Multiple Clients in Bankruptcy Cases When Do You Need Consent

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Mar 2002

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With a slide into recession, and the continuing aftershocks of the collapse of the
high tech and dot-com stock market boom, the bankruptcy system has been asked to deal
with some spectacular failures involving hundreds of billions of dollars in assets and
liabilities, and thousands of creditors. Recent examples include Enron, Global
Crossing, Pacific Gas & Electric and FINOVA Group. The proliferation of
megacases means, inevitably, that many bankruptcy lawyers or firms will have more than
one client in a case.

This article considers the need (and timing) for client consent where the conflicts
search you perform for your non-debtor bankruptcy client (NBC) discloses that one
or more non-debtor pre-existing clients of your firm (PEC) are parties in interest
in the case, but are represented by other firms.<a href="#2" name="2a">2</a> The article also considers
distinctions in practice and procedure to be followed where one or more PECs are being
represented in the bankruptcy case by others in your firm, or more than one client
(whether new or pre-existing) seek to have the same lawyer represent them.

Most lawyers have a strong revulsion to seeking consent from firm clients who are
represented by other firms in a case, because they see nothing but a downside in the
effort. Obtaining and documenting consent is often uncomfortable and burdensome. But it
is the direct threat to employment that is most troubling. Consent connotes the power
to refuse, and refusals can be irrational or unreasonable (not that any of my firm's
clients would act that way). So what lawyers want to hear is that where your PECs
are represented by other firms in a bankruptcy case, there is no need for their
informed consent to representation of NBC unless and until there is actual, as distinct
from hypothetical, adversity between them and your NBC.

The deferral (or avoidance) of informed consent from the PECs until an actual
adverse situation—a manifest conflict of interest—has arisen is probably the evolving norm
in complex bankruptcy cases, though it is apparently not supported by a strict reading
of the Model Rules of Professional Responsibility that govern conflicts and consents in
most jurisdictions.<a href="#3" name="3a">3</a>

There was an episode from the original Star Trek series in which Captain Kirk had
to come up with a way to defeat a malevolent computer. He did so by asking the
computer to solve a problem. He told the computer to assume as a premise that
everything he said was the truth. He then followed that with the statement that he
was lying. The computer's logic circuits burned to a crisp as it sought to evaluate
whether Kirk's statement that he was lying, which under the premise had to be assumed
to be true, thereby negated the original premise of truth. Then it considered that
if the opening premise was a lie (inasmuch as the second statement indicated he lied
about the premise to assume the truth) then Kirk's second statement that he was lying
might now be disbelieved, in which case the original premise of truth would be
restored, leading back to the second statement and then back to the first ad
infinitum. This loop could not be resolved, and the machine destroyed itself.

Lawyers' logic circuits can also be burned attempting to interpret how the law of
professional responsibility should apply in bankruptcy contexts, at least where one wishes
to link the need for client consent to actual, as distinct from potential, adversity.
The reason is that the professional conduct rules seem to treat a potential conflict
as an actual, present conflict, and an actual, present conflict is governed by Model
Rule of Professional Responsibility 1.7, which requires informed consent of each
client. As Kirk might say, assume there is no conflict today, and only a potential
conflict in the future. But then I tell you that a potential conflict in the future
is the same as an actual conflict today. Can you solve that without burning your
logic circuits?<a href="#4" name="4a">4</a>

It is fair to question whether the professional responsibility rules were even
intended to apply in the "strict" way in the bankruptcy context. In a large
bankruptcy case, isn't every party potentially adverse to every other party? The bulk
of the professional conduct rules appear to have been written with traditional litigation
in mind, or other matters in which there are essentially two sides, such that
potential adversity would almost inevitably ripen into actual adversity. Large bankruptcy
cases do not lend themselves to such neat, two-party analyses. Moreover, despite the
possibility of positing hypothetical adversity between and among every possible combination
of parties in interest, practitioners know that at the outset of a case, few, if
any, potential clashes could be considered inevitable.

Even conflicts that may seem inevitable will not pit creditor against creditor in
a direct manner. An unsecured creditor may compete with another unsecured creditor for
the same pool of assets, but will not inevitably challenge the other creditor's right
to recovery. An unsecured creditor is subordinate to a secured creditor, but will
not inevitably challenge the secured creditor's lien. They may have adverse positions,
but not direct adversity in the sense of a contest. Even where such challenges have
to be brought, contests over liens or claims are usually brought by the debtor or
a creditors' committee, not by one unsecured creditor against another, or by an
unsecured creditor against a secured creditor. Thus, even where there is direct
positional adversity, there is no inevitable adversity in fact, in the sense of one
client facing off against another, each being represented by the same firm.

