 U.S. at 15, 53 S.Ct. 465 (citations omitted). In this circuit, the standard for prima facie evidence “is not whether the evidence supports a verdict but whether it calls for inquiry.’”

Our Chicago breach of fiduciary duty lawyers with offices in Chicago, Oakbrook Terrace and Highland Park have extensive experience litigating the crime-fraud exception to the attorney-client privilege is LLC member and shareholder oppression cases involving closely held companies. For a free consultation call us at 630-333-0333.

Contact Information