Best Practices for Advance Conflict Waivers

Mulling Sheppard Mullin – What The California Supreme Court Opinion Signals to Law Firm Managing Partners

September 14, 2018

By Allen Michel, Certified Specialist, Legal Malpractice Law, State Bar of California

On August 30, 2018, the California Supreme Court issued its long-awaited decision in Sheppard, Mullin, Richter & Hampton, LLP v J-M Manufacturing Company, Inc., 2018 WL 4137013 (2018).[1]

The case addresses several issues not directly related to law firm management (e.g. whether a contract that is contrary to public policy and that contains an arbitration provision may validly be arbitrated). But legal rationale aside, what does the case mean in terms of ongoing operations of a law firm? If your firm’s customary engagement letter has an advance conflict waiver[2] provision, can you rely on it any longer? Are such provisions ever valid, and if so how should they be worded now? Aside from engagement letters, what does the decision suggest a well-run law firm should do to avoid the financial setback the Supreme Court implies will probably befall Sheppard Mullin on remand?

Here are some quick takes on the case, in Q and A format:

Q: I saw the headline but have not read the decision—remind me why this case was so closely watched.

A: Relying on an “advance conflict waiver” provision in its engagement letter, Sheppard Mullin represented J-M Manufacturing in an action (the “qui tam action”) against several entities, one of which was the South Tahoe Public Utility District (“Tahoe”). The firm had billed over $3 million in the qui tam action, of which about one-third remained unpaid when Tahoe brought to the superior court’s attention that Sheppard Mullin had been representing Tahoe in an unrelated employment matter. The superior court granted Tahoe’s motion and ordered Sheppard Mullin disqualified from further work for J-M on the qui tam case, apparently unimpressed by the conflict waiver provision in the engagement letter (and by Tahoe’s similar agreement to waive conflicts in its separate engagement letter with Sheppard Mullin).

After being disqualified, Sheppard Mullin took steps to collect the unpaid fees owed by J-M and succeeded in arbitration, but the $1.3 million award (and denial of a disgorgement claim by J-M) was set aside by the Court of Appeal on the grounds Sheppard Mullin’s violation of the Rules of Professional Conduct rendered the engagement letter invalid as against public policy and barred all recovery by Sheppard Mullin. When the Supreme Court granted review, many observers wondered whether the death knell for all advance conflict waiver provisions was about to be tolled.

“Vaguely worded advance conflict waivers are ineffective to inoculate the law firm from claims based on known and disclosable conflicts.”

As it turns out, the flaw in Sheppard Mullin’s advance conflict waiver argument was that the firm failed to disclose to J-M the identity of a client whose interests were already adverse, Tahoe. Noting that only a law firm is in possession of the most crucial information (the identity of the “other client” with whom there is a potential conflict), the Supreme Court agreed with the Court of Appeal that the boilerplate and broad conflict “waiver” by J-M was ineffective; as a consequence, there had been no compliance with the Rules of Professional Conduct which bars conflicted representation in the absence of informed written consent by each client. (RPC 3-310(C)(3)).[3] The Court held that J-M’s “waiver was not effective because the law firm failed to disclose a known conflict with a current client.”

But the Supreme Court stopped short of depriving Sheppard Mullin of all compensation for its time, returning the case to the lower court to determine whether Sheppard Mullin was entitled to an award under a quantum meruit theory.

Q: So if Sheppard Mullin had not been representing Tahoe when it agreed to represent J-M, would the advance conflict waiver been effective?

A: The case does not answer the hypothetical. However, in that circumstance, had Tahoe come to the firm, say, a year later and asked the firm to provide employment advice, the firm would have been required—in order to provide Tahoe with information essential to making Tahoe’s theoretical conflict waiver effective—to make certain disclosures. It would not only have had to advise Tahoe that it represented J-M in a matter in which Tahoe was adverse to J-M, but the firm would not have been able to accept the Tahoe employment representation without the consent of both Tahoe and J-M. In light of this, the problem of a non-disclosed conflict would not arise under these hypothetical facts.

At a minimum, the decision teaches that vaguely worded advance conflict waivers are ineffective to inoculate the law firm from claims based on known and disclosable conflicts, i.e., those which require informed written consent before a firm may represent two parties in different matters where they are adverse in one of them. It is not clear whether the agreement standing alone renders the engagement letter void; under the facts, the engagement letter was void because at the time it was entered into, the firm was ipso facto violating the rule barring concurrent representation of conflicted parties.

“Relying on technicalities simply will not work . . . there can be no mincing of words, no evasion.”

Q: How did a large firm like Sheppard Mullin fail to notice the conflict? Is there any lesson here about that?

A: It is not clear the Tahoe name was not noticed when the J-M matter was first brought to the firm in the Spring of 2010. The firm had first represented Tahoe in 2006, and the opinion suggests that a decision was made at Sheppard Mullin to deem Tahoe a former client because there had not been any active work for Tahoe in early 2010. The lack of a writing specifically declaring an end to the firm’s representation of Tahoe doomed Sheppard Mullin’s argument that Tahoe was not a client in 2010.  (The court had no occasion to comment on the failure of Sheppard Mullin to advise J-M that the firm had, in the past 5 years, represented Tahoe in unrelated matters, which it may well have been required to do under RPC 3-310(B)—the rule that requires written disclosure of certain pertinent past or present business or legal relationships.) Whether the advance conflict waiver gave the lawyers seeking to represent J-M a false sense of security is not addressed in the opinion or the facts, but that issue cannot be ruled out.

