Revisiting the Enforcement of Arbitration Clauses
LACBA Update, May 2012

By Robert K. Sall, who practices with The Sall Law Firm APC in Laguna Beach and is the chair of the LACBA Professional Responsibility and Ethics Committee. His practice focuses on business litigation, legal malpractice litigation, and attorney-client fee disputes. He can be reached at rsall@Sall-Lawoffice.com. The opinions expressed are his own.

A recent 2011 decision addressed the law applicable to enforcement of arbitration clauses in retainer agreements and concluded in somewhat unique circumstances that a lawyer did not have a fiduciary duty to separately explain the clause to the clients where the language of the agreement was understandable and the clients simply failed to read it.

In Desert Outdoor Advertising v. Superior Court,1 the clients were corporate officers and a corporate entity controlled by a sophisticated management team with significant litigation experience, one of whom was an attorney. The lawyer whom the company engaged to represent it in litigation changed law firms during the course of the representation and asked the client to sign a new engagement agreement. The new agreement contained a clearly worded, comprehensive arbitration clause. The lawyer’s original fee agreement had no provision for arbitration. While the negotiation of an original fee agreement with a client is generally considered to be an arm’s length transaction, considerations of fiduciary duty may apply when negotiating a new fee agreement in the course of an already existing attorney-client relationship.

The new agreement explained that the client was waiving the right to initiate court proceedings for a claim of legal malpractice and giving up the right to a jury trial. Although the clause was not set out in bold print or otherwise emphasized, the agreement did state that the client had the right to seek independent advice from other counsel and recommended that the client do so. The agreement was transmitted to the clients with a cover letter explaining that it was a new agreement, and that if they did not want to sign it, they could substitute lawyers.

The clients later brought a malpractice action in which they sought to avoid the application of the arbitration clause, claiming there had been a constructive fraud because the attorney had failed to explain the clause’s legal consequences while owing the clients a fiduciary duty of full disclosure. Among other things, the client’s officers asserted that they did not read the new agreement, having assumed it would be the same as the agreement with the lawyer’s previous firm. This evidence was contradicted by the fact that the agreement was nearly twice as long as the prior agreement. Another officer testified that he did not read the agreement because it contained too many pages. Yet another officer had actually made a handwritten change to the agreement. A fourth corporate officer, the one who was a lawyer, perhaps tellingly, did not submit a declaration.

The court of appeal was obviously influenced to a great degree by the client’s legal duty to read the agreement and its admitted failure to do so in the face of conflicting evidence. The court was also significantly influenced by the sophistication of the client’s officers and their considerable litigation experience.

The court considered a prior decision on enforcement of arbitration clauses between lawyer and client, Powers v. Dickson, Carlson & Campillo,2 a case that had previously concluded there was no requirement that the arbitration clause be set out in bold print or prominently featured. Both the Powers court and the Desert Outdoor Advertising court considered and disposed of an ethics opinion from the State Bar’s Standing Committee on Professional Responsibility and Conduct, Formal Opinion No. 1989-116, as not being binding on the courts. That opinion suggests the arbitration clause be bolded in prominent typeface and also concludes that where the attorney seeks a new agreement containing an arbitration provision with an existing client, the attorney has a fiduciary obligation to adequately disclose the terms and consequences of such a provision to obtain the client’s informed consent.

One rationale for disregarding a bold disclosure requirement in this case was that no matter what the disclosure says, it assumes the client is going to read the agreement. Whether or not the disclosure was adequate does not particularly matter where the client simply neglects a legal duty to read the contract. Further, in this case, the clients’ explanation for the failure to read it—that it was too long and the officers assumed it was the same as the previous agreement—strained credulity.

Most significant for future cases is the court’s recognition that the lawyer’s failure to explain the significance of the arbitration provision to the client could excuse the client from the failure to actually read it, and that the existence of a duty to explain depends on the circumstances. “The scope of a fiduciary’s obligations depends on the specific facts of the case. [Citation] Such factors may include, for example, the relative sophistication and experience of the vulnerable party. [Citation]."3 The duty “varies with the facts of the relationship.”4 In reaching the conclusion that “under the circumstances of this case” the lawyer did not have a duty to explain the arbitration provision, the court took into consideration a number of factors, including:

•  The prominence of the corporate client in the industry;
•  The experience and sophistication of the clients and officers;
•  The fact that the clients were sent a new fee agreement and encouraged to read it;
•  The letter of transmittal explained that it was a new agreement and that if the clients did not want to sign it, they could change lawyers;
•  The agreement contained a provision encouraging the clients to seek the advice of their own counsel before signing it;
•  One of the officers had read the agreement sufficiently to suggest a correction to it;
•  The chief executive officer was an attorney;
•  The arbitration provision was readily discernible and unambiguous, and there was no misrepresentation or effort to conceal it.

As the court noted, “These were not unsophisticated people unschooled in the ways of litigation. Nor was the agreement a contract of adhesion that was forced on them.”5 The court reasoned that the apparent failure of the officers to read the agreement was not reasonable and did not justify a conclusion that the lawyer’s fiduciary duty was broadened under these circumstances so as to require a specific explanation of the clause.

The court concluded, under the circumstances of this case and where the client is sophisticated yet did not even read the agreement, the attorney had no fiduciary duty to separately explain the effect of the arbitration clause. The arbitration provision would be enforced, and the client’s petition for writ of mandate was denied.

This decision points out a significant consideration for enforceability of arbitration clauses. Whether or not the lawyer has a fiduciary duty to fully explain the consequences of an arbitration provision will depend greatly on the circumstances. Many factors will be taken into consideration, including the client’s sophistication and familiarity with the litigation process. Were the lawyer dealing with an unsophisticated client or one that had read but did not understand the agreement, the results in this case might have been different.

Also of significance is the court’s apparent willingness to consider differing standards of fiduciary duty depending on whether or not the client is sophisticated. The case potentially lays a controversial groundwork for future decisions that client sophistication is a factor to be considered in determining applicable ethical standards.

1 Desert Outdoor Advertising v. Superior Court, 196 Cal. App. 4th 866 (2011).

2 Powers v. Dickson, Carlson & Campillo, 54 Cal. App. 4th 1102 (1997).

3 Desert Outdoor Advertising, 196 Cal. App. 4th at 873.

4 Id., citing to Rosenthal v. Great Western Fin. Securities Corp., 14 Cal. 4th 394, 425 (1996).

5 Id. at 874.