The Adequacy of DisclosuresAvoiding Even the Appearance of Impropriety

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Feb 2004

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To state the obvious, practitioners in law firms find it increasingly difficult to represent large corporate debtors
without a conflict or, at least, a potential conflict arising from former, current and/or imputed representation of one
or more creditors. Such conflicts or potential conflicts often result in disqualification, regardless of whether the
conflict exists directly with proposed bankruptcy counsel or arises from the business dealings of one's partners.

In fact, there are divergent opinions about whether the Bankruptcy Code's disinterestedness inquiry is directed to
specific attorneys in a law firm or the law firm in its entirety. And, although a party may waive a conflict under
applicable state rules, such waivers do not necessarily result in counsel's disinterestedness as required under the
Bankruptcy Code.

As such, counsel must remain vigilant in their efforts to discover conflicts of interest and/or circumstances that may
affect their disinterestedness, as well as be mindful of the effect, and extent, of any waiver obtained concerning such
conflicts. Indeed, one must not only disclose any potential conflicts, but also offer the court a method for
addressing such conflicts as even an imputed conflict can result in disqualification. See In re Essential Therapeutics
Inc., 295 B.R. 203, 208-09 (Bankr. D. Del. 2003).

<h3>Imputed Representation</h3>

In Essential Therapeutics, the proposed debtor's counsel, which included a member who previously served as the
debtor's corporate secretary, sought employment as general bankruptcy counsel. The proposed debtor's counsel
asserted that it remained disinterested and could represent the debtor because (1) the position of corporate secretary
with the debtor was not an executive officer position and was more ministerial in nature; (2) the lawyer that served
as corporate secretary would not participate in the case; and (3) proposed debtor's counsel would erect a "Chinese
wall."

The court, however, refuted the assertion that a professional could serve as corporate secretary, regardless of the
actual duties and executive status of that position, yet remain eligible to represent that corporation within two years
of the petition date. See Essential Therapeutics, 295 B.R. at 206 (citing 11 U.S.C. §101(14)). Specifically, the
court held that 11 U.S.C. §101(14)'s language was unambiguous and precluded retention if "the professional served
as an officer of the [d]ebtors within two years of the petition date." Id. As such, and irrespective of whether service
as corporate secretary created an actual conflict, the court held the former secretary was disqualified from representing
the debtor. See Id. at 207.

More importantly, the court held that irrespective of whether the former corporate secretary would participate in the
bankruptcy case, and regardless of any "Chinese wall," the disqualification of one member of a law firm under
§101(14) resulted in the disqualification of the entire law firm. See Id. at 209-10. Although the court did not hold
that all conflicts that would disqualify a particular professional are impugned to that professional's entire firm, it
did find that §101(14) evidenced Congress's concerns regarding "the essential character of independence and
disinterestedness which is required of counsel for the estate." See Id. at 210 (citing In re Philadelphia Athletic Club
Inc., 20 B.R. 328, 333 (E.D. Pa. 1982)). As such, disqualification of one member of a law firm pursuant to
§101(14) may very well result in disqualification of the entire law firm for purposes of retention under 11 U.S.C.
§327. Id.

Thus, Essential Therapeutics presents circumstances where no waiver could cure the conflict. Indeed, even if the
applicable state rules and regulations allowed a former officer to represent a corporation, §101(14)'s express language
prohibits such representation, without mention of any discretion or exception via waiver.

<h3>The Effect and Extent of Waivers</h3>

Not all conflicts automatically disqualify counsel from representing a corporate debtor. In fact, it is increasingly
common to see debtor's counsel's employment applications containing pages of potential conflicts.

Upon the discovery of such potential conflicts, one should obtain a waiver letter, particularly when the conflicting
party is a secured creditor. In obtaining such waivers, even a seemingly harmless limitation must be disclosed and
abided by to fully satisfy one's duties. See, e.g., In re Jore Corp., 298 B.R. 703 (Bankr. D. Mt. 2003).

In Jore, debtor's counsel recognized the debtor's major secured creditor (the bank) as an existing client.
Accordingly, debtor's counsel sought and obtained a conflict waiver from the bank. The waiver, however, came 21
days after the petition date, and it waived the conflict only to the extent that debtor's counsel "did not represent the
debtor in litigation directly adverse to [the bank]...."

Debtor's counsel had filed its application for employment on the petition date, along with a verified statement
under Rule 2014(a). Though debtor's counsel filed its verification prior to receiving the limited waiver, debtor's
counsel filed subsequent amendments to the verification as additional conflict issues arose. In fact, debtor's counsel
had a "fallback plan" in the event of an actual, unwaived conflict, which included use of conflict counsel and/or
local counsel for such matters. However, none of the amendments to the verification mentioned the waiver's
limitations or the "fallback plan." In fact, the "fallback plan" was never implemented, despite the lack of a full
waiver of the conflict.

Despite the limited nature of the bank's waiver, debtor's counsel remained lead counsel in a number of contested
matters and negotiations adverse to the bank, including, but not limited to, negotiating DIP financing with the
bank, which included a fee carve-out for debtor's counsel, litigating a contested asset sale and bid procedure dispute,
and litigating an emergency cash collateral dispute, which was subsequently appealed.

