Sheppard, Mullin, Richter & Hampton v. J-M Manufacturing Co.

Filed 1/29/16
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
SECOND APPELLATE DISTRICT
DIVISION FOUR
SHEPPARD, MULLIN, RICHTER &
HAMPTON, LLP B256314
Plaintiff and Respondent, (Los Angeles County
Super. Ct. No.YC067332)
v.
J-M MANUFACTURING CO., INC.,
Defendant and Appellant.
APPEAL from a judgment of the Superior Court of Los Angeles County, Stuart
Rice, Judge. Reversed and remanded.
Greines, Martin, Stein & Richland, Kent L. Richardson, Barbara W. Ravitz, and
Jeffrey E. Raskin for Defendant and Appellant.
Gibson, Dunn & Crutcher, Kevin S. Rosen, Theane Evangelis, and Heather L.
Richardson for Plaintiff and Respondent.
INTRODUCTION
Appellant J-M Manufacturing Company, Inc. (J-M) appeals from a judgment in
favor of its former attorneys, Sheppard, Mullin, Richter & Hampton, LLP (Sheppard
Mullin). Sheppard Mullin sought recovery of attorney fees relating to litigation in which
Sheppard Mullin represented J-M. Sheppard Mullin was disqualified from that litigation
because, without obtaining informed consent from either client, Sheppard Mullin
represented J-M, the defendant in the litigation, while simultaneously representing a
plaintiff in that case, South Tahoe Public Utility District (South Tahoe), in unrelated
matters. J-M argued that its engagement agreement with Sheppard Mullin was
unenforceable because it was illegal and it violated the public policy embodied in the
California Rules of Professional Conduct Rule 3-310 (Rule 3-310),1 which bars
simultaneous representation of adverse clients. J-M argued that as a result of Sheppard
Mullin’s violation, J-M did not owe Sheppard Mullin outstanding attorney fees and
Sheppard Mullin should return to J-M all attorney fees paid pursuant to the agreement.
The trial court ordered the case to arbitration based on the parties’ written
engagement agreement. A panel of three arbitrators found that the agreement was not
illegal, denied J-M’s request for disgorgement of fees paid, and ordered J-M to pay
Sheppard Mullin’s outstanding fees. The trial court confirmed the award and J-M
appealed, arguing that the trial court enforced an illegal contract in violation of public
policy.
Under California law, because J-M challenged the legality of the entire agreement,
the issue of illegality was for the trial court, rather than the arbitrators, to decide. The
undisputed facts establish that Sheppard Mullin violated the requirements of Rule 3-310
by simultaneously representing J-M and South Tahoe. Sheppard Mullin failed to disclose
the conflict to either J-M or South Tahoe, and it failed to obtain the informed written
consent of either client to the conflict. The representation of both parties without
informed written consent is contrary to California law and contravenes the public policy
1
All further references to a “Rule” refer to the California Rules of Professional
Conduct unless otherwise indicated.
2
embodied in Rule 3-310. 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. We therefore
reverse the judgment.
J-M also seeks disgorgement of all fees paid to Sheppard Mullin. Sheppard
Mullin, on the other hand, argues that under principles of quantum meruit, it is entitled to
attorney fees despite its violation of the Rules of Professional Conduct. We follow
established California law and find that Sheppard Mullin is not entitled to fees for the
work it did while violating Rule 3-310, which exemplifies the inviolate duty of loyalty an
attorney owes a client. Because the point at which the actual conflict arose is unclear
from the record, however, we remand for a factual finding on that issue.
FACTUAL AND PROCEDURAL BACKGROUND
We take portions of our factual history from the declarations submitted to the
arbitration panel, which are in the record on appeal.
A. The underlying litigation: the Qui Tam Action
In 2006, a qui tam action was initiated against J-M and Formosa Plastics
Corporation U.S.A. on behalf of approximately 200 real parties in interest, including the
United States, seven states, and other state and local government entities. (United States
ex rel. Hendrix v. J-M Manufacturing Company, Inc., United States District Court for the
Central District of California, case No. 5:06-cv-00055-GW-PJW (Qui Tam Action).) J-
M manufactures polyvinyl chloride (PVC) pipe. The Qui Tam Action alleged that J-M
falsely represented to its customers that the PVC pipe products it sold conformed to
applicable industry standards for water works parts. It also alleged that, contrary to this
representation, J-M was aware of numerous tests proving that its PVC pipe regularly
failed to meet the minimum longitudinal tensile-strength requirements. The complaint
demanded over $1 billion in damages.
Another law firm represented J-M in the initial phases of the Qui Tam Action. By
February 2010, the complaint was unsealed, and numerous governmental entities were
filing notices of intervention. Camilla Eng, J-M’s general counsel, invited Sheppard
3
Mullin attorneys Bryan Daly and Charles Kreindler to meet with her and J-M chief
executive officer Walter Wang to discuss replacing J-M’s current counsel. They
discussed the experience of the Sheppard Mullin attorneys in qui tam actions and their
proposed defense strategy. J-M retained Sheppard Mullin shortly thereafter.
Sheppard Mullin represented J-M in the Qui Tam Action for sixteen months,
litigating motions, conducting discovery, reviewing documents, and conducting an
extensive internal investigation at J-M. It billed J-M nearly $3.8 million for
approximately 10,000 hours of work.
B. Conflict waiver provision
In March 2010, before J-M retained Sheppard Mullin, Daly and Kreindler ran a
conflicts check to determine whether Sheppard Mullin had represented any of the real
parties in interest identified in the Qui Tam Action. They discovered that Jeffrey Dinkin,
a Sheppard Mullin labor-and-employment partner, had done work for South Tahoe, one
of the municipal intervenors in the Qui Tam Action. Dinkin stated in a declaration that
he began working with South Tahoe early in his career when he worked at a different
firm. When he moved to Sheppard Mullin in 2002, he brought South Tahoe with him as
a client. South Tahoe signed an engagement agreement with Sheppard Mullin in 2002,
and it renewed that agreement in 2006. The agreement had a broad advance conflict
waiver provision similar to the one in the J-M agreement, discussed below. Dinkin did
occasional, as-needed labor and employment work for South Tahoe between 2006 and
November 2009.
When Sheppard Mullin’s conflict check for J-M revealed that South Tahoe was a
client, Daly and Kreindler consulted with an assistant general counsel to Sheppard
Mullin. That unidentified attorney informed them that South Tahoe had “agreed to an
advance conflict waiver and that Sheppard Mullin had done no work for [South Tahoe]
for the previous five months (since November 2009).” In addition, Daly and Kreindler
discussed the issue with Ronald Ryland, Sheppard Mullin’s general counsel, “who
analyzed [South Tahoe’s] conflict waiver and informed us that it allowed us to represent
J-M in the Qui Tam Action.”
4
Daly met with Eng for two hours on March 4, 2010, to discuss a draft engagement
agreement. The draft contained the advance conflict waiver provision that ultimately was
included in the final engagement agreement. It stated, “Conflicts with Other Clients.
Sheppard, Mullin, Richter & Hampton LLP has many attorneys and multiple offices. We
may currently or in the future represent one or more other clients (including current,
former, and future clients) in matters involving [J-M]. 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 on behalf of another client adverse to [J-M] in litigation or arbitration) and
can also, if necessary, examine or cross-examine [J-M] personnel on behalf of that other
client in such proceedings or in other proceedings to which [J-M] is not a party 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 limitations. We seek this consent to allow our Firm to meet the needs of
existing and future clients, to remain available to those other clients and to render legal
services with vigor and competence. Also, if an attorney does not continue an
engagement or must withdraw therefrom, the client may incur delay, prejudice or
additional cost such as acquainting new counsel with the matter.” (Italics added except
for word “provided.”) We refer to this as the “conflict waiver provision.”
