Guessing wrong about the enforceability of an advanced conflict waiver could lead to unexpectedly bad consequences. One doomsday scenario is illustrated by a recent California immediate appellate court decision in the case of Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing, 244 Cal.App.4th 590 (2016).
Sheppard Mullin represented J-M Manufacturing (“J-M”) in a Qui Tam litigation. The Qui Tam action alleged that J-M falsely represented to its customers that PVC pipe products it sold conformed to applicable industry standards for waterworks parts. The complaint demanded over $1 billion in damages. The action involved over 200 real parties in interest.
The Advanced Conflict Waivers
In March 2010, prior to undertaking the representation, Sheppard Mullin conducted a conflict check. It determined that one of its attorneys had done occasional labor and employment work for South Tahoe Public Utility District (“South Tahoe”), which was one of the parties in interest in the Qui Tam action. The conflict check further revealed that in 2006, South Tahoe had signed an engagement agreement with Sheppard Mullin that included a broad advanced conflict waiver.
The engagement agreement with South Tahoe stated as follows:
Conflicts with Other Clients. Sheppard, Mullin, Richter & Hampton LLP has many attorneys and multiple offices. We may currently or in the future represent one or more other clients in matters involving [South Tahoe]. We undertake this engagement on the condition that we may represent another client in a matter in which we do not represent [South Tahoe], even if the interests of the other client are adverse to those of [South Tahoe] (including appearance on behalf of another client adverse to [South Tahoe] in litigation or arbitration) and can also, if necessary, examine or cross-examine [South Tahoe] personnel on behalf of that other client in such proceedings or in other proceedings to which [South Tahoe] is not a party provided the other matter is not substantially related to our representation of [South Tahoe] and in the course of representing [South Tahoe] we have not obtained confidential information of [South Tahoe] material to representation of the other client. [South Tahoe]’s consent to this arrangement is required because of its possible adverse effects on performance of our duties as attorneys to remain loyal and available to those other clients and to render legal services with vigor and competence. Also, if an attorney does not continue an engagement or must withdraw therefrom, the client may incur delay, prejudice or additional cost such as acquainting new counsel with the matter
In-house counsel for Sheppard Mullin analyzed the South Tahoe conflict waiver. They concluded that the waiver permitted the firm to represent J-M in the Qui Tam action. The law firm further noted that no work had been done for South Tahoe in the prior five months. Sheppard Mullin concluded that, in addition to the advanced waiver, South Tahoe was a former client and the Qui Tam action was not substantially related to the subject matter of the firm’s prior representation. For this further reason, Sheppard Mullin concluded that it could represent J-M.
Believing it had cleared that hurdle, Sheppard Mullin then negotiated an engagement agreement with J-M regarding its proposed representation in the Qui Tam action. The firm failed to advise J-M about its prior client relationship with South Tahoe. The firm further obtained a broad consent to future conflicts of interest. The J-M conflict waiver stated:
We may currently or in the future represent one or more other clients (including current, former, and future clients ) in matters involving [J–M]. We undertake this engagement on the condition that we may represent another client in a matter in which we do not represent [J–M], even if the interests of the other client are adverse to [J–M] (including appearance on behalf of another client adverse to [J–M] in litigation or arbitration) and can also, if necessary, examine or cross-examine [J–M] personnel on behalf of that other client in such proceedings or in other proceedings to which [J–M] is not a party provided the other matter is not substantially related to our representation of [J–M] and in the course of representing [J–M] we have not obtained confidential information of [J–M] material to representation of the other client. By consenting to this arrangement, [J–M] is waiving our obligation of loyalty to it so long as we maintain confidentiality and adhere to the foregoing limitations.”
The J-M litigation was extensive. Sheppard Mullin represented J-M in the Qui Tam Action for 16 months, litigating motions, conducting discovery, reviewing documents, and conducting an extensive internal investigation at J-M. It billed J-M nearly $3.8 million for approximately 10,000 hours of work.
Additional Work For South Tahoe
Within three weeks of the execution of the J-M engagement letter, South Tahoe came back to Sheppard Mullin seeking additional representation on labor matters. The firm took on the new assignment.
Sheppard Mullin failed to advise South Tahoe about the J-M matter, relying instead on South Tahoe’s broad consent to future adversity as permitting the work for J-M. The firm also failed to tell J-M about the South Tahoe matter, relying on J-M’s broad advance waiver.
Over the following 14 months, Sheppard Mullin would bill a total of 12 hours of work in employment matters for South Tahoe, while the firm represented J-M against South Tahoe in the Qui Tam litigation.
