State High Court Rejects Lawyer Retainer Arbitration Clause

A state supreme court found an arbitration clause in a law firm’s retainer agreement unenforceable because the lawyers did not sufficiently discuss pros and cons of arbitration. In so ruling, the court placed arbitration clauses in engagement contracts on a higher footing than arbitration clauses in other contracts. ABA Litigation Section leaders recommend lawyers pay close attention to this decision and subsequent guidance by advisory committees because it may represent a departure from how many attorneys have approached retainer agreements.

Arbitration Clause Gone Wrong

The dispute in Delaney v. Dickey arose after “a sophisticated businessman” hired a prominent law firm to represent him in a dispute with his business partners. The businessman signed the firm’s four-page engagement agreement, which said any dispute about the firm’s services or fees would be determined by binding arbitration. The agreement stated the businessman would be waiving his right to a jury trial and agreeing the arbitral result would be final and unappealable. It also stated arbitration would be conducted through JAMS, a private organization, pursuant to its rules and procedures. The firm did not include a copy of the rules but offered to answer any questions the businessman had and included a hyperlink to 33 pages of JAMS’ rules and procedures.

Later, the law firm invoked arbitration to recover outstanding fees from the businessman, who then filed a lawsuit alleging legal malpractice. Relying on the arbitration provision, the law firm argued both the fee dispute and malpractice claim should be arbitrated. The trial court agreed. But the court of appeals reversed, so the firm appealed to the Supreme Court of New Jersey.

Attorneys Must Explain Pros and Cons

The supreme court found the arbitration clause unenforceable because the law firm did not explain the benefits and disadvantages of arbitrating a future fee dispute or legal malpractice claim. Such issues could include the absence of a public jury trial, non-appealability, confidentiality, client responsibility for costs, and potentially limited discovery. The court found the firm’s fiduciary duties were not satisfied by the content of the engagement agreement or by the link to the JAMS rules and procedures.

Relying on New Jersey’s Rule of Professional Conduct 1.4(c), ABA Formal Opinion 02-425, and Model Rules of Professional Conduct 1.4(b) and 1.8(h), the court held the client must understand “the fundamental differences between an arbitral forum and a judicial forum in resolving a future fee dispute or malpractice action” in order to make an informed decision.

The court explained “the formation of the attorney-client relationship is not an ordinary commercial transaction, and ‘a retainer agreement is not an ordinary contract.’” A retainer agreement must satisfy both ordinary contract principles and ethical rules governing attorney-client relationships. “Unlike the vendor in a typical commercial transaction, a lawyer serves in a fiduciary role,” which “raises the spector of conflicting interests.”

While the firm’s arbitration clause satisfied the requirements for “a typical consumer or commercial agreement,” the heightened responsibilities of an attorney “demand more.” The court reasoned that “an attorney is held to an even higher degree of responsibility in these matters than is required of all others.”

Discuss, Disclose, and Detail

Litigation Section leaders caution lawyers who want to include arbitration provisions in retainers to review this decision. “One thing that is well settled and oft quoted about arbitration clauses is that they’re contracts; courts generally interpret them like contracts and enforce them like contracts,” explains Betsy A. Hellmann, New York City, NY, cochair of the Section’s Alternative Dispute Resolution Committee. But the Delaney decision represents that, at least in New Jersey, “attorney-client retainer agreements are special kinds of contracts and thus arbitration provisions within those agreements are treated specially,” adds Hellmann.

For example, the Delaney decision stands in contrast to decisions by other courts, which compelled arbitration based on incorporation by reference to arbitration rules. However, those cases involved other types of contracts—not attorney retainer agreements.

Future Impact

“There are a lot of open questions after this decision,” notes Hellmann. For example, “the court deferred to Model Rules, but some lawyers interpret rules relating to prospective clients more narrowly than the court did,” explains Laura K. Lin, San Francisco, CA, cochair of the Section’s Ethics & Professionalism Committee. The “idea that duties to prospective clients may extend beyond just narrow duties of confidentiality” seems “ripe for guidance” by the state advisory committee, she adds.

Hellmann agrees, noting “it would be useful for the advisory committee to opine on what steps lawyers should take to comply” with the decision. For example, “would reciting the court’s list of arbitration pros and cons in the retainer agreement satisfy the lawyer’s obligations?”

It is also not clear if lawyers must always ensure prospective clients receive independent counsel, Lin observes. In this respect, model language could be helpful, including “what specific advantages or disadvantages should fall into the retainer letter,” she suggests.

But arriving at that language may be difficult because “the facts and circumstances surrounding each client relationship” are so important and should be looked at “on a granular level,” Lin explains. For example, “if a retainer agreement includes a hyperlink to arbitration rules, but the lawyer prints the agreement and hands it to the client, think about how that prevents the client from clicking the link to review the rules.” And “don’t assume a prospective client has the sophistication to understand the advantages and disadvantages of arbitration just because they are a businessperson,” Lin warns.