In any event, one lesson to be learned is that relying on technicalities (dealing with a possible conflict during intake of a new case by trying to minimize the significance of the relationship with the conflicted party by calling it a “recent but not current” client, or a “former” client, or a “dormant” client) will simply not work. When the issue is direct adversity in a given matter, full, bilateral written consent is required, and the consent must be informed, meaning there can be no mincing of words, no evasion.

“The quantum meruit remedy will provide at best a payment of some lesser sum, stripping the firm of any “profit” from the engagement and possibly resulting in no net recovery at all.”

Another lesson may be to “trim” the client list when a matter is resolved. Had Sheppard Mullin written to Tahoe at the conclusion of its prior work, offering to return client materials, and otherwise formally concluding the relationship, the Supreme Court could not have so readily concluded that Sheppard Mullin’s engagement letter with J-M violated public policy. Of course, given the economic realities of attorney compensation at most firms, based as it so often is on the size of a lawyer’s “book of business,” firm management would have been unlikely to obtain agreement by the originating partner for the initial Tahoe engagement to say “yes, Tahoe is now a former client.” Tahoe would be described by that lawyer as an ongoing client to make sure that any new work for the entity would be credited to that partner as the relationship or originating attorney.

Although the details of how the Sheppard Mullin conflict system operates are not known, a well-run firm wanting to avoid the ethical issues faced by Sheppard Mullin would appoint a neutral yet powerful person or committee to evaluate any potential direct conflict. The issue cannot safely be left to non-attorneys or to lawyers lacking political power within the firm.

Q: Given the decision, what would be the purpose of having the kind of broad advance waiver Sheppard Mullin’s engagement letters contained?

A: Engagement letters often contain provisions designed to control client expectations and to disclose a firm’s perspective on the engagement. There are plenty of issues that a client might raise in a dispute with a law firm, and not all of them involve the kind of direct informed written consent required in a case like Sheppard Mullin. The language of the advance conflict waiver, which is quoted at length in the opinion, provides useful information that establishes a context for the relationship, and may well help the firm defend against unwanted claims or unwarranted refusals to pay fees. One example could be a complaint asserting that the firm took a position for another client that was contrary to the business or legal goals of the complaining client, even where the matters are completely unrelated factually and no actual conflict exists. Another example would be familiarity with counsel in a particular field by virtue of frequently handling matters in that field—the client may well benefit from such familiarity, and the firm may not be able to identify a particular relationship between its lawyers and others in the same field that, depending on certain factors, might be deemed to fall into a category of matters the law firm is required to disclose in writing. The advance conflict waiver alerts the client to these possibilities, and particularly if the client is sophisticated and represented by general counsel, the advance conflict waiver should have some beneficial effect for the firm if a client later complains about fees or the case outcome, and such issues are raised.

Q            What will be the financial impact of the opinion on Sheppard Mullin, and are other firms likely to face the same concern?

Sheppard Mullin confirms that an effective waiver requires a meaningful disclosure, which the Supreme Court held the firm never provided. The client was kept in the dark about the relationship between the firm and Tahoe, so the entire engagement letter, including its arbitration provision, was rendered invalid and unenforceable. Sheppard Mullin is now left with a far less effective remedy than its fee agreement—the decision makes clear that quantum meruit in this case will not be as remunerative as enforcement of the fee agreement. The quantum meruit remedy will provide at best a payment of some lesser sum, stripping the firm of any “profit” from the engagement and possibly resulting in no net recovery at all, given J-M’s counterclaim for disgorgement of the $2 million it had already paid. And of course the firm’s contractual right to arbitration (where it fared quite well before the Court of Appeal’s ruling) is lost forever; the quantum meruit matter must be tried in court.

Will this case start a run of cases by clients whose matters were subject to broad advance waivers? That is possible but unlikely—the facts here were extreme. When the conflict was first raised by Tahoe, the firm dug in and required Tahoe to move to disqualify it in the qui tam case; it then pursued litigation against its former client despite the trial court’s disqualification ruling establishing that Sheppard Mullin had been handling the case for J-M while having an unwaived conflict. Not all firms would have been so insistent.

Hindsight being perfect, it is likely that greater candor by the firm at the outset may well have resulted in the loss of a new client with a seemingly profitable case. But had the firm been more transparent at the beginning, at least it would not have allowed its lawyers to incur $3 million in fees, some of which it may now need to return to the client.

Allen Michel, a California State Bar-certified Legal Malpractice Specialist, is the chair of the Professional Liability Group at Gipson Hoffman and Pancione. Allen has over three decades of experience managing law firms while also representing lawyers in legal malpractice trials and appeals and in State Bar proceedings. To the extent this article is deemed advertising or solicitation, it is hereby identified as such.  It is not intended to constitute legal advice; the statements made are opinions about general situations, and they are not a substitute for advice as to any specific matter.

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[1]  Excellent discussions of the case and its legal rationale are available here http://fkks.com/news/category/legal-ethics-and-professional-responsibility and here https://www.ipethicslaw.com/leaving-south-tahoe-will-your-advance-conflict-waiver-survive-sheppard-mullin-v-j-m-manufacturing/. The present piece focuses instead on the practical significance of the decision on law firm management.

[2] Particularly popular with large firms, advance conflict waivers purport to secure on retention the new client’s agreement to waive conflicts that might later come to light. They commonly apply not only to future events but to circumstances that are present at the outset, such as where the client and the firm are not aware of the significance of an existing relationship between the firm and another client of the firm.

[3] On November 1, 2018, the new Rules of Professional Conduct will become effective, and this Rule will be known as Rule 1.7.