Written Disclosure Requirements: More Than a Technicality
LACBA Update, April 2012
By Joan Mack, of Caldwell Leslie & Proctor, PC, www.caldwell-leslie.com. She is currently the vice chair of LACBA’s Professional Responsibility and Ethics Committee. The opinions expressed are her own.
Certain of the California Rules of Professional Conduct require written disclosures and/or written consent from clients before an attorney may proceed with a representation or a transaction. This is true of Rule 3-310(C), which requires informed written consent to potential or actual conflicts between and among clients. It is also true of Rule 3-300, which requires that an attorney who is entering into a business transaction with a client disclose the terms of the transaction in writing to the client, advise the client in writing that he or she may seek the advice of independent counsel, and obtain the written consent of the client to the terms of the transaction. Those who regard such requirements as optional or mere formalities that can be ignored without serious consequence may find themselves sorely mistaken.
A case in point, decided by the California Court of Appeal, First District, in 2011, is Fair v. Bakhtiari.1 In 1990, Thomas Fair was an experienced business attorney practicing at a firm. He was also a licensed real estate broker. Karl Bakhtiari obtained legal advice from Fair concerning a potential investment opportunity. In April 1990, Fair and Bakhtiari went into business together forming a real estate investment business where, according to Bakhtiari, he would supply the capital, and Fair would supply the legal expertise. They orally agreed to split ownership of their corporation 70 percent to Bakhtiari and 30 percent to Fair. They also formed two additional partnerships together in 1993 and 1996 in which Fair acquired minority ownership shares, 27.5 percent in one and 5 percent in the other. Fair represented each business from its inception and claimed to have provided business and real estate-related services, including analyzing and identifying markets, finding acquisition targets, soliciting investors, and negotiating deals with owners and lenders. Fair also rendered legal opinions, provided legal advice relating to the real estate transactions, documents and contracts, and drafted all of the related agreements.2
In late 1993, Fair began receiving a salary from the corporation.3 In August 1994, Fair left his law firm and worked full time for the corporation. Fair also negotiated for, claimed entitlement to, and/or received other monetary benefits from the other investment entities. However, Fair and Bakhtiari entered into their business agreements without reaching final agreement on many essential terms, including their respective rights to compensation and division of profits. This “was a constant source of debate and disagreement throughout the course of their business relationship and contributed to its demise” in or about 2001.4
Despite the lack of agreement between the owners, the corporation’s business was “tremendously successful.”5 When Bakhtiari forced Fair out in 2001, Fair filed suit seeking dissolution of the business and compensatory and punitive damages. Bakhtiari and the business entities cross-complained for breach of fiduciary duty and sought a declaration that Fair’s interests in the entities were void for failure to comply with Rule 3-300. Fair allegedly did not comply with the rule upon entering into business with Bakhtiari and not at any time thereafter. The case was set for trial in July 2008, and on that date Fair moved for leave to amend his complaint to add causes of action for quantum meruit.6
Following Phase I of a bifurcated bench trial, the court found that Fair had violated Rule 3-300, thereby raising a presumption of undue influence under Probate Code Section 16004(c).7 Although Fair had established that “each of the subject business transactions was fair and reasonable” and that the business was “tremendously successful,” the court found that the terms and conditions of these business transactions were not fully explained to and understood by Bakhtiari at the time. Consequently, the court found the presumption of undue influence under Section 16004 was not rebutted, and the business agreements between Fair and Bakhtiari were void and unenforceable. The court also denied Fair’s motion for leave to amend to add a claim in quantum meruit.8 The court concluded “that, based upon its findings relating to Fair’s violations of rule 3-300, his breaches of his fiduciary duties to these clients, and the inability to separate services provided by Fair from the unenforceable business transactions, quantum meruit was not available.”9
Accordingly, Fair lost not only his shares in the real estate investment company and related partnerships but also his claim for compensation for his services rendered during the nearly seven years that he worked for the company. Fair appealed the denial of his motion for leave to amend to state a claim in quantum meruit.10