According to Daly, Eng carefully reviewed the entire draft agreement with him,
and she “did not ask me any questions or express any concern about the advance conflict
waiver.” Eng declared that Sheppard Mullin attorneys never discussed the conflict
waiver provision with her, nor did they explain it. Eng also said the Sheppard Mullin
attorneys assured her there were no conflicts in representing J-M in the Qui Tam Action.
J-M’s practice was to ensure that its outside attorneys had neither potential nor actual
conflicts of interest. Although Eng made a number of handwritten edits related to the fee
provisions, and also edited the paragraph preceding the conflict waiver provision, she did
5
not edit the conflict waiver provision. She ultimately executed the engagement
agreement (the Agreement) on March 8, 2010, and sent it to Daly by email.
C. South Tahoe raises the conflict of interest in the Qui Tam Action
Dinkin began actively working for South Tahoe again on March 29, 2010.
Between March 2010 and May 2011, Sheppard Mullin billed South Tahoe for 12 hours of
work, including telephone conversations and work on employment matters.
In March 2011, Day Pitney, counsel for South Tahoe in the Qui Tam Action,
wrote a letter to Sheppard Mullin asserting that Sheppard Mullin had a conflict as a result
of its simultaneous representation of J-M and South Tahoe. In response to the Day Pitney
letter, Sheppard Mullin took the position that South Tahoe had agreed to an advance
conflict waiver in its engagement agreement with Sheppard Mullin and therefore no
conflict existed. Day Pitney’s position was that there was an actual conflict. In April
2011, Day Pitney informed Sheppard Mullin that South Tahoe planned to bring a motion
to disqualify Sheppard Mullin from the Qui Tam Action.
According to Eng’s declaration submitted in the arbitration proceedings, she first
heard about the conflict with South Tahoe on April 20, 2011, which she asserts was about
50 days after Day Pitney first contacted Sheppard Mullin about the conflict. Eng stated
that Sheppard Mullin did not inform J-M that counsel for South Tahoe had contacted
Sheppard Mullin about a potential disqualification motion because of the conflict until
after the disqualification motion was filed.
Eng also stated that she first learned about the results of the March 2010 conflicts
check on June 22, 2011, when she read in Sheppard Mullin attorneys’ declarations that
the conflicts check had revealed South Tahoe as a client. She declared that Sheppard
Mullin never requested a conflict waiver from J-M in light of the South Tahoe conflict,
and had Sheppard Mullin requested it, J-M would have declined.
D. Sheppard Mullin is disqualified as counsel in the Qui Tam Action
South Tahoe’s disqualification motion in the Qui Tam Action was heard on June
6, 2011. The district court tentatively ruled that the advance waiver in South Tahoe’s
engagement agreement with Sheppard Mullin was invalid. In its tentative ruling, the
6
court cited Rule 3-310(C)(3), which bars an attorney from representing clients in adverse
positions without the informed written consent of each client.2 The court referred to the
engagement agreement letters between Sheppard Mullin and South Tahoe, and said that
“the prospective waivers contained within the 2002 and 2006 letters were ineffective to
indicate South Tahoe’s informed consent to the conflict at issue here.” The court added,
“The Court cannot conclude that South Tahoe was in any way close to ‘fully informed’”
about the conflict with J-M.
The court rejected Sheppard Mullin’s suggestion that it could drop South Tahoe as
a client and remain counsel for J-M in the Qui Tam Action, citing American Airlines, Inc.
v. Sheppard, Mullin, Richter & Hampton (2002) 96 Cal. App. 4th 1017, 1037 (American
Airlines v. Sheppard Mullin): “A lawyer may not avoid the automatic disqualification
rule applicable to concurrent representation of conflicting interests by unilaterally
converting a present client into a former client.” The parties suggested bifurcating South
Tahoe from the Qui Tam Action, with separate counsel for J-M working on that portion
of the case. The hearing was continued to give the parties an opportunity to determine if
that was a viable solution.
On June 9, 2011, Sheppard Mullin sent a letter to South Tahoe that began, “We
write to address the long-standing relationship between the [South Tahoe Public Utility]
District and our Firm. We have been pleased to provide labor advice to you for the last 9
years.” Sheppard Mullin offered to “promptly pay to the District the sum of $100,000”
and to “provide up to 40 hours of free labor and employment legal advice and services.”
In return, Sheppard Mullin asked that South Tahoe “consent to the Firm’s continued
representation of J-M in the pending federal district court action and any other state or
federal action that the District and J-M may be involved in.” South Tahoe declined on
June 16, 2011. On July 1, Sheppard Mullin increased its offer to $250,000 and 40 hours
2
Rule 3-310(C)(3) states, “A member shall not, without the informed written
consent of each client . . . . Represent a client in a matter and at the same time in a
separate matter accept as a client a person or entity whose interest in the first matter is
adverse to the client in the first matter.”
7
of employment work in exchange for a conflict waiver. South Tahoe’s response is not in
the record, but it appears that the offer was rejected. Meanwhile, J-M rejected the
proposal to bifurcate South Tahoe from the Qui Tam Action with separate counsel
defending that portion of the case.
On July 14, 2011, the district court granted South Tahoe’s motion to disqualify
Sheppard Mullin.
E. The present action
After Sheppard Mullin was disqualified, J-M took the position that J-M was not
required to pay Sheppard Mullin any fees that were outstanding at the time of the
disqualification. J-M also demanded that Sheppard Mullin return all fees relating to the
Qui Tam Action that J-M had already paid.
In June 2012, Sheppard Mullin filed an action against J-M for specific
performance, breach of contract, account stated, services rendered, and quantum meruit.
It sought approximately $1.3 million as payment for services rendered to J-M in the Qui
Tam Action and related matters. It also sought specific performance of the arbitration
provision in the Agreement. J-M cross-complained for breach of contract, an accounting,
breach of fiduciary duty, and fraudulent inducement. It also sought disgorgement of fees
previously paid to Sheppard Mullin.
Sheppard Mullin petitioned for an order compelling arbitration. J-M opposed
arbitration, partly on the basis that the entire Agreement containing the arbitration
provision was illegal and void as against public policy because Sheppard Mullin’s
conflict of interest between J-M and South Tahoe violated Rule 3-310(C)(3). J-M argued
that the court was required to determine whether the contract was enforceable before
sending the case to arbitration, because “the Court has an independent duty to ensure that
it does not use its power to enforce an illegal contract.”
The trial court granted Sheppard Mullin’s motion to compel arbitration. The court
noted that the parties “contract[ed] out of the procedural requirements of the Federal
Arbitration Act (FAA) . . . by providing that California law applies to disputes arising out
of the subject retainer agreement.” The court rejected J-M’s argument that the contract
8
was unenforceable based on illegality, instead interpreting J-M’s arguments as arising
under the doctrine of fraudulent inducement: “[J-M] argues that circumstances
unbeknown to it at the time of signing the agreement, i.e. [Sheppard Mullin’s] alleged
conflict of interest, caused the entire retainer agreement to be unenforceable. Thus, [J-M]
knew what it was signing, but [Sheppard Mullin] allegedly induced such consent by
fraudulent means. . . .” The court found that J-M had alleged fraud in the inducement,
and the issue should be presented to the arbitrator. J-M’s petition for writ of mandate
challenging this ruling was denied.
F. Arbitration
Pursuant to the terms of the arbitration provision, the arbitration was conducted
before a panel of three arbitrators. The parties stipulated that J-M waived any challenge
to the value or quality of Sheppard Mullin’s work in the Qui Tam Action and any claim
for costs (fees included) associated with replacing Sheppard Mullin in the Qui Tam
Action.
The arbitrators’ final award considered the claimed ethical violation and
“fraudulent concealment of the conflict.” The arbitrators found “that the better practice
would have been [for Sheppard Mullin] to disclose the full South Tahoe situation to J-M,
and seek J-M’s waiver of it.” But the arbitrators concluded that they need not decide
whether Sheppard Mullin’s failure to seek such a waiver constituted an ethical violation,
and for purposes of their analysis assumed that the ethical violation occurred. The
arbitrators rejected J-M’s claim for fraudulent concealment, based on their finding that
Sheppard Mullin honestly and in good faith believed that no conflict existed when it
undertook J-M’s representation in the Qui Tam Action.
