Recently, the California Supreme Court issued an opinion, Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing Company, Inc. (August 30, 2018, S232946) __ Cal.5th __, addressing whether a law firm's conflict of interest rendered an engagement agreement, including its arbitration clause, unenforceable as against public policy and, if so, whether the ethical violation categorically disentitled the law firm from recovering the value of the services rendered to the client. While the court concluded the engagement agreement was unenforceable in its entirety, the law firm could still seek to recover its unpaid fees under a quantum meruit theory.
Sheppard Mullin represented a manufacturing company in defending an action brought on behalf of a number of public entities. The law firm concurrently represented the public entity in an unrelated matter. Both clients executed engagement agreements that purported to waive all conflicts of interest, but did not specifically refer to any conflict, and the law firm did not tell either client about the representation of the other. When the public entity discovered the concurrent representation of the manufacturer in an adverse capacity, it successfully moved to have the law firm disqualified from representing the manufacturer in that matter. Shepard Mullin spent 10,000 hours on the matter and the manufacturer owed Sheppard Mullin about $1 million, but a dispute arose and the matter was sent to arbitration in accordance with an arbitration clause in the parties' engagement letter.
The arbitrator ruled in favor of Sheppard Mullin, which was confirmed in the superior court. But the Court of Appeal reversed. It held the undisclosed conflict of interest violated rule 3-310(C)(3) of the Rules of Professional Conduct and rendered the agreement, including the arbitration clause, unenforceable in its entirety. The Supreme Court agreed, but the court did not agree that the law firm could not receive any compensation for the work it performed during the concurrent, conflicting representation. (Slip opn., p. 2.)
First, the Supreme Court concluded the failure to disclose the known concurrent representation and conflict meant the clients had not given "informed" consent and therefore violated the Rules of Professional Conduct. The unconsented-to conflict of interest affected the entire engagement agreement, which was void in its entirety because it violated public policy of the state as expressed in those rules. (Slip opn., p. 20.) The Supreme Court rejected the law firm's contention that the illegality must arise out of a violation of public policy as declared by the Legislature in a statute. It reaffirmed the continuing validity of Loving & Evans v. Blick (1949) 33 Cal.2d 603, including the proposition that the question of illegality is one for the courts, not the arbitrator, to decide.
The Court concluded the law firm's quantum meruit claim for recovery of fees was not ripe for resolution since the superior court refused to review the merits of the arbitral award denying all fees. It "repositioned" the parties to give them an opportunity to litigate their noncontract claims. (Slip opn., p. 32.) Although every attorney conflict of interest violation is serious to some degree, the court rejected a bright-line rule. (Ibid.) Instead, applying equitable principles, it was up to the trial court decide the issue after considering such factors as "the egregiousness of the attorney's conduct, its potential and actual effect on the client and the attorney-client relationship, and the existence of alternative remedies...." (Slip opn., pp. 32-33.)
In a lengthy and vigorous dissenting opinion, Justice Chin agreed with the majority's conclusion that the entire agreement was unenforceable, but disagreed that the law firm could seek any recovery for its fees because a quantum meruit award would compensate the law firm for legal services it was expressly precluded from providing and would not be consistent with case law. The dissenting opinion provides a detailed discussion of case law on the subject of quantum meruit recovery and concludes that allowing recovery would be contrary to the function of the rules of professional conduct, which protect the integrity of the attorney-client relationship. (Dissenting opn., p. 24.)
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