Disclose (Publish) or Perish - Part II Post-employment Connections Issues and Disclosure Techniques

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Sep 2001

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In Part I, published in the June 2001 issue of the ABI Journal, we reviewed
techniques for discovering Rule 2014 "connections" and determining whether, to what
extent and how to disclose them in seeking employment under the Bankruptcy Code. In
this Part II, we review issues of supplemental connections searches and disclosure,
including a discussion of new procedures being followed by some judges in the U.S.
Bankruptcy Court for the Southern District of New York.

The "connections" search and disclosure obligation stems from Bankruptcy Rule
2014(a), which provides, as a condition of employment of "attorneys,
accountants, appraisers, auctioneers, agents or other professionals," for debtors,
official committees and otherwise—where the professional engagement must be approved by
the court—disclosure of "all of the person's connections with the debtor, creditors,
any other party in interest, their respective attorneys and accountants, the U.S.
Trustee or any person employed in the office of the U.S. Trustee." The information
must also be verified by the person to be employed "to the best of the applicant's
knowledge."

Once the employment application is filed together with appropriate disclosure
information and approved, does the professional have an obligation to continue to
monitor developments in the case and within his or her firm for either previous
connections missed or future connections that might arise, and to make supplemental
disclosures thereof? The answer is emphatically "yes," but you won't find it in the
Bankruptcy Code or Rules. As articulated by Chief U.S. Bankruptcy Judge Stuart
M. Bernstein:

<blockquote>
Rule 2014(a) does not expressly require supplemental or continuing disclosure.
See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Caldor Inc., 193 B.R. at 176</a>. Nevertheless, §327(a)
implies a duty of continuing disclosure and requires professionals to reveal
connections that arise after their retention [citations omitted]. "[T]he need for
professional self-scrutiny and avoidance of conflicts of interest does not end
upon appointment." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Braunstein, 19 F.3d at 57-58</a>; accord,

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Unitcast Inc., 214 B.R. 979, 986 (Bankr. N.D. Ohio
1997)</a>. Continuing disclosure is necessary to preserve the integrity of the
bankruptcy system by ensuring that the trustee's professionals remain conflict free.
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Granite Partners L.P., 219 B.R. 22, 35 (Bankr. S.D.N.Y. 1998)</a>.

The easiest case for supplemental disclosure arises when the initial connections search
cannot be completed in time for the filing of the employment application. It may
simply not be possible to know or feasible to discover all disclosable connections at
the time the employment application must be filed with the court. For example, where
employment as debtor's counsel is concerned, and where there is a need to maintain
confidentiality regarding an imminent filing, a full "connections" inquiry among partners,
key employees and staff at law or other professional service firms may be infeasible
before the filing has become public knowledge.<a href="#1" name="1a">1</a> The best course of action in such
cases is (a) include in the initial Rule 2014 affidavit a disclosure of any
inquiries that could not be completed, why, and when it likely will be completed,
and (b) promptly complete the inquiries and file a supplemental disclosure affidavit.

Supplemental disclosures are often a source of stress (which may explain why some
are not made promptly or at all) because, however innocuous they may be, they draw
attention from parties in interest and they present a risk of challenge to the
professional's continued employment. The longer a case endures, the more likely that
the number of parties in interest paying close attention to developments (with
heightened self-interest) will grow larger. Indeed, in many chapter 11 cases,
professional employment is approved with first-day orders at a time when the list of
parties requesting notice is likely to be limited and a creditors' committee has not
yet been appointed.

To mitigate this stress, regularize the timing of supplemental disclosure where the
initial disclosure is based on incomplete information, and otherwise provide some level
of employment protection for professionals; some judges in the U.S. Bankruptcy Court
for the Southern District of New York have been following a practice of approving
professional retention with the typical first-day orders on what is in substance an
"interim" 30-day basis. Disclosure (including supplemental disclosure) can then be
made to all parties who have requested notice and, if objections are filed, a further
hearing can be held, after which the employment order can be made, in substance,
"final."

