Laborers Local 1298 Annuity Fund Ex Rel. Rite Aid Corp. v. Grass

Citations: 139 F. Supp. 2d 649; 2001 U.S. Dist. LEXIS 4669; 2001 WL 389341Docket: 1360, 99-2493, Civ.A. 99-2493

Court: District Court, E.D. Pennsylvania; April 17, 2001; Federal District Court

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In the case of *In re Rite Aid Corporation Securities Litigation*, the former CEO and CFO of Rite Aid Corporation filed a motion to disqualify the law firm Ballard Spahr Andrews, which had represented all defendants in a consolidated multi-district litigation concerning alleged violations of the Securities Exchange Act of 1934 related to Rite Aid securities. This motion arose five weeks after the executives became aware of a partial class action settlement that excluded them. They argued that the settlement was tainted by Ballard Spahr's alleged unethical involvement in its negotiation. Following a fairness hearing on the class action and derivative settlements, testimony regarding the disqualification motion was heard. The former CFO, Frank Bergonzi, withdrew his motion due to Fifth Amendment concerns, while the former CEO, Martin L. Grass, continued to press his motion. The factual background notes that Rite Aid's stock price plummeted by $14.44 following the public announcement of disappointing earnings on March 12, 1999, resulting in a significant loss in market capitalization.

Litigation was initiated the day after significant events on March 12, 1999, with multiple putative class action suits filed primarily in one district, later consolidated into a multi-district litigation. Rite Aid's Senior Executive Vice-President and General Counsel, Elliot S. Gerson, retained Alan Davis from the Ballard Spahr law firm to represent Rite Aid and senior officer Martin Grass, believing there was no merit to the allegations and thus a shared interest among defendants. Davis confirmed this in a March 24, 1999 engagement letter, stating no current conflicts existed, but acknowledged the possibility of future conflicts that would require Grass to seek separate counsel. Gerson had also engaged the D.C. firm Wilmer Cutler, Pickering to represent Grass personally, prompted by a January 1999 exposé on related-party transactions involving Grass. Grass testified he was unaware of engagement letters from either firm and relied on Gerson for counsel retention. Following the initial engagement, additional putative class actions emerged, leading Gerson to request Ballard Spahr's representation for new defendants Grass, Frank Bergonzi, and Timothy Noonan on March 26, 1999. After a motions hearing on June 2, 1999, Ballard Spahr moved to dismiss a corrected complaint on September 1, 1999. A significant shift occurred on October 11, 1999, when Rite Aid announced the need to restate its financial statements, resulting in a $500 million reduction in pre-tax earnings. Subsequently, Martin Grass resigned as Chairman and CEO at a Finance Committee meeting on October 15, 1999, with the resignation publicly announced on October 19, 1999.

Grass's resignation was notably contentious, resulting in no compensation or retirement benefits for him, unlike Bergonzi, who received a substantial severance package of $525,000 annually until 2002 upon his resignation as Chief Financial Officer. In response to these events, Rite Aid's Audit Committee initiated an internal investigation, engaging outside legal counsel and forensic accountants from Ten Eyck. This investigation is in cooperation with the Securities and Exchange Commission and the U.S. Attorney's Office for potential federal securities law violations and criminal misconduct.

On October 29, 1999, Davis met with Gerson and the forensic accountant, revealing that Grass and Bergonzi may have committed serious breaches of fiduciary duty, which they had concealed from Rite Aid and its law firm, Ballard Spahr. Consequently, Davis informed Gerson that he could no longer represent Grass and Bergonzi, advising them to seek independent counsel. After attempts to contact Bergonzi, Davis communicated the conflict to him on November 12, 1999, leading Bergonzi to retain O'Melveny. 

Subsequently, Grass engaged Dilworth Paxson, LLP as local counsel while O'Melveny retained Duane Morris for Bergonzi. From the conflict notice on October 29, 1999, until Grass's motion to disqualify on December 15, 2000, Grass did not object to Ballard Spahr representing Rite Aid in ongoing litigation. At a pretrial hearing on February 14, 2000, there was no objection to Davis's representation of Rite Aid.

The disqualification motion was triggered by a Memorandum of Understanding regarding a settlement with the shareholder class, excluding Grass, Bergonzi, Noonan, and KPMG. On April 10, 2000, Rite Aid's new management, led by Gerson, instructed Ballard Spahr to negotiate a settlement, which required preserving claims against Grass and KPMG and excluding Bergonzi and Noonan due to their roles in the alleged fraudulent activities. The negotiations resulted in the Memorandum of Understanding dated November 8, 2000. Importantly, Grass no longer asserts that he shared any confidential information with Davis or Ballard Spahr, which contradicts prior claims made on his behalf.