The arbitrators found the assumed ethical violation did not require automatic fee
disgorgement or forfeiture. Instead, they engaged in an equitable weighing of whether
the ethical violation was serious or egregious. The arbitrators concluded that Sheppard
Mullin’s conduct was not so serious or egregious as to make disgorgement or forfeiture
of fees appropriate. They also found that Sheppard Mullin’s representation of South
Tahoe involved a matter that was unrelated to the subject of the J-M representation, and
9
therefore the conflict did not pervade the whole relationship with J-M or go to the heart
of Sheppard Mullin’s representation of J-M.
The arbitrators awarded Sheppard Mullin $1,118,147 in unpaid fees, pre-award
interest of $251,471, and interest of $302 per day from January 8, 2014 until the date of
the award against J-M. They awarded no recovery to J-M from Sheppard Mullin.
G. Petitions to confirm or vacate the award
Sheppard Mullin petitioned the trial court to confirm the arbitration award; J-M
petitioned the court to vacate the award, again arguing that Sheppard Mullin violated
Rule 3-310(C)(3), and sought an order requiring Sheppard Mullin to disgorge the fees it
received from J-M. The trial court confirmed the award. It found the arbitrators did not
exceed their powers in that the Agreement was not illegal or void and the arbitration
award did not violate public policy or a statutory right. The court concluded that a
violation of Rule 3-310 did not render the entire retainer agreement illegal, void, or
unenforceable. It reasoned that whether an attorney should be entitled to attorney fees
despite the existence of an ethical violation was at the heart of the determination made by
the arbitrators, and that the court could not disrupt the legal and factual findings of the
arbitrators.
The court entered judgment confirming the arbitration award on March 18, 2014.
This timely appeal by J-M followed.
DISCUSSION
A. Standard of review
“On appeal from an order confirming an arbitration award, we review the trial
court’s order (not the arbitration award) under a de novo standard.” (Lindenstadt v. Staff
Builders, Inc. (1997) 55 Cal. App. 4th 882, 892 fn. 7 (Lindenstadt).) This is “the standard
of review that governs a trial court’s review of an arbitrator’s decision where one of the
parties claims that the entire contract or transaction underlying the award is illegal.”
(Ibid.) This is such a case.
10
B. Where a party challenges an entire contract as illegal or in violation of
public policy, the question of enforceability is for the court
A central issue in this case is the court’s role where a party has alleged that an
entire contract, rather than a portion of a contract, is unenforceable because it violates
public policy. Here, J-M has challenged the entire Agreement—rather than just a
portion—as unenforceable.3 J-M argues that the trial court should not have confirmed the
arbitration award, because by doing so the court enforced a contract that violates
California’s public policy as articulated in the Rules of Professional Conduct for
attorneys.
Sheppard Mullin, on the other hand, argues that the arbitration award was properly
confirmed because a court’s role in reviewing arbitration awards is extremely limited.
Following arbitration, review is typically limited to the grounds set forth in Code of Civil
Procedure section 1286.2 (section 1286.2), which provides that an arbitration award may
be vacated only if the trial court makes particular findings, such as determining that the
award was procured by fraud or corruption, the rights of the parties were substantially
prejudiced by the actions of the arbitrators, or “the arbitrators exceeded their powers and
the award cannot be corrected without affecting the merits of the decision upon which the
controversy submitted.” (§ 1286.2.)
Determining whether federal or state law governs the Agreement is crucial to
whether the court or the arbitrators should have decided if the Agreement was
enforceable, and therefore how we review that decision. The trial court held that this
question was properly presented to the arbitrators, noting that Phillips v. Sprint PCS
(2012) 209 Cal. App. 4th 758 (Phillips) holds that a “challenge . . . that contests the
3
In its opposition to Sheppard Mullin’s petition to compel arbitration, J-M argued
the Agreement was illegal and void as a violation of public policy because of Sheppard
Mullin’s conflict of interest while it represented J-M. In its petition to vacate the
arbitration award, J-M again argued the Agreement was “void and unenforceable”
because of Sheppard Mullin’s violation of Rule 3-310. On appeal, J-M argues that “the
trial court erred in confirming the arbitration award, thereby enforcing an illegal contract
that contravenes . . . public polic[y].”
11
validity of the agreement as a whole, is decided by the arbitrator.” (Id. at p. 774.)
Phillips, however, and the U.S. Supreme Court case upon which it relied, Buckeye Check
Cashing, Inc. v. Cardegna (2006) 546 U.S. 440 (Buckeye), were governed by the Federal
Arbitration Act (FAA; 9 U.S.C. § 1, et seq.), not California law. (See Phillips, supra,
209 Cal.App.4th at p. 764 [noting that under the terms of the contract at issue, “the
Federal Arbitration Act (FAA), not California law, ‘govern[s] all questions of whether a
claim is subject to arbitration.’”]; Buckeye, supra, 546 U.S. at pp. 445-446 [as a matter of
“substantive federal arbitration law,” “the issue of the contract’s validity is considered by
the arbitrator in the first instance”].)
However, the Agreement states that J-M “agrees that this agreement will be
governed by the laws of California without regard to its conflict rules.” Where the parties
agree that California law governs the contract, the FAA does not apply. (Mastick v. TD
Ameritrade, Inc. (2012) 209 Cal. App. 4th 1258, 1264 (Mastick); see also Volt Information
Sciences, Inc. v. Board of Trustees of Leland Stanford Junior University (1989) 489 U.S.
468, 470 [California arbitration law is not preempted by the FAA where the parties have
agreed that their arbitration agreement will be governed by California law].) Cases
applying the FAA, therefore, are not controlling here.
Under California law, a challenge to the legality of an entire contract that contains
an arbitration provision must be determined by the trial court, not the arbitrator. “The
power of the arbitrator to determine rights under a contract is dependent upon the
existence of a valid contract under which this right might arise, and the question of the
validity of the basic contract is essentially a judicial question, which cannot be finally
determined by an arbitrator.” (1 Witkin, Summary 10th (2005) Contracts, § 450, p. 490,
citing Loving & Evans v. Blick (1949) 33 Cal. 2d 603, 610 (Loving).) And if a party
challenges the enforceability of a contract after arbitration in a motion to vacate the
arbitration award, the court should “review[ ] the evidence de novo to determine whether
the arbitration award was based on illegal agreements or transactions.” (Lindenstadt,
supra, 55 Cal.App.4th at pp. 888-889.) “[A]ny preliminary determination of legality by
the arbitrator, whether in the nature of a determination of a pure question of law or a
12
mixed question of fact and law, should not be held to be binding upon the trial court.”
(Loving, supra, 33 Cal.2d at p. 609.)
Sheppard Mullin, arguing that limited judicial review applies, relies on Moncharsh
v. Heily & Blase (1992) 3 Cal. 4th 1 (Moncharsh) and Ahdout v. Hekmatjah (2013) 213
Cal. App. 4th 21, 33 (Ahdout). These cases are not controlling, however, because they
address judicial review when a party has alleged that only a portion of an otherwise
enforceable contract—rather than the contract as a whole—is illegal or unenforceable.
The Supreme Court explored this distinction in Loving, supra, 33 Cal. 2d 603. In
that case, the Court held it was error to confirm an arbitration award in favor of
unlicensed contractors. The Court stated that “ordinarily with respect to arbitration
proceedings ‘the merits of the controversy between the parties are not subject to judicial
review,’ [citations]. But . . . the rules which give finality to the arbitrator’s determination
of ordinary questions of fact or of law are inapplicable where the issue of illegality of the
entire transaction is raised in a proceeding for the enforcement of the arbitrator’s award.”
