BANKRUPTCY

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        Federal bankruptcy law is unique among all bodies of substantive law.  It has superimposed upon the bankruptcy practice conflict-of-interest concepts that are quite removed from conflicts rules that apply to every other body of law.  One seemingly innocuous sentence has spawned dozens of cases, numerous law review articles, and little agreement about what it means or whether it should be changed.  We are referring to 11 U.S.C. § 327(a), which provides in part:

[T]he trustee, with the court's approval, may employ one or more attorneys, . . . that do not hold or represent an interest adverse to the estate, and that are disinterested persons . . . .

(Similar language appears at 11 U.S.C. § 328(c) with respect to compensation of committee representatives.)

        11 U.S.C. § 1107(a) provides that a debtor-in-possession (DIP) shall have the rights and duties of a trustee, so § 327(a) also applies to lawyers hired by DIPs.  A "disinterested person" is defined at § 101(14).  "Interest adverse to the estate" is not defined.

        To get an idea about the complexity that these concepts introduce into the bankruptcy practice, consider that a leading - and very concise - law review article discussing them is 110 pages long.  Gerald K. Smith, Conflicts of Interest in Workouts and Bankruptcy Reorganization Cases, 48 S.C.L. Rev. 793 (1997).  Mr. Smith, a bankruptcy practitioner with a Phoenix law firm, discusses not only the cases construing the above provisions but also the struggles to get Congress to amend the law and to get the drafters of the Restatement to deal with these concepts in a useful way.  He also discusses the interplay between state ethics rules and the concepts introduced by §§ 327 & 328.

        Mr. Smith points out tellingly that none of the recognized treatises on legal ethics attempts to sort out the conflicts principles applicable to bankruptcy law.  We are no better and will attempt little more.  What follows are sources that anyone with a bankruptcy conflicts issue might find helpful.  While we will not attempt a survey of the law in this area, this site will report significant new cases and helpful articles as they appear in the future.

        Volume 18 of the Miss. C.L. Rev., published in 1998, contains a series of articles explaining attempts to change the law, describing attempts to get the American Law Institute to deal with these issues in the Restatement, and describing the debate over whether the "disinterestedness" standard should be abandoned.  The articles are as follows: Todd J. Zywicki, Mend It, Don't End It: The Case for Retaining the Disinterested Requirement for Debtor in Possession Professionals, 18 Miss. C.L. Rev. 291 (1998); Gerald K. Smith, Standards for the Employment of Professionals in Bankruptcy Cases: A Response to Professor Zywicki's "Case for Retaining the Disinterested Requirement for Debtor in Possession's Professionals," 18 Miss. C.L. Rev. 327 (1998); Charles W. Wolfram, The Boiling Pot of Lawyer Conflicts in Bankruptcy, 18 Miss. C.L. Rev. 383 (1998); and Todd J. Zywicki, Of Bubbling Pots and Bankruptcy Ethics: A Comment on Wolfram and Smith, 18 Miss. C.L. Rev. 399 (1998).

        The Wolfram article contains a refreshingly candid description of how the Restatement wound up not dealing with conflicts in the bankruptcy practice at all.  It reminds one of the "making sausage" simile applied to legislation.

        Other Articles.  Kohn, Shuster & Powar, Deciphering Conflicts of Interest in Bankruptcy Representation: An Update, 105 Commercial L.J. 95 (2000); Richman, Multiple Clients in Bankruptcy Cases: When Do You Need Consent?, 21 Am. Bankr. Inst. J. 14 (March 2002).

        "Actual" Versus "Potential" Conflicts.  This is a rubric found in the bankruptcy cases.  The only other practice area where those concepts are used is the criminal practice.  R. Craig Smith, Conflicts of Interest under the Bankruptcy Code: A Proposal to Increase Confidence in the Bankruptcy System, 8 Geo. J. Legal Ethics 1045 (1995) discusses four kinds of cases in dealing with "actual" versus "potential" conflicts: (1) cases that would disqualify or punish firms for actual conflicts only; (2) a case recognizing that a potential conflict, if significant enough, might cause a disqualification; (3) cases that find both actual and potential conflicts disqualifying; and (4) cases that recognize a  rebuttable presumption that potential conflicts are disqualifying.

        (1) Only Actual Conflicts Disqualify.  In re The Leslie Fay Companies, Inc. 175 B.R. 525 (S.D.N.Y. 1994); In re: Global Marine, Inc., 108 B.R. 998 (S.D. Tex. 1987); In re: Waterfall Village of Atlanta, Ltd., 103 B.R. 340 (N.D. Ga. 1989); and In re: Stamford Color Photo, Inc., 98 B.R. 135 (D. Conn. 1989). 

        (2) Potential Conflicts Might Disqualify.  In re: Martin, 817 F.2d 175 (1st Cir. 1987).