Grass participated in two brief phone conversations involving him, Gerson, and Davis, but Davis testified he did not recall such discussions with Grass, especially given the significance of Grass's position as CEO of Rite Aid. Davis stated he was instructed by Gerson not to communicate directly with Grass and instead coordinated with Harry Weiss from Wilmer Cutler for any matters related to Grass. 

The document addresses the disqualification of the law firm Ballard Spahr under Pennsylvania Rule of Professional Conduct 1.9, which prohibits an attorney from representing a new client in a matter materially adverse to a former client unless the former client consents. Grass contends that Ballard Spahr, having previously represented him, should be disqualified due to its current representation of Rite Aid, which is adverse to Grass's interests, and claims that no consent was obtained. 

However, upon review, the conclusion reached is that Ballard Spahr did not engage in unethical conduct regarding Grass. The court referenced previous cases to support its determination that Ballard Spahr’s actions were acceptable and did not warrant disqualification, suggesting that similar circumstances had been deemed unobjectionable in past rulings.

Nella Walston filed a derivative action on behalf of duPont Walston against Perot and duPont Glore after a joint venture merged their operations. Allegaert sought to disqualify law firms Weil, Gotshal & Manges and Leva, Hawes, Symington, Martin, arguing they had previously represented duPont Walston in the derivative suit. Allegaert asserted that the firms billed duPont Walston for services and that Leva Hawes was on retainer at the suit's initiation. The firms countered that their fees were incurred while representing duPont Glore under the joint venture arrangement and that all work in the derivative case was for duPont Glore. The Allegaert panel determined that disqualification was not warranted, emphasizing that breaching Canon 4 requires showing that an attorney could have received confidential information from a former client that would not be shared with a current client. The panel noted that duPont Walston was aware that any information shared would also be relayed to duPont Glore due to their joint venture relationship and had its own legal counsel throughout the relevant period. The panel distinguished this case from previous disqualification cases, highlighting that the attorneys had not changed allegiances from a former client to a current adversary. The analysis referenced Kempner v. Oppenheimer, where the court similarly ruled against disqualification, indicating that the expectation of shared interests during initial representation negated the basis for disqualification when the clients later became adverse. The situation was paralleled with Rite Aid, where Ballard Spahr was retained to represent both the corporation and Grass based on representations that the claims were without merit.

Rite Aid is identified as the 'primary' client of Ballard Spahr, which represented Grass solely at Rite Aid's request. All interactions between Grass and Ballard Spahr were mediated through Rite Aid's general counsel, Gerson, with no direct communication between Grass and the firm. The situation differs from cases where a law firm switched sides in litigation; here, any change in position was due to Grass rather than Ballard Spahr. Grass contends that precedents like Allegaert and Kempner do not apply since they were evaluated under Canon 4 rather than Rule 1.9, which includes a duty of loyalty. However, the court disagrees, asserting that the principles in Allegaert and Kempner are relevant to assessing loyalty under Rule 1.9, as district courts have cited these cases in disqualification motions. The discussion of a 'primary' client relationship from Allegaert relates to the loyalty owed by counsel. The Restatement (Third) of the Law Governing Lawyers supports Ballard Spahr's conduct, stating that a lawyer cannot represent a new client in a matter substantially related to a former client's interests without consent. Given that Grass engaged Ballard Spahr through Rite Aid and the nature of their interactions, Grass is considered an 'accommodation client,' and it is inferred that he consented to Ballard Spahr's continued representation of Rite Aid despite any conflicts.

Ballard Spahr's actions were consistent with the Restatement's guidelines, indicating that a violation of Rule 1.9(a) was not justified. Grass, as Rite Aid’s CEO, effectively consented to Ballard Spahr's representation of Rite Aid through an engagement letter, which clearly stated that in the event of a conflict, Ballard Spahr would cease to represent Grass but continue with Rite Aid. Despite Grass's claim of ignorance regarding the letter, his role at Rite Aid put him on constructive notice of its contents. Additionally, Rite Aid argued that Grass waived his right to object to Ballard Spahr’s continued representation due to his delay in raising the objection. The court noted several factors, including the nine-month delay from when Grass became represented by counsel and his knowledge of the conflict, which was apparent prior to his claim of ignorance. Grass’s prior experiences, including his pressured resignation and refusal to cooperate with internal investigations, as well as Ballard Spahr's refusal to enter a joint defense agreement, indicated he was aware of the adversarial relationship. Consequently, the lengthy delay in seeking disqualification amounted to a waiver of his objections, allowing Ballard Spahr to continue representing Rite Aid regardless of the merits of Grass's concerns.

