January 07, 2016 Practice Points

Mandatory Arbitration Clause Ruled Unenforceable

By Mitchell Marinello

In an issue of first impression in Pennsylvania, a state court has ruled that the mandatory arbitration clause in Reed Smith’s client engagement letters is unenforceable because it was not specifically signed by the client and did not inform the client of the rights he was giving up and the potential costs he might incur. The court rejected Reed Smith’s argument that the arbitration clause should be enforced because their client was a sophisticated businessman and attorney.

Plaintiff Jerald S. Batoff sued Reed Smith and attorney Widin for legal malpractice in negotiating a $20.5 million settlement with Batoff’s insurance company after Batoff’s Villanova mansion burned down in April 2012. Batoff alleged that Reed Smith advised him to enter into the settlement without the involvement of the tenants who were living in the home at the time of the fire and who had an option to purchase the home. The lease and option-to-buy agreement required the tenants to be involved in any such negotiations.

Batoff alleged that he incurred more than $500,000 in damages from legal fees he paid in litigation with the tenants plus potentially millions of dollars in additional damages, because the settlement required Batoff to indemnify the insurance company if the tenants sued the insurer, which they did.

In April, Philadelphia Court of Common Pleas Judge John M. Younge denied without explanation Reed Smith’s preliminary objections to Batoff’s suit under the theory that the case was required to be sent to arbitration. In his December 18 opinion, which revisited and expounded on that decision, Younge said the Pennsylvania Supreme Court has yet to weigh in on the issue of attorney-client arbitration agreements. He noted that Pennsylvania Rule of Professional Conduct 1.8 allows such mandatory arbitration agreements if the client is “fully informed of the scope and effect of the agreement,” but found the client was not so fully informed here. With no Pennsylvania case law to rely on, Younge cited a recent Eastern District of Pennsylvania case, Sanford v. Bracewell & Guiliani, which relied on a test outlined by the Louisiana Supreme Court in the case Hodges v. Reasonover, to determine whether an arbitration agreement fully informed the client of the rights being given up by agreeing to arbitration.

The Hodges case stated that clients signing arbitration clauses should be informed they are waiving their right to a jury trial, their right to an appeal, and broad discovery rights, and should also be informed that they could pay substantial upfront costs, could still make a disciplinary complaint against their attorney and could speak with independent counsel before signing the agreement. Hodges also stated that clients should be fully informed of the types of claims that would have to be submitted to arbitration. Applying this law to the facts, Judge Younge stated that:

the defendants were unable to establish that [Batoff] ever read the arbitration clause, or was even aware of its existence, because it was found in an addendum to the engagement letter that was neither signed nor initialed by [Batoff]. Based on the language of the arbitration agreement, the defendants were also unable to establish that [Batoff] was informed of the ramifications and scope of arbitration.

Younge said that Reed Smith’s arbitration clause did not provide any explanation of the rights Batoff was waiving, including his right to a jury trial and his right to engage in full discovery, nor did it inform him that he could face substantial upfront costs. The Court discounted the fact that Batoff was a successful businessman and attorney, noting that Batoff was not licensed to practice law at the time of the engagement and “no proof was presented that he was specialized in contract law or arbitration agreements.” The Court also noted that Batoff did not feel capable of handing the dispute himself which is why he hired defendants to serve as his counsel. The Court said that defendants submitted no law to support their argument that lawyers should face a lower standard of proof about the disclosures they must make when their clients are sophisticated.

Practice Pointers: Attorneys who want to put arbitration provisions into their engagement agreements should review their state law, including any professional rules or opinions, to see whether and with what qualifications arbitration provisions are enforced. As a matter of conservative planning, attorneys may want to specifically include the kind of disclosures referenced in this Pennsylvania decision. Interested observers should also keep a lookout for any further developments on appeal.

Key words: alternative dispute resolution, adr, litigation, legal malpractice, attorney-client arbitration, waiver of rights, mandatory disclosures, discovery, costs, jury trial

Mitchell L. Marinello is with Novack and Macey LLP in Chicago, Illinois.

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