        (3) Both Actual and Potential Conflicts Disqualify.  In re: Kendavis Ind. Int'l., Inc., 91 B.R. 742 (N.D. Tex. 1988); and Roger J. Au & Son, Inc. v. Aetna Ins. Co., 64 B.R. 600 (N.D. Ohio 1986).

        (4) Presumption that Potential Conflicts Will Disqualify.  In re: BH&P Inc., 949 F.2d 1300 (3d Cir. 1991); and In re: American Printers & Lithographers, Inc., 148 B.R. 862 (N.D. Ill. 1992).

       A more recent article that discusses bankruptcy conflicts in the context of a helpful hypothetical and that cites more recent cases is Arthur J. Gonzalez, Conflicts of Interest and Other Ethical Issues Facing Bankruptcy Lawyers: Is Disinterestedness Necessary to Preserve the Integrity of the Bankruptcy System?, 28 Hofstra L. Rev. 67 (1999).

        Fee Forfeitures for Violations.  11 U.S.C. 328(c) provides that violations of bankruptcy conflict rules can result in fee forfeitures.  These are discussed, and the cases are cited, at the page entitled, "Malpractice Liability/Fee Forfeitures."  To go there, click here.

Recent Cases
(post May 2000)

        $13 Million Fee Forfeiture from Conflict.  In re Congoleum Corp., 03-51524 (D.N.J. Feb. 7, 2006).  This is taken from the February 13, 2006, online edition of the New Jersey Law Journal.  A bankruptcy judge ordered 45-lawyer Gilbert Heintz & Randolph LLP to forfeit some $13 million in fees for failure to disclose all its relationships to the various parties when it was retained as “special insurance counsel” for the debtor.  The relationships are complex, and we will not go through them here.  The lessons are clear enough.  The case was on remand from the Third Circuit, In re Congoleum, 426 F.3d 675 (3d Cir. 2005).

        On the Role of Examiners.  In re: Big Rivers Electric Corp., 355 F.3d 415 (6th Cir. 2004).  This is a very large Chapter 11 Bankruptcy proceeding.  The bankruptcy court appointed an examiner, one of whose tasks was to see if he could resolve disputes among the creditors and other parties.  The examiner, a lawyer, identified ways to enhance the estate, and, according to the court, he was successful.  But, he secretly attempted to cut a deal with three creditors for a percentage of any recovery they might realize from the estate.  Two creditors rebuffed his overture.  A third ultimately agreed.  The opinion (and the story) is a long one.  The Sixth Circuit affirmed the district court’s ruling that the examiner must forfeit his entire fee of approximately $1 million.  The opinion is a comprehensive discussion of the role and obligations of bankruptcy examiners, including, importantly, his/her obligation to remain “disinterested.”

        Differences between General Counsel under § 327(a) and Special Counsel under § 327(e).  In re Running Horse, L.L.C., 371 B.R. 446 (E.D. Cal. 2007).  Debtor sought to retain Lawyer as “special counsel” to the estate under § 327(e) of the Bankruptcy Act.  In this opinion the court denied the application.  The court felt that the duties described for Lawyer were too close to those prescribed in § 327(a).  Because that section requires that the lawyer be “disinterested,” and because Lawyer represented other parties involved, Lawyer was not qualified to serve in the designated role.  [Note: the opinion is a pretty good description of the differences between lawyers acting as “general counsel” and “special counsel.”]

        Structuring Role as Counsel for Unsecured Creditors Committee to Avoid Conflict Claims.  Exco Resources, Inc. v. Milbank, Tweed, Hadley & McCloy LLP (In re Enron Corp.), 2003 U.S. Dist. LEXIS 1442 (S.D.N.Y. February 3, 2003).  Milbank was hired as counsel for the official Committee of Unsecured Creditors in the Enron bankruptcy.  One of the creditors of the estate, Exco, moved to disqualify Milbank.  The bankruptcy judge denied the motion, and in this opinion, the district judge affirmed.  Exco predicated its motion on the many relationships Milbank had, and has, with entities having interests in Enron, Enron affiliates, and the Enron estate.  The motion also claims that Milbank’s disclosures regarding these relationships were not adequate.  These relationships are too complex to detail here.  In denying the motion, the court did an analysis of the disclosure requirements of Bankruptcy Rule 2014(a), and the conflict-of-interest provisions of 11 U.S.C. §§ 101, 327, 328 & 1103.  The court also approved of a system using “ethical walls” and conflicts counsel to monitor situations that might require employment of other counsel.

