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.

5 thoughts on “Undisclosed Conflict of Interest Causes Unenforceable Arbitration Clause, Disgorgement of Some Fees

  1. 2

    Interesting holding relevant to the Trump v Stormy Daniels case. It was alluded to by Sarah Sanders that Trump won the arbitration (and a judgment) against Stormy for violating her hush agreement with Trump. If the “hush agreement” was an “illegal contract” (because Trump never signed it as her lawyer Avenatti alleges, or the better argument is that it violated campaign finance laws) then Stormy may have her day in court after all.

    1. 2.1

      pl,

      Read the contract – it is written in such a manner as allowing Trump to not sign it.

  2. 1

    I thought that quantum meruit was unavailable for cases involving transgressions of ethics.

    One cannot profit from ill-actions, even under a “work-earned” basis.

    Willful?
    Severity?

    Are not those belonging to the “case within a case” of whether or not the ethics transgression occurred? That underlying matter is binary – and I do not see the “shading” as being applied as something that should matter as a matter of course once the underlying case is decided. It is NOT a matter of “were the services of value – the basis of quantum meruit – it is whether or not quantum meruit may even be sought.

    Am I missing something?

    1. 1.1

      Fee disgorgement varies, a lot, by state. My recollection is, for example in Texas, there has to be a serious ethical breach to obtain any, and then it’s degree/quantum meruit approach, but this is from memory.

      I’m writing a book on remedies right now, and I can emphasize that in equity, all things are possible.

      1. 1.1.1

        Thanks David – look forward to your views

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