The possibility of some flexible interpretation for bankruptcy scenarios is suggested
by comment 3 to Rule 1.7, which states that "simultaneous representation in
unrelated matters of clients whose interests are only generally adverse, such as
competing economic enterprises, does not require consent of the respective clients.
Paragraph (a) [of Rule 1.7] applies only when the representation of one client
would be directly adverse to the other." (emphasis supplied). Direct adversity, in
the sense of one creditor suing another or seeking relief against another, in a
bankruptcy context is actually pretty rare. Challenges to claims and positions more
often come from debtors and committees against creditors and vice versa, not from
creditor to creditor. Furthermore, creditors are generally adverse to one another, in
that they may be seen as competing for common assets. Even though the comment
expressly refers to representation in unrelated matters, the spirit of the comment
would appear to support an argument that the NBC undertaking can be accepted without
obtaining consents from PECs, except where it is clear that there "would" be direct
adversity.

Perhaps future commentary to the professional responsibility rules will more fully
address bankruptcy scenarios and expressly provide the interpretive flexibility that is
now merely implied at best. Few bankruptcy lawyers are likely to either agree with
or follow a strict construction that would require informed consent at the outset in
any case where there is potential adversity somewhere along the line, or otherwise to
equate potential conflict to an actual conflict requiring present consent. It is so
easy to find hypothetical conflicts in a complex bankruptcy case that such a rule would
seriously burden the bankruptcy practices of many firms by requiring consents (perhaps
multiple consents) before beginning work in almost every case. In virtually every
large case, consents would have to be obtained from every firm client who is a party
in interest, as the condition of representing any one of them. The notion of having
to obtain consent (and possibly losing an engagement) due to a hypothetical direct
adversity that in most cases might never ripen into actual adversity is enough to burn
the logic circuits of the most seasoned bankruptcy professionals.

Another way of justifying a more flexible approach to the conflict and consent rules
is to ask, in the bankruptcy context, what purpose would be served by strict
application. Absent an actual or inevitable conflict, it is difficult to see benefit
to either the NBC or the PEC. The NBC seeking to engage you in the bankruptcy
case would not seem to be served by a policy that accorded to other firm clients (who
are not in this scenario even being represented by the firm) the power to refuse
consent to the engagement. The PECs whose consent would be needed would not seem to
be doing anything to advance or protect their position by refusing to consent at the
point at which the conflict or adversity is hypothetical, especially where the rules are
clear that their consent would be needed once the adversity were actual.

It can be argued that the PECs should have the right to prevent "their" lawyers
from using their brains and skill to develop positions that some other party might
eventually use against them. However, this argument is rather weak in the scenario
where the PECs have already taken their bankruptcy representation in the particular
case to other firms. It is much stronger where the PECs have already engaged your
firm and do not wish at that point to have your firm take on any other parties in
the same case. In that situation, however, as discussed below, the PECs very
definitely have the right of consent, and they should.

None of these approaches should be followed without careful analysis of the facts
each time the consent issue becomes relevant. There may be situations in which the
potential adversity is so clearly bound to ripen into actual adversity that the actual
adversity standard for consent under Rule 1.7 would apply, and it would be
appropriate to equate potential with actual. In those situations, clients whose
consents are needed might legitimately feel that their law firm should not be lending
assistance to the potential adverse party, even if their consent would later be
required in the event of actual adversity. Where adversity is inevitable, a lawyer
or firm should also consider whether the rules of client loyalty are implicated in
developing of strategies by which one client, to be armed with special counsel, goes
against another client.

The Attorneys' Liability Assurance Society Inc. (ALAS) takes note of this
ethics "practice" in the bankruptcy context as follows:

Bankruptcy counsel frequently contend that there is no "actual" conflict in a
given situation. They do so in light of the anticipated positions each party is
likely to advance and frequently argue that if a "real" conflict arises, special
counsel may be retained to deal with that matter. From a strict legal ethics
point of view, the situation presents a current conflict, which may be
consentable with full disclosure, but which presents a slight possibility of
developing into a non-consentable conflict in the future.

2001 ALAS Loss Prenvention Manual, p. 93. ALAS adds that the use of
special counsel might obviate the conflict at the non-consentable stage, so long as
the matter does not become embroiled in a disqualification contest before a court that
follows the strict construction rule: potential = actual.<a href="#5" name="5a">5</a>

Firms that follow a policy of deferring consent from pre-existing clients until
there is an actual conflict should still take care to get the informed consent of the
NBC before undertaking the engagement. The NBC should be informed about the
potential limits of the engagement vis-a-vis the other firm clients, when and in what
manner the consent of other clients will be sought, and what are the implications if
consent is refused. That client must understand (and agree) that if direct adversity
arises, it will have to resort to special or new counsel. "To be valid, client
consent to a conflict of interest must...be given...after 'communication of
information reasonably sufficient to permit the client to appreciate the significance of
the matter in question.'" <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… 2001 Loss Prevention Manual,</a> p. 75 (quoting
from Model Rules of Professional Conduct, Terminology (1999)).