        Debtor's Counsel: What if Clients Are Creditors?  ABCNY Op. 2005-1 (Jan. 2005).  This opinion deals with pro bono representation of individuals filing Chapter 7 proceedings.  The interesting conflict-of-interest discussion is whether a lawyer can do this if several of his other clients are listed as creditors.  The opinion says this is not a conflict unless and until the creditor takes some action in the case, such as objecting to the debtor’s discharge.

         Debtor's Counsel Taking Stock in Lieu of Fee.  In re: ALTA+CAST, LLC, 2004 Bankr. LEXIS 222 (March 2, 2004).  In this Chapter 11 proceeding the debtor did not have enough cash to pay debtor’s counsel.  Debtor’s counsel agreed to take stock in the debtor as part of his fee.  The court held that this arrangement did not render debtor’s counsel not disinterested.

        Debtor's Counsel Denied Fees for Failure to Disclose Intent to Invest in Debtor.  In re West Delta Oil Co., Inc., Debtor, 432 F.3d 347 (5th Cir. 2005).  Debtor’s special counsel had, at some point, considered being part of an investor group to put money into debtor.  That apparently never happened.  They did not disclose this relationship to the court when they were retained to represent the debtor.  Nevertheless, and over the objection of one of the parties, the Bankruptcy Court allowed their fees.  The district judge affirmed, pointing out that a conflict does not mandate denial of fees and that the Bankruptcy Court did not abuse its discretion in allowing the fees.  In this opinion the Fifth Circuit reversed.  The opinion contains a lengthy analysis of the conflict rules as they apply to debtor’s counsel.

         Lawyer Taking Real Estate in Lieu of a Fee Just Prior to Filing.  In re Wentzell, 656 N.W.2d 402 (Minn. 2003).  Lawyer disciplinary proceeding.  Just prior to his client’s filing for bankruptcy, the lawyer had the client convey property to the lawyer in payment of fees the client owed the lawyer.  The lawyer was disciplined because his disclosures to the bankruptcy court were inadequate and because of misstatements the lawyer made in connection with the conveyance.  [Note: we have been asked by law firms about taking real estate from nearly-insolvent clients in payment of fees.  While it certainly may be possible, it should be done extremely carefully, with due regard for the law of preferences, fraudulent conveyances, and the bankruptcy disclosure rules for conflicts of interest.]

        Lawyer/Creditor May not Represent Chapter 12 Debtor.  In re Brown, 354 B.R. 535 (N.D. Okl. 2006).

        In re Development Corp. of Plymouth, 283 B.R. 464 (E.D. Mich. 2002).  A law firm represented party A in suing Party B and obtained a $2.4 million verdict on behalf of A.  B filed a Chapter 7 bankruptcy proceeding.  The trustee for B's bankruptcy estate applied to retain A's law firm to represent the trustee in pursuing actions against various defendants.  Parties to the bankruptcy objected, claiming the law firm had a conflict under 11 U.S.C. § 327(a).  The court approved the firm's retention saying that the firm's interest in collecting A's judgment was entirely consistent with the trustee's attempts to enhance the estate via the new suits.

        In re Pillowtex, 304 F.3d 246 (3d Cir. 2002).  The district court had approved retention of debtor’s counsel over the objection of the U.S. Trustee.  The debtor had paid the law firm about $1 million in fees, in several installments, within the 90 days prior to the bankruptcy filing.  The Trustee claimed that at least some of the payments were avoidable preferences and that the law firm could not claim that it was “disinterested.”  The law firm proposed that the district court approve its retention on condition that if any payments were later proved to be preferential, the law firm would reimburse the estate.  The Third Circuit reversed the district court and remanded for a determination whether, in fact, any of the payments were preferential.

        Incomplete Affidavit under Rule 2014 not Cured by other Filings.  In re Jennings, 2006 U.S. App. LEXIS 24746 (11th Cir. Oct. 4, 2006).

        In re Pittsburgh Corning Corp., Debtor, 308 B.R. 716 (W.D. Pa. 2004).  This was an opinion and order denying an application to appoint a law firm as special counsel to a creditors’ committee.  The relationships are complex and not worth detailing here.  Suffice it to say, it is a wide-ranging discussion of the law dealing with law firms that may be perceived to be changing sides in the context of insurance representations.

        Tevis v. Wilke, Fleury, Hoffelt, Gould & Birney, LLP, 347 B.R. 679 (B.A.P. 9th Cir. 2006).  The court found that trustee’s counsel was not disinterested because the debtors had earlier interviewed the law firm about representing them.

        ICM Notes , Ltd. v. Andrews & Kurth, L.L.P., 278 B.R. 117 (S.D. Tex. 2002).  Andrews & Kurth represented the debtor in possession.  ICM Notes was formed to purchase notes held by a creditor, NationsBank.  NewCorp was formed to purchase certain assets of the debtor in possession.  Andrews & Kurth made certain demands regarding funds for administrative expenses, and the sale never occurred.  ICM Notes sued Andrews & Kurth for breach of fiduciary duty to it and for tortious interference with the sale contract.  Andrews & Kurth moved for summary judgment.  After a lengthy analysis the court held that counsel for the debtor in possession can owe no fiduciary duty to a specific creditor and granted that part of the motion.  The court held that there was some evidence to support the tortious interference claim and allowed it to stand.

