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March 30, 2017 Practice Points

California Court Vacates Award Due to Law Firm’s Conflict

By Ramsey Kadri

In Sheppard Mullin Richter & Hampton LLP v. J-M Mfg. Co. 244 Cal. App. 4th 590 (2016), a California court vacated an arbitration award in favor of a law firm (Sheppard) because it found that Sheppard’s simultaneous representation of adverse clients violated public policy and invalidated its engagement agreement.

Sheppard defended J-M Manufacturing (JM) in a qui tam litigation without disclosing that Sheppard had an ongoing client relationship with an entity (South Tahoe) that had intervened as a plaintiff in the qui tam suit. Sheppard’s conflict investigation recognized that one of its partners (Dinkin) had done employment and labor work for South Tahoe from time to time since 2002.  However, because Dinkin’s latest legal assignment from South Tahoe had ended in November, 2009, about five months before the JM engagement, because that work was unrelated to the qui tam lawsuit, and because both South Tahoe and JM had signed engagement agreements that contained an advance conflict waiver, Sheppard did not believe that it had a conflict that prevented it from representing JM.  Sheppard did not disclose the potential conflict to South Tahoe or to JM. Instead, it accepted the JM engagement and, over a 16-month period, did a lot of litigation work and billed JM about $3.8 million.

Meanwhile, in March 2010, just a couple of weeks after Sheppard had completed its conflict investigation, Dinkin began working on another unrelated assignment for South Tahoe. One year later, South Tahoe contacted Sheppard, asserted that Sheppard had a conflict of interest and demanded that Sheppard withdraw from representing JM in the qui tam suit. When Sheppard refused, South Tahoe filed a motion to disqualify. In July 2011, the court granted the motion to disqualify, finding that Sheppard had failed to obtain the “informed consent” of both clients to its dual representation of JM and South Tahoe and that the advance conflict waivers in its engagement agreements were insufficient. 

At that point, JM refused to pay Sheppard any outstanding fees and demanded a refund of the fees it had paid to date. Sheppard sued JM to collect its unpaid fees, and JM filed a cross-claim seeking a full refund. Sheppard moved to compel arbitration based on an arbitration clause in the parties’ engagement agreement, and its motion was granted.

The arbitration panel ruled in Sheppard’s favor, awarding it the unpaid fees and denying JM’s claim for a refund. The panel assumed that Sheppard committed an ethical violation, but it found that Sheppard honestly believed that no conflict existed at the time it accepted the JM engagement, noted that the conflict arose from an unrelated matter, and reasoned that Sheppard’s conduct was not so egregious as to justify a forfeiture of the firm’s compensation. The trial court affirmed that award.

On appeal, a different result obtained. The appellate court ruled that Sheppard’s representation of both parties without disclosing the conflict or obtaining a valid consent to it violated Rule 3-310 of the California Rules of Professional Conduct as well as public policy. The appellate court stated that only a fully informed waiver is effective and that the arbitration award had to be vacated. Id. at 272–273. The appellate court quoted Loving & Evans v. Blick, 33 Cal. 2d 603, 610 (1949), which states that “the power of an arbitrator to determine rights under a contract is dependent upon the existence of a valid contract under which this right may arise, and the question of the validity of the basic contract is essentially a judicial question, which cannot be finally determined by an arbitrator.” The court held that Sheppard’s engagement agreement was invalid due to the ethical violation. It remanded for the trial court to decide the exact date that the conflict arose and whether Sheppard was required to refund all or just a part of the fees JM had paid it.

Practice Point
This decision demonstrates that the California courts take conflicts of interest seriously and have strict rules about them. Attorneys should be doubly careful when doing conflict checks to avoid potential disqualifications, fee challenges, and other sanctions and should not rely on advance conflict waivers. Here, an early and complete disclosure to both clients might have avoided any problem. At the very least, Sheppard might have had the opportunity to terminate South Tahoe as a client and accept the JM engagement because Sheppard was not doing any legal work for South Tahoe at that time. 

The matter is not over, however. Although the case was remanded on January 29, 2016, Sheppard filed a petition for review with the California Supreme Court and, on April 27, 2016, that petition was granted. The California Supreme Court will hear the case sometime this year, and its decision will certainly have the attention of law firms and clients.

Ramsey Kadri is a student at DePaul University College of Law in the Class of 2018.

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