Nearly $4 million in fees are at stake in a California Supreme Court fight between a big law firm and a big client over broad advance conflict waivers the firm used in its client engagement letters.

Sheppard Mullin Richter & Hampton LLP got disqualified from representing J-M Manufacturing Co. Inc. in a $1 billion qui tam action because the firm concurrently represented one of the hundreds of defendants in an unrelated matter. The state appeals court held the advance conflict waiver J-M gave Sheppard Mullin didn’t absolve the firm of its duty to tell J-M about the specific conflict once it came to light.

A law firm can’t simultaneously represent parties who are adverse to one another unless the clients give informed consent to the conflict of interest. Justices in a case of first impression will consider whether a law firm needs to tell a sophisticated client about a specific conflict when it arises, or whether the firm can instead rely a boilerplate advance conflict waiver in the client’s engagement agreement. But the case could turn on a different issue: whether the state appeals court erred in overturning an arbitration award in Sheppard Mullin’s favor.

The June 6 oral arguments in the closely watched case come a month after the California Supreme Court approved rules revisions. A comment to the newly numbered Rule 1.7, Conflict of Interest: Current Clients, says that when consenting to a lawyer’s conflict the “experience and sophistication of the client giving consent, as well as whether the client is independently represented in connection with giving consent, are also relevant in determining whether the client reasonably understands the risks involved in giving consent.”

“California has always looked at whether consent was informed, and the comment makes clear that the factors of client sophistication and representation are relevant to this inquiry. But they are not dispositive, and the critical inquiry will be, as it always has been, the quality of the disclosures given to the client to secure the disclosure,” said Robert Hillman, a University of California Davis law professor who signed the brief six law scholars filed.

“At the margins, the change will make it a little easier to get enforceable consents when sophisticated clients are involved,” Hillman told Bloomberg Law. “But boilerplate disclosures not customized to the circumstances of each situation will not cut it.”

What does cut it should be known by the end of the summer, as the opinion is due within 90 days after oral argument.

$4M ‘Windfall’

Sheppard Mullin paints the case as about a sophisticated legal consumer that signed a consent to conflict waiver, got millions of dollars in legal work, suffered no damages, refused to pay any legal fees, and still could “obtain a $4 million windfall.”

J-M Manufacturing, the world’s largest PVC pipe manufacturer, faced “potentially ruinous liability in a $1 billion federal qui tam action” alleging it knowingly supplied customers with substandard polyvinyl chloride pipes and hired Sheppard Mullin to fight the action, the firm said in its opening brief. J-M’s counsel negotiated an agreement with Sheppard Mullin that included a 22 percent fee reduction and a broad current and advance conflict waiver forthe qui tam action and any future actions.

Sheppard Mullin’s acceptance of the engagement and the document that created the attorney-client relationship “itself violated law and public policy because Sheppard Mullin withheld the information necessary to obtain J-M’s informed consent,” J-M said in response to the amici. “That illegality permeated everything, including the various terms of the engagement agreement that defined the minutiae of the illegal relationship.”

J-M was accused of misrepresenting the strength of its plastic pipe and sold defective pipe to nearly 200 governmental entities. The company is still fighting the allegations 12 years later.

Lateral Hire

Sheppard Mullin logged 10,000 hours over 16 months on the qui tam action.One of the public entities suing J-M is South Tahoe Public Utility District, a water agency that held 0.0004 percent of the potential qui tam claims, or about $97,000, the firm said.

A Sheppard Mullin lawyer represented STPUD in an unrelated labor issue earlier in his career and brought the agency with him as a client when he joined the firm in 2002. Sheppard Mullin obtained two advance conflicts waivers from the agency. The firm informed neither J-M nor STPUD after the firm’s conflict check detected the conflict. Sheppard Mullin billed STPUD for 12 hours of work intermittently performed by another lawyer in a different office, starting three weeks after it began representing J-M.

Counsel for the utility district in the qui tam matter moved to disqualify Sheppard Mullin about 14 months after the firm began representing J-M. J-M initially encouraged the firm to fight disqualification and keep working, but then dropped its objections to disqualification “after its General Counsel received advice that J-M might obtain disgorgement of its previously paid fees if Sheppard Mullin were disqualified,” the firm said.