        Stanley v. Keravision, Inc. (In re Keravision, Inc.), 273 B.R. 614 (N.D. Cal. 2002).  The court held that a law firm could serve as debtor’s counsel even though one of the partners had been the bankrupt’s corporate secretary until three months before the filing.  The court held that the law firm was not thereby “not disinterested,” within the meaning of 11 U.S.C. § 327(a). 

        In re Andover Togs, Inc., 2001 U.S. Dist. LEXIS 2690 (S.D.N.Y. 2001).  This case involves whether the Debtor can hire an accounting firm.  Of the three issues, two would also apply to lawyers.  The accounting firm was an unsecured creditor of the Debtor for pre-petition work.  The Debtor sought to retain the accounting firm to complete an audit it had already begun, relying upon 11 U.S.C. §§ 327(e), 105(a) & 1107(b).  The court said no.  First, the court held 11 U.S.C. § 327(e) applies only to lawyers, not to accountants.  Second, the court held that the Debtor could not rely on the catchall provisions of 11 U.S.C. § 105(a), because 11 U.S.C. § 327(e) is "specific and unambiguous."  Last, the court held that no professional could be hired pursuant to 11 U.S.C. § 1107(b), if the professional was "not disinterested."  An unsecured creditor is not disinterested.  See KLM, below.

        In re Doctors Hospital of Hyde Park, Inc., 2001 U.S. Dist. LEXIS 2051 (E.D. Ill. 2001).  Unsecured creditors committee sought to employ American Express as accountants and financial advisors.  Among other things, they were to consult regarding a possible claim against a physician.  The physician objected to the retention of American Express, because a low-level accountant at American Express had once worked on the physician's tax returns.  When American Express found out about this relationship, it erected a screen around the accountant.  The court overruled the objection and allowed the retention of American Express.  The court cited only one case, In re Capen Wholesale, 184 B.R. 547 (N.D. Ill. 1995), in which the court refused to disqualify a lawyer under similar circumstances.

        In re Water's Edge Limited Partnership, 251 B.R. 1 (D. Mass. 2000).  The court allowed a law firm to represent the debtor in possession even though the law firm had earlier briefly represented an individual who had attempted to gain control of the debtor in possession.  

         In re LKM Industries, Inc., 252 B.R. 589 (D. Mass. 2000).  The court held that the debtor in possession could not hire an accountant who was a creditor of the estate by virtue of his pre-petition work for the debtor.  The court said:

I conclude that § 1107(b) excludes only previous employment, and not a debt arising therefrom, as cause per se for disqualification. . . By virtue of the debt [the accountant] is a creditor and therefore not a disinterested person.

To the same effect is In re PHP Healthcare Corp., 2002 Bankr. LEXIS 449 (D. Del. May 7, 2002).

        Kittay v. Kornstein, 230 F.3d 531 (2d Cir. 2000).  This case dealt with a conflict not unique to the bankruptcy practice.  A special counsel for the debtor also represented a party ("Party X") in a completely different matter seeking to recover substantial funds from a person and entity that the debtor also had a claim against.  The court resolved the conflict by ordering any recovery from Party X to be paid into escrow in the bankruptcy court, where the court ruled it would apportion the proceeds between the bankruptcy estate and Party X.  The case is discussed in more detail at "Current Client - Direct Adversity."  To go there, click here.

        Seibers v. Pepsi-Cola Bottling Co., 2000 Tenn. App. LEXIS 818 (Tenn. App. December 21, 2000). Jared represented Seibers in a personal injury claim against Pepsi-Cola.  At the same time he filed a proof of claim on behalf of a creditor of Seibers in Seibers' Chapter 13 proceeding.  Jared later made a fee claim against Seibers.  Seibers claimed that Jared had had a conflict of interest and that denial of the fee should be the penalty.  The court held that Jared did have a conflict, but allowed Jared to collect the fee.  The court based its holding on Seibers' delay in raising the conflict and his inability to show how the conflict hurt him.

        Sanctions for Conflict.  In Re Kujawa, 256 B.R. 598 (8th Cir. 2000).  A lawyer appeared for creditors in a bankruptcy proceeding in which the lawyer's client was the debtor.  The debtor successfully moved to disqualify the lawyer.  The Bankruptcy Court awarded fees to the debtor of $65,000 (cost of the disqualification battle) and an addition sanction against the lawyer of $100,000.  The District Court affirmed.  The Bankruptcy Panel of the Eighth Circuit affirmed, saying that the sanction was appropriate under the court's inherent power to punish lawyers.  The opinion does not say whether the court treated the matter as one involving a current client or former client.  The court mentions neither Rule 1.7, which deals with current clients,  nor Rule 1.9, which deals with former clients.

