Undisclosed Conflict of Interest Causes Unenforceable Arbitration Clause, Disgorgement of Some Fees

by David Hricik

Sheppard, Mullin, Richter & Hampton, LLP v. J-M Mfg. Co. __ P.3d __ (Cal. Aug. 30, 2018) has been on a lot of people’s radar for while.  Boiled down, the firm represented a J-M Mfg., in a qui tam action against a number of public entities while representing one of the public entities in an unrelated and small matter.  The firm billed 10,000 hours in the qui tam action and 12 to the public entity, South Tahoe.

South Tahoe moved to disqualify the firm, and that motion was granted over the firm’s argument that South Tahoe had agreed to a broad waiver of conflicts long before the matter for J-M had even existed.

Later, J-M refused to pay the final $1 million of the $3 million the firm had billed it.  The firm sought arbitration in accordance with its fee agreement  with J-M, which also contained a broad waiver clause. In response, opposed arbitration and J-M sought disgorgement of the $2 million it had paid, since the firm had earned it while having a conflict of interest.

J-M was forced to arbitrate and the arbitrators found in the firm’s favor, though stating the firm should have disclosed the conflict.  When the firm moved to confirm the award, J-M opposed it. J-M prevailed in the California high court.

The Court concluded that it could set aside an arbitral award based upon an illegal contract, and that the ethical rules provided a basis for so finding.  It rejected the idea that a broad blanket waiver permitted the firm to represent J-M while representing South Tahoe without informing both clients of the conflict.  Thus, the arbitral award was vacated.

The court held, however, that the firm would be entitled to pursue relief under a quantum meruit theory and not have to disgorge all of the $2 million it had received, nor lose any claim to the $1 million it was still owed.  In the regard, the court wrote:

When a law firm seeks compensation in quantum meruit for legal services performed under the cloud of an unwaived (or improperly waived) conflict, the firm may, in some circumstances, be able to show that the conduct was not willful, and its departure from ethical rules was not so severe or harmful as to render its legal services of little or no value to the client. Where some value remains, the attorney or law firm may attempt to show what that value is in light of the harm done to the client and to the relationship of trust between attorney and client. Apprised of these facts, the trial court must then exercise its discretion to fashion a remedy that awards the attorney as much, or as little, as equity warrants, while preserving incentives to scrupulously adhere to the Rules of Professional Conduct.

The difficult issues this creates for patent lawyers, and others, should be clear.  Spotting conflicts of interest is difficult enough, but this case substantially increases the price of not doing.

The opinion just issued, and I’m doing a webinar for the AIPLA on conflicts in patent practice on 9/11, and so will think on this more, and discuss it then.

Federal Circuit Grants Motion to Disqualify Jones Day on Appeal

The general rule is that a lawyer can’t be adverse to a current client; but, mere economic adversity is not enough.  What if I’m seeking to enjoin party A, who sells products to one of my clients, and so any injunction may cause economic harm to my client?

This is a potentially very dangerous opinion for patent firms.  Jones, Day was representing Apple when it entered an appearance in a case where the defendant had been preliminarily enjoined from making certain batteries.  Apple used those batteries.

Apple moved to intervene in the Federal Circuit to disqualify Jones, Day from representing the battery maker on appeal.  The motions panel (Dyk-auth; Newman Hughes) granted the motion to disqualify, though in a non-prec opinion.

Jones, Day stated it would not be adverse to Apple in any direct negotiations for licensing, etc.  Nonetheless the panel disqualified the firm.  The key passage:

[T]he burden placed on the attorney- client relationship here extends well beyond the sort of unrelated representation of competing enterprises allowed under Rule 1.7(a). Apple faces not only the possibility of finding a new battery supplier, but also additional targeting by Celgard in an attempt to use the injunction issue as leverage in negotiating a business relationship. Thus, in every relevant sense, Jones Day’s representation of Celgard is adverse to Apple’s interests. This conclusion is not altered by the fact that Apple is not named as a defendant in this action. The rules and cases such as Freedom Wireless interpreting them make clear it is the total context, and not whether a party is named in a lawsuit, that controls whether the adversity is sufficient to warrant disqualification. 2006 WL at *2; see also Arrowpac Inc. v. Sea Star Line, LLC, Nos. 3:12-cv- 1180-J-32JBT et al., 2013 WL 5460027 at *10 (M.D. Fla. Apr. 30, 2013) (interpreting same rule as encompassing “any representation directly adverse to the interests of a current client.”). Celgard contends that despite the conflict we should not grant disqualification because of the prejudice involved in impinging on Celgard’s right to choose their counsel and secure new counsel. Celgard further suggests that if Rule 1.7(a) were to cover conflicting representations merely because the client is up or down the supply chain then “lawyers and clients would have no reliable way of determining whether conflicts of interest exist in deciding whether to commence engagements.” Opposition at 13, Celgard, LLC v. LG Chem, Ltd., Appeal Nos. 2014- 1675 et al. (Oct. 14, 2014).