(Id. at p. 609.) The Court went on to say that deference to the findings of the arbitrators
was not warranted in such circumstances: “When so raised, the issue [of illegality] is one
for judicial determination upon the evidence presented to the trial court, and any
preliminary determination of legality by the arbitrator, whether in the nature of a
determination of a pure question of law or a mixed question of fact and law, should not
be held to be binding upon the trial court.” (Ibid.; see also All Points Traders, Inc. v.
Barrington Associates (1989) 211 Cal. App. 3d 723, 737.)
The Supreme Court again emphasized this distinction in Moncharsh, which
involved a challenge to only the fee-splitting clause of the relevant agreement, rather than
the entire agreement. (Moncharsh, supra, 3 Cal.4th at p. 32 [“Moncharsh challenges but
a single provision of the overall employment contract”].) Since only a claim of partial
illegality was raised, the Court ruled that the issue of illegality was for the arbitrator to
resolve. (Id. at p. 30.) Indeed, the Moncharsh Court said that if the parties had
established that the entire contract was illegal, the arbitration clause would not be
enforceable: “[I]f an otherwise enforceable arbitration agreement is contained in an
13
illegal contract, a party may avoid arbitration altogether.” (Id. at 29; see also Richey v.
AutoNation, Inc. (2015) 60 Cal. 4th 909, 917 [“Moncharsh noted that judicial review may
be warranted when a party claims that an arbitrator has enforced an entire contract or
transaction that is illegal.”].)
Lindenstadt, supra, 55 Cal. App. 4th 882 also held that the trial court, not the
arbitrator, must determine the legality of an entire contract. There, the court recognized
the general rule that courts should not interfere with arbitration awards, but noted that in
Loving “the Supreme Court recognized a narrow exception to the general rule” when a
party challenged the legality of the entire contract. (Lindenstadt, supra, 55 Cal.App.4th
at p. 889.) In that case, plaintiff Lindenstadt assisted defendant Staff Builders in locating
home health care businesses to acquire. Lindenstadt brought an action against Staff
Builders seeking finder’s fees for locating several businesses; Staff Builders asserted that
Lindenstadt was statutorily barred from seeking fees because he acted as an unlicensed
real estate broker. (Id. at pp. 885-886.) The case went to arbitration based on the parties’
contract, and the arbitrator concluded Lindenstadt was entitled to fees. (Id. p. 887.) In its
opposition to Lindenstadt’s motion to confirm the arbitration award, Staff Builders
argued that the trial court was obligated to undertake a de novo review of the evidence to
determine whether the arbitration award was based on illegal contracts or transactions.
(Id. p. 888.) The Court of Appeal agreed, saying that Lindenstadt “‘cannot be permitted
to rely upon the arbitrator’s conclusion of legality’ ([Loving, supra, 33 Cal.2d] at p. 614)
since ‘. . . it would violate public policy to allow a party to do through arbitration what it
cannot do through litigation’ (Ericksen, Arbuthnot, McCarthy, Kearney & Walsh, Inc. v.
100 Oak Street (1983) 35 Cal. 3d 312, 316, fn. 2, [Ericksen]).” (Lindenstadt, supra, 55
Cal.App.4th at pp. 892-893.) The Court of Appeal remanded the case to allow the trial
court to determine whether Lindenstadt acted as an unlicensed real estate broker in each
transaction at issue.
Ahdout, supra, 213 Cal. App. 4th 21, also discussed the different standards of
review of an arbitration award depending on whether a party challenges an entire
contract, or only a portion of a contract, as illegal or unenforceable. Ahdout contrasted
14
Loving, where the entire agreement was challenged, with Moncharsh, where only a
portion of the contract was challenged: “Whereas the building contract in Loving was
rendered void in its entirety by the contractor’s lack of a license, the illegality alleged in
Moncharsh affected only one provision of an employment contract. . . .” (Ahdout, supra,
at p. 36.) Ahdout recognized that the enforceability of the entire contract was also
challenged in Lindenstadt, and added, “Indeed, the court in Lindenstadt noted the
language in Moncharsh limiting the scope of Loving to cases where the entire contract or
transaction was illegal.” (Ibid.) By comparison, Ahdout noted that “the alleged illegality
in the instant case does not infect the entire contract.” (Ibid.) As a result, Ahdout found,
review of the arbitrator’s decision on the narrow grounds articulated in section 1286.2
was appropriate in that case, and “the exception enunciated in Loving and Lindenstadt, as
considered by Moncharsh, is not applicable.” (Ibid.) Here, judicial determination is
required because, as in Loving and Lindenstadt, J-M has challenged the legality of the
contract as a whole.4
J-M argued that the entire Agreement was unenforceable because Sheppard Mullin
had a conflict of interest when it simultaneously represented J-M in the Qui Tam Action
and adverse party South Tahoe in other matters. As stated in Loving, Moncharsh,
Lindenstadt, and Ahdout, a challenge to the enforceability of a contract as a whole, rather
4
Sheppard Mullin also argues that the public policy supporting arbitration
compels us to affirm the arbitration award. We recognize the “strong public policy in
favor of arbitration as a speedy and relatively inexpensive means of dispute resolution.”
(Ericksen, supra, 35 Cal.3d at p. 322.) But the public policy supporting arbitration does
not take precedence over the mandate that contracts comply with California’s other
public policies. “The laws in support of a general public policy and in enforcement of
public morality cannot be set aside by arbitration, and neither will persons with a claim
forbidden by the laws be permitted to enforce it through the transforming process of
arbitration.” (Loving, supra, 33 Cal.2d at p. 611, quoting Tandy v. Elmore-Cooper Live
Stock Commission Co. (Mo. App. 1905) 87 S.W. 614, 618; see also Moncharsh, supra, 3
Cal.4th at p. 32 [allowing judicial scrutiny of an arbitral award when a court is presented
with “a clear expression of illegality or public policy undermining this strong
presumption in favor of private arbitration”].) The public policy supporting arbitration
therefore does not limit the scope of judicial review of an allegedly unenforceable
contract.
15
than a portion of an otherwise enforceable contract, must be decided by the court rather
than the arbitrator.5 The trial court therefore erred by deferring to the arbitrators in
determining the enforceability of the Agreement.
C. Sheppard Mullin violated Rule 3-310
Turning to the substance of the case, we determine whether Sheppard Mullin’s
simultaneous representation of J-M and South Tahoe violated Rule 3-310 of the
California Rules of Professional Conduct. As noted above, we consider this question de
novo.
Rule 3-310(C)(3) provides that an attorney “shall not, without the informed written
consent of each client . . . [r]epresent a client in a matter and at the same time in a
separate matter accept as a client a person or entity whose interest in the first matter is
adverse to the client in the first matter.” (Italics added.) “‘Informed written consent’
means the client’s . . . written agreement to the representation following written
disclosure.” (Rule 3-310(A)(2).)
J-M argues that the Agreement violated “the fundamental public policy embodied
in rule 3-310(C) of the Rules of Professional Conduct, which required J-M’s informed
written consent to any conflicting representation by Sheppard.” Sheppard Mullin, on the
5
The trial court erred by characterizing J-M’s illegality argument as an assertion
based only on fraudulent inducement to be determined by the arbitrators: “Defendant has
attempted to characterize this case as one based upon illegality, rather than fraudulent
inducement. The Court is not convinced of this distinction . . . .” Indeed, there is a
distinction. The Supreme Court has held that under California law, “claims of fraud in
the inducement of the contract (as distinguished from claims of fraud directed to the
arbitration clause itself) will be deemed subject to arbitration.” (Ericksen, supra, 35
Cal.3d at p. 323.) But in so holding, the court was careful to distinguish cases in which a
defendant alleges the contract was illegal or in violation of public policy. “Questions of
public policy which are implicated by an illegal agreement, and which might be ill-suited
for arbitral determination, are not presented when garden-variety ‘fraud in the
inducement,’ related to performance failure, is claimed.” (Id. at p. 316, fn. 2.) Here,
although J-M did assert garden-variety fraudulent inducement, it also placed the illegality
question squarely before the court. The trial court therefore erred in holding that J-M’s
illegality argument implicated only fraud in the inducement to be determined by the
arbitrators.
