December 2012 - Counsel’s Ethical Violation Bars Fee Recovery
by Heather Porter Condon
You raise a glass and let out a sigh of relief. On the eve of trial, after years of personal and professional sacrifice, you, on behalf of the class that you represent, have settled a major class action. The journey began three years ago when you pitched your representation to the class leaders. It was your proposal of incentive agreements that secured your representation of the class. In essence, the incentive agreements provided for a direct correlation between the amount of recovery and counsel’s request for incentive awards and attorneys’ fees. Now, the case is winding to a close. You quickly calculate your anticipated fees—the countless hours of tireless work were worth it. Or, were they?
Picking up a copy of your firm’s case development bulletin, you pause at the first caption: “Counsel’s execution of incentive agreements with certain class representatives implicates an ethical conflict barring fee recovery.” Your glass drops to the floor and shatters—as does your hope of recovering the fees you so desperately need.
In August 2012, the United States Court of Appeals for the Ninth Circuit opined on a novel class action fee recovery matter implicating the California Rules of Professional Conduct. The Ninth Circuit in Rodriguez v. Disner, 688 F.3d 645 (9th Cir. 2012) (Rodriguez II), addressed various separate appeals challenging the district court’s decision to deny attorneys’ fees to class counsel due to counsel’s execution of incentive agreements with certain named plaintiffs. The Ninth Circuit affirmed the district court’s decision.
In Rodriguez II, Van Etten Suzumoto & Becket LLP (which later merged with McGuireWoods LLP) (the Firm), entered into incentive agreements with five of the named plaintiffs in connection with, and at the commencement of, a major federal antitrust class action against West Publishing Corp., a provider of bar preparatory classes. Id. at 649. These incentive agreements required the Firm to seek incentive compensation for each of its clients based upon the value of the potential settlement or verdict, and in turn, authorized the Firm to apply for a fee award based on any award recovered against West Publishing. Id. at 649–50.
A nationwide class was thereafter certified pursuant to Federal Rule of Civil Procedure 23(a), the five named plaintiffs who had entered into the incentive agreements were designated as class representatives, and the Firm was appointed as class counsel. Id. at 650. Two remaining class representatives, who did not enter into the incentive agreements, were separately represented. Id. The Firm never disclosed the incentive agreements to the remaining members of the class nor at any point to the court. Id. at 657–58.
Shortly before trial, the parties settled. Id. at 650. The terms of the multi-million dollar settlement were agreed upon and presented to the district court. Id. Prior to the final fairness hearing, the Firm filed motions seeking incentive awards and attorneys’ fees for their representation of the class. Id. A number of unnamed class members challenged the settlement agreement under Federal Rule of Civil Procedure 23(e), as well as counsel’s applications for incentive awards and attorneys’ fees at both the district court and the appellate level.
Along with other discrete issues, Rodriguez II addresses the propriety of the district court’s rejection of the Firm’s application for attorneys’ fees based on the Firm’s execution of incentive agreements with certain of the named plaintiffs which resulted in a conflict of interest. In the underlying matter, the district court held that the “incentive agreements gave rise to a conflict of interest between the class representatives and the other members of the class that tainted [the Firm’s] representation, and that, under California law, such conflict constitutes an automatic ethics violation that results in the forfeiture of attorneys’ fees.” Id. at 652.
Rule 23(h) of the Federal Rules of Civil Procedure allows for fee recovery in class action litigation. Rule 23(h) provides in relevant part, “In a certified class action, the court may award reasonable attorney’s fees and nontaxable costs that are authorized by law or by the parties’ agreement.” In a class action setting, where no contractual or statutory basis exists, the court may rely on the “common fund doctrine.” Rodriguez II, 688 F.3d at 653. Under the common fund doctrine, “a litigant or a lawyer who recovers a common fund for the benefit of persons other than himself or his client is entitled to a reasonable attorney’s fee from the fund as a whole.” Id.
In evaluating reasonable attorney’s fees, a district court may consider any misconduct exhibited by the lawyer. Id. at 653. “A court has broad equitable power to deny attorneys’ fees (or to require an attorney to disgorge fees already received) when an attorney represents clients with conflicting interests.” Id.
The Ninth Circuit’s holding in Image Technical Service, Inc. v. Eastman Kodak Co., 136 F.3d 1354 (9th Cir. 1998), is instructive. Id. at 653–54. In Image Technical Service, the Ninth Circuit denied attorney’s fees due to a conflict of interest that arose as a result of a law firm’s representation of plaintiffs against a defendant whom the law firm previously had represented in an unrelated matter. Image Technical Service, 136 F.3d at 1359. The Ninth Circuit deemed the law firm’s representation of the plaintiffs in the present action “a clear violation of the applicable ethical rules.” Id.
Although not required, a federal court also may look to California law for guidance. Rodriguez II, 688 F.3d at 654. California courts generally have denied attorneys’ fees where an actual conflict of interest exists. Rodriguez II follows on the heels of Fair v. Bakhtiari, 195 Cal. App. 4th 1135 (2011), in which the court barred an attorney’s claim of quantum meruit recovery where the attorney entered into various successful real estate partnerships with clients absent full written disclosure and written client consent, thus resulting in an actual conflict of interest in violation of California Rule of Professional Conduct 3-300. In denying such recovery, the California appellate court explained:
Absent the required disclosures and consents, by entering into and conducting business transactions with his clients, [the attorney] breached his fiduciary duties to them and he violated rule 3-300—the ethical rule that proscribed the very conduct for which compensation was sought . . . . Unlike those rule violations in which counsel has been allowed to recover the reasonable value of services rendered and which involved no serious breach of fiduciary duty, the [trial] court could well determine that [the attorney’s] conduct here was so fundamentally at war with rule 3-300 and section 16400 [of the California Probate Code], that it infected the entire relationship between [the attorney] and his clients, and that [the attorney’s] breach of his fiduciary duties under the statute was therefore sufficiently serious as to warrant the denial of quantum meruit recovery.
