Testing Loyalty’s Limits
Thoughts on the Proliferation of Advance Waiversby Robert K. Sall
Has the duty of loyalty become a thing of the past? More and more frequently, law firms request their clients to sign fee agreements including a general waiver of future conflicts of interest, allowing for the law firm to represent someone else against the client in the future. Do these “advance waivers” protect the law firm? Are they ethically proper?
The trend seems to be in favor of permitting use of some form of advance waivers, a nod perhaps to intense lobbying from law firms that see the ethical rules of a former era as business impediments. Recently, the American Bar Association’s Committee on Ethics and Professional Responsibility withdrew a 1993 opinion which warned the bar that it could not rely with ethical certainty on a prospective waiver. In 2005, the ABA adopted a new opinion which, while retaining criticism of open ended advance waivers, partially endorses their use if the disclosure is sufficient to ensure that the client reasonably understands the material risks that the waiver entails, especially where given by experienced users of legal services or those represented by independent counsel. (See, ABA Formal Opinion No. 436 (2005).)
Likewise, California’s Commission for the Revision of the Rules of Professional Conduct (“RPC”) has prepared a draft of Proposed Rule 1.7, to replace existing Rule 3-310. Comment 33 to Proposed Rule 1.7 sets forth a discussion of advance waivers, suggesting that they will be permitted, and that their effectiveness will depend upon several factors including the nature and extent of the disclosure, whether the client had independent counsel, and whether an adequate screening procedure was established to avoid imparting confidential information of a client or former client. (For an analysis of the proposed rule and several recent authorities not mentioned here, see Prof. Carole Buckner’s article, “Addressing the Intricacies of Future Conflict Waivers”, (2008) Orange County Lawyer, vol. 50, pg. 46).
An advance waiver is one designed to seek a client’s present informed consent for the lawyer to represent an adverse party in some future conflict of interest that may or may not arise. Advance waivers often become a topic of discussion in merger negotiations between law firms. They are viewed as one potential means of melding together distinct groups of clients who may present actual or foreseeable conflicts when firms merge. Advance waivers are predominantly for the benefit of law firms, allowing firms to accept or continue to represent clients they might otherwise have to reject due to concerns over loyalty or confidentiality. In that regard, such waivers potentially diminish these two traditional stalwarts of the legal profession.
Advance waivers are not limited to merger situations. For example, a law firm has a major client (“Client #1”) that has long been a primary source of business to the firm, a valuable relationship the law firm wishes to protect. Another potential client (“Client #2”) comes along and needs, say, patent work, but it is conceivable that Client #2’s product could be developed or marketed to compete with Client #1’s product line. A myriad of competition based issues may lead to future litigation between the clients. Law Firm wants to accept the new business, but does not want to preclude itself from being able to represent Client #1 against Client #2 in the future. In this situation, an advance waiver of future conflicts of interest might be presented to Client #2, even though the exact nature of the potential future dispute between the clients is not known.
Another scenario in which a law firm could seek an advance waiver might be where it undertakes to represent two persons jointly in the same action, such as jointly defending both an Employer Client and an Employee Client in a lawsuit. (See, for example, Los Angeles County Bar Association, Formal Opinion No. 471, for such a fact pattern and discussion of its ethical implications). The Employer Client may have had a long term relationship with the Law Firm, while the Employee Client is new. Such clients are sometimes represented as an “accommodation” to the regular client. Because of the long term relationship, the law firm attempts to use an advance waiver to preserve an ability literally to fire the accommodation client and to continue to represent the regular client when the interests of the two clients later become adverse.
An employee may be entitled to indemnity for liability arising from actions within the course and scope of employment. Typically, the corporate employer provides a defense for both the corporation and the employee. But it could develop that the actions of the employee prove contrary to corporate policies. The employee could testify in a manner the employer believes is contrary to its interests or even its version of events. Suddenly the lawyers may find themselves advancing inconsistent legal positions or facts, possibly representing two clients with conflicting defenses. The employee might be terminated by the employer, even while the lawsuit is still being defended. How is the lawyer going to respond when the Employee Client asks: “I want a different firm to represent me, and I want Employer to pay for it?” Or, how will the law firm respond when the Employer Client says: “Employee is now working for our competitor. We want to stop providing a defense for him, and you are to no longer represent him.” Worse yet, one of the clients could ask the law firm to sue the other client.
Is it conceivable that one client can be entitled to preferential treatment over another client? The duties of loyalty owed to each client are no different – both are owed equal duties once representation has been undertaken – unless perhaps one of the clients has knowingly and intelligently consented to different treatment. Without both clients providing informed consent to waive the actual conflicts of interest at the time they arise, these scenarios would lead to irreconcilable conflict. Absent full disclosure, waiver and informed consent, the lawyer is normally unable to advance the interests of one client against another client and, as such, may violate the duty of loyalty, or the duty of confidentiality. (See, RPC Rule 3-310 (A), (B), (C) and (E).)
