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By Samson Habte
May 18 — A trial court went too far by ordering an in-house lawyer to disgorge $550,000 in wages as a penalty for fiduciary breaches he allegedly committed when negotiating bonuses with his company's Alzheimer's-afflicted principal, the Washington Court of Appeals, First Division, declared May 9 ( Chism v. Tri-State Constr., Inc., 2016 BL 147746, Wash. Ct. App. Div. 1, No. 72844-0-I, 5/9/16 ).
The lower court's order drew heavy criticism from corporate counsel advocacy groups. The appellate court decision resolved questions that, according to lawyers contacted by Bloomberg BNA, no U.S. court had ever addressed about what ethics obligations in-house lawyers owe their employers.
The appellate ruling was a victory for attorney Geoffrey Chism, who won $1.5 million in a lawsuit accusing his former employer of breaching bonus contracts but was then ordered to disgorge $1.1 million of that award based on the trial court's finding that he violated ethical and fiduciary duties to his employer when negotiating those bonus payments.
The main questions on appeal were
The trial judge said “yes” to both questions. He then found that Chism violated several ethics rules—including rules governing conflicts of interest and business transactions with clients—when negotiating the bonuses with his company's cognitively impaired president.
As a penalty for those purported ethical breaches, the judge ordered Chism to disgorge $550,000 in unpaid wages and $550,000 in exemplary damages.
The appeals court reversed. “By ordering disgorgement of Chism's wages based on novel interpretations of several [Washington Rules of Professional Conduct], the trial court exceeded the disciplinary authority delegated to it by our Supreme Court,” Judge Stephen J. Dwyer wrote.
Several authorities—including experts on attorneys' fee disputes, corporate governance and legal malpractice—told Bloomberg BNA they have never encountered a case that addressed the issues in this case.
That sentiment was echoed by the Association of Corporate Counsel, which sharply criticized the trial judge's order in an amicus brief supporting Chism.
“Not only does the case raise numerous issues of first, or limited impression, but it also strikes at the heart of the in-house counsel's relationship with his or her corporate client, namely how in-house counsel are to be compensated,” the ACC said.
The brief said “few courts in any jurisdiction have considered the positions adopted by the trial court,” and that the appellate panel's decision will thus “carry great weight in other states.”
“If the decision were to stand without revision, its breathtaking scope would retroactively undermine employment negotiations and agreements between in-house counsel and their employers not only in Washington, but across the country,” the ACC said.
The verdict—particularly the jury's rejection of defendant Tri-State Construction Co.'s contractual defense of undue influence—didn't sit well with the trial judge, who, Chism said, “repeatedly evidenced [his] disregard for the jury's decision.”
Chism said the judge abused his authority to rectify what he viewed as the jury's mistakes. Chism cited a post-trial hearing in which the judge expressed dismay at the jury's failure to recognize what the trial judge later described as “numerous misrepresentations and omissions” that Chism made to Tri-State when negotiating changes to his compensation arrangement.
Those alleged misrepresentations were the basis for the lower court's post-verdict finding that Chism exercised “undue influence” and breached several ethics rules, and thus had to disgorge nearly 75 percent of the $1.5 million award Chism won at trial.
After serving as Tri-State's outside counsel for years, in 2008 Chism proposed that he become Tri-State's in-house general counsel, working from home.
The company agreed, and it paid him a $190,000 salary that, according to Chism, was “based on me spending an average of less than an hour and a half a day on Tri-State matters, or about seven hours a week.”
In 2010, Chism proposed a new salary structure that made him eligible for a discretionary bonus. The trial court said Chism subsequently provided Tri-State with a memo that “essentially requested a $310,000 bonus” for 2010, and that Tri-State agreed to pay it.
The trial court said Chism's memo included an estimate of the hours he worked that was “not reliable.”
In 2011 Chism sought a $500,000 bonus. According to the trial court, Chism made the request to Tri-State's president, Ron Agostino, despite the fact that “Ron's health condition and memory lapses were impacting his ability to run” the company.
Chism also requested a $250,000 bonus in 2012. Tri-State's refusal to pay that bonus triggered the lawsuit against the company, which paid Chism's $310,000 bonus but had not paid the $500,000 or $250,000 bonuses.
The jury found that Tri-State breached the bonus agreements. The verdict supported a total award of $1.5 million: $750,000 in unpaid bonuses and $750,000 in exemplary damages for unlawful wage withholding.
The post-verdict disgorgement order was based on the trial judge's finding that “Chism breached his fiduciary duties and the RPCs [Washington Rules of Professional Conduct] when he modified his compensation to include a bonus for FY 2010, sought bonuses for FY 2010, FY 2011, and half of FY 2012.”
