Sheppard Mullin loses conflict waiver fight in state Supreme Court

Broad waivers that fail to disclose known conflicts of interests are unenforceable, according to an opinion filed by the state Supreme Court Thursday.

The state Supreme Court affirmed an appellate court ruling that Sheppard, Mullin, Richter & Hampton LLP's failure to disclose a conflict of interest was an ethical violation, despite its client, J-M Manufacturing Co. Inc, signing a broad conflict waiver included in their engagement agreement.

The state high court disagreed with the lower court, however, that this violation categorically disentitled the firm from recovering costs for services rendered and will leave the recoverable amount to be decided by a trial court.

Justice Ming Chin, joined by Chief Justice Tani Cantil-Sakauye, dissented, writing not only did the firm commit an ethical violation, but it should not be entitled to recover any of the costs. Sheppard, Mullin, Richter & Hampton LLP, v. J-M Manufacturing Company Inc., S232946.

"The law firm contended that there was no violation of the code of ethics whatsoever, that there was no conflict of interest that had to be disclosed," said lead counsel Kent L Richland, representing J-M Manufacturing Co. "The California Supreme Court in resounding terms made it clear that there absolutely was a conflict, and the agreement, as a result, was voided and completely unenforceable."

It all began when Sheppard Mullin was disqualified from representing its then-client, J-M Manufacturing, in a $1 billion qui tam action in which J-M was accused of misrepresenting the strength of its plastic pipe sold to nearly 200 governmental entities.

One of the entities was South Tahoe Public Utility District, which Sheppard Mullin was concurrently representing in an unrelated matter. After South Tahoe discovered the conflict, it moved to disqualify Sheppard Mullin from the qui tam action. A federal judge granted South Tahoe's motion.

After Sheppard Mullin was disqualified, J-M challenged its engagement agreement and refused to pay outstanding legal fees, stemming from work done by Sheppard during the qui tam action. According to Sheppard Muulin attorney Charles Kreindler, the firm's billings totaled more than $3 million, of which more than $1 million remained unpaid.

Sheppard then sued for the unpaid fees, leading to a fee dispute hinging on a broad conflict waiver, included in J-M's engagement agreement that the firm said addressed possible conflicts of interest.

The fee dispute was submitted to binding arbitration, resulting in an award of $1.3 million to Sheppard Mullin. A trial court later confirmed the award. However, when the matter was brought to the 2nd District Court of Appeal, a panel ruled J-M's challenge to the enforceability of the engagement agreement couldn't be decided by arbitration.

The 2nd District found that although J-M signed a broad conflict waiver, the waiver was not effective because Sheppard Mullin failed to disclose a known conflict with a current client. As a result, Sheppard Mullin was ordered to disgorge its fees.

The state Supreme Court agreed in part with the decision but also concluded, contrary to the Court of Appeal, that the ethical violation did not categorically disentitle Sheppard Mullin from recovering the value of the services rendered to J-M.

The court is now leaving it up to a trial court to decide if any amount of the fees should be recovered. However, the fact that two of the justices on the panel, including the chief justice, dissented and opined that the firm is not entitled to any of the fees, does not bode well for the firm's chances of recovering a substantial amount, if any at all, said Stephen L. Raucher, an attorney with Reuben Raucher & Blum who wrote an amicus brief.

"Shepard Mullin knew about this conflict but decided because of their broad waiver language that they didn't need to disclose it," Raucher said. "In light of this decision, if they were in the same fact situation, they should think much more carefully about disclosing it, otherwise they may end up having to disgorge all their fees, like the dissenters said."

When asked to comment on the opinion, Kevin S. Rosen, lead counsel for Sheppard Mullin, issued a statement:

"Sheppard Mullin previously established before a panel of three distinguished arbitrators and the trial court that the firm acted in good faith at all times, and we anticipate a similar outcome upon remand. Indeed, J-M stipulated that it had no issues with "the value or quality of Sheppard Mullin's work." As such, we fully expect that the undisputed quality and value of Sheppard Mullin's work, based on effective and laudable advocacy for J-M in the qui tam action, will be confirmed once again."