A novel legal issue involving arbitration clauses in engagement letters arose in federal court in Philadelphia on Monday as a judge weighed whether to send a legal malpractice case against Bracewell & Giuliani to arbitration in New York.

The plaintiffs in Sanford v. Bracewell & Giuliani questioned whether arbitration clauses in engagement letters between clients and attorneys were violative of public policy, and more specifically, whether the clause in plaintiffs Craig and Mary Jo Sanford’s engagement letter with the firm fully informed the couple what they were giving up by agreeing to arbitration.

"This is a case of first impression not only in Pennsylvania but in the Third Circuit," said U.S. District Judge Joel H. Slomsky of the Eastern District of Pennsylvania.

But before the judge could rule on the issue, confusion arose as to whether the Sanfords ever signed the engagement letter in question.

Though the complaint alleges the parties entered an engagement agreement in September 2009, the version in the record wasn’t signed by the Sanfords and Craig Sanford testified Monday first that he never saw or signed the agreement and then that he signed only a signature page months after he paid the firm a $50,000 retainer fee.

Steven M. Schneebaum of Fox Rothschild, one of the attorneys representing Bracewell, said he had a signed copy of the engagement letter signed in December 2009. He said he didn’t think to bring it with him to the hearing because the Sanfords agreed in their complaint that they entered an engagement agreement.

Slomsky continued the hearing to allow Schneebaum to supplement the record with the signed agreement and bring a witness to testify to its authenticity. The Sanfords’ attorney, Clifford E. Haines of Haines & Associates, will be given the chance to cross-examine that witness.

Haines argued there was no dispute that the Sanfords had a contractual relationship with Bracewell. He said the question for Slomsky to answer was whether the couple was fully informed of what it was giving up by agreeing to an arbitration clause. Haines relied on a 2012 Louisiana Supreme Court case, Hodges v. Reasonover, in which the court ruled an arbitration clause violates ethical rules on duty of candor and loyalty if it doesn’t enumerate seven factors a client is waiving by agreeing to arbitration.

Slomsky read through those factors with Schneebaum and noted only three or four of the seven were addressed in Bracewell’s standard engagement letter.

The letter included mention, for example, that the Sanfords would give up their right to a jury trial, would not be able to appeal an arbitrator’s ruling and that they should seek outside counsel before signing the engagement letter.

Schneebaum noted the American Bar Association’s ethics opinion on the issue says only that an engagement letter must not limit the liability of the lawyer. He also noted the Philadelphia Bar Association required a clear waiver of a jury trial, the client be advised to seek outside counsel and that there is consent from the client in writing. Schneebaum said all three of those criteria were met in this case. He added Hodges was not controlling in this case, noting further that it was a decision only by the plurality of the Louisiana court.

There was also a dispute as to whether the language in Bracewell’s engagement letter was not clear as to what disputes were covered by arbitration.

The letter states the parties agree "’any controversy, dispute or claim, including any dispute as to B&G’s fees for legal services,’" will be resolved by arbitration in New York. The Sanfords argued that meant only fee disputes should go to arbitration under the agreement.

Slomsky asked Schneebaum why Bracewell wasn’t more "upfront" with what was covered by the agreement, "instead of using this broad language to throw a client off." He asked why specific types of legal matters, such as malpractice, weren’t specifically listed in the letter. Schneebaum said he wasn’t there to argue it was the best written engagement letter, but he said it was clear it covered the controversy at issue.

Haines said he took issue with arbitration clauses in engagement letters because they took away a private citizen’s right to a trial by jury. Haines said it was particularly "reprehensible" in this case because in order to win a legal malpractice case, the Sanfords would have to prove the underlying claim Bracewell was hired to take on would have been meritorious as well. In order to do that, Haines said, he would have to depose people in Virginia and other jurisdictions.

"We can’t prove our case in arbitration," he said, adding that effectively limits the liability of the Bracewell lawyers.

Bracewell was sued in the Bucks County Court of Common Pleas on February 15 by the Sanfords, who allege the firm didn’t do enough to recover the lost proceeds of the sale of their business, which was more than $12.5 million. Bracewell removed the matter to federal court the following month and its next filing was a motion to stay the matter pending arbitration.

The Sanfords pointed out in a response that the law firm hadn’t asked for arbitration, just a stay of the litigation pending a yet-to-be-filed motion for arbitration. Schneebaum said it was up to the plaintiff to compel arbitration if the litigation is stayed. He said the stay would remain in effect as a reminder the Sanfords had agreed to arbitration as part of their engagement letter until such time that the Sanfords compelled arbitration.

According to the complaint, the Sanfords owned and operated a medical waste disposal business. In 2005, the Sanfords sold the company for more than $14 million, ultimately leaving the couple with more than $12.5 million in U.S. bank accounts.

In 2007, the Sanfords met Jamie Smith, an apparent well-known international security expert, former Navy SEAL and CIA operative, and owner and CEO of SCG International LLC. The Sanfords said in their complaint Smith represented he had the knowledge and experience to move the Sanfords’ money offshore.

Under the terms of the deal, according to the complaint, Smith would hold the Sanfords’ money in a secured account and the Sanfords would earn interest on it. The money was to be returned May 27, 2009, according to the complaint.

In the spring of 2009, Sanford began receiving letters from an attorney for Smith who said the $12.5 million had not performed well in the market and that Smith wanted to reach a new payback agreement, according to the complaint.

Sanford insisted he didn’t "invest" his money and demanded a return of the full $12.5 million. When the note came due in May 2009, the Sanfords did not receive their money, according to the complaint.

Craig Sanford spoke of his situation to his neighbor in the Pocono Mountains, who happened to be a Bracewell partner.

Bracewell agreed to represent the Sanfords, who paid the firm $50,000, they said in the complaint. New York white-collar defense partner Jonathan N. Halpern entered the engagement agreement with the Sanfords in September 2009, according to the complaint. By March 2010, the parties agreed to terminate the representation and the file was returned to the Sanfords a month later, according to the complaint.

The Sanfords said in their complaint that Bracewell purportedly investigated the return of the couple’s $12.5 million. But the Sanfords said the work was "incomplete, inconclusive and inadequate to accomplish the goals" of the Sanfords. According to the complaint, Bracewell took "no steps" to locate or recover the Sanfords’ money.

But according to an attorney for Bracewell, the firm accomplished what it was hired to do.

Bracewell is being represented by Fox Rothschild attorneys Abraham C. Reich, Peter C. Buckley and Schneebaum.

"The goals for which the firm was hired were accomplished and that’s why the representation terminated," Buckley said at the time the matter was removed to federal court. "The firm was not hired to file litigation, just to investigate and tee up the next steps and when that next step was determined to be a lawsuit in Virginia where B&G doesn’t have an office" the firm connected the Sanfords with a former Bracewell attorney in Virginia who proceeded with a lawsuit against Smith.

The Sanfords were successful in getting a $9.5 million judgment against Smith in the Virginia litigation. In November 2012, the U.S. Court of Appeals for the Fourth Circuit upheld that judgment.

Gina Passarella can be contacted at 215-557-2494 or at gpassarella@alm.com. Follow her on Twitter @GPassarellaTLI.