The federal court disqualified Sheppard Mullin, and J-M then took the position that it didn’t have to pay the firm $1.1 million in outstanding bills and was entitled to return of $2.7 million it already paid. The law firm prevailed in the ensuing arbitration over the fees, and the state trial court upheld the arbitrator’s fee award. The appeals court reversed.

Even a client’s consent to future conflicts is neither informed nor valid if the attorney conceals known information about an impending conflict, as occurred in this case, Greines, Martin, Stein & Richland LLP in Los Angeles representing J-M said in its answer brief on the merits.

Biblical Disgorgement

One of the issues that makes this a tough case is California’s disgorgement remedy, Matthew Herrington, a partner with Steptoe & Johnson LLP in Washington, told Bloomberg Law.

“California has what I call an ‘old testament’ disgorgement remedy – one toe over the line and everything gets disgorged, period. Many other states have over the years moved to a ‘new testament’ system where the trial judge is empowered to craft a disgorgement remedy tailored to the nature and scope of the (mis)conduct in question,” Herrington said in an email.

“So on the remedy side it is very hard to split the baby in California, which is why the action has all centered on the question of whether there was a misstep or not,” Herrington said.

The court shouldn’t adopt a rule of automatic fee disgorgement in all situations involving an attorney’s conflict of interest, the Association of Discipline Defense Counsel, which represents attorneys in California Bar matters, said in a brief supporting Sheppard Mullin.

Justices instead should adopt a standard for determining reasonable attorney fees that includes considering the value of services provided “because a rule of automatic disgorgement is contrary to established California law and risks creating a disincentive for lawyers to represent multiple parties, as well as increasing the risk of fee disputes among lawyers and clients,” the association said.

The court should also consider whether the client suffered damage and the seriousness of the attorney’s misconduct, Merri Baldwin, Rogers Joseph O’Donnell PC, San Francisco, wrote for the ADDC.

Amici Aplenty

The case also drew briefs from 51 law firms, the Association of Corporate Counsel, Kimberly-Clark Corp., and CNA Financial Corp. And all agreed public policy and the California Rules of Professional Conduct require disclosure to protect the client and the public and to further public trust.

“Though some—presumably large firms with multiple offices—may insist that advance waivers give potential clients freedom in obtaining and retaining counsel, that freedom must not come at the cost of ethical integrity,” the Beverley Hills Bar Association said in a brief supporting the appellate decision.

Disclosure is needed, not perfection, the law firms said in support of Sheppard Mullin. The law firms include Cooley LLP; Holland & Knight LLP; Hunton & Williams LLP; Manatt, Phelps & Phillips LLP; O’Melveny & Myers LLP; Perkins Coie LLP; Reed Smith LLP; and Seyfarth Shaw LLP.

“Although it may be tempting to default to a one-size-fits-all approach, the fact is that many clients are sophisticated business entities supported by other counsel, are bargaining heavyweights in the purchase of legal services, and neither want nor accept extended conflict waiver letters that exhaustively catalog all potentially relevant details,” the firms said in a brief by Holland & Knight.

Holland & Knight also represented J-M co-defendant Formosa Plastics Corp. USA, which agreed in 2013 to pay $22.5 million to settle claims in the qui tam lawsuit.

Large law firms, J-M said in response to the amici, have such a “hefty appetite for general, open-ended conflict waivers because it allows them to grow their profits without the mess of obtaining conflict waivers as conflicts arise.”

The gravamen is lawyer honesty—how much must be disclosed for the client to make an informed decision, Diane Karpman, with Karpman & Associates in Beverly Hills who represents lawyers in ethics cases and co-wrote the brief, told Bloomberg Law.

“Our jurisprudence is designed to empower clients; that cannot occur if deception is involved,” Karpman said in a May 31 email.

Case is Sheppard, Mullin, Richter & Hampton LLP v. J-M Manufacturing Co., Inc., Cal., No. S232946, oral arguments scheduled 6/6/18.