California Supreme Court Refuses to Enforce Law Firm Advance Conflict Waiver

In a long awaited decision, the California Supreme Court has weighed in on a question of increasing significance to law firms: under what circumstances will a conflict waiver contained in an initial client engagement agreement be deemed an effective waiver, in advance of any future conflict of interest that might arise in the firm’s representation of a different client. Sheppard, Mullin, Richter & Hampton, LLP v. J-M Manufacturing Co., Inc., 425 P.3d 1 (Cal. 2018).

The Background

In 2010, J-M engaged the Sheppard Mullin law firm in defending it in a pending qui tam/whistleblower action being prosecuted by approximately 200 public entities around the country. The basis of the claim was that J-M had made misrepresentations in its sale of polyvinyl chloride pipe to the claimant entities. The firm ran a conflicts check to determine whether it had previously, or was currently, representing any of the public entities identified as the real parties in interest in the qui tam action. The conflicts check showed that another firm attorney had done employment related work for one of the public entities (South Tahoe Public Utility District) on and off since at least 2002 and most recently in November 2009. However, in the qui tam action, Southern Tahoe was represented by another firm.

In its engagement agreement with the firm, the other client, South Tahoe, had signed an advance waiver of conflicts, at least with respect to cases unrelated to employment matters. According to the Court, “after internal consultation, Sheppard Mullin’s general counsel opined that because of this advance conflict waiver [by South Tahoe], the firm could take on representation of J-M in the [unrelated] qui tam action.”

Wording of the Advance Conflict Waiver at Issue

J-M then entered into an engagement agreement with the firm for the defense of the qui tam action. Included in the agreement was a conflict waiver similar to the one South Tahoe had signed when it had engaged the firm for employment matters.

The waiver provision at issue provided, in part, as follows:

Conflicts with Other Clients ... We undertake this engagement on the condition that we may represent another client in a matter in which we do not represent [J-M], even if the interests of the other client are adverse to [J-M] (including appearance [sic] on behalf of another client adverse to [J-M] in litigation or arbitration ... provided the other matter is not substantially related to our representation of [J-M] and in the course of representing [J-M] we have not obtained confidential information of [J-M] material to representation of the other client. By consenting to this arrangement, [J-M] is waiving our obligation of loyalty to it so long as we maintain confidentiality and adhere to the foregoing limitation.

The Disqualification Motion

As it happened, a few weeks after the firm began its representation of J-M in defense of the qui tam action, the firm’s employment partner handling matters for South Tahoe began actively working on a new matter for that client. Over the course of that year, the firm billed South Tahoe for about 12 hours of work.

Having become aware that the firm was representing J-M, South Tahoe’s counsel in the qui tam action wrote to the firm complaining of the firm’s failure to specifically inform South Tahoe that the firm had taken on the representation of J-M in a matter adverse to it. According to the court: “Sheppard Mullin responded by reminding South Tahoe of its earlier conflict waiver. Dissatisfied with this response, South Tahoe filed a motion to qualify [the firm] in the qui tam proceeding.”

The trial court in the qui tam action granted South Tahoe’s motion to disqualify the Sheppard Mullin firm from continuing to represent J-M in the action.

The Fee Dispute

But that was not the end of the firm’s troubles. Having been disqualified from performing further work for J-M in the qui tam action, the firm was left with unpaid invoices of approximately $1.3 million. The firm sued J-M to collect the unpaid fees. In response, J-M not only asserted it was excused from paying the unpaid account balance, but because of the firm’s failure to disclose its representation of South Tahoe in the unrelated employment matters, it was entitled to disgorgement of the approximately $2 million it already had paid the firm.

J-M’s position in the fee collection action therefore put into issue, among other questions, whether under California law a court may invalidate a law firm’s entire client engagement agreement, and thereby forfeit the firm’s contractual right to be paid, when another provision of the agreement is improper; in this case, the challenged conflict waiver provision which a trial court already had determined to be unenforceable under the Rules of Professional Conduct.

It was the firm’s collection claim against J-M that landed at the California Supreme Court.

With respect to the enforceability of the advanced conflict waiver, the Sheppard Mullin firm, together with several national law firms which filed amicus briefs, acknowledged that the firm’s simultaneous representation of the two clients on unrelated matters was covered by the conflict of interest provisions of the California Rules of Professional Conduct. But they argued that by agreeing to the advanced conflict waiver provision of the engagement agreement, J-M had given its informed consent to the concurrent representation of the existing client (South Tahoe).

The Court rejected this argument. It did so on essentially two grounds. First, it pointed to the undisputed fact that at the time the firm agreed to represent J-M in the defense of the qui tam action, the representation of the adverse client, South Tahoe was not in “the future” but it was in the present. “...Sheppard Mullin’s blanket waiver would not be effective in this case because the law firm failed to disclose a known-existing conflict before soliciting J-M ’s consent.”

The Court expressly declined to address “whether, or under what circumstances, a blanket advanced waiver...would be permissible.” It instead held as follows: “That without full disclosure of existing conflicts known to the attorney the client ’s consent is not informed for purposes of [the] ethics rules.”

The Firm ’s Improper Reliance on an Advance Conflict Waiver Limits Its Right to be Paid

Having found that, under the circumstances, the firm’s request that the client (J-M) sign the advance conflict waiver provision was improper, the court also concluded that the engagement agreement was unenforceable in its entirety. And this meant the firm was not entitled to collect its unpaid fees in reliance on the engagement agreement. However, the court concluded that on remand to the trial court the firm would be permitted to pursue a recovery under a quantum meruit theory for the value of the services it provided to the client.

Lessons Learned

The California Supreme Court ’s decision in the Sheppard Mullin case does not represent a death knell to law firm advance conflict waiver provisions. However, the decision warns law firms not to reflexively rely on such provisions when it is aware of potential adversity between an existing client and the new client at the time it presents the new client with the conflict waiver provision. As the court saw it, the law firm should not have asked the new client to agree to its standard conflict waiver provision because as of the date of signing, it had “available information about a known, existing conflict” between the new client and another existing firm client.

Other lessons from the decision.

• A law firm cannot assume that the sophistication of the client in question means that the client’s consent was “informed” within the meaning of the conflict of interest rules. And this includes the circumstance where, as in the Sheppard Mullin case, the advance conflict waiver was signed by the client’s own in-house attorney. “No matter how large and sophisticated, a prospective client does not have access to a law firm ’s list of other clients and cannot check for itself whether the firm represents adverse parties. Nor can it evaluate for itself the risk that it may be deprived, via [a] motion for disqualification of its counsel of choice, as happened here.’
• A law firm cannot excuse the failure to specifically disclose its relationship with a party directly adverse to the new client, by characterizing the adverse client, as the Sheppard Mullin firm did, as a “dormant” client. If there is any basis to conclude that at the time the challenged conflict waiver provision was entered into, the firm had an existing attorney-client relationship with a client whose interests were directly adverse to the new client (even if in an unrelated matter), both clients will be deemed “concurrent” within the meaning of the conflict of interest provisions of the Rules of Professional Conduct.
• Law firm risk managers and general counsel must emphasize that, as with any provision in the firm’s “standard” client engagement agreement, an advance conflict waiver provision cannot be a “one size fits all” proposition. Colleagues need to be instructed that if a conflict search discloses the existence of an open (including a “dormant”) matter or matters for a client with interests directly adverse to the prospective client, even if the subject of the firm’s existing representation of the other client is unrelated, the best protection for the firm is this: don’t take on the new client matter without first obtaining an individualized conflict notice and consent separate and apart from the standard advance conflict waiver.