September 2022 Ethically Speaking - Navigating the Boundaries of the “Hot Potato” Rule

by Fred L. Wilks

Avoiding conflicts of interest between clients is fundamental to the practice of law. Of critical importance is appreciating that the ethical rules governing conflicts of interest apply differently depending on whether the clients are current or former clients. Understanding which rule applies, however, requires an understanding of the primary fiduciary duties each rule is intended to protect. It is also important to understand how lawyers may try to maneuver around the rules.

Concurrent Clients Versus Successive Clients
Absent informed written consent of each client, a lawyer shall not concurrently represent a client if the representation is adverse to the interests of another client in the same or a separate matter. See California Rule of Professional Conduct (CPRC) 1.7. A lawyer who undertakes concurrent representation of adverse clients in violation of CPRC 1.7, is subject, among other things, to an order disqualifying the lawyer, and his or her law firm, from adverse representation. See Flatt v. Superior Court, 9 Cal. 4th 275, 284-86 (1994). The rule of disqualification in concurrent representation cases is a “per se or ‘automatic’ one.” Id. (emphasis in original). The rule of automatic disqualification applies even where the concurrent representations have nothing in common, and there is no risk of a breach of the duty of confidentiality because, in such cases, the primary value at stake is the “attorney’s duty—and the client’s legitimate expectation—of loyalty, rather than confidentiality.” Id. at 284-85 (emphasis in original).

The ethical rules applicable to conflicts in successive representation cases—i.e., conflicts between a present and former client—differ. Absent informed written consent, a lawyer may not represent a client in which that client’s interests are materially adverse to the interests of a former client in the “same or a substantially related matter.” CRPC 1.9(a). Thus, absent a former client’s informed written consent, a law firm faces disqualification only where a former client shows a “substantial relationship” between the subject of the prior and successive representations or that the attorney actually received confidential information during the prior representation that is material to successive representation. See San Francisco v. Cobra Sols., Inc., 38 Cal. 4th 839, 847 (2006). The “substantial relationship” test protects against a lawyer’s violation of two fiduciary duties. First, a lawyer’s duty of loyalty continues in force after termination of the representation such that the lawyer may not “do anything which will injuriously affect the former client in any matter in which the attorney formerly represented the client.” CRPC 1.9, Comment 1, citing Oasis W. Realty, LLC v. Goldman, 51 Cal. 4th 811, 821 (2011). Second, a lawyer’s duty of confidentiality continues after termination such that the lawyer may not “at any time use against the former client knowledge or information acquired by virtue of the previous relationship.” Id. Two matters are substantially related if they involve a substantial risk of a violation of either of these duties to a former client. CRPC 1.9, Comment 3.

The “substantial relationship” test, of course, is a less onerous and fact-sensitive inquiry, not automatic. The inquiry involves determination of the similarities between the two factual situations, the similarities between the legal questions, and the extent of the lawyer’s involvement in the matters. See Morrison Knudsen Corp. v. Hancock, Rothert & Bunshoft, 69 Cal. App. 4th 223, 234 (1999). In sum, unlike concurrent representation of adverse clients, a law firm may under certain circumstances accept matters adverse to a former client.

The Rule Against Converting a Current “Hot Potato” Client Into a Former Client
Where adverse concurrent representation exists, a law firm cannot avoid automatic disqualification by unilaterally dropping one client like a “hot potato” in order to continue representing an adverse client: “a law firm that knowingly undertakes adverse concurrent representation may not avoid disqualification by withdrawing from the representation of the less favored client before hearing.” Truck Ins. Exch. v. Fireman’s Fund Ins. Co., 6 Cal. App. 4th 1050, 1057 (1992). Attempting to convert a current client into a former client “may itself be a breach of loyalty.” American Airlines, Inc. v. Sheppard, Mullin, Richter & Hampton, 96 Cal. App. 4th 1017, 1037 (2002). The court in Flatt referred to this as the “hot potato rule.” Flatt, 9 Cal. 4th at 288.

The effect of the rule is that even after a lawyer has unilaterally withdrawn from representing one client in favor of another, the automatic rule prohibiting concurrent representation applies. The substantial relationship test does not apply. A lawyer or law firm violating the so-called hot potato rule violates Rule 1.7. Disqualification will be automatic and the law firm will find itself unable to represent either client. As with many legal principles, however, circumstances may arise where application of the hot potato rule is debatable.

Sequencing a Hot Potato Termination and New Representation
California cases have applied the hot potato rule where the concurrent representation already existed before the law firm attempted to jettison one client in favor of another. At least one court has applied the rule even where the overlapping representations lasted only a few days. In American Airlines, the lawyer accepted an engagement that was at least potentially adverse to an existing client and began preparatory work, then three days later the lawyer wrote to his existing client to inform it that he had “completed” his work for that client. See American Airlines, 96 Cal. App. 4th at 1027-28. The court held that the lawyer could not avoid breaching the duty of loyalty by unilaterally converting a present client into a former client. Id. at 1037.

Imagine instead that the lawyer terminated the attorney-client relationship with the existing client before accepting the new client. Should the substantial relationship test apply so long as the lawyer accepts the new engagement only after first terminating the existing client?