<blockquote>
[T]he key requirement for effective client consent is adequate disclosure. Ideally,
the disclosure should be as thorough as possible, conveying all relevant facts,
possible adverse effects from the conflicts, the reason those effects should not
occur and alternative courses of action. Both the disclosure and the consent
should be set forth in a written document. As to concurrent conflicts, the
additional test of whether the lawyer's representation, or the lawyer-client
relationship, will be adversely affected, must be satisfied.
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 77</a>.

Some distinctions in practice and procedure should also be noted where the conflict
search for the NBC discloses that PECs are currently being represented by your firm,
or where multiple potential NBCs want to engage you personally. In these situations,
even if potential adversity might otherwise support a deferral of any effort to obtain
consents (as discussed above), the fact that the emergence of an actual adversity will
necessarily impact one or more of the clients' choice of lawyer makes initial written
consent essential all the way around. According to Rule 1.7 (b)(2), "[w]hen
representation of multiple clients in a single matter is undertaken, the consultation shall
include explanation of the implications of the common representation and the advantages and
risks involved." For example, an engagement letter might provide that in the event of
such adversity, one of the parties agrees to obtain separate counsel and consents to
the lawyer continuing as counsel to the other party. Alternatively, the parties might
agree that in the event of direct adversity, they must each obtain new counsel and
neither may use the lawyer first engaged.<a href="#6" name="6a">6</a> Where different lawyers within a firm are
representing different clients, it is typical and appropriate to establish ethical walls
to protect the privacy and confidentiality of each lawyer's advice to the respective
client. Where the same lawyer is involved in multiple representations, it is typical
and advisable to establish confidentiality understandings. Lawyers who are representing more
than one creditor in a bankruptcy case (or whose firms are doing so), should also
be aware of the disclosure rules (Bankruptcy Rule 2019 requires certain disclosures
with respect to the representation of multiple creditors and equity-holders) and the
various "positional" conflict rules of the Model Code of Professional Responsibility and
related ethics rules, which address, and in some cases restrict, the extent to which
a lawyer or firm can simultaneously advocate positions that are in conflict with one
another.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> This article is intended to be an opinion piece, and not by any means an exhaustive or definitive analysis of the relevant professional
responsibility rules. Nevertheless, it does have a grounding in the ABA's Model Rules of Professional Responsibility and the 2001 Loss
Prevention Manual of the Attorneys' Liability Assurance Society Inc. (ALAS). Special thanks are due to Andrew Shaffer, a bankruptcy
associate in the New York office of Mayer, Brown, Rowe & Maw, who assisted with the research, and to ALAS. <a href="#1a">Return to article</a>

<a name="2">2</a> The Bankruptcy Code's disinterestedness and conflicts requirements make it extremely difficult, if not virtually impossible, for a lawyer
or firm to represent, simultaneously, a debtor and any other party in interest (especially creditors) in a bankruptcy case. Those rules and
requirements are fairly well-known and are not discussed here. For similar reasons, this article does not address simultaneous representation
of an official committee and any other party in interest. <a href="#2a">Return to article</a>

<a name="3">3</a> The Model Rules of Professional Responsibility have not been adopted uniformly. Some states have their own codes, or variations of the
Model Rules. It is important to consult your own state's rules before making any definitive decisions about the consent requirements. <a href="#3a">Return to article</a>

<a name="4">4</a> Another way of looking at it is to conclude that there is no such thing as a potential conflict in the law of professional
responsibility. See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kendavis,</a><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 91 B.R. 742 (Bankr. N.D. Tex. 1988)</a> (concept of "potential" conflict
incompatible with disinterestedness requirements of 11 U.S.C. §327). <a href="#4a">Return to article</a>

<a name="5">5</a> ALAS cites <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Michigan General Corp., 78 B.R. 479 (N.D. Tex. 1987)</a>, as an example of disqualification in this
kind of situation. <a href="#5a">Return to article</a>

<a name="6">6</a> Lawyers should be wary of resolving such direct adversity issues through arrangements that would be detrimental to their continued employment,
because such arrangements may compromise the independence of advice that must be provided. For example, the lawyer may try to "guide" the
clients away from the adversity (even though addressing the adversity might be to the benefit of one or the other of them) for fear that
he or she will lose the engagement at that point. <a href="#6a">Return to article</a>

Journal Authors

Michael P. Richman

Journal Date

Friday, March 1, 2002 - 12:00

Bankruptcy Rule

2002