An example of this practice, taken from an order in the chapter 11 cases of

Loews Cineplex Entertainment Corp. (ch. 11 case nos. 01-40346 through
01-20582, U.S. Bankruptcy Court, Southern District of New York; Bernstein,
C.J.), follows:

<blockquote>
ORDERED that, pursuant to §§327 and 328 of the Bankruptcy Code and
Bankruptcy Rule 2014, the debtors are authorized and empowered to retain and
employ Fried Frank as their attorneys for 30 days, without prejudice to the
debtors' right to present a proposed order, and serve the proposed order by
notice of presentment<a href="#2" name="2a">2</a> on (i) the Office of the U.S. Trustee, (ii)
O'Melveny & Myers LLP, counsel to Bankers Trust Co. as administrative agent
for the debtors' pre-petition and proposed post-petition working capital facility,
(iii) counsel to the official committee of unsecured creditors, if appointed,
and (iv) all other parties that have filed a notice of appearance in these
chapter 11 cases, approving the retention of Fried Frank for the remainder
of these cases.
</blockquote>

The order does not use the terms "interim" and "final," but rather approves the
employment for a 30-day period. Unless the debtors (and the professionals) file
and serve a further proposed order with supporting papers, the employment authorization
will expire after 30 days. So the effect is the same as if those terms were used.

Some orders following this practice explicitly characterize the employment as
"interim." For example, an "Interim Order Authorizing Retention of LeBoeuf, Lamb,
Greene & MacRae L.L.P. as counsel to the debtors" in In re RSL Com Primecall
Inc. (ch. 11 case nos. 01-11457 and 01-1469, U.S. Bankruptcy
Court, Southern District of New York; Gropper, J.) entered April 3, 2001
provided:

<blockquote>
ORDERED, that the debtors are authorized to employ and retain LeBoeuf as
general and bankruptcy counsel, on an interim basis, nunc pro tunc to March
16, 2001, pursuant to the terms set forth in the application; and it
is further

ORDERED, that on or before April 4, 2001, the debtors serve this
order, together with the application and declaration, by first class mail,
postage prepaid, upon the 20 largest creditors, counsel to the creditors'
committee by hand and all parties having filed notices of appearance in these
cases; and it is further

ORDERED, that objections, if any, to the retention of LeBoeuf becoming
final must be...served in accordance with General Order M-182 or by
first-class mail so as to be received no later than 5:00 p.m. on April
23, 2001...; and it is further

ORDERED, that if there are no objections to final retention of LeBoeuf that
are timely filed and served by April 23, 2001, at 5:00 p.m., then
the retention of LeBoeuf as bankruptcy and general counsel for the debtors in
these cases shall be deemed final without need for a hearing or entry of a
further order of this court; and it is further

ORDERED, that if objections are timely filed and served, a hearing in
connection with the final retention...shall be held on April 30, 2001,
at 10:00 a.m...
</blockquote>

Conflicts of Interest vs. Conflicts of Independence. Conflicts of interest are
generally easy to identify and monitor because most professional firms have good
computerized systems in place for client and matter identification and searching. Any
prospective new engagement should be checked against that database. This search should
show whether the prospective client is now or has been previously represented by the
firm, as well as show whether the firm is already involved in the new matter on
behalf of another client. Simultaneous engagement by two or more clients in the same
matter is a bright red flag of a potential conflict-of-interest problem.

A conflict of independence is more difficult to identify and monitor. A conflict
of independence occurs when the professional firm's relationship with a party in
interest, on matters completely unrelated to the bankruptcy case, rises to a level
sufficient to create an appearance that the bankruptcy professional's independence in
dealing with that party in interest in the bankruptcy case might be compromised. These
types of conflict are readily identified when employment is first sought, assuming the
professional has run a computer search of all parties in interest in the case.
However, unless the bankruptcy professional has taken care to record not only the
client names, but also the names of all parties in interest that were searched for
"connections" disclosures, the creation of supplemental conflicts of independence may be
overlooked.

