Feb. 3 — The law firm Sheppard Mullin cannot recover its contractual fee or even quantum meruit for representing a defendant in a huge qui tam action while the firm was simultaneously representing one of the plaintiffs in unrelated matters, the California Court of Appeal, Second District, declared Jan. 29.
The ruling raises the specter of big losses for law firms as they struggle to meet traditional conflicts rules in an era of increasingly large firms and lateral hires that bring in unfamiliar clients.
In addition, the decision casts doubt on firms' reliance on broad advance waivers as a viable method of overcoming conflicts when clashing interests ultimately develop among a law firm's current clients.
In an opinion by Justice Audrey B. Collins, the court scuttled an arbitration award requiring J-M Manufacturing Co. to pay Sheppard, Mullin, Richter & Hampton LLP more than $1.3 million in fees and interest.
Instead, the law firm must disgorge all fees it received from the point when the unethical concurrent representation began, the court directed.
It made clear that when the conflict surfaced, Sheppard Mullin had a duty to tell the client and obtain its informed consent rather than relying on a broad advance waiver in its engagement agreement.
Sheppard Mullin was disqualified from defending J-M in a massive False Claims Act suit when it came out that the firm was concurrently representing one of the 200 plaintiffs, South Tahoe Public Utility District, in unrelated matters.
When Sheppard Mullin sued J-M for unpaid fees, J-M resisted the claim and sought disgorgement of what it already paid the firm. J-M said that in light of the conflict and the law firm's ouster, the parties' engagement agreement was unenforceable as contrary to the public policy embodied in California's ethics rule that bars simultaneous representation of adverse clients.
The arbitration panel concluded that the agreement was enforceable and ordered J-M to pay Sheppard Mullin's outstanding fees along with substantial interest.
On J-M's appeal from an order confirming the arbitration award, the court held as an initial matter that under California law the enforceability of the engagement agreement was a question for the court—not the arbitrators—to decide.
Although the Federal Arbitration Act differs on that issue, the agreement here called for application of California law, and a line of California cases holds that a challenge to the entire validity of a contract is a judicial question that cannot be decided by arbitrators, Collins said.
On the merits, the court concluded that by simultaneously representing J-M and South Tahoe, Sheppard Mullin violated California Rule of Professional Conduct 3-310(C)(3), which provides that an attorney “shall not, without the informed written consent of each client … [r]epresent a client in a matter and at the same time in a separate matter accept as a client a person or entity whose interest in the first matter is adverse to the client in the first matter.”
Sheppard Mullin's violation of Rule 3-310(C) rendered the engagement agreement unenforceable as contrary to public policy, the court decided.
Numerous court decisions have relied on California professional conduct rules to find contracts unenforceable, Collins said. She said Rule 3-310(C) expresses public policy because it is based on an attorney's duty of undivided loyalty, which constitutes the foundation of a lawyer-client relationship.
The court decided that from the day Sheppard Mullin encountered an actual conflict between the two clients, the firm's violation of Rule 3-310 precluded it from receiving compensation—even quantum meruit recovery for the value of its post-conflict work.
In reaching this conclusion, the court cited Section 37 of the “Restatement (Third) of the Law Governing Lawyers” (2000), along with two seminal California cases that it said drew a line between serious ethics violations such as conflicts of interest, in which compensation is prohibited, and technical violations or potential conflicts, in which compensation may be allowed.
The court said that the ethics violation here went to the heart of Sheppard Mullin's relationship with J-M and pervaded the entire relationship. The violation of Rule 3-310(c) caused the firm to be disqualified, thereby undercutting the very purpose for which J-M had hired it, Collins stated.
The court distinguished decisions in which attorneys have been awarded fees despite conflicts of interest that could lead to disqualification. Those cases did not involve an actual conflict, it said.
Sheppard Mullin pointed to a provision in the engagement agreement that allowed the firm to engage in conflicting representations “provided the other matter is not substantially related to our representation of [J-M] and in the course of representing [J-M] we have not obtained confidential information of [J-M] material to representation of the other client.”
The court rejected the firm's reliance on that provision—or “boilerplate waiver,” as Collins put it—saying the firm's argument ignored the reality that Rule 3-310(c)(3) requires truly informed consent from the client.
“Written consent to all potential and actual conflicts in the absence of any knowledge about the existence of such conflicts cannot comply with the requirement of ‘informed written consent' in Rule 3-310(C),” the court said.
Judges Thomas L. Willhite Jr. and Laurie D. Zelon joined the opinion.
Gibson, Dunn & Crutcher represented Sheppard Mullin. Greines, Martin, Stein & Richland represented J-M.
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Copyright 2016, the American Bar Association and The Bureau of National Affairs, Inc. All Rights Reserved.
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