        In re Von Behren Electric, Inc., 2002 Bankr. LEXIS 1463 (C.D. Ill. December 23, 2002).  The court denied compensation to debtor’s counsel because he had begun putting the interests of the debtor’s principals over that of the debtor.  The court reached that conclusion because debtor’s counsel admitted billing some time separately to the debtor’s principals.  The opinion does not specify what debtor’s counsel did to favor the principals.  [According to the local newspaper, the Trustee reported to the court that the debtor’s principals may have diverted company funds and property to themselves just prior to the bankruptcy filing.  Also, according to article, debtor’s counsel was denying the allegations on behalf of the principals.  Natalie Morris, Criminal Investigation Possible for Von Behrens, The State-Journal Register (Springfield, Ill.), Nov. 4, 2002.]

        Creditors' Committee Allowed to Sue Derivatively.  In re Cybergenics Corp., 330 F.3d 548 (3d Cir. 2003).  The court held that a creditors' committee could bring fraudulent conveyance proceedings for the estate where the debtor in possession declined to do so.  The court distinguished Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000), which disallowed such an action in a Chapter 7 case.  The court noted that both the Second and Seventh Circuits have reached the same result.

        In re Gutierrez, 309 B.R. 488 (W.D. Tex. 2004).  The entire thrust of the opinion is captured by the following paragraph:

For all of the foregoing reasons, the court finds that the attorney who has represented a debtor in a prior chapter 13 case will not be disqualified from representing the debtor in a subsequent case simply by virtue of the existence and assertion of a claim for unpaid fees from the previous case. The state bar rules do not impose such a per se rule, and, even if such a per se rule could be divined from section 327(a), it would not apply in the chapter 13 context because section 327(a) does not control the retention of debtor's counsel in a chapter 13 case.

        Lawyer May Represent Estate and Creditor Where Conflict not "Actual."  In re Johnson, 312 B.R. 810 (E.D. Va. 2004).  Law Firm represented a creditor in this bankruptcy case.  The trustee then sought, and obtained, leave to retain Law Firm as special counsel.  Later, over objection, the Bankruptcy Court granted Law Firm's fee petition for work done for the estate.  In this opinion the district judge affirmed, holding that a lawyer for the debtor and for a creditor does not necessarily have an "actual" conflict of interest.  The court noted that here there was not an actual conflict because Law Firm's interest, both on behalf of the estate and the creditor/client, was to maximize the value of the estate.

        Just Plain Ugly Conflict.  In re Gary Mercury, Debtor, 2004 U.S. App. LEXIS 25481 (2d Cir. Dec. 10, 2004).  This was the denial of fees to a law firm based upon a conflict of interest.  The court laid out the basis for the denial eloquently, as follows: 

It is undisputed that the Fellows firm (1) advised the Mercurys to enter Chapter 7, (2) advised the Mercurys to engage in mediation of their personal injury claim, (3) reassured the Mercurys that they would not be bound by the result of the mediation, (4) informed the Mercurys only after the mediation that they could, in fact, be bound by its result because the Chapter 7 trustee was in control of their claim, and (5) recommended to the trustee that she accept the settlement proposed by the mediator and accepted by the insurer over the Mercurys' objection. As the bankruptcy court pointed out, the firm confuses the duty it had to its clients with some imagined duty it believed it had to the claim. See In re Mercury, 280 B.R. 35, 61 (Bankr. S.D.N.Y. 2002). Recognizing that the Mercurys did not wish to accept the proposed settlement, the firm was obligated either to oppose the trustee's effort to secure court approval of the settlement, or to seek to withdraw from the matter altogether.

        Lousy Application to Become Debtor's Counsel.  In re EZ Links Golf, LLC, Debtor, 2004 Bankr. LEXIS 1956 (D. Col. Dec. 6, 2004).  This is a Chapter 11 case involving the appointment of debtor’s counsel.  The opinion has no precedential value, but may have some educational value.  The debtor’s sole owner was Corporation A.  Corporation B owns 80% of the Corporation A.  An individual, X, owns 50% of Corporation B.  X is the sole beneficiary of a family trust, which owns a bank.  The bank holds a $1.1 million note from debtor.  Moreover, in 2002 the debtor conveyed all its assets to Corporation A.  A law firm that represented various of the foregoing interests sought to be appointed debtor’s counsel.  The law firm’s initial application was pathetically deficient in identifying these relationships.  When the court became aware of some of these deficiencies, it ordered the law firm to file an amended application.  The amended application, while better, was still pretty bad.  As a result, the court denied the law firm’s application to be debtor’s counsel.

