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December 06, 2018 Practice Points

Ethics Misstep Leads to Fee Award Being Vacated

By Mitchell L. Marinello

On August 30, 2018, the California Supreme Court vacated a fee award in favor of a law firm, holding that the firm’s conflict of interest invalidated the law firm’s entire agreement with its client, including the arbitration clause, and thereby rendered its fee award a nullity. Sheppard Mullin Richter & Hampton, LLP v. J-M Manufacturing Company, 237 Cal. Rptr. 3d 424, Case No. S232946 (August 30, 2018). 

Sheppard Mullin Richter & Hampton, LLP (Sheppard) agreed to represent J-M Manufacturing Company (J-M) in a federal qui tam action brought on behalf of various public entities. While the suit was pending, Sheppard represented one of those same public entities in an employment matter unrelated to the qui tam suit. Both clients had signed engagement agreements stating that they waived any such conflicts of interest, present or future, but the agreements did not disclose the specific conflicts, nor did Sheppard advise the clients of them. When the public entity discovered the conflict, it successfully moved to disqualify Sheppard in the qui tam suit. A dispute then arose about Sheppard’s legal fees in the qui tam action and the dispute went to arbitration in accordance with the arbitration clause in Sheppard’s engagement agreement with J-M.

Sheppard won a fee award in the arbitration, but the California Court of Appeal reversed. It held that Sheppard’s undisclosed conflict of interest violated the California Rules of Professional Conduct and rendered the engagement agreement, including its arbitration clause, invalid in its entirety. The appellate court held that Sheppard was not entitled to any compensation for the work it performed for J-M while also representing the public entity. 

The Supreme Court of California largely affirmed this holding. It agreed that Sheppard’s ethical violation rendered the entire engagement agreement, including the arbitration clause, unenforceable as against public policy, resulting in vacatur of the arbitration award. Succinctly stating California law, the Supreme Court said:

California cases have made clear that the legislative policy favoring contractual arbitration, and the finality of arbitral awards, applies only when there is, in fact, a valid contract to arbitrate. . . . [W]hile a claim that a single provisions of a contract is illegal ordinarily has no bearing on the validity of the parties’ agreement to arbitrate, the same is not true of a claim that that the entire contract is void for illegality. In such cases, . . . the agreement to arbitrate cannot be severed from the remainder, and the court is not bound to confirm the results of an arbitration conducted under such a contract.

Sheppard, 237 Cal. Rptr. 3d 424, 437.

Despite this holding, the court gave Sheppard the opportunity to show that it was entitled to some fee award under the doctrine of quantum meruit, and it remanded the case to the trial court for that purpose.

The central lesson of the Sheppard case is clear: Lawyers should specifically disclose conflicts of interest to clients at the beginning of the engagement to avoid the risk of disqualification, loss of the client, and loss of compensation for the work performed.

Mitchell L. Marinello is a partner at Novack and Macey LLP in Chicago, Illinois.

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