<hr>
<big><center>
Bankruptcy professionals must have systems in
place to monitor for the possibility of further
connections disclosures on a regular basis.
</center></big>
<hr>
</blockquote></blockquote>

If the parties-in-interest list is input (even though such parties are not
"clients"), then the firm's future engagement by a party in interest should result
in a "hit" that will get to the attention of the bankruptcy professional, permitting
the firm either to avoid accepting an engagement that might cause a conflict of
interest or independence problem, or to accept the engagement while making the
appropriate supplemental disclosure to the bankruptcy court in a timely manner.

Where parties in interest are clients of a professional firm on matters unrelated
to the bankruptcy case, the question of whether the bankruptcy professional's independence
will be affected is often answered with reference to the magnitude of the client
business with the firm. Many disclosure affidavits include information about the amount
of the firm's billings to the "connected" party, in absolute terms as well as a
percentage of the firm's total revenues. There is no bright-line dollar value or
percentage test for determining whether a professional may be compromised in his or her
treatment of the party's claims in the bankruptcy context. Much depends on the views
of the bankruptcy judge, and can be affected further by the anticipated magnitude of
the claim that might be asserted by or against the party.

Suppose then that when the professional employment is approved, the court has
considered that a secured creditor of the estate, with a relatively large claim, is
a client of the firm representing the debtor, but only on one matter (tax, for
example) involving under $100,000 in billings, and less than .01 percent
of the firm's revenues.<a href="#3" name="3a">3</a> Concluding that this type of "connection" will not
compromise the firm's independence in the bankruptcy case, the employment is
approved. Subsequently, however, the secured creditor begins to hire the firm for
other and larger matters. A few litigation matters here, some corporate matters
there. The creditor may be a large institution, and the people making the decision
to expand the business may well be unaware of the bankruptcy case. What was
$100,000 in billings suddenly turns into several million dollars in billings,
with a greater percentage of firm revenues.

Bankruptcy professionals must have systems in place to monitor for the possibility
of further connections disclosures on a regular basis. The monitoring must extend in
at least two directions: to the court dockets to find and search with respect to
newly arriving interested parties who were not known to the professional earlier; and
to the professional's firm to find and search with respect to new clients, or larger
engagements for pre-existing clients, that might now be considered disclosable
connections, or might require supplementing of a prior disclosure.

Monitoring the court dockets should be relatively easy to accomplish. New parties
are typically identified through notices of appearance or motions. Although a search
through a firm's conflicts computer system can be done every time a new party is
introduced, it might be reasonable and less burdensome to run such a search
periodically (e.g., every two weeks), with the previous two weeks' parties listed.
Care should be taken not to allow too long a period of time to elapse between
searches, though what is too long will depend on the particular case and parties
involved. As soon as it is learned that a newly-identified party has a connection
of any kind with the professional, a supplemental disclosure affidavit under Rule
2014 should be filed and served on all parties who have requested notice (as well
as the usual core group of U.S. Trustee, the debtor, the creditors' committee,
etc.).

If the connection rises to the level of a conflict of interest, the mere filing
of a supplemental disclosure is insufficient. In such cases, the professional should
proactively raise the issue with the court and parties in interest. If it is not
clear whether the conflict creates an employment disqualification or not, the professional
should file a supplemental employment motion and seek the court's approval for continued
employment.

Regular monitoring within the professional firm itself is somewhat more cumbersome,
but most large firms have conflict clearance computer systems that can assist with the
monitoring with appropriate information inputs. To illustrate how this might work,
consider a recurring problem for supplemental connections disclosures: the case of the
after-acquired client. In this example, assume that at the outset of a bankruptcy
case, the professional firm ran a computer search and otherwise made inquiry of
partners and selected employees regarding connections with a list of 100 parties in
interest then known. The results were memorialized in a Rule 2014 affidavit, with
any discovered connections being disclosed. A month later, the firm acquires as a
new client a company that was on the original list of 100. It wasn't a connection
before, but now it has become one. The engagement is not related to the bankruptcy
case, but is a disclosable connection.<a href="#4" name="4a">4</a> How do those responsible for the bankruptcy
case find out about it in an timely manner?