        In re Coal River Resources, Inc., 321 B.R. 184 (W.D. Va. 2005).  Four corporations, all owned and controlled by the same person, are being administered jointly in this Chapter 11 proceeding.  All four petitioned the court for leave to hire the same law firm as debtor’s counsel.  The court affirmed the Bankruptcy Court’s ruling that the law firm could represent just two of the companies.  This was because various of the companies owed others substantial amounts of money and because of substantial inconsistencies in the way each company accounted for these debts.

        In re R&R Associates of Hampton, 402 F.3d 257 (1st Cir. 2005).  The Chapter 7 trustee of Debtor, R&R, brought a malpractice action against the law firm that had previously represented R&R in the preceding Chapter 11 proceeding.  R&R had two individual general partners (“the partners).  The law firm created family limited partnerships for the partners to assist the partners in avoiding creditors while at the same time petitioning the Bankruptcy Court for leave to be Debtor’s Counsel.  The law firm claimed it had no conflicts of interest and that it was “disinterested.”  The law firm did not disclose the work it had done, and was doing, for the partners.  The district court held that the law firm was not liable to the Chapter 7 estate.  The First Circuit reversed outright, holding that the law firm should have been pursuing R&R’s contribution rights against the partners, that the law firm’s conflicts constituted breaches of fiduciary duty, and that the law firm was liable to R&R under New Hampshire state law.  The court also found outright that the damages were $412,000.

When Law Firm Ineligible to be Debtor's Counsel Can Be Debtor's "Special Counsel."  In re Woodworkers Warehouse, Inc., 323 B.R. 403 (D. Del. 2005).  The Bankruptcy Court had disqualified Law Firm from being Debtor’s Counsel in this proceeding.  Subsequently, the Debtor moved to have Law Firm appointed “special counsel” for the purpose of conducting tasks such as:

  (1) obtaining court approval for the use of its cash collateral, (2) selling assets through a "going out of business sale" and disposing of related executory contracts, and (3) preparing and negotiating the Debtor's key employee retention program and providing payment to critical personnel of the Debtor.

  The United States Trustee objected, claiming that appointing Law Firm for these purposes would be a circumvention of the order denying Law Firm the status of Debtor’s Counsel.  The court overruled the objection finding that Law Firm’s functions would not constitute “conducting the case” within the meaning of Section 327(e) of the Bankruptcy Code.

        Appealability of Order Approving Appointment of Special Counsel.  In re M.T.G., Inc., 403 F.3d 410 (6th Cir. 2005).  Chapter 7.  The bankruptcy judge denied the trustee’s application to employ a lawyer as special counsel.  The district judge reversed the denial and sent the matter back to the bankruptcy judge.  A former trustee filed this appeal.  The Sixth Circuit in this opinion held that the district judge’s order was interlocutory and not of the sort of interlocutory order that can be appealed as of right.

        In re Big Mac Marine, Inc., 326 B.R. 150 (8th Cir. Bankr. App. Panel 2005).  Individuals A and B owned the stock in Co. C.  A and B filed a Chapter 11 proceeding for themselves, with Lawyer X as debtors’ counsel.  This is a separate proceeding involving Co. C as debtor.  Lawyer X attempted to be approved as debtor’s counsel for Co. C in this proceeding.  However, because A and B were Co. C’s largest creditor, the district court and this court held that X was not disinterested and had a conflict.  The court reasoned that in the A and B proceeding, A and B, represented by X, would be trying to maximize their recovery from Co. C in this proceeding.  Yet, debtor’s counsel in this proceeding would be charged with evaluating claims and seeing that all creditors were treated fairly.  This, the court held, X could not do.

        Representing Driver and Passengers in Injury Case Results in Fee Denial.  In re Bruno, 327 B.R. 104 (E.D.N.Y. 2005).  A, B, and C were passengers in a car driven by D.  They had an accident.  Law Firm X filed an action on behalf of A, B, C, and D.  A then filed a Chapter 7 bankruptcy.  The trustee filed an application to retain Firm X to represent the bankruptcy estate in the injury case.  A member of Firm X filed an affidavit stating that Firm X did not have a conflict.  On the eve of trial another member of Firm X wrote a letter to the court seeking leave to withdraw from representing the estate because Firm X had a conflict.  Firm X was immediately replaced with Firm Y.  Firm Y tried the case, and before the jury came in with a verdict, Firm Y negotiated a settlement on behalf of the estate.  The trustee made a motion to pay the full contingent fee to Firm Y.  Firm X objected claiming it should get most of the fee.  The court allowed Firm Y to receive the full fee.  The court found that Firm X had a conflict in representing the driver and the passengers, that Firm X did not obtain a knowing waiver of the conflict, and that the Firm violated Bankruptcy Rule 2014 in not disclosing the representation of the driver when Firm X was retained by the estate.