Fair v. Bakhtiari, 195 Cal. App. 4th at 1169.
In fee recovery matters, California law, however, does distinguish between an actual and a potential conflict of interest, the latter allowing for the potential of recovery depending upon the equities of the matter—“the gravity and timing of the violation, its willfulness, its effect on the value of the lawyer’s work for the client, and the adequacy of other remedies.” Rodriguez II, 688 F.3d at 654–55 (quoting Pringle v. La Chapelle, 73 Cal. App. 4th 1000, 1006 n.5 (1999) (affirming award of partial attorneys’ fees where representation resulted in a potential conflict)).
In common fund class actions, the equitable principles discussed above are applied assiduously because of the court’s duty to protect the interests of the class. Id. at 655. In applying these principles, the district court should “act with a zealous regard to the rights of those who are interested in the fund in determining what a proper fee award is”—“the district court must consider whether class counsel has properly discharged its duty of loyalty to the absent class members.” Id. As with any set of facts, there are exceptions. Id. But, the Ninth Circuit cautions, where the conflict neither was one that developed beyond the control or perception of class counsel nor was disclosed to the court, it is within the district court’s discretion to deny a request for fees in its entirety. Id.
In Rodriguez II, the issue of whether an ethical violation resulted from the Firm’s execution of the incentive agreements was a question of California state law. Id. at 656. Most attorneys, who litigate in California (and elsewhere), are familiar with the ethical dilemma associated with conflicting representation. California Rule of Professional Conduct 3-310(C) provides, in relevant part:
A member shall not, without the informed written consent of each client: (1) Accept representation of more than one client in a matter in which the interests of the clients potentially conflict; or (2) Accept or continue representation of more than one client in a matter in which the interests of the clients actually conflict . . . .
A potential conflict is created where a “lawyer’s representation of one client might, in the future, become less effective by reason of his representation of the other.” Rodriguez II, 688 F.3d at 656. On the other hand, an actual conflict results “whenever a lawyer’s representation of one of two clients is rendered less effective because of his representation of the other.” Id. As discussed at length in a prior appeal, the Ninth Circuit held that the incentive agreements created an actual conflict of interest between the Firm and its clients on one hand, and the remaining class members on the other. Id.; see also Rodriguez v. W. Publ’g Corp. (“Rodriguez I”), 563 F.3d 948, 959 (9th Cir. 2009). The incentive agreements “put class counsel and the contracting class representatives into a conflict position from day one” because “[b]y tying their compensation—in advance—to a sliding scale based on the amount recovered, the incentive agreements disjoined the contingency financial interests of the contracting representatives from the class.” Rodriguez II, 688 F.3d at 656. Under California law, “[s]imultaneous representation of clients with conflicting interests (and without written informed consent) is an automatic ethics violation . . . and grounds for disqualification.” Id. at 657. The Firm at no point disclosed the incentive agreements to the non-signatory class members (or to the court), and the Firm sought no waiver. Id. According to the Ninth Circuit, it could not be disputed (nor was it) that the Firm, through the execution of its incentive agreements, committed an ethics violation under California law—specifically, Rule 3-310(C) of the California Rules of Professional Conduct. Id. (affirming the district court’s holding of the same).
Next, the Ninth Circuit addressed the issue of whether the Firm’s ethics violation precluded it from collecting fees—notwithstanding its “notable success” in the underlying litigation. Id. at 657–58. In light of the equitable principles relied upon by the district court, the Ninth Circuit answered in the affirmative. First, the conflict that resulted from the agreements was neither one that developed during the course of litigation nor one that was beyond the control or perception of class counsel. Id. at 657. Instead, the incentive agreements created an irreconcilable conflict that “was inserted into the retainer agreement,” inhibiting the Firm from discharging its duty of loyalty to the non-signatory class members “from day one.” Id. Second, the Firm never disclosed the incentive agreements to the remaining members of the class nor at any point to the court, violating the Firm’s “fiduciary duties to the class and duty of candor to the court.” Id. at 657–58. Based on the above and despite the Firm’s “notable success” in the underlying matter, the Ninth Circuit affirmed the district court’s holding that [the Firm’s] ethical violation precluded it from recovering attorneys’ fees. Id. at 658.
In sum, Rodriguez II holds that an attorney’s ethical violation may result in fee forfeiture regardless of whether the attorney’s representation in the matter is successful. The ethical violation in Rodriguez II stemmed from the conflict created by counsel’s execution of incentive agreements with a select group of class members without first seeking the informed written consent of the remaining class members. Let Rodriguez II serve as a warning to those attorneys seeking to secure class representation via the lure of incentive agreements: representation at any price may end up being the most costly of all.
Heather Porter Condon is an associate in the Irvine office of Morgan, Lewis & Bockius LLP. Ms. Condon is a member of the OCBA Ethics and Professionalism Committee. She may be reached at firstname.lastname@example.org.