That, however, is not our holding. Nor is it the facts of this case. As evidenced by Jones Day’s attempts to limit the nature of the representation, Jones Day and Celgard clearly knew the potential for conflict here yet elected to continue with the representation. See id. at 4 (“Jones Day explained that it could represent Celgard against LG Chem, but not against customers of LG Chem who were also Jones Day clients—such as Apple.”). Thus, the legal costs and delay in proceedings that may result from a disqualification are attributable in no small way to Celgard and Jones Day themselves.

The case is not on-line but I’ve posted it, I hope, here.

So… watch out for injunctive relief that might affect current clients!  Good luck running conflicts checks on this one (though seemingly Jones Day knew of the ‘conflict’ before it appeared, in this case).  By the way, there is another case, in the ITC, involving Google where the ITC came to a somewhat different conclusion, though under more attenuated facts.

Brilliant New Book on Ethics in Prosecution 2015 Edition Out Now!

By David Hricik

Proud to announce that the 3rd edition of Patent Ethics: Prosecution that I co-authored with Mercedes Meyer is now available here!  This edition adds a massive amount of new material to deal with the new PTO ethics rules and the fast-moving, roller coaster world of ethical issues in patent practice!

From the description:

Patent Ethics: Prosecution (2015 Edition), by David Hricik and Mercedes Meyer, is an essential guide to the ethical issues arising in the course of the patent prosecution process. By providing relevant rules and case law, it allows practitioners to identify ethical problems before they arise and to address them most effectively when they do. Patent Ethics: Prosecution is one of two volumes on patent ethics — the second focuses on litigation — and is the first of its kind to combine the United State Patent and Trademark Office (PTO) rules with commentary by the authors, which distills the authors’ own experience and expertise in patent prosecution into effective practice strategies.

The 2015 Edition is particularly relevant considering the significant ramifications with the United States Patent & Trademark Office (USPTO) repealing its existing rules, the USPTO Code of Professional Responsibility, and replacing them with the new USPTO Rules of Professional Conduct. Furthermore, the 2015 Edition also comprehensively discusses ethical issues of major concern for patent law practitioners such as:
•   The increase in malpractice claims based upon patent prosecution as well as recent significant verdicts of $30 million and $70 million.

•   The USPTO’s Office of Enrollment and Discipline’s vigorous enforcement efforts, continued persistence in asserting a broad view of its jurisdiction, and resulting increase in the volume of case law and other authorities.

•   The troublesome issue of best mode and the America Invents Act.

•   The various ethical issues surrounding patent agents.

The 2015 Edition features new analysis of current client conflicts in patent practice, including when prosecution and opinion work become “adverse” to a client, the conflicts of interest created by the AIA’s approach to the best mode, and duty of candor post-Therasense. It also includes an updated PTO Code completely annotated with OED decisions on each provision.

Makes a perfect Christmas present, too!  Buy one for every lawyer in your firm!  Heck, buy two so they have one at home!

Federal Circuit: Firm Cannot Switch Sides in Patent Case

By Dennis Crouch

In re ATopTech (Fed. Cir. 2014)

Professor Hricik already wrote some on this case [link], but I wanted to discuss it in a bit more depth as well.

In 2013, Synopsys sued ATopTech for infringing its U.S. Patent No. 6,507,941. The ‘941 patent covers a sub-grid connectivity method used in chip layout automation software known as electronic design automation (EDA). ATopTech hired the 800-lawyer behemoth firm of O’Melveny & Myers to handle the defense. However, N.D. California Judge Chesney disqualified the O’Melveny firm based upon a conflict of interest.

O’Melveny has some history with the parties. The ‘941 patent was previously owned by Magma Design and O’Melveny represented Magma Design for almost a decade, including in its 2012 merger with Synopsys. O’Melveny had also represented Magma Design in several EDA-patent lawsuits against Synopsys and had apparently considered asserting the ‘941 patent against Synopsys. Further, two of the attorneys on the O’Melveny trial team had been part of the Magma Design team, including Luann Simmons (Managing Partner of OMM San Francisco).

Based upon these facts, the district court found that the relationship between the current and former representation substantial enough to create an irrefutable presumption that confidential material information was transmitted to the attorneys regarding the current dispute. The result of that conclusion is that O’Melvany cannot now switch sides to represent the opposing party. The district court did not, however, go so far as to particularly find that the O’Melveny attorneys had actually breached any ethical duties.

In a Mandamus action, ATopTech asked the Federal Circuit to overrule the lower court decision. However, the appellate panel denied the Mandamus petition – finding instead that the lower court “had a sound basis for disqualifying OMM.”