In a highly anticipated decision concerning attorney-client conflicts, the California Supreme Court on Thursday found that the burden is on law firms to identify and disclose ongoing conflicts to potential clients.

The underlying case, Sheppard, Mullin, Richter & Hampton v. J-M Manufacturing Company Inc., pits the parties—an Am Law 100 law firm and the world's largest plastic pipe-maker—against each other in a fight over millions of dollars in legal fees. But beyond the dollars at stake, the case has become something of a proxy fight between corporate clients who demand firm loyalty and large law firms which look broadly to generate more business.

In Thursday's decision, the court found that Sheppard Mullin failed to inform J-M that it had an ongoing relationship with a municipality that was party to a whistleblower the firm was hired to handle.

“Simply put, withholding available information about a known, existing conflict is not consistent with informed consent,” wrote Justice Leondra Kruger, in a partially divided opinion.

“No matter how large and sophisticated, a prospective client does not have access to a law firm's list of other clients, and cannot check for itself whether the firm represents adverse parties,” Kruger wrote. “In any event, clients should not have to investigate their attorneys.”

J-M's appellate counsel, Kent Richland of Greines, Martin, Stein & Richland, said Thursday that ruling makes it “absolutely crystal clear” that, “If a law firm has an information about an ongoing conflict, it has a total and complete obligation to disclose that to the client or potential client.”

“There are no exceptions to that rule,” he added.

Richland's client refused to pay Sheppard Mullin over $1 million in legal fees after the firm was disqualified from the whistleblower litigation after the city of South Tahoe—for whom the firm had worked on employment matters—raised the issue with the court. Sheppard Mullin sued J-M in 2012 and routed the case to arbitration, where it was awarded $1.3 million in outstanding fees.

The Second District Court of Appeal, however, turned the tables on the firm in January 2016. The court found that, because of the undisclosed conflict, Sheppard Mullin had not only forfeited its claim to the unpaid fees, but also must disgorge $2.7 million already received from J-M.

Although Thursday's California Supreme Court decision sided with J-M on the waiver issue, the court found that “the ethical violation does not categorically disentitle the law firm from recovering the value of the services it rendered to the manufacturer.” The court routed the case back to the trial court to determine “whether principles of equity entitle the law firm to some measure of compensation” for its work for J-M.

The court, however, put the burden on the law firm to show that its ethical breach was “neither willful nor egregious” and that its conduct wasn't so potentially damaging to warrant “a complete denial of compensation.”

“Although the law firm may be entitled to some compensation for its work, its ethical breach will ordinarily require it to relinquish some or all of the profits for which it negotiated,” Kruger wrote.

The firm's lawyer, Kevin Rosen of Gibson, Dunn & Crutcher, said in an emailed statement that the firm previously has been found to have acted in “good faith” by an arbitration panel and the trial court below and anticipates a similar outcome on remand. “Indeed, J-M stipulated that it had no issues with 'the value or quality of Sheppard Mullin's work,'” Rosen said. “As such, we fully expect that the undisputed quality and value of Sheppard Mullin's work, based on effective and laudable advocacy for J-M in the qui tam action, will be confirmed once again.”

Large firms and their clients alike were awaiting Thursday's decision. Matt Fawcett, the general counsel of NetApp, who has kept tabs on the case, said the court “punted” on an opportunity to weigh in on the validity of “blanket” forward-looking waivers that law firms often ask potential clients to sign.

“That's a potentially pernicious issue that really deserves some guidance,” Fawcett said, adding that he was “disappointed” the court took a “gray area approach” to the question of whether the firm was due any compensation from the conflicted engagement. Fawcett said he liked the “bright line” approach endorsed by the partial dissent and partial concurrence written by Justice Ming Chin and joined by Chief Justice Tani Cantil-Sakauye which held the firm was owed no fees due to the undisclosed conflict.

Sean SeLegue, a San Francisco partner with Arnold & Porter Kaye Scholer, agreed with Fawcett that the court sidestepped “an important part of the case” by avoiding weighing in on the advance waiver. But he did say that it did provide some important guidance to law firms.

“It's important to take conflicts into account at the beginning of a matter,” SeLegue said. “The violation of the conflicts rules at the time of the engagement can void the entire agreement.”

Read the decision:

Read more: