Recently, the Ninth Circuit Court of Appeals issued a decision that calls to task the unethical behavior of class counsel. As a result, class counsel was denied some of its fees and a serious blow to the legitimacy of incentive agreements was dealt.

In the consolidated case of Rodriguez vs. Disner, case no. 10-55309 (9th Cir.), the court held that due to the inherent conflict of interest created by the incentive agreement in place between the McGuireWoods law firm as class counsel and select class members, it would award neither incentive compensation to the select class members nor incentive fees to McGuireWoods.

The case arose out of an antitrust class action law suit brought by the plaintiffs against West Publishing (owner of BAR/BRI) and Kaplan. The plaintiffs alleged that these two defendants conspired to prevent competition and wrongfully monopolize the full-service bar review course market, all in violation of applicable federal law. Shortly before trial, the allegations were resolved and the case was settled. West Publishing and Kaplan agreed to pay $49 million into a settlement fund, with 25 percent of that amount set aside for attorneys’ fees.

The twist here is that the original class counsel, Van Etten Suzumoto & Becket LLP (which later merged with McGuireWoods LLP), had entered into incentive agreements with five of the plaintiffs. Pursuant to these agreements, the law firm would apply for additional compensation for these plaintiffs, together with the concomitant attorneys’ fees. Per the terms of the agreement, the law firm would seek incentive awards upwards of $75,000 per plaintiff.

Many of the other class members objected to this preferential treatment for the five plaintiffs. As a result, the court declined to approve the incentive awards (totaling $325,000) for these class representatives, stating that such incentive agreements (1) created an appearance of impropriety, (2) potentially violated ethics rules pertaining to fee-sharing with non-lawyers, and (3) created a conflict of interest between the class representatives and other class members. Following suit, the court also denied McGuireWoods’s application for additional fees based upon the incentive awards.

In upholding the lower court’s decision to deny McGuireWoods its fee request, the court discussed at length the equitable principles associated with an attorney’s entitlement to fees, particularly when ethical violations are present. The court noted that in California, courts have routinely affirmed decisions to deny attorneys’ fees where there is an actual conflict of interest. However, where there is only potential for a conflict of interest, the courts in California looked closer at the equities in play. California courts have upheld the notion that it is appropriate to look at the gravity of the potential conflict of interest, together with its timing, its willfulness, its effect upon the quality of the lawyer’s work and the actual harm to the client. Ultimately, the most critical factor is the egregiousness of the violation.

Building on that, the Ninth Circuit held that in common fund class action cases, the application of such equitable principles must be more carefully applied. Recognizing that class counsel serves as a fiduciary for an entire class of plaintiffs, one key determination is whether or not the conflicted attorneys have properly fulfilled their duties of loyalty to all of the members of the class, not just a select few. While conflicts of interest may arise between individual class members, it is a different matter when the conflict arises at the behest of class counsel.

On the issue of incentive agreements, the Ninth Circuit reaffirmed its prior ruling that incentive agreements create an actual conflict of interest between the incentivized class members (together with class counsel) and the non-incentivized class members. The court noted that such agreements create a disincentive to go to trial. Since the incentive award agreement was predicated upon hitting certain milestones, once a potential milestone was reached, the financial “incentive” actually acted as a financial “disincentive” to pursuing the case to its proper conclusion. The court noted that going to trial would put the achieved incentive at risk in return for only a marginally more significant individual gain, even if the verdict were significantly greater. As a result, this places parties who are supposed to be united at odds with each other.

By contrast, the court ruled that it was appropriate for those class members who first brought the conflict of interest to light, and objected to it, to be awarded their attorneys’ fees for their work associated with the issue.

The Ninth Circuit has made it clear that incentive agreements for plaintiffs are simply unacceptable. For lawyers, they can be unethical.