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By: Greg Fayard
The California Supreme Court has weighed in on the vital importance of conflict of interest waivers. A flawed one could deprive attorneys of their fees.
On August 30, 2018, the Supreme Court analyzed the validity of a conflict of interest waiver in a law firm’s retainer agreement for a high stakes case. In Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing Co., Inc. (2018) 2018 Cal. LEXIS 6399, J-M Manufacturing Company, Inc. (J-M) retained California law firm Sheppard Mullin to represent it in a large federal lawsuit where J-M was sued for over $1 billion in damages. Sheppard Mullin’s agreement had a general conflict waiver, where J-M waived any and all conflicts of interest. It turns out, however, that Sheppard Mullin had, and was, representing one of J-M’s adversaries in the federal case—specifically the South Lake Tahoe Public Utility District (South Tahoe), but in unrelated employment matters. That prior and concurrent representation was not specified in the conflict waiver that J-M agreed to.
South Tahoe learned of the conflict, and successfully moved to disqualify Sheppard Mullin. Unfortunately, Sheppard Mullin had already billed 10,000 hours in the huge federal action, to the tune of some $3 million in fees, with over $1 million unpaid by J-M. Sheppard Mullin then sued J-M for its unpaid fees. J-M cross-complained, seeking to disgorge its fees it paid to Sheppard Mullin and to not have to pay the additional fees owed. The law firm’s retainer agreement had an arbitration clause, which Sheppard Mullin successfully invoked. The arbitrators ruled in favor of Sheppard Mullin, allowing the law firm to keep its earned fees, but also requiring J-M to pay Sheppard Mullin the over $1 million it still owed. The arbitrators described Sheppard Mullin’s flawed conflict waiver as a minor and it did not warrant disgorgement of all the fees J-M had paid. J-M claimed the flawed conflict waiver was an ethical breach by Sheppard Mullin that rendered the whole contract illegal and unenforceable, in violation of public policy (to protect the public from unethical attorney conduct). The trial court disagreed and affirmed the arbitrators’ ruling. J-M appealed. The Court of Appeal reversed, holding the entire agreement was illegal, and Sheppard Mullin was not entitled to any of its $3 million in fees, including the millions J-M already paid the firm. Sheppard Mullin petitioned the Supreme Court, which granted review and issued a 41-page opinion and dissent.
The Supreme Court held that the whole Sheppard Mullin-J-M contract was unenforceable because the flawed conflict waiver violated public policy. The Supreme Court held that at the time it represented J-M, Sheppard Mullin represented an adverse party in that case, which the firm knew about but did not tell J-M. Hence, the general conflict waiver J-M agreed to was not “informed.” Sheppard Mullin’s representation of J-M’s adversary (South Tahoe), was a “present reality” and not a “future possibility” and should have been specifically disclosed. Hence, the Supreme Court vacated Sheppard Mullin’s attorneys’ fee award. Sheppard Mullin was therefore not entitled to the over $1 million in unpaid fees.
But what about the millions of dollars J-M already paid Sheppard Mullin? Should those fees be disgorged? Could Sheppard Mullin keep those fees based on a quantum meruit theory? The Supreme Court held that quantum meruit was not before the court, as it did not have a robust-enough factual record on the fees J-M already paid, and remanded to the trial court. The Supreme Court provided guidance to the trial court on the quantum meruit analysis. Attorneys may be entitled to quantum meruit fees even under the cloud of an unwaived or improperly waived conflict of interest, which is a case-specific inquiry that focuses on whether the flawed conflict waiver was willful, whether any value had been provided to the client, and the amount of harm to the client. The Court held that there is no categorical rule barring quantum meruit fees when an unwaived or improperly waived conflict of interest exists. It depends on the circumstances.
Specifically: “When a law firm seeks fees in quantum meruit that it is unable to recover under the contract because it has breached an ethical duty to its client, the burden of proof on these or other factors lies with the firm. To be entitled to a measure of recovery, the firm must show that the violation was neither willful nor egregious, and it must show that its conduct was not so potentially damaging to the client as to warrant a complete denial of compensation. And before the trial court may award compensation, it must be satisfied that the award does not undermine incentives for compliance with the Rules of Professional Conduct. For this reason, at least absent exceptional circumstances, the contractual fee will not serve as an appropriate measure of quantum meruit recovery. . . Although the law firm may be entitled to some compensation for its work, its ethical breach will ordinarily require it to relinquish some or all of the profits for which it negotiated.” (Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing Co., Inc., 2018 Cal. LEXIS 6399, *56.)
The trial court, therefore, should decide if such legal fees should be completely or partially forfeited.
The lesson here is straightforward and applies to all jurisdictions, not just California: conflict of interest waivers are very important. They should be as clear and specific as possible so that the client knows exactly what it is waiving. Blanket, general, waivers can be insufficient, creating the risk of attorneys losing millions of dollars in legal fees.
If you have any questions or would like more information, please contact Greg Fayard at [email protected].