Arbitration Clauses in Engagement Letters:
Be Careful What you Wish For
By Justin Fabella, Esq. and David Grossbaum, Esq.1
An engagement letter at the start of every representation is critical to avoid later misunderstandings. Some lawyers include arbitration clauses in these letters. The clauses come in different forms: some apply only to fee disputes, others include malpractice claims. Most states have strong statutory or other public policies favoring alternative dispute resolution, including arbitration.2 Before including such a provision, however, lawyers must have a thorough appreciation of the practical and legal limitations of arbitration, and state laws that may restrict the use of such clauses.
I. Pros and Cons of Arbitration
The primary advantage of arbitration is the time and costs savings over full scale civil litigation. While arbitration is certainly cheaper, it is not cheap. The parties to an arbitration usually must pay an administrative fee to the arbitration company, and must pay the hourly fees of the arbitrator. Discovery will be less expensive: the parties may only get to conduct written discovery, and the arbitrator may allow depositions only upon a showing of need. The rules of evidence are significantly relaxed, so this procedure is well-suited for clients who decide to forego a lawyer and where both parties want to present the "big picture." There are no appellate costs, because there is no right of appeal except in unusual circumstances, such as fraud by the arbitrator. Arbitrations also give the parties flexibility in choosing the location of the arbitration, and establishing a firm date for the hearings. These proceedings move along at a much faster pace than do court cases.
Arbitration is a less adversarial, less formal, less emotional, and essentially private proceeding. Thus, parties may be more willing and able to present their positions candidly, and to compromise their disputes without worrying about "losing face." This makes it more likely that the attorney and client can arbitrate without ending the relationship, at least where the dispute involves only the fee.
Many of the reasons that make arbitrations less expensive also make them more risky. Parties must select arbitrators from lists provided by arbitration companies. If the parties cannot agree on an arbitrator, the company can select one on its own. For small disputes, only one arbitrator will decide the case, and there will be no appeal just because someone disagrees with the decision or thinks the arbitrator made a mistake of law. Giving up the right to engage in broad discovery can make it difficult to fully develop certain defenses to a client's claim. Moreover, arbitrators are very unlikely to grant dispositive motions.
Another important consideration is that most professional liability policies specifically reserve to the insurer the right to decide if a covered claim should be arbitrated. If an insured agrees in advance to arbitration without first getting the consent of the insurer, this could jeopardize coverage. Be sure to consult the insurer before inserting an arbitration clause that will apply to malpractice claims.
II. Arbitrating Fee Disputes
The most common form of arbitration clause applies only to fee disputes, and these are less likely to run afoul of ethical constraints and constitutional provisions. Indeed, many jurisdictions have gone to, or are leaning toward, some system for arbitration of fee disputes, regardless of what the engagement letter says. Most of these programs fall into one of two types: where the lawyer and the client voluntarily agree to go to fee arbitration, and where the client can compel the lawyer to go to fee arbitration, but the lawyer cannot make the client do so.
With the exception of Ohio, all courts and ethics panels that have considered the issue allow lawyers to condition their engagement on a client's agreement to go to fee arbitration. Moreover, the American Bar Association has approved these clauses, and has even issued Model Rules for Fee Arbitration. ABA Ethics Committee, Formal Ethics Opinion 02-425. In about a dozen states, neither the courts nor the ethics panels have yet to address this issue.
The question arises as to the lawyer's obligation to explain the arbitration provision to the client, including the benefits and limits of arbitration, and even advise the client to seek independent counsel before agreeing to the arbitration clause. This concern arises generally from the fiduciary nature of the lawyer-client relationship and from ABA Model Rule 1.8(a) and similar state rules, which apply whenever a lawyer enters into a business relationship with the client. These rules require that the terms of the relationship are "fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner which can be reasonably understood by the client" and the client is given the chance to "seek the advice of independent counsel." It may be necessary, for example, to tell the client that he or she is waiving a right to a jury, the ability to conduct full discovery, the right to have a decision-maker who is bound by the law and who will issue a written decision, and the right to an appeal, and to tell the client that he or she will have to pay a portion of the arbitration fees. These requirements are more likely to be enforced where the arbitration clause includes legal malpractice claims, but lawyers should consult state ethics law to determine their obligations even where the clause only applies to fee disputes. Get the consent in writing, even if not technically required.
III. Arbitrating Legal Malpractice Claims
If a lawyer wants to force a client to arbitrate legal malpractice claims, greater restrictions will likely apply. Nonetheless, many states (about 20) specifically allow such clauses. In some states the issue is still undecided, with Ohio barring such clauses. In states that allow such clauses, a number require that the client actually receive independent advice, not just be given the opportunity to obtain such advice.
Still further, if the lawyer tries to make the clause too one-sided, this may result in the entire clause being stricken. For example, a Louisiana court recently found that the arbitration provision in a fee agreement was not fair and reasonable because it only required that the client's disputes, and not the attorney's, be arbitrated and also shifted the responsibility to pay for the arbitration proceedings to the client. See Lafleur v. Law Offices of Anthony G. Buzbee, P.C., 960 So. 2d 105 (La. Ct. App. 1st Cir. 2007).
The lawyer must also consider whether the arbitration provision in the fee agreement attempts to limit the lawyer's liability, which can result in an ethical violation. In that regard, the ABA Model Rule 1.8(h) states that "[a] lawyer shall not make an agreement prospectively limiting the lawyer's liability to a client for malpractice unless permitted by law and the client is independently represented in making the agreement,..." Thus, if the clause (or the state law as to arbitration generally) limits the remedies available to the client as compared to those available in traditional litigation, such as precluding an award of attorneys fees or punitive damages, this could be a violation of Rule 1.8(h). On the other hand, a simple arbitration clause may be upheld, because "arbitration is a procedure to decide the extent of liability and does not limit that liability." See Mallen & Smith, Legal Malpractice (2009 ed.) § 2:50, pgs. 391-392 (internal citations omitted).
The decision to include an arbitration provision in an engagement letter is a significant and important one. While there may always be a lawyer-client dispute that is better litigated than arbitrated, if after careful consideration the lawyer determines that most of the potential claims are better suited for arbitration, then such clauses can be important tools of risk management resulting in the preservation of client relationships and significant cost savings. As the laws in each state differ, a lawyer needs to consult the applicable cases, statutes and ethical rules and opinions.
1Justin Fabella and David Grossbaum are attorneys with the law firm of Hinshaw & Culbertson LLP. Justin is admitted in Massachusetts and New York and David is admitted in Massachusetts and Rhode Island. Both of them concentrate their practices in the areas of legal malpractice defense and risk management. Justin can be reached at 617-213-7004 and at firstname.lastname@example.org and David can be reached at 617-213-7003 and 401-751-0842 and at email@example.com.
2The authors would like to thank Anthony E. Davis, Esq. and David J. Elkanich, Esq., both partners at Hinshaw & Culbertson LLP, who provided very helpful source materials.
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