Chism's newer contracts “contained terms that were much more favorable” to him and “resembled neither a typical outside lawyer's fee structure nor a typical inside lawyer's compensation,” the trial judge said.
“These differences were unfair and unreasonable to Tri-State, and Mr. Chism did not fairly and fully disclose facts to Tri-State about these differences,” the judge wrote.
The judge said Chism violated Rule 1.7(b), which deals with conflicts between a client's interests and a lawyer's personal interests, by, among other things, “requesting that Tri-State pay him $500,000 for FY 2011 and indicating that was reasonable” without fully disclosing “the full nature of [his] self-interest in the transaction and the potential risks to the client.”
Additionally, the judge said Chism breached Rule 1.8(a). That rule provides that a business transaction with a client is improper unless the terms are fair and the client receives full disclosure and the opportunity to consult outside counsel.
Finally, the judge said Chism “violated his duty of honesty and forthrightness to Tri-State under RPC 8.4(c)” by making numerous misrepresentations to the company.
The appellate panel said the trial judge's order couldn't stand because it was “based on novel interpretations of several RPCs,” and thus “exceeded the disciplinary authority delegated to [the trial judge] by our Supreme Court.”
“The trial court's exercise of disciplinary authority based on a lawyer-employee negotiating a wage increase and then requesting payment of the increased wages was without precedent,” Dwyer said.
“Accordingly, even were we to decide that the trial court's conclusions were correct (a decision that we need not make), the resulting disgorgement order exceeded its authority,” the panel said.
“While the parties cite numerous cases involving fee disgorgement, they cite no case authorizing the disgorgement of an attorney’s wages,” Dwyer wrote. “Neither do they cite any other authority, such as a bar opinion, in support of this proposition. Indeed, counsel for Tri-State confirmed at oral argument in this court that, to his knowledge, no such authority exists—in Washington or elsewhere.”
Judges Ronald Cox and Mary Kay Becker concurred in Dwyer's opinion.
On the other hand, several authorities Bloomberg BNA contacted expressed concern about the jury verdict Chism won in his breach of contract suit against Tri-State.
In its amicus brief, the ACC said that although “in-house counsel—like outside counsel—are subject to ethical rules,” the standards cited by the trial court “do not extend to the specific and narrow context of in-house compensation arrangements.”
James E. King, a San Diego attorney who serves as an expert witness in malpractice and attorneys' fee disputes, told Bloomberg BNA in-house counsel “serve in a grey zone,” occupying a role “between company management without the rules of ethics attached and outside counsel with the rules of ethics attached.”
In-house lawyers “are not arms length fiduciaries like outside counsel,” but the relationship isn't that of a typical employee either, King said.
For that reason King said he was not entirely convinced by the ACC's argument that the ethics rules the trial court cited didn't apply to Chism's conduct and could not support the trial judge's disgorgement order.
The case “could come out either way” if Washington's highest court agrees to hear it, King said.
Debra S. Rade, who spent more than a decade as head of a corporate legal department, was even less convinced by the appellate panel's claim that the disgorgement order was a clear abuse of authority.
“The Court of Appeals takes the stance that applying the RPC to in-house counsel in this case is ‘novel,'” Rade told Bloomberg BNA in an e-mail. “Applying all the RPC standards to in-house counsel is certainly not novel,” she said.
Rade practices at Rade Law LLC in Chicago and teaches legal ethics at Northwestern University's Pritzker School of Law.
Rade said the least convincing claim by both the appellate court and the ACC related to the applicability of Rule 1.8 on business transactions with clients.
According to Rade, the facts suggested that Chism's salary modifications were in fact a business transaction with Tri-State.
“At the very least, Chism should not have prepared his own employment contract without directing the CEO to seek an outside legal opinion,” Rade said. “He should have explained why this was necessary and appropriate. If the CEO declined, Chism should have required the CEO to sign an acknowledgement of informed consent.”
Rade also said “Rule 1.8 was specifically written to recognize that a lawyer can overreach the relationship established with his client.”
“It also anticipates that this will inevitably happen from time to time and prescribes the manner in which this risk may be reduced to an acceptable level,” Rade said. “Accordingly, Chism should have advised Ron [Agostino] (and his brother owners, if Chism was aware that Ron had been diagnosed with early onset Alzheimer's) that the fee/wages and new relationship he was forging was based in part on his own personal interests.”
Lindsay Halm and Thomas Breen of Schroeter Goldmark & Bender, Seattle, and Phil Talmadge of Talmadge/Fitzpatrick/Tribe, Seattle, represented Chism.
Jillian Barron and Tina Marie Aiken of Sebris Busto James, Bellevue, Wash., and John S. Riper and Sarah E. Cox of Ashbaugh Beal, Seattle, represented Tri-State.
To contact the reporter on this story: Samson Habte in Washington at email@example.com
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