Rice v. Downs

         [As modified June 23 and 28, 2016.]

         APPEALS from a judgment of the Superior Court of Los Angeles County, No. BC506921Yvette M. Palazuelos, Judge. Affirmed in part and reversed in part.

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         COUNSEL

         Glaser Weil Fink Howard Avchen & Shapiro, Michael Cypers, Julia B. Cherlow; Greines, Martin, Stein & Richland, Robin Meadow and Jeffrey E. Raskin for Plaintiff and Appellant.

         Shartsis Friese, Joel Zeldin, Frank A Cialone and Felicia A. Draper for Defendant and Appellant.

         Lui, J., with Chaney, Acting P. J., and Johnson, J., concurring.

          OPINION

          [203 Cal.Rptr.3d 558] LUI, J.

          William E. Rice and others^[1] sued Attorney Gary P. Downs for legal malpractice, breach of fiduciary duty, and breach of a written agreement Downs drafted to govern a limited liability corporation he formed with Rice and others. The trial court ordered Rice to arbitrate all of his claims pursuant to an arbitration provision in the written agreement. After arbitration, both Rice and Downs appealed, raising various contentions, including Rice's contention that the arbitration provision did not encompass his tort claims. We agree with Rice on this point and conclude the trial court erred by

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compelling arbitration of those claims. Accordingly, we partially reverse the judgment and conclude the other contentions on appeal are moot.

         BACKGROUND

         1. Allegations of Rice's complaint

         In April 2013 Rice filed a complaint in Los Angeles Superior Court alleging legal malpractice and other claims. (Super. Ct. L.A. County, No. BC506921.) The complaint [203 Cal.Rptr.3d 559] alleged that as of 2003, Downs and law firms in which he was a partner served as counsel for Rice, Kristoffer Kaufmann, and companies they were affiliated with. Rice, Kaufmann, and their companies did business in the affordable housing market. " Downs, Rice and Kaufmann decided they would form a company together to develop properties with affordable rents and government subsidies." To that end, Downs, acting as counsel for Rice, Kauffmann, and the new company, Highland Property Development, LLC (HPD), prepared an operating agreement and formed HPD. Downs entered into joint ownership of HPD with Rice and Kaufmann while still acting as counsel to them, but " neither Downs, nor any of the law firms in which he was a partner, advised Rice, Kaufmann or HPD with respect to actual or potential conflicts of interest, nor did they comply with California Rules of Professional Conduct, Rule 3-300."

         The operating agreement contained the following provisions relevant to this appeal: " Each member hereby consents to the exclusive jurisdiction of the state and federal courts sitting in California in any action on a claim arising out of, under or in connection with this Agreement or the transactions contemplated by this Agreement." " Except as otherwise provided in this Agreement, any controversy between the parties arising out of this Agreement shall be submitted to the American Arbitration Association for arbitration in Los Angeles, California." It further provided, " No Member or Affiliate of a Member, is entitled to remuneration for services rendered to the Company except as otherwise expressly provided for in this Agreement."

         In 2007, Douglas B. Day joined HPD as a fourth member. The complaint alleges that Downs, " again acting as counsel for all of the Plaintiffs," prepared an amended operating agreement for HPD and formed Highland Property Construction, Inc. (HPC), to contract for construction work on HPD projects. Downs, Rice, Day, and Kaufmann were the shareholders in HPC. " At no time did Downs, or the law firms of which he was a partner, advise of potential or actual conflicts, or comply with California Rules of Professional Conduct, Rule 3-300." The amended operating agreement contained the same terms regarding arbitration, jurisdiction, and compensation quoted above.

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         The complaint further alleges that pursuant to the compensation provisions in the operating agreement and the amended operating agreement, Downs was not entitled to bill HPD for time he spent working on HPD legal (or other) matters, and he was not entitled to " be personally compensated for any HPD related work performed by others at his law firm."

         The complaint further alleges that in 2012, based upon legal advice by Downs, Kaufmann was removed as a member and manager of HPD for cause. Kaufmann demanded arbitration, seeking a declaration that his removal was improper and he was still a member of HPD, along with damages and attorney fees. Downs arranged for a single attorney to represent himself, Rice, and Day in the Kaufmann arbitration, without disclosure or waiver of conflicts of interest.