        Failure to Disclose Conflicts Cause Partial Fee Forfeiture for Debtor's Counsel and for Creditors' Committee Counsel.  In re EToys, Inc., 331 B.R. 176 (D. Del. 2005).

        Representing Multiple Debtors and Inter-Debtor Disputes.  In re Adelphia Communications Corp., 336 B.R. 610 (S.D.N.Y. 2006).  Law Firm represented 231 debtors, all related to Adelphia, in this Chapter 11 proceeding.  Certain creditors moved to disqualify Law Firm from representing certain of the debtors and any debtors in any inter-debtor disputes.  The Bankruptcy Court held that Law Firm would have to step aside during resolution of inter-debtor disputes.  The district judge affirmed at In re Adelphia Communications Corp., 342 B.R. 122 (S.D.N.Y. 2006).

        Can't Represent First Lien Creditors in Chapter 11 if Represented Second Lien Creditor Pre-Petition.  In re Meridian Automotive Systems-Composite Operations, Inc., 340 B.R. 740 (D. Del. 2006).  Law Firm did work for Creditor A in part to protect Creditor A’s second lien status with Meridian, ultimately the Debtor in Possession in this bankruptcy proceeding.  Before the bankruptcy, Creditor A stopped using Law Firm.  During the bankruptcy an informal committee of first lien creditors (“Committee”) hired Law Firm to assist Committee in the bankruptcy.  Creditor A moved to disqualify Law Firm, and in this opinion the Bankruptcy Judge granted the motion.  The opinion contains a lengthy discussion of the “substantial relationship” test, but the crux of the court’s reasoning is this sentence: 

The legal advice which [Law Firm] is now providing to the [Committee] concerns the same intercreditor issues, only this time [Law Firm] is advising the first lien creditors how to protect themselves from the second lien creditors, including [Creditor A, Law Firm’s former client].

        In re Contractor Tech., LTD, 2006 U.S. Dist. LEXIS 34466 (S.D. Tex. May 30, 2006).  Chapter 7.  The trustee sought to hire Law Firm as special counsel to investigate and prosecute avoidance claims against creditors.  Law Firm represented eight of the 400 creditors of the estate.  For that reason the largest creditor of the estate objected to the hiring of Law Firm.  The bankruptcy judge approved Law Firm, but provided that Law Firm was not to be involved in investigating or prosecuting avoidance claims against any of its eight clients.  The record also reflected that, with near certainty, no post-petition payments had been made to any of the eight clients.  On appeal the district judge sustained the bankruptcy judge’s order, holding that Law Firm had no “actual” conflict of interest and that it was disinterested. 

        Harrington v. Kapila, 2006 U.S. Dist. LEXIS 87133 (S.D. Fla. Nov. 30, 2006).  Lawyer represented Debtor when Debtor filed a Chapter 11 bankruptcy and continued to represent Debtor while in Chapter 11.  Later Lawyer filed for Debtor a Chapter 7 petition.  When that was granted, Trustee was appointed and hired another law firm.  When Trustee filed an adversary proceeding against Debtor’s 60-percent shareholder, Lawyer appeared for the shareholder.  Trustee moved to disqualify Lawyer, and the court, in this opinion, granted the motion, using a standard Rule 1.9 analysis.

        Conflict Resulting from Defective Pre-petition Opinion Letter.  In re SonicBlue, Inc., 2007 Bankr. LEXIS 1057 (N.D. Cal. March 26, 2007).  This is a brief summary of a very complex case.  In this rather harsh opinion the bankruptcy judge ordered debtor’s counsel (“Law Firm“) disqualified.  For some years Law Firm had represented debtor in numerous pre-petition matters.  One matter was debtor’s issuance of notes to several investors.  In the third-party opinion to the investors Law Firm had omitted the bankruptcy exception from part of the remedies opinion.  Post-petition the investors threatened to sue Law Firm if they failed to recover all their investments.  Law Firm failed to notify the court of the original transaction or the investors’ threat.  The U.S. Trustee moved to have the firm disqualified, and the court granted the motion.  The conflict was that the law firm found itself in the position of evaluating claims, knowing that if the claims of the investors were allowed, the law firm’s exposure to the investors would be reduced.  The court held the “disgorgement of fees” issue for a later date.

        Good Discussion of Fraud on the Court, which Led to Vacating Several Orders Favorable to Secured Creditor.  In re M.T.G., Inc., 366 B.R. 730 (E.D. Mich. 2007).

