In today’s post I recount an epic battle between the Rules of Professional Conduct (tagline: saving clients from unscrupulous lawyers for over 100 years!) and the Uniform Arbitration Act (tagline: saving arbitration from hostile judges for 60 years!) in the Supreme Court of California. Spoiler alert: the Rules of Professional Conduct win.
The story in Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing Co., 2018 WL 4137103 (Cal. Aug. 30, 2018), begins with a “large law firm” [ed: with too many names] taking over the defense of J-M in a qui tam action in federal court in March of 2010. The problem was that one of the public entities that had been identified as a real party in interest in the qui tam case was also a client of the firm (for employment matters). Because both clients had signed engagement letters with general language waiving potential conflicts, the firm concluded it could take on the qui tam action.
The SMRH firm defended J-M for just one year before its employment client moved to disqualify it. In that time, the firm had put in 10,000 hours defending J-M, and was still owed over one million dollars in fees. The district court disqualified the firm based on the firm’s failure to adequately inform the employment client and J-M of the adversity before obtaining waivers, as required by the Rules of Professional Conduct.
At that point, the law firm sought its million dollars of unpaid fees from J-M in a state court action, and J-M in turn sought disgorgement of the two million dollars it had already paid. The law firm successfully moved to compel arbitration, with the trial court dismissing J-M’s argument that the conflict of interest made the whole contract illegal and unenforceable. (And, the Court of Appeals refused a discretionary review which could have avoided the wasted fees of the arbitration.)
A panel of arbitrators awarded the law firm more than $1.3 million. The parties were then back in state court with cross-motions to confirm and vacate the award. The trial court confirmed the award. However, the Court of Appeal reversed.
On appeal, the Supreme Court of California agreed that the arbitration award must be vacated. It rested its decision on precedent from 1949, noting that “an agreement to arbitrate is invalid and unenforceable if it is made as part of a contract that is invalid and unenforceable because it violates public policy.” In this case, the court found that the Rules of Professional Conduct were an expression of public policy, such that a violation of those rules could render an arbitration agreement void. And it also found that the firm’s failure to give both of its clients notice of the actual adversity, and obtain informed consent of the representation, was a violation that tainted the entire contract and made it illegal. (For you ethics geeks, the rule violated was 3-310(C)(3).)
Because the contract between the law firm and J-M was unenforceable, the court found the firm was “not entitled to the benefit of the arbitrators’ decision” and the parties could resume “where they were before the case took its unwarranted detour to arbitration.” (Not sure why the court refused to say it was vacating the arbitration award.) But, don’t shed too many tears for the lawyers. The law firm will be able to argue in the trial court regarding whether it is entitled to any of its fees under the equitable doctrine of quantum meruit. (Two judges dissented from that last part, finding that the ethical conflict should prevent the firm from recovering at all.)
I leave it to other blogs to discuss the ethical issues for lawyers present here, and to therapists and firm counsel to address the rising panic that lawyers may feel when reading this opinion. For my purpose, this case is further demonstration that the type of arbitration agreement that is most susceptible to arguments of invalidity is the one between an attorney and client. (Recall the recent decision in Maine.) It is also interesting in that it does not discuss whether J-M “waived” its objection to arbitrability at all by participating in the arbitration, indeed there is no discussion of whether or how often J-M raised its objection during the arbitration. That is a sharp contrast to the rule cited by the 9th Circuit in the Asarco decision (summarized last post), and an example of how inconsistent the rules are regarding waiver.