Fee Agreements Ethics Violation Voids $4 Million Attorney Fee

An attorney’s failure to advise his clients that he lacked malpractice insurance prompted the reversal and remand of a $4.3 million class action settlement attorney fee award. In so ruling, the Fifth District Court of Appeal of the State of California underscored its long-held principle that attorneys must not violate ethics rules while securing their own financial gain. ABA Section of Litigation leaders agree this ruling reminds attorneys to carefully structure their fee-splitting agreements and to keep their clients advised of all elements of representation, including insurance coverage.

Fee-Splitting Agreement Gone Wrong

In John Hance v. Super Store Industries et al., an attorney referred his client to a labor law attorney to represent the client in an action against his employer based on wage-and-hour claims. The labor law attorney discussed the matter with the potential client and concluded his case could become a class action. As the labor law attorney had limited experience with class actions, he brought in experienced class action attorneys. At no point during these discussions did the labor law attorney mention to his client, or any of the other attorneys, that he lacked legal malpractice insurance.

The client and a second class representative signed representation agreements in which they retained all four attorneys to represent them in a potential class action against the employer. The representation agreements provided that attorney fees would be shared among the attorneys according to agreements among them. The attorneys subsequently reached an agreement, over email, for the remaining fee divisions. Under its terms, the labor law attorney was to receive a 30 percent referral fee, and the class action attorneys were to handle the case and pay the costs from that point forward.

After adding a third class representative, the parties moved for settlement of the action, which included an attorney fee award of $4.3 million. Thereafter, a dispute arose between the class action attorney and the labor law attorney regarding the share of the award to which the labor law attorney was entitled. Despite this disagreement, the trial court ultimately ordered that 5 percent of the fees be awarded to an attorney brought in by the class action attorney, 15 percent be awarded to the originating attorney, 30 percent be awarded to the labor law attorney, and the remaining 50 percent be awarded to the class action attorney. The court based its reasoning on the validity of the emailed attorney fee agreement. The class action attorney appealed.

Duty to Inform of No Malpractice Insurance

The Fifth District Court of Appeal of the State of California reversed the $4.3 million fee. It found the attorney fee agreement unenforceable because of the labor law attorney’s “egregious” failure to comply with former California Rule of Professional Conduct 3-410 (now Rule 1.4.2). The court’s analysis underscored the longstanding principle that “contracts which violate the canons of professional ethics of an attorney may for that reason be void.” It further noted that the purpose of the Rules of Professional Conduct is “to protect the public and to promote respect and confidence in the legal profession.”

Former rule 3-410(A) requires that, at the time of engagement, attorneys inform their clients in writing if the attorney has no professional liability insurance. The court found the labor law attorney failed to disclose to any of the class representatives in writing that he lacked such insurance. Neither the representation agreements nor the attorney fee division consent forms, which the class representatives signed, mentioned that the labor law attorney did not have professional liability insurance. To allow the labor law attorney to recover his agreed-upon percentage of the fee award, despite noncompliance with the rule, would effectively condone that violation.

The court then turned its analysis to compensation alternatives in light of the fee agreement’s unenforceability. It noted that when a rule violation invalidating a fee agreement is not sufficiently serious to warrant a complete forfeiture of attorney fees, allowing recovery of those fees in quantum meruit would not discourage rule compliance. However, the court ultimately did not reach a conclusion and remanded the issue to the trial court to determine an appropriate fee division under this theory.

Protect Yourself from Fee Reversal: Follow the Rules

Section of Litigation leaders agree that a few simple precautions can protect all attorneys, not just class action litigators, from a similar fee-stripping order. One such precaution is to include “an affirmative statement in fee-splitting agreements that each attorney carries professional liability insurance or a provision that calls on every attorney who does not carry such insurance to stay apprised of the litigation and notify each client/named plaintiff of his or her lack of such insurance,” suggests David Gevertz, Atlanta, GA, cochair of the Section’s Labor & Employment Law Committee. However, “referring counsel can oblige day-to-day counsel to make such disclosures on their behalf, but I don’t believe that will fully absolve them of their ethical obligations,” Gevertz cautions.

“Failure to comply with ethical rules can have far-reaching and unforeseeable consequences. It drives home the point that lawyers need to be ever mindful of the ethical rules and diligent in compliance,” concludes Robert E. Poundstone IV, Montgomery, AL, cochair of the Section’s Ethics & Professionalism Committee.