        Lawyer for Debtors' Children's Spendthrift Trusts Could Also Be Debtors' Counsel.  In re Marble, 2007 Bankr. LEXIS 1743 (N.D. Tex. May 25, 2007).  The debtors-in-possession in this Chapter 11 proceeding sought to employ Law Firm as debtors‘ counsel.  The United States Trustee objected because Law Firm represented spendthrift trusts set up by debtors for their children.  The court could not find a conflict and granted the debtors’ petition “without prejudice” to the rights of any creditor to raise any conflict that might arise in the future.

        In re The Brown Schools, 368 B.R. 394 (D. Del. 2007).  This opinion dealt with a motion to dismiss, so we should not make too much of it at this stage.  Nevertheless, it is illustrative of what a bankruptcy trustee can allege against the former law firm for the debtor.  The claims here included breach of fiduciary duty (motion denied), aiding and abetting a breach of fiduciary duty (motion granted with leave to replead), aiding and abetting a fraudulent transfer (motion granted with leave to replead), deepening insolvency (motion denied pending further developments in the Delaware courts),  civil conspiracy (motion granted with leave to replead), and a declaratory finding that the law firm’s claim for fees should be subordinated (motion granted - no mention of repleading).  As to deepening insolvency the bankruptcy judge said that the opinion in Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168 (Del. Ch. 2006), was “well reasoned,” but she denied the motion pending a decision by the Delaware Supreme Court.

        Discussion of "Potential" vs. "Actual" Conflicts.  In re Hammer, BAP No. WW-06-1373-MoDJ, (9th Cir. Bankr. Appeals Panel Aug. 17, 2007).  This is a fact-intensive matter, in which a law firm attempted to be debtor’s counsel while at the same time representing a city, which had claims against the debtor, and against which the debtor might have a claim.  The law firm had been sloppy in its conflicts checking and in complying with its disclosure obligations to the court.  The court discussed the “potential” versus “actual” conflict dichotomy recognized by some courts and concluded that it is really a question of semantics.  Either the law firm might be influenced by its dual relationship or not, depending upon the facts.  Upon remand to the district court the Panel ordered the district court to determine periods for which fees must be denied and to determine whether the law firm can continue as debtor’s counsel.  [Note: anyone having trouble retrieving the opinion online should send an E-mail to wfreivogel@yahoo.com, and we will send a PDF.]

        Partial Fee Forfeiture for Failure to Disclose Relationships.  In re Matco Electronics Group, Inc., 2008 WL 141908 (N.D.N.Y. Jan. 11, 2008).  In an application to be counsel to creditors’ committee Law Firm failed to disclose that a lawyer in Law Firm (“Lawyer”) was the son-in-law of the CEO and President of a major creditor of the estate.  After Law Firm’s appointment Lawyer’s wife became in-house counsel to that same creditor.  As a result of the failure to disclose the court, in this opinion, ordered that Law Firm forfeit a portion of its fees.

        Tenth Circuit's Approach to § 327(a) and Rule 2014.  In re Harwell, 2008 U.S. Dist. LEXIS 9629 (D. Col. Jan. 25, 2008).  Bankruptcy.  Debtor objected to Lawyer’s appointment as counsel to the Chapter 7 trustee.  In this opinion the district judge affirmed the bankruptcy judge’s overruling the objection.  The merits are trifling, but the opinion contains a nice discussion of how the Tenth Circuit deals with § 327(a) of the Bankruptcy Act and Rule 2014 of the Federal Rules of Bankruptcy Procedure.

        Trustee Could Hire Special Counsel who Represented Creditors when the Estate Has Interests Identical to the Creditors.  In re Winterville Marine Services, Inc., 2008 Bankr. LEXIS 1112 (N.D. Miss. April 16, 2008).  Chapter 7 bankruptcy.  Trustee sought to employ Law Firm as special counsel pursuant to §327(a) of the Bankruptcy Act to bring an adversary action against other parties.  Several parties objected because Law Firm represented several creditors of the estate.  The court approved the appointment because the interests of the estate and Law Firm’s other clients were identical. 

        Another Special Counsel Case.  In re Buffalo Coal Co., 2008 Bankr. LEXIS 1259 (N.D. W. Va. April 30, 2008).  Chapter 7 trustee sought to retain Law Firm for the purpose of suing VEPCO.  While this proceeding was under Chapter 11, Law Firm represented the creditors’ committee.  VEPCO was a member of the committee.  Several parties objected to retention of Law Firm because of this relationship.  After a confusing discussion of Bankruptcy Act § 327(a), (c), & (e), the court allowed the retention.  Among other things, the court said that Law Firm’s representation of the creditors’ committee was not tantamount to representation of VEPCO.  The court also said that any information Law Firm may have obtained from VEPCO while representing the creditors’ committee would eventually come to light in the case between the debtor and VEPCO.

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Freivogel on Conflicts