16
other hand, argues that the “Engagement Agreement’s conflict waiver was plainly legal.”
“Whether a contract is illegal or contrary to public policy is a question of law to be
determined from the circumstances of each particular case.” (Jackson v. Rogers & Wells
(1989) 210 Cal. App. 3d 336, 349-350; see also Brisbane Lodging, L.P. v. Webcor
Builders, Inc. (2013) 216 Cal. App. 4th 1249, 1256-1257; Bovard v. American Horse
Enterprises, Inc. (1988) 201 Cal. App. 3d 832, 838.)
Sheppard Mullin argues that J-M’s “illegality argument rests entirely on disputed
factual issues that are not reviewable.” Sheppard Mullin cites Loving to argue that
illegality must be proved by “uncontradicted evidence.” (See Loving, supra, 33 Cal.2d at
p. 610 [if “it appears to the court from the uncontradicted evidence that the contract is
illegal,” the court should deny a petition to compel arbitration or enforce an arbitration
award].) Courts have rejected this interpretation of Loving. “[A] reading of Loving &
Evans to require uncontradicted evidence of illegality is too formalistic. The court did
not explicitly condition its holding on the existence of uncontroverted evidence. Rather,
the case merely stands for the proposition that the legality of the underlying agreement
should first be judicially determined.” (Green v. Mt. Diablo Hospital Dist. (1989) 207
Cal. App. 3d 63, 74.)
Nonetheless, the essential facts are not in dispute. Sheppard Mullin partner Jeffery
Dinkin did work for South Tahoe before the parties entered into the Agreement.
Sheppard Mullin’s conflicts check revealed Dinkin’s work for South Tahoe before
Sheppard Mullin gave the Agreement to J-M, but Sheppard Mullin concluded that there
was no reason to disclose this relationship to J-M. J-M signed the Agreement without
knowing that Sheppard Mullin represented South Tahoe in unrelated matters. The parties
disagree about whether South Tahoe was a “former” client or a “current” client at the
time the Agreement was signed. However, it is undisputed that three weeks after J-M
signed the Agreement, Dinkin began working for South Tahoe again, so there is no
question that there was an actual conflict at that point. Sheppard Mullin was disqualified
from the Qui Tam Action as a result.
17
Sheppard Mullin argues that it proceeded as required by Rule 3-310(C)(3): “The
conflict waiver in the Engagement Agreement waives both current and future conflicts.
Waivers of current and future conflicts are commonplace and enforced by California and
other courts.” The conflict waiver provision in the Agreement stated that Sheppard
Mullin “may currently or in the future represent one or more other clients (including
current, former, and future clients) in matters involving [J-M].” The Agreement allowed
Sheppard Mullin to engage in conflicting representations “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.” It continued, “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 limitations.”
What Sheppard Mullin ignores, however, is that Rule 3-310(C)(3) requires
informed written consent. “Where . . . a fully informed consent is not obtained, the duty
of loyalty to different clients renders it impossible for an attorney, consistent with ethics
and the fidelity owed to clients, to advise one client as to a disputed claim against the
other.” (Klemm v. Superior Court (1977) 75 Cal. App. 3d 893, 898.)
Here, the undisputed facts demonstrate that Sheppard Mullin did not disclose any
information to J-M about a conflict with South Tahoe. The Agreement includes a
boilerplate waiver that included no information about any specific potential or actual
conflicts. Dinkin was working for South Tahoe while Sheppard Mullin was defending J-
M against South Tahoe in the Qui Tam Action. It strains credulity to suggest that the
Agreement constituted “informed written consent” of actual conflicts to J-M, when in fact
Sheppard Mullin was silent about any conflict.
Even assuming Sheppard Mullin was not representing South Tahoe at the time it
entered into the agreement with J-M, Sheppard Mullin nonetheless began performing
additional work for South Tahoe three weeks later. It did not inform either client of this
actual conflict. Because “waiver must be informed, a second waiver may be required if
the original waiver insufficiently disclosed the nature of a subsequent conflict.” (Concat
18
LP v. Unilever, PLC (N.D. Cal. 2004) 350 F. Supp. 2d 796, 820 (Concat), citing Visa
U.S.A. Inc. v. First Data Corp. (N.D. Cal. 2003) 241 F. Supp. 2d 1100, 1106 (Visa); see
also Rule 3-310(C)(3) [an attorney may not “accept” new representation creating an
actual conflict with an existing client without obtaining informed, written consent];
Western Sugar Coop. v. Archer-Daniels-Midland Co. (C.D. Cal. 2015) 98 F. Supp. 3d
1074, 1082 (Western Sugar).)
In asserting its position that the waiver in the Agreement was sufficient, Sheppard
Mullin relies on Zador Corp. v. Kwan (1995) 31 Cal. App. 4th 1285 (Zador) and Visa,
supra, 241 F. Supp. 2d 1100 to argue that its broadly worded future waiver was sufficient.
These cases, however, demonstrate the appropriate steps an attorney should take to obtain
a client’s informed written consent to a conflict pursuant to Rule 3-310—and thus
highlight Sheppard Mullin’s failure to do so.
Zador, supra, 31 Cal. App. 4th 1285 addressed informed waivers of potential future
conflicts. In that case, Zador Corporation purchased a parcel of property through its
agent, C. K. Kwan. A subsequent conveyance of the property gave rise to a claim by
another party that he was entitled to an interest in the property, and he sued Zador, Kwan,
and another entity. Zador asked the law firm Heller, Ehrman, White & McAuliffe
(Heller), which had represented Zador’s ownership for ten years, to handle the lawsuit.
Kwan asked Heller to represent him as well. Heller made clear to Kwan that it
was also representing Zador, and presented Kwan with an agreement waiving and
consenting to potential conflicts of interest. The agreement explained that while there
was no present, actual conflict between Zador and Kwan, actual conflicts could arise if
the interests of Zador became inconsistent with Kwan’s interests. The agreement
explained possible risks if an actual conflict arose, including “shared attorney-client
loyalties” and possible erosion of attorney-client privilege, and stated that Heller would
continue to represent Zador if its interests became adverse to Kwan. The agreement
encouraged Kwan to seek independent counsel regarding the “import of this consent” and
asked him to agree not to seek disqualification of Heller if an actual conflict arose.
19
(Zador, supra, 31 Cal.App.4th at pp. 1289-1290.) Kwan took twenty minutes to study
the agreement and then signed it. (Id. at p. 1290.)
Two months later, Heller learned of a possible conflict between Kwan and Zador.
Heller informed Kwan of the possible conflict and recommended he retain independent
counsel. Kwan reaffirmed his consent to Heller’s continued representation of Zador. In a
confirming letter to Kwan, Heller memorialized this consent. Eventually, however,
Zador (through Heller) named Kwan as a cross-defendant. (Zador, supra, 31
Cal.App.4th at pp. 1291-1292.) Kwan then moved to disqualify Heller and the trial court
granted the motion. (Id. at p. 1292.)
The Court of Appeal held that disqualification of Heller was not required because
Kwan had provided informed consent to Heller’s continued representation of Zador in the
event of a conflict. (Zador, supra, 31 Cal.App.4th at p. 1295.) The court noted with
approval that “The waiver and consent form was detailed.” (Id. at p. 1299, repeated at p.
1301.) The court pointed out that when adversity arose between Kwan and Zador, Kwan
obtained separate legal counsel but initially “reaffirmed his agreement to the consent
form and to Heller’s continued representation of Zador.” (Id. at p. 1301.) The order
disqualifying Heller was therefore reversed. (Id. at p. 1303.)
The second case Sheppard Mullin cites, Visa, supra, 241 F. Supp. 2d 1100, also
involved a motion to disqualify Heller in a case involving a potential future conflict.