Fair did not dispute the court’s finding that he had violated Rule 3-300. Rather, he argued that the court erred in finding that he had violated Section 16004 because Fair contended that he had rebutted the presumption of undue influence.11
The court of appeal disagreed, noting that, contrary to Fair’s assertion, his violation of Rule 3-300 “constituted not merely a technical rule violation, but the breach of Fair’s fiduciary duty to Bakhtiari and the [other] entities, and that the conflict of interest that occurred as a result of Fair’s violations of the rule precluded quantum meruit recovery.”12 The court went on to explain that Section 16004 “is a statutory complement to rule 3-300.”13 It “applies to the fiduciary relationship between attorney and client.14 Accordingly, a transaction between an attorney and client which occurs during the relationship and which is advantageous to the attorney is presumed to violate that fiduciary duty and to have been entered into without sufficient consideration and under undue influence.”15
Fair argued that there was no damage to Bakhtiari from his ethical violations because the parties’ real estate investments were very successful.16 The court explained that Fair was conflating the tort cause of action for breach of fiduciary duty, which requires damages as an element, with the breach of a fiduciary duty to a client under Section 16004, sufficient to warrant voiding of an agreement. The purpose of the first is to make the plaintiff whole for harm caused by defendant whereas the purpose of the forfeiture of legal fees serves to deter attorney misconduct and recognizes that damage caused by attorney misconduct is often difficult to assess. It also prevents fiduciaries from profiting from their fiduciary breach and disloyalty.17
Fair also argued that he did not obtain an “advantage” from Bakhtiari within the meaning of Section 16004.18 The court disagreed, citing to the fact that both Fair’s acquisition of ownership interests in the real estate investment entities and the back-end compensation he claimed to be entitled to were advantages within the meaning of the statute.19 The court further explained that to rebut the presumption of undue influence, the attorney must show that the dealing was fair and just, and that the client was fully advised. The court found that Fair did not fully explain the material terms of the transactions to Bakhtiari at the time, Fair never gave advice against himself to Bakhtiari, and Bakhtiari never had any independent advice—all circumstances of undue influence.20
The court emphasized in its conclusion that “rule 3-300 absolutely prohibits a member from entering into a business transaction with a client or knowingly acquiring a pecuniary interest adverse to a client, unless the transaction is fair and the full written disclosure and consent requirements of the rule are met.”21 Fair’s rule violation was not a single point in time but a series of violations occurring each time he conducted a transaction with Bakhtiari without complying with the requirements of the rule.22 The court of appeal therefore affirmed the finding that Fair’s breach of his fiduciary duties under the statute was sufficiently serious as to warrant the denial of quantum meruit recovery.23
The court’s decision drives home the point that an attorney’s obligations as a member of the bar and as a fiduciary are vigorously enforced when he or she engages in a business transaction with his or her clients, and that failure to strictly comply with the requirements of Rule 3-300 in such situations will not be viewed as a mere technical violation.
1 Fair v. Bakhtiari, 195 Cal. App. 4th 1135, 1142 (2011).
3 Id. at 1143.
5 Id. at 1146.
6 Id. at 1144-45.
7 Fair, 195 Cal. App. 4th at 1146; Probate Code §16004, entitled “Conflicts of Interest,” provides in pertinent part: “(a) The trustee has a duty not to use or deal with trust property for the trustee’s own profit or for any other purpose unconnected with the trust, nor to take part in any transaction in which the trustee has an interest adverse to the beneficiary....
(c) A transaction between the trustee and a beneficiary which occurs during the existence of the trust or while the trustee’s influence with the beneficiary remains and by which the trustee obtains an advantage from the beneficiary is presumed to be a violation of the trustee’s fiduciary duties. This presumption is a presumption affecting the burden of proof.”
8 Fair, 195 Cal. App. 4th at 1146.
9 Id. at 1149.
10 Id. at 1151.
13 Id. at 1152.
14 Id. Notably, Probate Code §16004 does not apply to the agreement between a trustee and a beneficiary relating to the hiring or compensation of the trustee.
15 Id. (internal quotations and citations omitted); see also BGJ Associates, LLC v. Wilson, 113 Cal. App. 4th 1217, 1227-29 (2003).
16 Fair, 195 Cal. App. 4th at 1153.
18 Id. at 1154.
20 Id. at 1155-56; see also Beery v. State Bar, 43 Cal. 3d 802, 813 (1987); Gold v. Greenwald, 247 Cal. App. 2d 296, 305 (1966).
21 Fair, 195 Cal. App. 4th at 1162.
22 Id. at 1163.
23 Id. at 1169.