One could argue that jettisoning an existing client for the very purpose of accepting an adverse engagement, even one that has not yet been accepted, is no less a breach of the duty of loyalty than doing so with only a few days of overlap in the representations. Flatt emphasized the client’s legitimate expectation of loyalty. Flatt, 9 Cal. 4th at 284. One would be hard pressed to find a client who viewed it as anything but disloyal for their lawyer to terminate them for the purpose of accepting an adverse representation. It would also seem anomalous that the hot potato rule—a rule designed to prevent a breach of the duty of loyalty—could be avoided with deft, though transparently disloyal, timing on the part of the lawyer.

On the other hand, one could argue with some force that a lawyer’s disloyal intentions and hopes about a future representation do not, alone violate the duty of loyalty. So long as there is no binding verbal or informal commitment by either the lawyer or the “new” client regarding the adverse representation, arguably the lawyer may withdraw from an attorney-client relationship for any reason consistent with the engagement agreement and Rule 1.16 governing the termination of a representation. If the mere proximity in time between the termination and acceptance of the adverse representation is to be treated as a presumptive breach of the duty of loyalty, how long must the cooling off period be? Would requiring a cooling off period be consistent with the principle that the duty of loyalty ends when the representation ends, surviving only with respect to a matter in which the attorney formerly represented the client? See CRPC 1.9, Comment 1.

There is room for disagreement on the issue of whether there must be an actual “concurrent representation” in the technical sense for the automatic rule of disqualification to apply. How a court decides the issue may well depend on how much of a spectacle the lawyer creates by way of the termination, the retention of the new client, and the legal action the lawyer takes adverse to the “former” client.

Ongoing, Open-Ended Attorney-Client Relationships
Another issue that may arise is whether a representation has already concluded at the time the lawyer “confirms” the representation has concluded. Whether a client has become a former client is not always clear.

Many lawyers have long-term clients whom they represent episodically in various matters over time, with periods of inactivity. A lawyer cannot assume that a client has become a former client simply because past matters have concluded and a period of inactivity follows. Even during periods of inactivity, a long-term representation may be continuous and ongoing. See Sheppard, Mullin, Richter & Hampton, LLP v. J-M Mfg. Co., 6 Cal. 5th 59, 82-83 (2018). The question is whether the client would reasonably understand that the representation has terminated. Id. Courts will not impose on a client the burden of discerning that a law firm has ceased to be the client’s attorney simply by lapse of time. Id.

Determining whether a representation is ongoing depends largely on the terms of the engagement agreement. For instance, an engagement agreement may be construed as a “framework” agreement pursuant to which the lawyer and client establish a structure for establishing future attorney-client relationships on an “as requested” basis by the client, and subject to confirmation by the lawyer depending upon such considerations as conflict checks, caseload and work flow situations. See Banning Ranch Conservancy v. Superior Ct., 193 Cal. App. 4th 903, 913 (2011). Under a “framework” agreement, the representation is not ongoing and open-ended. Id. Once a matter has concluded, the Rule 1.9 substantial relationship test will apply.

On the other hand, a “classic” retainer agreement involves clients who pay a retainer fee to secure ongoing availability for legal representation over a given period of time. See CRPC 1.5(d). Under a classic retainer fee agreement, the client remains a current client during periods of inactivity and a lawyer’s attempt to terminate the relationship to accept adverse representation will not only constitute a breach of the agreement, but it will also violate Rule 1.7.

Most engagement agreements contem­plating legal representation on more than one matter fall somewhere in between the agreements described above. For instance, in Sheppard, Mullin, Richter & Hampton, LLP, the engagement agreement provided that the law firm would represent the client in connection with “general employment matters” and that either party could terminate the agreement, but there had been no prior termination of the representation. The court concluded that representation was ongoing with respect to general employment matters. See Sheppard, Mullin, Richter & Hampton, LLP, 6 Cal. 5th at 83. Under such circumstances, the hot potato rule would apply to any attempt to convert the client into a “former” client.

Adverse Clients “Thrust Upon” a Law Firm
As the court recognized in Truck Insurance Exchange, a law firm may find itself concurrently representing adverse clients through no fault of its own, by “mere happenstance.” Truck Ins. Exch., 6 Cal. App. 4th at 1058. This circumstance can arise in a number of ways. A classic example arises when a corporate client is acquired by a party adverse to another client of the law firm, creating adversity through no fault of the law firm. Truck Insurance Exchange agreed, albeit in dicta, that where the conflict arises by mere happenstance, the substantial relationship test applicable to former client conflicts should apply. Examining this issue, the Orange County Bar Association reached the same conclusion. See Orange Cty. Bar Ass’n Form Opn. 2012-01 (discussing “Thrust-Upon Conflicts”). There is, however, no controlling California law on point and a court may rule that a “thrust-upon” conflict could trigger the hot potato rule. How a court decides this issue may very well depend on the degree to which the event that gave rise to the “thrust-upon” conflict was foreseeable by the law firm.

What It All Means
A lawyer for a client that believes it has been double-crossed by the client’s prior lawyers should closely examine the circumstances of that representation, including the circumstances of the termination and the prior lawyers’ engagement of the adverse client.

Meanwhile, a law firm concerned that it may one day find itself having to choose between two masters should review the authorities above and consider whether the law firm’s client engagement agreements establish an ongoing, open-ended attorney-client relationship and, if so, whether a “framework” agreement is preferable. The law firm should consider adopting a standardized client communication to be sent with final billing on all matters, indicating that work for the client has concluded. Finally, a violation of the rules governing conflicts of interest can be avoided by obtaining the client’s informed written consent, but not in all cases.

Fred L. Wilks is a business litigation partner at Hodel Wilks LLP in Irvine, California, and can be reached at FWilks@hodelwilks.com.