Some law firms have taken to the practice of anticipating such future conflicts, crafting a waiver to be signed by clients in advance of the conflict actually arising that would permit the law firm to continue to represent one of the clients, even adverse to the other client. Such advance waivers are being used in ways once never thought imaginable. As law firms have grown in size conflicts of interest have become more inevitable, exacerbated by issues such as firm mergers, lawyer migration and clients jumping from one firm to another. The critical issue in the formulation of advance waivers is whether there can ever be informed consent from the affected clients when the facts have not yet developed, the conflict doesn’t yet exist, and the relevant circumstances and the reasonably foreseeable adverse consequences are not fully known.
Let’s take a closer look at one advance waiver that successfully avoided a law firm’s disqualification when a conflict of interest arose. In Zador Corporation v. Kwan ((1995) 31 Cal.App.4th 1285), the law firm had represented joint clients in the defense of a lawsuit. The clients were the principal (referred to as Zador, or the Companies) and an agent (Kwan). When both were sued, the agent requested indemnity from the principal. Zador accepted the defense and retained its long time law firm, Heller Ehrman, to provide joint representation.
In the retainer agreement, Kwan agreed to waive conflicts that may arise out of any adversity that might develop between Zador and Kwan, and to permit Heller Ehrman to continue to represent Zador. The agreement contained a lengthy waiver (fully recited in the opinion) that loosely described potential conflicts without providing specific examples. The waiver did not state that the law firm might actually sue Kwan on behalf of Zador. The waiver did inform Kwan of his right to consult independent counsel, and further stated, in part: “Accordingly, we are now asking that you consent to our continued and future representation of the Companies and agree not to assert any such conflict of interest or to seek to disqualify us from representing the Companies, notwithstanding any adversity that may develop.”
Factual disputes later arose about how certain discovery responses would be answered. Discovery revealed that Kwan may have received a secret profit from the adverse party in the transaction that was the subject of the lawsuit. Heller Ehrman informed Kwan in writing of the possible conflict between his interests and Zador’s interests, and told Kwan that he needed to retain other counsel, while Heller would continue to represent Zador. Kwan signed a reaffirmation of the waiver.
Kwan retained independent counsel, who requested that Zador continue to provide indemnity. Although an indemnity agreement was ultimately reached, Kwan’s attorneys said that if Zador sued Kwan, they would move to disqualify Heller. Kwan eventually admitted that he had secretly profited from the deal. Zador withdrew its indemnity, demanded reimbursement of its expenses, and Heller amended Zador’s pleadings to include claims against Kwan. Thus, Heller sued its own former client in the same lawsuit in which it had previously defended him. Kwan moved to disqualify, and the trial court granted the motion.
The Court of Appeal took a different view. Here, there was a joint representation, in which the waiver fully disclosed to Kwan the effect of Evidence Code Section 962, the joint client exception to attorney-client privilege. Thus, the communications between Heller and Kwan were not confidential, as between Zador and Kwan, in any action between them. It was also significant that after the conflict arose, Kwan was informed of the potential conflict and signed another writing acknowledging that Heller would continue to represent the Zador Companies in the lawsuit. The Appellate Court reversed the disqualification order, even though the waiver did not expressly state that Heller might sue Kwan in the same lawsuit it had previously defended. The Court interpreted “any adversity” broadly, to include a lawsuit. It further stated: “California law does not require that every possible consequence of a conflict be disclosed for a consent to be valid.”
In another California decision the federal court upheld an advance waiver as a basis to deny a disqualification motion, even though the waiver did not specifically state the exact nature of the future conflict. (Visa U.S.A. Inc. v. First Data Corporation, 241 F. Supp. 2d 1100, 1106-07 (N.D., Cal. 2003).) In Visa U.S.A., plaintiff Visa sued First Data for trademark infringement, dilution and various breach of contract claims arising out of contracts for the processing of financial transactions. The law firm, coincidentally Heller Ehrman, had a long-standing relationship with Visa. Recently, First Data had retained Heller to handle a different matter involving patent infringement, but was requested at that time to sign a waiver stating that First Data would permit Heller to represent Visa in any future disputes, “including litigation” that might arise between them. The disclosure described the fact that Heller had a long term relationship with Visa, and that, in light of that relationship, it wished to preserve the ability to represent Visa in matters which may arise in the future, including matters adverse to First Data. The waiver also provided that if adverse representation were to be provided, Heller would staff the project with attorneys different than those engaged in First Data’s representation, and would establish an ethical wall screening the attorneys handling the matters from communicating with each other regarding the respective engagements. Approximately eight months later, with Heller as its counsel, Visa sued First Data, and First Data sought to disqualify Heller. First Data argued that the waiver was improper in that it did not fully disclose the nature of the conflict, and consent was therefore not informed. First Data also argued that a second disclosure was required once the actual conflict arose, under Rule 3-310(C) of the RPC. The District Judge, in a somewhat unique interpretation of Rule 3-310, denied disqualification, and stated: “In some circumstances, a second waiver will be warranted, but only if the attorney believes that the first waiver was insufficiently informed. There is no case law requiring a second disclosure in all circumstances for an advance waiver to be valid.” The District Judge cited to and relied upon Zador, stating that it did not require a second written waiver, yet under the facts of Zador, the disclosure had in fact been made twice and reaffirmed in writing when Kwan was informed that Heller would continue to represent Zador, and that he should get his own counsel.