         The complaint alleges that, as a result of the Kaufmann arbitration, Rice and Day " learned that Downs had been billing HPD, through his law firm, for his personal time in providing legal services, both with respect to internal HPD affairs, and with respect to the various projects, contracts and other activities of HPD, even though this was prohibited under the terms of the Operating Agreement. Rice, Day and Kaufmann were not aware of this previously" because the law firms sent non-detailed invoices that did not specify [203 Cal.Rptr.3d 560] the attorneys working on matters or the hours and billing rates of those attorneys. Rice and Day also " learned, for the first time, that Downs had ... also been sharing in overrides and/or bonuses from his law firm, as a billing partner, for HPD work done by other attorneys at the firm. When confronted with this disclosure, Downs became hostile, accused Rice and Day of breaching the Operating Agreement or attempting to rescind or modify it unlawfully by challenging the payments Downs had received for HPD related legal services, and Downs filed an arbitration demand against Rice and Day, making those same accusations."

         The complaint alleges Downs, acting as counsel for Rice, Day, Kaufmann, HPD, and HPC, committed legal malpractice by, inter alia, " failing to advise his clients of potential or actual conflicts, and obtain their informed consent before forming HPD and HPC, and drafting the Operating Agreements" ; " entering into business transactions with his clients, specifically the formation of HPD and HPC, and the preparation and execution of their Operating Agreements, without advising of the potential conflicts and without complying with California Rules of Professional Conduct, Rule 3-300" ; " placing his own interests above those of his clients, in part by drafting and structuring the Operating Agreement for HPD in a manner that, based on Downs' present contentions, was detrimental to his clients and beneficial to Downs" ; and " providing poor or incorrect legal advice and counseling with respect to the dispute with Kaufmann, resulting in exposure of HPD, Rice and Day to

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damages and litigation, including strategies premised on incorrect readings of the Operating Agreement, or ambiguities in the Operating Agreement drafted by Downs, and by arranging for a single attorney to represent Downs, Rice and Day without disclosing and obtaining informed consent to actual or potential conflicts."

         The legal malpractice cause of action also alleges five categories of deficiencies in the original and amended operating agreements and alleges that Downs " cost HPD and the plaintiffs hundreds of thousands of dollars of damages and extra expenses by deliberately interfering with pending transactions involving HPD which were being handled by Nixon Peabody [Downs's firm], in order to obtain personal gain at the expense of HPD and the other members. ... Downs caused the attorneys at Nixon Peabody to take actions that were detrimental to HPD and Plaintiffs, in an effort to coerce benefits for himself at the expense of his clients."

         The complaint further alleged Downs and Nixon Peabody (also a named defendant) owed a fiduciary duty to Rice and the other plaintiffs " by virtue of their relationship as attorney and client," which Downs and Nixon Peabody breached by, inter alia, " failing to disclose and obtain waivers of actual and potential conflicts between Downs and his law firms on the one hand, and the other members ... or ... HPD or HPC on the other hand" ; " by engaging in business transactions with clients without complying with the provisions of [California Rules of Professional Conduct,] Rule 3-300" ; and causing " the attorneys at Nixon Peabody to take actions that were detrimental to HPD and plaintiffs, in an effort to coerce benefits for himself at the expense of his clients."

         The complaint also asserted a breach of contract cause of action against Downs alleging that he breached the operating agreement " by secretly billing and being compensated for his own time" working on HPD matters and receiving " overrides or bonuses ... for the services provided by others in his firm." The complaint further alleged Downs and Nixon Peabody were [203 Cal.Rptr.3d 561] unjustly enriched by plaintiffs because Downs and Nixon Peabody were " paid attorneys fees that were not owed, and which Downs, individually, and as a partner of Nixon Peabody, had agreed would not be charged."

         Finally, the complaint sought rescission and restitution, alleging: " By virtue of Downs's legal malpractice, breach of fiduciary duty, his failure to comply with California Rules of Professional Conduct, Rule 3-300, and his failure to disclose and obtain informed consent with respect to actual and potential conflicts with his clients, Downs has improperly obtained benefits under the terms of the Operating Agreement and the Amended Operating Agreement of HPD. [¶ ] ... But for the breach of fiduciary duty, legal malpractice and other

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misconduct of Downs, he would not have obtained those benefits and would not have rights under the Operating Agreement. Based on the conduct of Downs, his rights under the Operating Agreement are rescinded, and he is obligated to pay restitution to Rice, Day and Kaufmann, specifically, his 25% share of all profits received from HPD and HPC."

         2. Downs's complaint

         The day after Rice's complaint was filed, Downs filed his own complaint in the Los Angeles Superior Court against Rice, Day, and Kaufmann. (Super. Ct. L.A. County, No. BC507050.) Downs sought declaratory and injunctive relief to void and prevent performance of a settlement agreement between Rice, Day, and Kaufmann.

         3.Trial court compels ...