First Data, which was developing a system to processes credit card transactions, asked
Heller to represent it in a patent infringement action pending in Delaware. The parties
recognized a possible future conflict with Visa, with whom Heller had a longstanding
relationship. Heller informed First Data that although it saw no current conflict in
representing First Data in the Delaware action, it would only agree to represent First Data
if First Data agreed to permit Heller to represent Visa in any future disputes, including
litigation, that might arise between First Data and Visa. First Data agreed, and signed an
engagement letter that clearly stated these terms. (Visa, at p. 1102.)
About a year later, Visa sued First Data in California for trademark infringement
and other claims. First Data moved to disqualify Heller as counsel for Visa in the
20
California case, arguing that Heller’s violation of Rule 3-310(C) required automatic
disqualification. (Visa, supra, 241 F.Supp.2d at p. 1104.)
The district court observed that an advance waiver of potential future conflicts,
such as the one executed by First Data and Heller, is permitted under California law, even
if the waiver does not specifically state the exact nature of the future conflict. (Visa,
supra, 241 F.Supp.2d at p. 1105.) Citing Zador, the Visa court emphasized that the “only
inquiry that need be made is whether the waiver was fully informed,” and noted that “[a]
second waiver by First Data in a non-related litigation would only be required if the
waiver letter insufficiently disclosed the nature of the conflict that subsequently arose
between Visa and First Data.” (Id. at p. 1106.)
Citing People ex rel. Dept. of Corporations v. SpeeDee Oil Change Systems, Inc.
(1999) 20 Cal. 4th 1135, 1145 (SpeeDee Oil), Zador, supra, 31 Cal. App. 4th 1285, and
other authority, the Visa court identified factors to be taken into account in evaluating
whether full disclosure was made and the client made an informed waiver, such as the
breadth of the waiver, the temporal scope of the waiver, the quality of the conflicts
discussion between the attorney and the client, and the nature of the actual conflict.
(Visa, supra, 241 F.Supp.2d at p. 1106.) Applying these factors, the Visa court found that
the waiver was sufficient because Heller had identified the adverse client and disclosed as
fully as possible the nature of any potential conflict. Heller had also explained that in the
event of an actual conflict, it would represent Visa in any matters against First Data,
including litigation. (Id. at p. 1107.) The court found that First Data signed the waiver
with fully informed consent to any conflict with Visa. (Id. at pp. 1108-1109.)
Zador and Visa stand in sharp contrast to the facts here. Unlike Heller in Zador
and Visa, Sheppard Mullin did not disclose the circumstances regarding a potential or
actual conflict with South Tahoe to either J-M or South Tahoe. The Sheppard Mullin
attorneys on the Qui Tam Action were aware the firm had a relationship with South
Tahoe, and even sought advice from firm counsel as to whether it had to be disclosed
before J-M signed the Agreement. The conflict waiver provision in the Agreement did
not mention South Tahoe. Instead, it broadly waived all current and future conflicts with
21
any client: “Conflicts with Other Clients. Sheppard, Mullin Richter & Hampton LLP has
many attorneys and multiple offices. We may currently or in the future represent one or
more other clients (including current, former, and future clients) in matters involving [J-
M]. . . . 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 limitations.”
The facts here therefore are not analogous to Zador and Visa, because Sheppard
Mullin (1) failed to inform J-M about any potential or actual conflict with South Tahoe,
and (2) did not obtain J-M’s informed, written consent to continued representation
despite the actual conflict that occurred while Sheppard Mullin was working for J-M and
South Tahoe at the same time. Written consent to all potential and actual conflicts in the
absence of any knowledge about the existence of such conflicts cannot comply with the
requirement of “informed written consent” in Rule 3-310(C). Because Sheppard Mullin
failed to secure informed written consent to the conflict before or during its
representation of J-M, the Agreement violated Rule 3-310.6
D. Rule 3-310 is an expression of public policy central to the attorney-
client relationship, the violation of which warrants finding the
Agreement unenforceable
Having found that Sheppard Mullin violated Rule 3-310, the next question is
whether the violation renders the parties’ Agreement unenforceable. We find that it
does.
A contract must have a lawful object or the contract is void. (Civ. Code, §§ 1550,
subd. (3), 1596, 1598.) An unlawful contract is not valid. (Civ. Code, §§ 1607, 1667.)
6
Sheppard Mullin argues that finding the conflict waiver provision inadequate
would “upend countless agreements between lawyers and their clients and wreak havoc
on the practice of law in this State.” We disagree. We would not be the first court to
reject an uninformed, blanket advance waiver such as the one at issue in this case. (See,
e.g., Concat, supra, 350 F.Supp.2d at pp. 801, 821; Lennar Mare Island, LLC v. Steadfast
Ins. Co. (E.D. Cal. 2015) 105 F. Supp. 3d 1100, 1115; Western Sugar, supra, 98 F.Supp.3d
at p. 1083.) Moreover, our holding is consistent with the purpose of the Rules of
Professional Conduct—to “protect the public and to promote respect and confidence in
the legal profession.” (Rule 1-100(A).)
22
A contract is unlawful if it is “1. Contrary to an express provision of law; 2. Contrary to
the policy of express law, though not expressly prohibited; or, 3. Otherwise contrary to
good morals.” (Civ. Code, § 1667; see also Civ. Code, §§ 1441 [“A condition in a
contract, the fulfillment of which is . . . unlawful . . . is void”], 1608 [“If any part of a
single consideration for one or more objects, or of several considerations for a single
object, is unlawful, the entire contract is void”].) Therefore, courts have long held that
“[a] contract made contrary to public policy or against the express mandate of a statute
may not serve as the foundation of any action, either in law or in equity [citation], and the
parties will be left, therefore, where they are found when they come to a court for relief.”
(Tiedje v. Aluminum Taper Milling Co. (1956) 46 Cal. 2d 450, 453-454; see also Kashani
v. Tsann Kuen China Enterprise Co., Ltd. (2004) 118 Cal. App. 4th 531, 541.)
At issue in this case are the public policies embodied in the California Rules of
Professional Conduct, which “are not only ethical standards to guide the conduct of
members of the bar; but they also serve as an expression of public policy to protect the
public.” (Altschul v. Sayble (1978) 83 Cal. App. 3d 153, 163 (Altschul).) “The effective
functioning of the fiduciary relationship between attorney and client depends on the
client’s trust and confidence in counsel. (Flatt [v. Superior Court (1994) 9 Cal. 4th 275,]
282, 285 [Flatt].) The courts will protect clients’ legitimate expectations of loyalty to
preserve this essential basis for trust and security in the attorney-client relationship.
(Ibid.)” (SpeeDee Oil, supra, 20 Cal.4th at pp. 1146-1147.) Sheppard Mullin breached
this essential basis for trust and security as to both J-M and South Tahoe.
A contract in violation of Rule 3-310(C) is against the public interest. “Rule 3-
310 and conflict of interest rules are designed to ‘assure the attorney’s absolute and
undivided loyalty and commitment to the client and the protection of client confidences.’
(1 Vapnek et al., Cal. Practice Guide: Professional Responsibility (The Rutter Group
2007 ¶ 4:4, p. 4–3.)” (Sharp v. Next Entertainment, Inc. (2008) 163 Cal. App. 4th 410,
427.) “It is well established that an attorney’s duties to his client are governed by the
Rules of Professional Conduct, and that those rules, together with statutes and general
principles relating to other fiduciary relationships, ‘help define the duty component of the
23
fiduciary duty which an attorney owes his client.’ [Citation.]” (American Airlines v.
Sheppard Mullin, supra, 96 Cal.App.4th at p. 1032.)
“The primary value at stake in cases of simultaneous or dual representation is the
attorney’s duty—and the client’s legitimate expectation—of loyalty, rather than
confidentiality.” (Flatt, supra, 9 Cal.4th at p. 284.) The Supreme Court explained the
underlying public policy: “A client who learns that his or her lawyer is also representing
a litigation adversary, even with respect to a matter wholly unrelated to the one for which
counsel was retained, cannot long be expected to sustain the level of confidence and trust
in counsel that is one of the foundations of the professional relationship.” (Id. at p. 285.)
