*Updated on 7/29 to insert missing url links.
Closely parsing the language in an arbitration clause, the California state court of appeals recently reversed an order compelling arbitration of a dispute between a lawyer and his client-turned-business-partner. The lawyer must now defend against a $1.5 million claim based on malpractice and breach of the operating agreement that the lawyer had drafted in connection with his real estate venture with the former client. With arbitration provisions becoming a common feature of lawyer-client retainer agreements, this ruling is worth attention.
Arbitration of malpractice case
The client’s 2013 malpractice complaint in Rice v. Downs alleged that while serving as counsel to the client and the companies he was affiliated with, the lawyer and the client decided that they would form a company together to develop properties in the affordable housing market. The lawyer prepared the operating agreement for the LLC, which provided that “any controversy between the parties arising out of this Agreement shall be submitted” to arbitration in Los Angeles.
The malpractice complaint alleged a variety of misconduct against the lawyer, including secretly billing the LLC for his time, overcharging, conflicts of interest and providing bad advice.
The lawyer moved to compel arbitration of all the causes of action, based on the arbitration provision in the operating agreement. The trial court granted the motion, and the lawyer won the arbitration, with the arbitrator dismissing the client’s claims with prejudice and declaring that the lawyer had not breached the operating agreement or any other obligation. The trial court almost entirely confirmed the award (although it made dismissal of the client’s complaint without prejudice). Both parties appealed.
“Arising out of” ≠ “arising in connection with”
In a reversal of the lawyer’s fortune, the court of appeals determined that the arbitration provision in the operating agreement did not apply to the malpractice case.
Under California law, the decision as to whether a contractual arbitration clause covers a particular dispute rests on whether the clause is “broad” or “narrow,” the court of appeals said. “Broad” clauses use language such as “any claim arising from or related to this agreement,” or any claim “arising in connection with” the agreement. With broad language, the court will command arbitration where the fact allegations even “touch matters covered by the contract.”
Not so where the parties choose to provide for arbitration only of controversies “arising from” or “arising out of” an agreement, ruled the court. Those are “narrow” clauses, and the more limited language may not extend to tort claims.
Here, the court framed the issue as whether the particular claims the client asserted were controversies “arising out of” the operating agreements. The court found very significant the fact that the parties broadly consented to jurisdiction in California courts of actions “arising out of, under or in connection with this Agreement or the transactions contemplated by this Agreement” — but they agreed to arbitrate only controversies “arising out of this Agreement.”
Thus, said the court, a tort claim based on violation of an independent duty originating outside of the agreement would not “arise from” the agreement, and would be outside the scope of the arbitration provision. That exactly characterized the claims for malpractice and breach of fiduciary duty, the court held, which were not based on failing to perform under the operating contract, but rather violating duties created by the lawyer-client relationship.
Words matter; so do state rules
Of course, it is no news that a case can turn on contract interpretation. But this one emphasizes the small drafting choices that can send a case to a full-blown jury trial or keep it in arbitration. That’s of special concern to lawyers and their clients at the front end of a relationship — pre-dispute agreements to arbitrate are increasingly included in retainer agreements.
As always, be aware of your jurisdiction’s ethics opinions and rules governing arbitrating malpractice claims. Most opinions on the subject indicate that the client’s informed consent is necessary; ethics opinions in a minority of states require consulting with independent counsel regarding the advisability of agreeing to arbitrate such claims. (Ohio mandates independent consultation by Rule 1.8(h)(1) of its Rules of Professional Conduct.)