In fact, almost a full year passed before debtor's counsel notified the court of the "no-litigation exception" in the
waiver, despite the continual disputes between the debtor and the bank. Such disclosure was made only after the
filing of a liquidating plan and a status report that disclosed the waiver's limitations. The case was subsequently
converted to chapter 7, after which debtor's counsel filed its final application for compensation requesting interim
approval of $132,003.50 in fees and expenses in the amount of $8,161.68, and final approval of $1,618,502.30 in
fees and $215,765 in expenses.

Upon the U.S. Trustee's motion to disqualify, the court disqualified debtor's counsel and vacated the order
authorizing the employment of debtor's counsel. Specifically, the court held that debtor's counsel's failure to
disclose the waiver's limitations violated Rule 2014's duty of disclosure irrespective of whether such failure was
intentional. See Jore, 298 B.R. at 726. The court further held that even though Rule 2014 does not require the
filing of a conflicts waiver letter, it does impose a duty to disclose conflicts to the court, not just to the client. See
Id. at 727.

The court reasoned that Rule 2014 does "not give the attorney the right to withhold information because it is not
apparent to him or her that a conflict exists," because "[a]ll facts that may be pertinent to a court's determination of
whether an attorney is disinterested or holds an adverse interest to the estate must be disclosed." Jore, 298 B.R. at
726 (citing In re Park-Helena, 63 F.3d 877 (9th Cir. 1995)). Debtor's counsel, "[h]aving advised the court in three
declarations...that it has disclosed 'all potential conflicts,' 'continues to review' its connections, and 'will notify the
court if any actual conflicts of interest or other significant connections are discovered,' ...was unarguably required to
disclose the bank's exceptions to its conflicts waivers." Jore, 298 B.R. at 726.

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[C]ounsel must remain vigilant in their efforts to discover conflicts of interest and/or circumstances that may affect their disinterestedness...
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Based on debtor's counsel's failure to disclose, the court denied the final fee application in totality and ordered
disgorgement of all previously paid fees. Jore, 298 B.R. at 729-30 (citing Park-Helena for the proposition that the
"[n]egligent or inadvertent as well as willful failure to disclose fully relevant information required under Rule 2014
may result in a denial of all fees").

In Jore, as opposed to Essential Therapeutics, the bank could have waived the conflict to the court's satisfaction.
The bank did not provide an unequivocal waiver, with two resulting problems: (1) debtor's counsel's failure to
disclose, and (2) debtor's counsel's failure to implement its "fallback plan" and use conflicts counsel.

<h3>Conflicts Counsel</h3>

Disqualification is not necessarily the result of an unwaived conflict if proper steps are taken to disclose, upfront,
such conflicts and provide a method of dealing with such conflicts. For example, in the Enron bankruptcies, the
official unsecured creditors' committee sought the approval of Milbank Tweed as counsel for the committee.
Milbank had certain conflicts, or at least potential conflicts, in that it represented, prior to the petition date, certain
debtors and non-debtors in various transactions. Such transactions were the subject of various investigations during
the Enron case, which resulted in one creditor moving for disqualification. See In re Enron Corp., 2002 WL
32034346, *1 (Bankr. S.D.N.Y. May 23, 2002).

The court carefully considered Milbank's multiple 2014 statements and concluded that Milbank adequately
disclosed its connections with the debtors and other creditors under Rule 2014. Specifically, the court noted that
Milbank was not required to disclose every conceivable interpretation of its connections and possible consequence
resulting from the connections, as well as a prediction as the outcome of any litigation that may result from, or be
related to, the referenced connection. Id. at *5. Indeed, such disclosures would be "an impossible task subject to
endless litigation over what would be enough," while Milbank's disclosures were "meaningful, forthright,
continuous and sufficiently detailed to fulfill its obligations under Rule 2014." Id.

Similarly, the court rejected the argument that Milbank was not disinterested, noting that conflicts counsel and the
examiner for Enron would also review, independently, every matter involving transactions in which Milbank was
involved pre-petition. Id. at *9. As such, the court determined that no evidence existed that Milbank would breach
any fiduciary duty. Id. at *11.

Milbank had conflicts of interest, or at least potential conflicts of interest, in the Enron cases. Milbank, however,
disclosed and provided a method for resolving such conflicts through the use of conflicts counsel that satisfied the
court.

<h3>Conclusion</h3>

While Enron provides a method for debtor's counsel to address and avoid potential conflicts of interest, some might
question if conflicts counsel can resolve potential conflicts of interest of debtor's counsel. After all, it is typically
the lead debtor's counsel that drafts a reorganization plan, which addresses the treatment of every creditor and party
in interest in a bankruptcy case.

While such concerns appear valid, one must question the full impact of prohibiting the use of conflicts counsel for
debtor's counsel. After all, if any potential conflict, including those in the plan formulation stage, would prohibit a
law firm from representing a debtor, then most, if not all, large law firms would be unable to represent the large
corporate debtor.

Journal Authors

Bruce H. White

William L. Medford

Journal Date

Sunday, February 1, 2004 - 12:00

Bankruptcy Rule

2004