Thus, “[t]he courts will protect clients’ legitimate expectations of loyalty to preserve this
essential basis for trust and security in the attorney-client relationship. (Ibid.)” (SpeeDee
Oil, supra, 20 Cal.4th at pp. 1146-1147.) “‘The paramount concern . . . [is] to preserve
public trust in the scrupulous administration of justice and the integrity of the bar.’”
(Fiduciary Trust International of California v. Superior Court (2013) 218 Cal. App. 4th
465, 485-486 (Fiduciary Trust), quoting SpeeDee Oil, supra, 20 Cal.4th at p. 1145.)
At oral argument, Sheppard Mullin cited Ahdout to argue that courts may consider
only public policy as expressly declared by the Legislature. As a result, Sheppard Mullin
argued, the Rules of Professional Conduct—adopted by the Board of Governors of the
State Bar of California and approved by the Supreme Court of California (Rule 1-100)—
do not represent a statement of California public policy sufficient to render a contract
unenforceable. (See Ahdout, supra, 213 Cal.App.4th at pp. 38-39 [“The fact that [Bus. &
Prof. Code] section 7031 reflects an explicit expression by the Legislature of its public
policy objectives sets this case apart from Moncharsh, which concerned alleged
violations of the Rules of Professional Conduct that are approved by the Supreme Court,
not the Legislature.”].) This is an incorrect reading of Ahdout, which distinguished cases
such as Moncharsh that discuss the Rules of Professional Conduct but did not hold that
such rules cannot serve as a valid expression of public policy.
Instead, “[t]here is no requirement that a contract violate an express mandate of a
statute before it may be declared void as contrary to public policy.” (Altschul, supra, 83
24
Cal.App.3d at p. 162; see also Margolin v. Shemaria (2000) 85 Cal. App. 4th 891, 901
[“Both legislative enactments and administrative regulations can be utilized to further this
state’s public policy of protecting consumers in the marketplace of goods and
services.”].) When determining whether a contract is unenforceable because it violates
public policy, courts may look to a variety of sources. “The public policy in question
may sometimes be based on statute (see, e.g., Wildman v. Government Employees’ Ins.
Co. (1957) 48 Cal. 2d 31 [ ]) but does not necessarily have to be—it can be based on other
policies perceived to be contrary to the public welfare. (See Altschul[, supra,] 83
Cal. App. 3d 153, 162 [court refuses to enforce fee-for-referral agreements among
attorneys as contrary to public policy].)” (Rosen v. State Farm General Ins. Co. (2003)
30 Cal. 4th 1070, 1081, Moreno, J., concurring; see also Cariveau v. Halferty (2000) 83
Cal. App. 4th 126, 132 [“Public policy, in the context of a court’s refusal to enforce a
contract term, may be based on the policy expressed in a statute or the rules of a
voluntary regulatory entity, or may be implied from the language of such statute or
rule.”].) Thus, in the context of determining whether a contract as a whole is illegal or
against public policy and therefore unenforceable, a determination of relevant public
policy is not limited to an explicit expression of public policy by the Legislature.
Moreover, Sheppard Mullin’s argument ignores the long line of cases relying on
the Rules of Professional Conduct to find contracts unenforceable. (See, e.g., Chambers
v. Kay (2002) 29 Cal. 4th 142, 161 [“[B]ecause this court approved rule 2–200 under
legislative authorization (see Bus. & Prof.Code, § 6076), and because the rule binds all
members of the State Bar (rule 1–100(A), 1st par.), it would be absurd for this or any
other court to aid Chambers in accomplishing a fee division that would violate the rule’s
explicit requirement of written client consent and would subject Chambers to
professional discipline.”]; Cotchett, Pitre & McCarthy v. Universal Paragon Corp.
(2010) 187 Cal. App. 4th 1405, 1417 [“Fee agreements that violate the Rules of
Professional Conduct may be deemed unenforceable on public policy grounds.”]; Bird,
Marella, Boxer & Wolpert v. Superior Court (2003) 106 Cal. App. 4th 419, 431 [A fee
agreement that violates Rule 4-200 is not valid and enforceable]; McIntosh v. Mills
25
(2004) 121 Cal. App. 4th 333, 346 [“In light of these public interest concerns, and because
there is no dispute here that the agreement at issue between McIntosh and Mills clearly
violates CPRC, rule 1–320(A), we conclude that the doctrine of illegality applies facially
to their fee-sharing agreement.”]
As discussed in Flatt, SpeeDee Oil, American Airlines v. Sheppard Mullin, and
Fiduciary Trust, the attorney’s duty of undivided loyalty that forms the basis of Rule 3-
310 constitutes the very foundation of an attorney-client relationship. The Agreement,
which violated Rule 3-310(C), therefore violated an expression of public policy. The
trial court erred in holding that the Agreement was valid and enforceable.
E. As a result of Sheppard Mullin’s violation of 3-310, it is not entitled to
attorney fees
Sheppard Mullin argues that despite its violation of Rule 3-310, it is nonetheless
entitled to its attorney fees for its representation of J-M in the Qui Tam Action.
However, when a conflict of interest is asserted as a “[d]efense in the attorney’s action to
recover fees or the reasonable value of services[, a] violation of the fiduciary obligation
will defeat recovery.” (1 Witkin, Cal. Proc. 5th (2008) Attys, § 104, p. 142.) Sheppard
Mullin’s violation of Rule 3-310 precludes it from receiving compensation for services
provided to J-M in the Qui Tam Action.
“A lawyer engaging in clear and serious violation of duty to a client may be
required to forfeit some or all of the lawyer’s compensation for the matter.
Considerations relevant to the question of forfeiture include the gravity and timing of the
violation, its willfulness, its effect on the value of the lawyer’s work for the client, any
other threatened or actual harm to the client, and the adequacy of other remedies.”
(Rest.3d of the Law Governing Lawyers, § 37.)
California cases have drawn a line between cases involving 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. The first is Goldstein v. Lees (1975) 46
Cal. App. 3d 614 (Goldstein), a case in which a law firm sought to recover fees for legal
26
services rendered. In the underlying case, a former corporate counsel represented a
minority shareholder and director in a proxy fight against the same corporation. Focusing
on the fact that the attorney knew confidential information about the corporation, the
Court of Appeal held that former Rule 5 barred recovery of attorney fees for the
underlying action.7 (Id. at pp. 620, 623-624.) The court reasoned, “It is settled in
California that an attorney may not recover for services rendered if those services are
rendered in contradiction to the requirements of professional responsibility.” (Id. at p.
618, citing Clark v. Millsap (1926) 197 Cal. 765, 785 [“acts of impropriety inconsistent
with the character of the profession, and incompatible with the faithful discharge of its
duties” will prevent an attorney from recovering for services rendered.].)
The second seminal case is Jeffry v. Pounds (1977) 67 Cal. App. 3d 6 (Jeffry). In
that case, a law firm represented a husband in a personal injury action, but also agreed to
represent his wife in a dissolution of marriage action she brought against him. The Court
of Appeal found that the law firm had breached former Rule 5-102(B),8 which precluded
an attorney from representing conflicting interests unless all parties concerned provided
informed written consent. The attorney did not obtain written consent of both parties.
(Id. at p. 11.) The Jeffry court denied any fees to the firm for work performed after the
conflict arose. (Id. at p. 12.) The court emphasized that this conclusion was not based on
an improper intent on the part of the firm: “We do not charge [the firm] with dishonest
purpose or deliberately unethical conduct.” (Id. at p. 11.)
7
At the time, Rule 5 stated, “‘A member of the State Bar shall not accept
employment adverse to a client or former client, . . . relating to a matter in reference to
which he has obtained confidential information by reason of or in the course of his
employment by such client or former client.’” (Goldstein, supra, 46 Cal.App.3d at pp.
618-619.)
8
Former Rule 5-102(B) (duty of loyalty) is a predecessor to current Rule 3-310, as
is former Rule 4-101 (requiring counsel to preserve the confidentiality of client matters).