The particular language at issue in Rule 3-310(A) and (C) is that which appears to require a two-stage disclosure of conflicts. The attorney may not, without first making written disclosure of “the relevant circumstances and of the actual and reasonably foreseeable adverse consequences” and obtaining the client’s informed written consent, “accept” a potentially conflicting representation, or “accept or continue” representation once actual conflict has arisen. Disclosure and informed consent are therefore required at two separate times, once when the conflict is merely potential, and again when the representation continues after the conflict has become actual. The Court’s determination in Visa U.S.A. therefore seems contrary to a plain reading of Rule 3-310.
There are three arenas in which the quality of an advance waiver is likely to be tested. These are (1) a disqualification motion in court; (2) a State Bar disciplinary proceeding; and (3) a malpractice or breach of fiduciary duty claim. Many lawyers view Zador and Visa U.S.A. as providing carte blanche for advance waivers and some have even taken to using variations of the Zador and Visa U.S.A. disclosures as a template for their own advance waivers. After all, the Zador disclosure was ultimately blessed by an appellate court. Yet, this is an area fraught with risk. The client always has the right to initiate litigation claiming that the disclosure was inadequate and the client did not understand the implications.
Virtually all of the published decisions deal only with disqualification in which the court must engage in a balancing test between the duties of loyalty or confidentiality owed to one client, and another client’s right to counsel of his or her own choice. The considerations are different in a malpractice action where the non-party client’s right to choice of counsel is not an issue. Instead, the focus is on the adequacy of the disclosure and whether the purported consent was sufficiently informed to establish that the client actually understood the material risks. To view an advance waiver as a literal waiver of tort claims would seem to run afoul of RPC Rule 3-400, which precludes a lawyer from contracting with a client prospectively to limit liability for malpractice. Whether the ruling on a disqualification motion might operate as an estoppel against a malpractice claim remains to be seen, but appears unlikely due to the different standards courts must use to determine disqualification.
Few advance waivers plainly disclose the real potential effects, such as: “You are giving me permission to sue you on behalf of another client. In my effort to sue you, I may be called upon to put you out of business, to take away your assets, to shut down your operations, possibly to prove that you acted maliciously or despicably. I may even seek to recover punitive damages or force you into bankruptcy. If my other client sues you, I will try to do those things diligently on behalf of my other client and you consent to that.” This is the kind of real disclosure that will make a client think. It is the failure to make honest, forthright disclosures that will give rise to the successful malpractice or breach of fiduciary duty claim should the client be able to prove that he or she did not understand. Despite their popularity among Big Law, the proliferation of advance waivers has not yielded consistent results nationwide. Having an advance waiver may provide no protection if the disclosure fails to meet the standard of care because it was inadequate to impart to the client a full understanding of the nature of the risks involved. Even a waiver that provides for ethical screening procedures, such as the one in Visa U.S.A., may prove insufficient, because screening is not a presently reliable solution in California. State courts here have yet to embrace screening as a means of avoiding conflict, except in limited circumstances involving government lawyers. In 2006, one federal court rejected an ethical screen and ordered disqualification of the law firm for the very reason that no California court had approved screening as a proper method to avoid breach of duty. (See Hitachi Ltd. v. Tatung Co., 419 F. Supp 1158 (N.D. Cal. 2006).) Other federal decisions in California have since followed suit.
The lesson is that advance waivers should be used with extreme caution, if at all. The disclosure needs to be as complete as possible under the circumstances, including sufficient detail as to all reasonably foreseeable adverse consequences. Law firms should anticipate that, if an actual conflict arises, a motion for disqualification is likely, with the results uncertain. It is also necessary to disclose to the first client that the law firm might be disqualified if the advance waiver signed by the other client is deemed insufficient. The malpractice risks are obvious when lawyers undertake to favor one client and sue another. No client is happy to learn it has been sued by its own law firm.
Robert Sall is a regular contributor to the Ethically Speaking column and bar programs on legal ethics. He is a member of the OCBA’s Professionalism and Ethics Committee, and practices with The Sall Law Firm in Laguna Beach in the areas of lawyer professional responsibility, legal malpractice cases and attorney-client fee disputes.