Disqualification and Fee Dispute
As a result of the actual conflict of interest between South Tahoe and J-M, Sheppard Mullin was later disqualified from representing J-M in the Qui Tam litigation.
After Sheppard Mullin’s disqualification, J-M asserted that J-M was not required to pay Sheppard Mullin any of the outstanding fees unpaid at the time of disqualification and demanded that Sheppard Mullin reimburse all fees that J-M had already paid in relation to the Qui Tam action.
The dispute went to arbitration. Sheppard Mullin prevailed in the arbitration proceeding, and the state court confirmed the arbitration award.
The Appeals Court Decision
The California intermediate appellate court reversed
The appellate court found that Sheppard Mullins’ failure to adequately disclose a conflict of interest between South Tahoe and J-M was sufficient to deny the firm any portion of the $3.8 million in fees billed for its work in the Qui Tam action.
The appeals court found the J-M engagement letter to be in contravention of California law and public policy, as embodied in California’s Rule 3-310 of Professional Conduct, which, like ABA Model Rule 1.7 and USPTO Rule 37 CFR Section 11.107, “bars simultaneous representation of adverse clients.”
The appeals court concluded that South Tahoe had been a current client; and that such representation had to be disclosed to J-M before taking on the Qui Tam matter and getting consent. The court further found that even assuming that South Tahoe had not been a current client at the time of the J-M engagement letter, Sheppard Mullin had failed to obtain informed consent from either J-M or its other client, South Tahoe, when it resumed work for South Tahoe.
Ultimately, the court of appeal was asked to consider whether the entire fee agreement between Sheppard Mullin and J-M was void as a result of the actual conflict of interest. It was undisputed that there was an actual conflict between J-M and South Tahoe; however, Sheppard Mullin argued that the boilerplate advance conflict waiver contained in its retainer agreement was sufficient to comply with California Rule 3-310.
The Court held as follows:
when a conflict of interest is asserted as a “[d]efense in the attorney’s action to recover fees or the reasonable value of services[, a] violation of the fiduciary obligation will defeat recovery.”Sheppard Mullin’s violation of Rule 3-310 precludes it from receiving compensation for services provided to J-M in the Qui Tam Action.
The court of appeal found that the advanced waiver was insufficient to avoid the conflict. The court held that California Rule 3-310 requires “informed written consent” to waive a conflict. In this context, “informed” consent meant that Sheppard Mullin was obligated to inform both J-M and South Tahoe of the actual conflict when it arose and obtain a knowing waiver following full disclosure. Finding that the actual conflict of interest began, at the latest, three weeks into Sheppard Mullin’s representation of J-M, the intermediate appellate court found that the conflict had pervaded the entire relationship between the parties and denied the firm all of its fees.
The appeals court further found that the law firm was not entitled to fees under a theory of quantum meruit. The court explained that, as a matter of public policy, the firm should not be entitled to retain any of the fees it had earned.
Issues for Appeal to Supreme Court of California
On April 27, 2016, the California Supreme Court accepted review of Sheppard Mullin. According to the Supreme Court of California, the case presents the following issues:
(1) May a court rely on non-legislative expressions of public policy to overturn an arbitration award on illegality grounds?
(2) Can a sophisticated consumer of legal services, represented by counsel, give its informed consent to an advance waiver of conflicts of interest?
(3) Does a conflict of interest that undisputedly caused no damage to the client and did not affect the value or quality of an attorney’s work automatically (i) require the attorney to disgorge all previously paid fees, and (ii) preclude the attorney from recovering the reasonable value of the unpaid work?
A decision from the Supreme Court of California is anticipated in 2017.
The current decision is a harsh result. Notably, no one disputes that J-M received the benefit of nearly $4 million of legal work from Sheppard Mullin. If the intermediate appellate court decision stands, J-M will have gotten a free ride for the 10,000 hours of attorney time invested by the law firm–all because another attorney in the firm provided 12 hours of unrelated legal services for the adverse party. The result appears inequitable to say the least.
The Sheppard Mullin debacle serves as a stark reminder of the importance of obtaining informed consent and the danger of relying upon advanced waivers. Following the California intermediate appellate court’s reasoning, a law firm may not be able to blindly rely upon the terms of a blanket advanced waiver and may be required to go back to the clients and seek their informed consent when an actual conflict arises—a rule which, if sustained, would seem to frustrate the purpose of advanced waivers in engagement agreements.