update-banner


Your Arbitration is a Terrible Thing to Waste
LACBA Update, May 2016

By James Arden, a member of LACBA’s Professional Responsibility and Ethics Committee, a member of the Association of Professional Responsibility Lawyers, and a member of the State Bar Committee on Professional Liability Insurance. The opinions expressed are his own.

Do I believe in arbitration? I do. But not in arbitration between the lion and the lamb, in which the lamb is in the morning found inside the lion. —Samuel Gompers

Businesses of all kinds force their customers to arbitrate disputes. The U.S. Supreme Court has issued several rulings in recent years upholding forced arbitration.

Attorneys, too, are ethically permitted to require clients to submit disputes to binding arbitration[1]and can have such provisions apply to legal malpractice claims.[2]

And yet, that arbitration is a “favored method of resolving disputes”[3] is a perplexing irony—because arbitrators don’t have to follow the law.[4] Isn’t that incongruent with the public’s obligation to act in conformity with the law, as well as an attorney’s usual duty to urge compliance with the law?[5]

Because California has a strong public policy favoring arbitration, and because an error of law is not a ground for vacating or correcting an arbitration award, the courts cannot review the validity of an arbitrator’s reasoning except where the award violates “an explicit legislative expression” or some other public policy.[6] That clear distinction means an attorney conflict or breach of duty of loyalty may justify vacating an arbitration award, because overlooking an attorney’s serious ethical breach is not a typic error of law for an arbitrator.[7]

The rule, that an arbitrator’s mistakes of law or facts is not a normal basis for refusing to confirm an arbitration award,[8] took an interesting turn recently in Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing (2016) 244 Cal.App.4th 590. The court of appeal there found a violation of Rule 3-310 to be a violation of an expression of public policy.

Sheppard Mullin was disqualified for simultaneously representing J-M and another client in a qui tam action without having either client’s informed written consent, in violation of Rule 3-310(C)(3) of the Rules of Professional Conduct. J-M then declined to pay any fees that were outstanding at the time of the disqualification, and it demanded a refund of all fees already paid for the qui tam action. Sheppard Mullin responded by doing what lawyers do. It sued for fees; and it petitioned to compel arbitration.

Opposing arbitration, J-M argued the court had to first determine whether the fee agreement was enforceable. The trial court ordered arbitration nevertheless.

A three-arbitrator panel found the fee agreement was not illegal, denied J-M’s request for disgorgement of fees paid, and ordered J-M to pay Sheppard Mullin’s $1.3 million in outstanding fees. The trial court confirmed the award.

J-M appealed, arguing the trial court had enforced an illegal contract in violation of public policy. The court of appeal agreed with J-M. It reversed, holding that because J-M challenged the legality of the entire agreement, as opposed to just part of it, that issue was for the trial court to decide, rather than the arbitrators. “Because Sheppard Mullin’s representation of J-M violated Rule 3-310 and public policy, the trial court erred by enforcing the contract between the parties and entering judgment on the arbitration award based on that contract.”[9]

The court found that Rule 3-310 is an expression of public policy central to the attorney-client relationship and for that reason, Sheppard Mullin was not entitled to fees for the work it did while violating Rule 3-310.[10] (The case was remanded because the point at which the actual conflict arose was not clear from the record.)

[W]hen a conflict of interest is asserted as a defense in the attorney’s action to recover fees or the reasonable value of services, a violation of the fiduciary obligation will defeat recovery.[11]

California cases distinguish serious ethical violations such as conflicts of interest (in which compensation is prohibited) and technical violations or potential conflicts (in which compensation may be allowed). Two seminal cases set out the governing principles: Goldstein v. Lees (1975) 46 Cal.App.3d 614, in which a corporate attorney sought fees for representing a minority shareholder and director in a proxy fight against the corporation, and Jeffry v. Pounds (1977) 67 Cal.App.3d 6, in which a law firm represented a husband in a personal injury action but also agreed to represent his wife in a marriage dissolution action against him. The lawyers breached the rule precluding attorneys from representing conflicting interests unless all parties provide informed written consent.

