Friday, August 31, 2018
Sheppard Mullin Gains Reversal of C.A. Opinion Barring Fees
Supreme Court: Violation of an Ethical Rule Does Not Necessarily Bar Recovery Under Quantum Meruit
By a MetNews Staff Writer
The California Supreme Court held yesterday that Sheppard, Mullin, Richter & Hampton, LLP’s failure to specifically inform a client of its representation of an adverse party in unrelated matters was an ethical violation which invalidated the engagement agreement, but that the firm might still be able to recover the value of its legal services under quantum meruit.
The majority opinion, authored by Justice Leondra R. Kruger, reverses the denial by the Court of Appeal for this district of the firm’s bid to recover some portion of the roughly $1 million in unpaid fees owed by its client, J-M Manufacturing Company, Inc., under the invalid contract. Justice Ming W. Chin wrote a partially dissenting opinion saying he would bar the firm from any recovery.
The case centers around California Rules of Professional Conduct, rule 3-310, titled “Avoiding the Representation of Adverse Interests.” The rule sets forth:
“A member shall not, without the informed written consent of each client:…Represent a client in a matter and at the same time in a separate matter accept as a client a person or entity whose interest in the first matter is adverse to the client in the first matter.”
Engagement of Firm
J-M Manufacturing retained Sheppard Mullin as a replacement for its previous counsel in a qui tam suit brought against the company for allegedly lying to various public agencies about the quality of its pipes.
Attorneys Bryan Daly and Charles Kreindler of Sheppard Mullin’s Los Angeles office determined that a third attorney, Jeffrey Dinkin (who has since left Sheppard Mullin) sometimes handled employment litigation for South Tahoe, an intervener in the qui tam action.
Although Dinkin was not actively working on a matter for South Tahoe at the time J-M Manufacturing retained the firm, Kruger noted that, under its retainer agreement with Sheppard Mullin, it was a current client.
Daly and Kreindler did not inform J-M Manufacturing about the firm’s representation of South Tahoe, but the new client did sign an agreement waiving any conflicts.
Kruger explained that, by not explicitly informing J-M Manufacturing about the existing client, Sheppard Mullin had not obtained “informed consent” from it and had violated rule 3-310’s clear public policy, rendering the agreement unenforceable.
Sheppard Mullin’s Suit
South Tahoe learned of Sheppard Mullin’s retention by J-M Manufacturing and successfully moved to have Sheppard Mullin disqualified in the qui tam action. Sheppard Mullin then sued J-M Manufacturing for its refusal to pay fees still owed under the engagement agreement, which the firm argued was valid.
Over J-M Manufacturing’s objection, Los Angeles Superior Court Judge Stuart M. Rice ordered the parties to arbitration, rejecting the former client’s assertion that the ethical breach had rendered the entire contract, including its arbitration clause, unenforceable.
The arbitrators found that, even if Sheppard Mullin had violated the ethical rules, it was not so egregious a violation as to render the firm’s work less valuable. They awarded the firm $1.3 million in fees and interest, which Rice confirmed.
Court of Appeal Justice Audrey B. Collins of this district’s Div. Four wrote the opinion reversing Rice’s judgment. Collins declared that the ethical violation not only rendered the contract unenforceable, but also barred any recovery by the firm.
Quantum Meruit Available
“We conclude, contrary to the Court of Appeal, that California law does not establish a bright-line rule barring all compensation for services performed subject to an improperly waived conflict of interest, no matter the circumstances surrounding the violation.”
She noted that the Court of Appeal relied “on a series of California cases in which courts denied compensation in the face of serious ethical breaches.”
The law firm might be able to establish a right to recover under quantum meruit for the value of its services, Kruger said. Citing the Restatement Third of Law Governing Lawyers, she wrote:
“The Restatement instructs, and we agree, that 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 are all also relevant to whether and to what extent forfeiture of compensation is warranted….
“The law takes these case-specific factors into account because forfeiture of compensation is, in the end, an equitable remedy. As California courts have often noted, the rule governing attorney forfeiture derives primarily from the general principle of equity that a fiduciary’s breach of trust undermines the value of his or her services.”
Kruger explained that the agreement being entirely unenforceable prevents Sheppard Mullin from recovering any contractual fees from its former client. However, she noted, the contract’s unenforceability also prevents the firm from compelling arbitration.
“The ultimate question whether Sheppard Mullin is entitled to any compensation at all is not ripe for our resolution. Because the superior court ordered the matter to arbitration before determining whether the parties had an enforceable contract and refused to review the merits of the arbitral award after it was made, it has yet to consider any of the noncontract issues framed by the parties’ pleadings. Our holding today will reposition the parties where they were before the case took its unwarranted detour to arbitration, giving them an opportunity to litigate their noncontract claims.”
Chin rejected Kruger’s reliance on the Restatement Third of Law Governing Lawyers, basing his analysis on previous Supreme Court cases. He focused, in particular, especially on the 1926 opinion in Clark v. Millsap, which said:
“Fraud or unfairness on the part of the attorney will prevent him from recovering for services rendered; as will acts in violation or excess of authority, and acts of impropriety inconsistent with the character of the profession, and incompatible with the faithful discharge of its duties.”
“In my view, knowingly representing clients with conflicting interests, without disclosing the conflict to either client and obtaining the clients’ written consent to the simultaneous representation, is an ‘act of impropriety inconsistent with the character of the [legal] profession, and incompatible with the faithful discharge of its duties.’ ”
The case is Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing Company, Inc., 2018 S.O.S. 4322.
J-M Manufacturing was represented before the Supreme Court by Kent L. Richland of Grein, Martin, Stein & Richland in Los Angeles. Kevin S. Rosen of Gibson, Dunn & Crutcher’s downtown Los Angeles office argued for Sheppard Mullin.
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