Grass and Bergonzi objected to proposed settlements, claiming they were tainted by alleged ethical breaches by Ballard Spahr, the counsel for Rite Aid. The court found no evidence of such breaches and overruled the objection. On April 17, 2001, the court denied Grass's motion to disqualify Ballard Spahr and dismissed Grass and Bergonzi's claims of ethical misconduct affecting the settlements. The court heard testimony from Grass, Rite Aid's General Counsel Elliot Gerson, and Ballard Spahr partner Alan Davis. Although Rite Aid had not compensated Grass, it had advanced his legal fees. The hearing revealed that Grass's counsel was not involved in prior discussions between Rite Aid and plaintiff class attorneys about extending the filing of an amended complaint. Testimony by Gerson detailed Grass's abrupt resignation from Rite Aid following a meeting regarding a credit facility, highlighting a moment of conflict when Grass was confronted about the unauthorized pledging of stock as collateral. Grass's interests became adverse to Rite Aid at that point.

Grass's departure from Rite Aid starkly contrasts with Bergonzi's substantial severance package, as Grass left without any compensation. His ultra vires pledge on September 24 raised significant non-disclosure issues relevant to Rule 10b-5 and materiality in ongoing derivative litigation, establishing a clear conflict between him and Rite Aid. This conflict intensified after October 15, 1999, when Grass refused to provide the complete cooperation Rite Aid demanded from former employees amid three investigations. While disqualification may be warranted due to alleged ethical violations, the court does not need to decide this matter at this stage. Grass initially cited Rule 1.9(b) regarding the use of former client information as grounds for disqualification but later withdrew this claim, asserting instead that disqualification is justified under Rule 1.9(a). The assessment of attorney conduct concerning ethical standards is fact-sensitive. The excerpt also references a prior case involving duPont Walston, noting that unrelated work did not affect the confidentiality expectation. Additionally, it discusses the implications of a defendant's communication with the plaintiff's counsel, and it addresses the "hot potato" doctrine concerning attorney-client relationships, clarifying that Ballard Spahr's representation of Rite Aid does not violate this principle. Ultimately, the court emphasizes the enduring duty of loyalty attorneys owe to clients even after representation ends, as established in precedent.

An attorney has a duty of continuing loyalty to their client and cannot abandon them to take an adverse position in the same case. In this instance, Ballard Spahr did not abandon Grass or violate any duty of loyalty, as their actions aligned with professional norms, supporting public confidence in the legal profession. Grass argued that prior cases, such as Allegaert, were not relevant since they involved different matters; however, those cases illustrate the propriety of Ballard Spahr's conduct. Grass did not separately retain Ballard Spahr but left representation decisions to the corporation's representative, Gerson, thus binding himself to the corporate representation terms. Throughout the proceedings, Grass had the benefit of additional legal counsel from Wilmer Cutler, as well as from Dilworth Paxson and Baker Botts LLP, which suggested he had adequate representation. Furthermore, while Rite Aid contended that the settlements proposed did not adversely affect Grass, the opposing positions on the settlements indicated a conflict. Although Grass's new attorneys entered their appearance officially on March 8, 2000, they had effectively done so earlier during a hearing, raising questions about whether Ballard Spahr formally withdrew its appearance.

Counsels' statements during the February 14, 2000 hearing indicated Ballard Spahr's withdrawal and the entry of new counsel. Evidence shows that Grass was already represented by Wilmer Cutler, who had engaged with him beginning in January 1999. Even if this prior representation did not directly apply to the current matter, Wilmer Cutler's notification to Ballard Spahr in November 1999 about transitioning representation confirms Cutler's involvement on Grass's behalf before the hearing. The cessation of Ballard Spahr's representation due to potential conflicts should have alerted Grass and his counsel to possible future adversities. Although Alan Davis did not explicitly inform Wilmer Cutler of possible claims against Grass, it seems unlikely that such experienced counsel would not recognize the implications of Grass's resignation, especially given the extensive media coverage of Rite Aid's issues. Grass's refusal to cooperate with Rite Aid's investigation, advised by counsel, is characterized by Rite Aid as non-cooperation, while Grass argues he complied by submitting a letter but found the interview conditions unfair without access to relevant documents. This situation underscores the adversarial relationship between Grass and Rite Aid, as Grass was one of only three individuals who did not fully cooperate with the internal investigation. Lastly, the document touches on potential grounds for disapproving a settlement if unethical behavior by counsel regarding a non-settling defendant is proven, although it does not resolve this issue definitively.