Sheppard Mullin also argued in its case that its fees should be allowed because J-M suffered no damage as the result of its ethical violations and because the arbitrators found it acted in good faith. The court found that issue “irrelevant” without regard for Sheppard Mullin’s quantum meruit claim:

Given Sheppard Mullin’s ethical misconduct here, it is irrelevant whether J-M suffered damage. "It is the general rule in conflict of interest cases that where an attorney violates his…ethical duties to the client, the attorney is not entitled to a fee for his…services. [Citations.]" J-M’s actual damages as result of Sheppard Mullin’s breach are irrelevant.[12]

Sheppard Mullin is important because lots and lots of lawyers require arbitration of client disputes. Trial courts grant more petitions to compel arbitration than they deny. But unlike yesteryear, when clients’ malpractice claims were typically based on blown statutes of limitation or other missed deadlines, today’s malpractice claims—meritorious or not—commonly allege conflicts of interest and other serious ethical violations. Courts, not arbitrators, must decide such issues.

 


 

[1] A binding private arbitration clause in attorney-client fee agreement may be enforced under the California Arbitration Act once the Mandatory Fee Arbitration Act process set forth in Business and Professions Code §§6200 et seq. is over. (Schatz v. Allen Matkins Leck Gamble & Mallory LLP (2009) 45 Cal.4th 557, 574-575.)

[2] Powers v. Dickson, Carlson & Campillo (1997) 54 Cal.App.4th 1102; State Bar Form. Op. No. 1989-116, “A standard arbitration provision does not detract from or limit an attorney’s duty to use reasonable care nor limit liability for breach of this duty.”

[3] Madden v. Kaiser Foundation Hospitals (1976) 17 Cal.3d 699, 706.

[4] See, e.g., Berglund v. Arthroscopic & Laser Surgery Center of San Diego, L.P. (2008) 44 Cal.4th 528, 538: “[T]he normal limitations on judicial review of arbitrator decision mean that arbitrators need not follow the law.” An arbitrator does not exceed his or her powers by making a wrong decision; this is why courts will generally not review the validity of an arbitrator’s reasoning or review “for errors of fact or law,” even when the error appears on the face of the award and causes substantial injustice to the parties. (SingerLewak LLP v. Gantman (2015) 241 Cal.App.4th 610, 616, quoting Moncharsh v. Heily & Blase (1992) 3 Cal.4th 1, 6, 10.)

[5] Business & Professions Code §6068(a) states that it is an attorney’s duty to “support the Constitution and laws of the United States and of this state,” and Rule of Professional Conduct 3-210 states that an attorney “shall not advise the violation of any law, rule, or ruling of a tribunal unless the member believes in good faith that such law, rule, or ruling is invalid.”

[6] Moncharsh v. Heily & Blase (1992) 3 Cal.4th 1, 11, 14, 32.

[7] See Pour Le Bebe, Inc. v. Guess? Inc. (2003) 112 Cal.App.4th 810, Hernandez v. Paicius (2003) 109 Cal.App.4th 452, Tsakos Shipping and Trading, S.A. v. Juniper Garden Town Homes (1993) 12 Cal.App.4th 74.

[8] Under California (but not federal) law, an arbitration award may be reviewed for errors of law if the parties expressly agree to such review. (Cable Connection, Inc. v. DIRECTV, Inc. (2008) 44 Cal.4th 1334, 1340.)

[9] Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing (2016) 244 Cal.App.4th 590, 597.

[10] Id. at 619-620.

[11] Id. at 616, internal quote marks, brackets and citation omitted.

[12] Id. at 618-619, citation omitted.

LACBA's Professional Responsibility and Ethics Committee welcomes new inquiries from LACBA members regarding ethical issues or concerns about professional responsibilities. The identity of the inquirer is kept confidential within the committee. The committee, however, does not publish formal opinions that are the subject of any pending litigation involving the inquirer. If you have an ethical question that you would like the committee to consider, you can mail your written inquiry to Los Angeles County Bar Association, Professional Responsibility and Ethics Committee, P.O. Box 55020, Los Angeles, CA 90055-2020, or e-mail your inquiry marked “Confidential” to Member Services at msd@lacba.org.