Law firms that want to include mandatory arbitration provisions in their client engagement agreements must explain to the client the benefits and disadvantages of arbitrating a prospective dispute, the New Jersey state supreme court held late last year — and merely providing a link to the arbitration rules doesn’t satisfy the requirement, the court said.  The 50-page ruling sent a legal malpractice case against a Newark-based firm back to court, where the former client had filed it, instead of to an arbitrator.

JAM-med up

The client, described in the court’s opinion as a “sophisticated businessman,” retained the 150-lawyer firm to represent him, and signed a four-page retainer agreement.  The client was invited to take his time reviewing the document and to ask any questions he had, according to the opinion.

The retainer agreement included an arbitration provision requiring any dispute about the firm’s legal services or fees to be determined by binding arbitration, and warning that the client was waiving his right to a jury trial.  The provision indicated that the arbitration would be conducted by the well-known JAMS private arbitration/mediation organization, and included a link to the 33-page JAMS rules.  As described in the court’s opinion, the client signed the retainer agreement without asking any questions.

After the representation ended, a fee dispute arose, and the law firm invoked the JAMS arbitration provision.   While that was ongoing, the client filed a malpractice claim against the firm in court, asserting that the arbitration provision violated the New Jersey Rules of Professional Conduct and his constitutional right to trial by jury.

The firm won in the trial court; the appellate division reversed in favor of the client, and the state supreme court likewise sided with the client, invalidating the arbitration provision.  In addition, the supreme court referred the issue to the state’s ethics advisory committee, so that it could give further guidance to Garden State lawyers on the scope of their disclosure duties in connection with arbitration provisions.

What’s higher than a fiduciary duty?

If the same arbitration provision were in an ordinary commercial contract, the court wrote, it would on its face have passed muster.  But, of course, unlike a vendor in a transaction, lawyers are fiduciaries.  And while all fiduciaries are held to duties of fairness, good faith and fidelity, the court said, “an attorney is held to an even higher degree of responsibility in these matters than is required of all others.”

According to the court, this ultra-high level of responsibility and the fact that it’s the lawyer who prepares the retainer agreement, means that the lawyer must make the disclosures necessary for the client to make informed decisions.  This duty, said the court, is expressed in New Jersey’s version of Model Rule 1.4(c), requiring lawyers to explain matters to the extent reasonably necessary to open the way to informed decision-making about the representation.

By virtue of their superior knowledge, lawyers are already thinking at the beginning of a representation about the “prospect that the client may be a future adversary,” and that leads lawyers to select the forum perceived to be most advantageous for resolving disputes, the court noted.  Calling that situation at least the “shadow” of a conflict, the court ruled that lawyers who insert arbitration requirements in their retainer agreements — either for fee disputes or legal malpractice claims — “must explain the advantages and disadvantages of the arbitral and judicial forums.”

ABA, courts weigh in

The court partly relied for its reasoning on the ABA’s Formal Op. 02-425 (Feb. 20, 2002) (“Retainer Agreement Requiring the Arbitration of Fee Disputes and Malpractice Claims”), which advised that binding arbitration provisions are permissible if the client “has been fully apprised of the advantages and disadvantages, and consented.”

The New Jersey Supreme Court opinion also helpfully collects cases and ethics opinions from around the country on the issue — and many of these jurisdictions bring their own twist (underscoring the need for you to be aware of your own bailiwick’s approach).

For instance, at one end of the spectrum is my own Buckeye State, where in Adv. Op. 96-9, the Board of Professional Conduct advised back in 1996, under former disciplinary rules, that a client retainer agreement “should not contain language requiring a client to prospectively agree to arbitrate legal malpractice disputes.”

Bottom line:  arbitration may be something you want to include in your retainer agreements, but you need to be savvy about complying with your jurisdiction’s requirements about client communication in order to create valid provisions.