You and your business partner are fighting. He hires a lawyer and has the company sue you. What's wrong with this picture? Why is our company suing me instead of him? How did he hire a company lawyer without my agreement? How can he use my company (and my money) against me? This happens every day. And, yes, its not right. Your partner didn't have authority to hire the lawyer. The lawyer didn't have authority to sue to. But you can send the lawyer packing and get the suit dismissed using this little known rule.
Using the Motion to Show Authority in Texas
In my practice, I encounter this scenario often. When there are two partners, two directors, two managers, and they disagree, you have a deadlock. You can also have a deadlock when the bylaws or company agreement gives one partner a veto. But one partner is still in control, right? Whoever has the title "president" still runs the business, still signs the checks. That partner will get sick of the fight and use his power. He will have the company hire (and pay) a lawyer to sue the other partner. This power play can be devastating. But what the partner (and even the lawyer) doesn't know is that Texas law provides a remedy. The Rule 12 Motion to Show Authority is rarely used and not well known, but it is effective.
This blog post is drawn from Hopkins Centrich Law White Paper: Deadlocked Companies Can't Hire Lawyers.
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Who Has Authority to Hire the Corporate Lawyer?
Only the "governing authority" of a business entity may hire a lawyer. That means the board of directors at a noticed meeting for a corporation. The managers at a noticed meeting for an LLC; or the members in a member-managed company. Retaining counsel and instituting litigation are board-level decisions. A majority must make the decision.
Texas law is clear that a director, owner, officer, or agent of a company is not authorized to hire a lawyer. Even the president of a company may not do it. The president of a corporation controls the "ordinary course of business." Hiring litigation counsel, particularly to sue one of the shareholders, doesn't qualify. Texas appellate courts hold that corporate presidents and LLC managers lack that authority. Learn More.
Texas Motion to Show Authority
Enter Texas Rule of Civil Procedure 12 -- the motion to show authority. If the president didn't have authority to hire the lawyer, then the lawyer doesn't have authority to represent the company. This rule is rarely used and not well known, but it can wreck a lawsuit.
Rule 12 of the Texas Rules of Civil Procedure provides:
A party in a suit or proceeding pending in a court of this state may, by sworn written motion stating that he believes the suit or proceeding is being prosecuted or defended without authority, cause the attorney to be cited to appear before the court and show his authority to act. The notice of the motion shall be served upon the challenged attorney at least ten days before the hearing on the motion. At the hearing on the motion, the burden of proof shall be upon the challenged attorney to show sufficient authority to prosecute or defend the suit on behalf of the other party. Upon his failure to show such authority, the court shall refuse to permit the attorney to appear in the cause, and shall strike the pleadings if no person who is authorized to prosecute or defend appears. The motion may be heard and determined at any time before the parties have announced ready for trial, but the trial shall not be unnecessarily continued or delayed for the hearing.
A motion to show authority argues that a lawyer has no authority to prosecute or defend a suit. Once challenged, the attorney must prove his authority to act. The challenged lawyer bears the burden of proof. The lawyer must prove that the board approved his engagement and the litigation. An Engagement Agreement with the president's signature is not enough.
If the lawyer doesn't meet the burden of proof, then the court must bar the attorney from the case. If a lawyer with authority doesn't appear, the court must strike the pleadings. The court must dismiss the lawsuit unless the other party filed a counterclaim. These provisions are mandatory. The court has no discretion.
Unlike a motion to disqualify counsel, a party may file a motion to show authority at any time before trial. Such delay on a motion to disqualify would constitute a waiver.
If the controlling shareholder simply neglected to go through the board process, then he can fix the problem. But if there is a deadlock on the board, he can't. Deadlocked companies can't hire lawyers. They can't institute litigation. The certainly can't sue one of the owners.
Attorneys are at considerable ethical and financial risk if they do not understand these rules. An attorney has an ethical duty to be sure he is acting with authority. If the attorney accepts company money to provide services, the company may compel him to return it. Even in a deadlock situation, one of the owners may assert that claim through a derivative action. An attorney also risks a malpractice claim.
A separate consideration is that the company (and the company's attorney) must remain neutral in a shareholder fight. The company cannot have an opinion about who owns or runs it. The company may not participate in a fight among the owners for control. The company may not defend a derivative claim against one of its officers or directors. Texas cases hold that the company attorney may not be used by one faction of members or shareholders against another. Corporate attorneys who side with the controlling shareholder or current management do so at their peril. They risk disqualification. They risk a Rule 12 motion to show authority. They risk an action for disgorgement of fees.
To learn more about this and related subjects:
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