One way is to repeat the computer search with the original list (expanded as
appropriate to include new parties in interest) on a fairly frequent basis. However,
it may be more effective (and automated) to input the list to the computer system
as though all the names on the list were clients, with instructions to be contacted
in the event of any "hits." That way, when the after-acquired client's name is
input, as a preliminary to accepting the engagement (to check for conflicts), there
will be a "hit" that will get to the attention of the bankruptcy people who must make
the disclosure.

Some readers may view this computer monitoring and information inputting for
supplemental disclosures to be tedious or burdensome. They should consider well the
consequences of not doing so. In Granite Partners, the law firm hired to represent
a trustee in an investigation of potential estate claims against certain broker-dealers
filed an initial disclosure affidavit revealing that it had "'client relationships' with
various (unidentified) creditors and broker-dealers, but the affidavit did not disclose
what this meant." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. at 28</a>. The affidavit also disclosed that the firm
"may have represented parties in interest in the past and may again in the future in
matters unrelated to the estate." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 38</a>. One of the client broker-dealers
of the law firm was Merrill Lynch, one of the parties to be investigated. The
bankruptcy court concluded that the "clear import of the [disclosure affidavit] is that
[the law firm] did not currently represent any parties in interest or broker-dealers,
and hence, that [it] did not have an existing client relationship with Merrill Lynch."
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

But what made the matter much worse is that the Merrill Lynch business with the
law firm, which accounted for approximately $225,000 in fees on five matters
during the year before the law firm's retention in the bankruptcy case, grew in the
next two-and-a-half years to 400 matters accounting for more than $9 million in
fees. At no time during that period had the law firm made a supplemental disclosure
of the growing relationship with this "connection." The information was revealed only after
the investigation was concluded and final fee applications were filed. Under these
circumstances, the court concluded that the law firm's "concurrent representation of the
trustee and Merrill Lynch created the appearance that its independent judgment and
impartiality might be compromised." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 36</a>. Although the court noted that there
was "no evidence that [the law firm] failed to discharge its duties in a thoroughly
professional manner," it believed that "the investigation and final report [was] tainted."
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 42</a>.

In its final fee application, the law firm sought total fees of
$4,666,970.92, of which $2,093,700.45 was attributable to the
claims investigation of the broker-dealers. As a sanction, the court denied every
penny of the fees attributable to the investigation, 15 percent of the fees
attributable to the non-investigative aspects of the case ($385,990.57) and
the costs associated with a pre-hearing investigation by a fee examiner
($257,079.11). A pro rata disallowance of expenses was also ordered.<a href="#5" name="5a">5</a>

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> There should be no reason, however, why a full conflict-of-interest search of known parties in interest cannot be completed on
a firm's computer system before filing. <a href="#1a">Return to article</a>

<a name="2">2</a> Under the notice-of-presentment procedure, the final order can be signed without a hearing if no objections are timely made, and
a hearing is held only if such objections are made. <a href="#2a">Return to article</a>

<a name="3">3</a> It might also be appropriate for that client to give a waiver of any conflict objection it might assert to a challenge to its
claim, or other adverse action by the firm in the bankruptcy case. <a href="#3a">Return to article</a>

<a name="4">4</a> If it was related to the bankruptcy case, the computer system would presumably report a "hit," and the firm would have been alerted
to an obstacle to taking the engagement. <a href="#4a">Return to article</a>

<a name="5">5</a> There were a number of other facts that influenced the court, including the law firm's acknowledgment that it had requested from
Merrill Lynch a prospective waiver to permit the firm to investigate and bring appropriate claims against Merrill Lynch, and that Merrill Lynch
had declined to give such a waiver in writing. Thus, it cannot be said that the severity of the sanction was based solely on the failure
to make a supplemental disclosure. The full text of the opinion is recommended as an excellent summary of the law on conflicts, disinterestedness
and disclosure. <a href="#5a">Return to article</a>

Journal Authors

Michael P. Richman

Journal Date

Saturday, September 1, 2001 - 12:00

Bankruptcy Rule

2001