“The former rules governing attorneys’ duties of confidentiality and loyalty were thus
consolidated into a single rule.” (Flatt, supra, 9 Cal.4th at p. 288, fn. 5.)
27
A number of cases have followed Goldstein and Jeffry. (See, e.g., Cal Pak
Delivery, Inc. v. United Parcel Service, Inc. (1997) 52 Cal. App. 4th 1, 16 [attorney not
entitled to fees after he offered to dismiss a class action in return for a personal payment
to him of millions of dollars]; A.I. Credit Corp., Inc. v. Aguilar & Sebastinelli (2003) 113
Cal. App. 4th 1072 [law firm not entitled to fees after it helped a new client enforce a
judgment against a former client by assisting the new client in locating and pursuing the
former client’s assets].) Another case, Fair v. Bakhtiari (2011) 195 Cal. App. 4th 1135
(Fair), noted that attorneys are not entitled to fees where the ethical violation is “one that
pervades the whole relationship.” (Id. at p. 1150.) Fair affirmed the trial court’s denial
of quantum meruit recovery where an attorney’s conduct “constituted not merely a
technical rule violation, but the breach of Fair’s fiduciary duty to” his clients. (Id. at p.
1151.)
As in Fair, the conflict here pervaded the entire relationship between Sheppard
Mullin and J-M. Even if, as Sheppard Mullin argues, it was not working for South Tahoe
at the time the Agreement was signed, it nonetheless began working for South Tahoe
three weeks later, thereby representing adverse clients without telling either client about
the actual conflict. The violation caused Sheppard Mullin to be disqualified from
representing J-M in the Qui Tam Action—the very purpose for which J-M had hired it. It
is clear, therefore, that Sheppard Mullin’s ethical breach went to the very heart of its
relationship with J-M.
Sheppard Mullin cites Mardirossian & Associates v. Ersoff (2007) 153
Cal. App. 4th 257, Slovensky v. Friedman (2006) 142 Cal. App. 4th 1518, and Sullivan v.
Dorsa (2005) 128 Cal. App. 4th 947 to argue that “courts routinely award attorneys their
fees despite conflicts of interest that could lead to disqualification.” These cases are
distinguishable in that none of them involved an actual conflict.
Sheppard Mullin also argues that 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. 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
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attorney violates his . . . ethical duties to the client, the attorney is not entitled to a fee for
his . . . services. [Citations.]” (Cal Pak, supra, 52 Cal.App.4th at p.14.) We note that the
Fair court rejected a similar argument regarding lack of damage: “No authority cited by
Fair holds that proof the client was damaged by the attorney’s breach of fiduciary duty or
conflict of interest is required to void the agreement between the two . . . where the
breach is sufficiently serious.” (Fair, supra, 195 Cal.App.4th at pp. 1153-1154.)
Moreover, forfeiture of attorney fees is intended to be a deterrent, which is invoked
because the “damage that misconduct causes is often difficult to assess.” (Restatement
(Third) of the Law Governing Lawyers § 37 (2000).) J-M’s actual damages as result of
Sheppard Mullin’s breach are irrelevant.
The analysis does not change because Sheppard Mullin has alleged that it is
entitled to fees under a quantum meruit theory. In Huskinson & Brown v. Wolf (2004) 32
Cal. 4th 453 (Huskinson), the Supreme Court acknowledged that quantum meruit recovery
had been denied in cases of ethical violations such as Sheppard Mullin’s here. It
observed that such cases “involved violations of a rule that proscribed the very conduct
for which compensation was sought, i.e., the rule prohibiting attorneys from engaging in
conflicting representation or accepting professional employment adverse to the interests
of a client or former client without the written consent of both parties.” (Huskinson, 32
Cal.4th at p. 463, italics added, citing Jeffry, supra, 67 Cal. App. 3d 6, 12 and Goldstein,
supra, 46 Cal. App. 3d 614.) The same result was reached in Fair, in which the Court of
Appeal concluded that Fair’s breach of fiduciary duty precluded recovery of fees in
quantum meruit: “[V]iolation of a rule that constitutes a serious breach of fiduciary duty,
such as a conflict of interest that goes to the heart of the attorney-client relationship,
warrants denial of quantum meruit recovery. [Citations.]” (Fair, supra, 195 Cal.App.4th
at pp. 1161-1162.)
We have found that Sheppard Mullin’s breach of the duty of loyalty set forth in
Rule 3-310 was a violation of public policy. A finding that Sheppard Mullin was
nonetheless entitled to its attorney fees as if no breach had occurred would undermine
this same public policy. We therefore follow the reasoning of Goldstein and Jeffry and
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hold that Sheppard Mullin is not entitled to its fees for the work it did for J-M while there
was an actual conflict with South Tahoe.
F. Disputed fact issue about when the actual conflict began
There is no question that starting from March 29, 2010, the date Dinkin resumed
work on behalf of South Tahoe while other Sheppard Mullin attorneys were representing
J-M in the Qui Tam Action, there was an actual conflict in violation of Rule 3-310(C).
At that point Sheppard Mullin “in a separate matter accept[ed] as a client a person or
entity [South Tahoe] whose interest in the first matter [the Qui Tam Action] is adverse to
the client in the first matter [J-M].” (Rule 3-310(C)(3).) Sheppard Mullin admits that in
late March 2010 South Tahoe “reemerged” as a client, and Dinkin stated in his
declaration that he worked for South Tahoe in March, April, June, October, and
December 2010, and in January, February, and March of 2011.
There is a fact question, however, as to whether there was an actual conflict
between the time J-M signed the Agreement (March 8, 2010) and when Dinkin resumed
actively working for South Tahoe (March 29, 2010). Sheppard Mullin argues that South
Tahoe was not a current client when the Agreement with J-M was signed because Dinkin
had not done any work for South Tahoe for five months before that. J-M argues that an
actual conflict nonetheless existed because Sheppard Mullin had an ongoing relationship
with South Tahoe for many years. Indeed, Dinkin stated in his declaration that he
brought South Tahoe with him as a client when he joined Sheppard Mullin in 2002.
Also, in a June 9, 2011 letter to South Tahoe after the conflict came to light, Sheppard
Mullin stated, “We have been pleased to provide labor advice to you for the last 9 years.”
Sheppard Mullin and South Tahoe executed engagement agreements in 2002 and
2006. The 2006 engagement agreement states, “Termination of Representation. You
[South Tahoe] have the right to terminate our representation of you at any time. Subject
to our ethical obligation to give you reasonable notice to arrange for alternative
representation, we may terminate our representation of you at any time. Unless we agree
to render other legal services to the District, our representation will terminate upon
completion of the Matter.” “Matter” is defined elsewhere in the contract as “general
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employment matters.” The record reveals no engagement agreements with South Tahoe
post-dating this 2006 agreement. Dinkin stated in his declaration that he “occasionally
handled discrete individual matters and provided advice to South Tahoe” through
November 2009 based on the 2002 and 2006 agreements. Therefore, it is unclear
whether Sheppard Mullin’s representation of South Tahoe was ongoing or if it terminated
before the Agreement with J-M was signed.9
This is a fact question we will not determine in the first instance. We therefore
remand for further proceedings in the trial court to determine this question, and for the
court to determine the amount of fees that Sheppard Mullin must reimburse to J-M.
DISPOSITION
The judgment is reversed and the matter is remanded for further proceedings
consistent with this opinion. J-M is awarded its costs on appeal.
CERTIFIED FOR PUBLICATION
COLLINS, J.
We concur:
WILLHITE, Acting P. J.
ZELON, J.*
9
Even if South Tahoe was a former client at the time the Agreement was signed,
Sheppard Mullin’s failure to disclose the relationship to J-M may have violated Rule 3-
310(B)(1). As the parties have not briefed this issue, we will not address it here.
*
Associate Justice of the Court of Appeal, Second District, Division Seven,
assigned by the Chief Justice pursuant to article VI, section 6 of the California
Constitution.
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