State High Court Takes Look at Duty of Loyalty Toward a Client and Attorney Fees

Thursday, October 4, 2018

Page 10

THE LEGAL COMMUNITY:

State High Court Takes Look at Duty of Loyalty Toward a Client and Attorney Fees

By THOMAS EDWARD WALL

(The writer is a Rancho Palos Verdes attorney. He is former editor of the Journal of Beverly Hills Bar Association and has been in practice for more than 40 years.)

One can make the argument that the recent California Supreme Court decision in Sheppard Mullin, Richter & Hampton, LLP (Sheppard) v. J-M Manufacturing Company, Inc. (J-M) (California Supreme Court No S232946 (8-30-2018) is primarily important only to major law firms that operate in the stratosphere when it comes to attorney fee billing. After all, Sheppard was seeking almost $4 million in attorney fees in the case. Of course, an attorney law firm with the reputation of Sheppard was probably required when an adverse conclusion in the underlying lawsuit could result in a judgment of $1 billion and the potential bankruptcy of the client. (The underlying case was a qui tam action brought against J-M Manufacturing and “hundreds of other defendants” for supplying substandard polyvinyl chloride pipes.)

Perhaps not surprising, it was the existence of one of the “hundreds of other defendants” that resulted in the lawsuit by Sheppard against J-M. and one of the most important ethics court decisions rendered by the California Supreme Court in a long time. Attorneys beginning in law school are taught in their first semester of legal ethics, that unless one receives informed written consent from the client, an attorney generally cannot represent a client, who is a defendant in a matter if the client represents another client in a different matter but who is also, a plaintiff in the same matter as the first client. This prohibition is contained in Rule 3-310 (C)(3) of the California Rules of Professional Conduct.

When Sheppard ran its conflicts checks to ensure it had no issue representing J-M, it discovered that it represents the entity, South Tahoe Public Utility District (South Tahoe) in an unrelated matter. South Tahoe was also one of the plaintiff’s in the case against J-M.

Sheppard, however, for unclear reasons, did not immediately inform J-M or South Tahoe of the possible conflicts and continued to perform legal services for J-M and South Tahoe. In the meantime, South Tahoe on its own found out about the potential conflict and was considering to disqualify Sheppard.

$2.7 Million Paid

Once the conflict was disclosed, J-M had paid Sheppard $2.7 million in fees and Sheppard sought an additional $1.1 million in outstanding bills. J-M sought disqualification of Sheppard as its legal counsel and return of the $2.7 million already paid to Sheppard as well as cancellation of the $1.1 million statement. The federal court disqualified Sheppard as counsel for J M but upheld the fees requested by Sheppard. The California trial court confirmed the federal decision but was reversed by the Court of Appeal and accepted for decision by the California Supreme Court.

The California Supreme Court in essence unanimously upheld the disqualification of Sheppard as legal counsel, and found the agreement between Sheppard and J-M including the arbitration provision to be unenforceable as against public policy.

However, as to whether Sheppard was entitled to any compensation under such facts, which has been answered generally, in the negative in California, caused a substantial dissent by Chief Justice Cantil-Sakauye and Justice Ming Chin (who wrote the dissent). The majority of the court for the first time in such a situation, held Sheppard had the right to have the trial court decide whether Sheppard was entitled, under quantum meruit, to the value of the legal services it provided to J-M in the qui tam action, and if entitled, the amount of the value of the legal services it provided. This is the approach which several defense counsel organizations had argued to the court.

Dissenters’ View

The dissenters opined that “Sheppard Mullin’s failure to disclose its known conflict of interest precludes it from any recovery.” The dissent primary relied on the 2004 decision of Huskinson & Brown v, Wolf (2004) 32 Cal.4th 453. which allowed recovery in quantum meruit for the reasonable value of their legal services when their contractual fee arrangements were found by the court to be invalid or unenforceable. In such cases the trial court itself or through arbitration could reasonably come to a reasonable amount.

The focus of the dissent in Sheppard was that before the trial court could make the determination of the reasonable value of the legal services rendered by the subject law firm, the majority required the trial court first to make, on a case-by-case determination, “whether a quantum meruit award would, under the circumstances “undermine incentives for compliance with the Rules of Professional Conduct.” (Maj. opn. at pp. 40-41). This standard, the dissent argued, assisted the trial courts very little and was made without “any authority of this novel approach.” It would also produce inconsistent results and perhaps a resulting increase in appeals.

The dissent further warned that because of lack of standards offered by the majority, the issue may never reach an appellate court. As the dissent states:

“Because the majority offers no standards to guide the inquiry, is the trial court’s determination reviewable, or is it effectively standard less and unreviewable? If it is reviewable, then what standard of review applies? The majority offers no guidance on any of these questions.”

‘Invisible Approach’

One possible reason for the majority’s “invisible approach,” could be that the majority on the court itself was uncertain what standard would be appropriate to use and wanted the trial courts to come up with their own solutions to the problem. If this reason is correct, one can expect the appellate court to revisit this issue in the non to distant future. See, Clark & Kastellec, “The Supreme Court and Percolation in the Lower Courts: An Optimal Stopping Model” The Journal of Politics Vol.75 No.1 (2013).

However, the dissenters also raised a very fundamental issue that this writer has seen sometimes lost in the “business side” of the legal profession. Attorneys since the very beginning of time have been charged with a high degree of loyalty toward their clients. The duty of loyalty prevents an attorney from undertaking a representation which is directly adverse to an existing client, even if it is on a matter wholly unrelated to the existing representation. (See Rules of Professional Conduct, rule 3-310, subsection (B); Model Rule 1.7(A); Jeffrey v. Pounds (1977) 67 Cal.App.3d 6, 10.

Merely acting in “good faith” (as the majority opinion appears to state is sufficient) should not be the test that should be used whether the attorney has breached his or her loyalty to their client, not should the amount of money the attorney receives from one client vs another client should have any bearing on the duty of loyalty. Members of the California State Bar should not even be tempted as the dissenters warned, “to engage in questionable behavior that they may later attempt to justify as having been done in good faith” which the majority has created. As the dissenters’ state in closing, “At least where the fundamental and inviolate duty of loyalty is at stake, we should instead adopt a rule that encourages attorneys to err on the side of caution, and to scrupulously honor their ethical obligations.” As a member of the California Bar, I trust all members of the California Supreme Court will follow this recommendation.