Amend Rule 2014(a) to Include a Rule of Reason or Safe Harbor Guidelines

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Dec/Jan 2004

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Rule 2014(a) provides, in
part, that accompanying an application for the approval of employment of a
professional on behalf of a bankruptcy estate pursuant to 11 U.S.C.
§§327, 1103 or 1114 must be an affidavit by the professional
that, inter alia, sets forth "all of the person's connections with the debtor,
creditors, any other party in interest, their respective attorneys and
accountants...." Fed. R. Bankr. P. 2014(a). This article suggests
that the literal application of Rule 2014(a) requires a massive
over-disclosure not possibly contemplated by the drafters of the Rule, and
therefore, that the Rule should be amended to more precisely identify the
types of "connections" deemed worthy of mandated disclosure.
Alternatively, safe-harbor guidelines should be designated so that the
failure to disclose immaterial connections that do not evidence or tend to
evidence disqualifying conflicts of interest will not leave professionals
at risk of serving pro bono.<a href="#1" name="1a">1</a>

The disclosure requirements in Rule 2014(a) have been
described as "very serious business." In re Sabre Intern. Inc., 289 B.R.
420, 426 (Bankr. N.D. Okla. 2003). Courts have applied a strict literal
interpretation of the disclosure requirements, "even if the results
are sometimes harsh." In re Park-Helena
Corp., 63 F.3d 877, 882 (9th Cir. 1995).
"The disclosures in the Rule 2014 Affidavit must be explicit enough
for the court and other parties to gauge whether the person to be employed
is not disinterested or holds an adverse interest." In re Midway Industrial Contractors Inc., 272 B.R. 651, 662 (Bankr. N.D. Ill. 2001).

The seminal conflict of interest case in the
bankruptcy context is Woods v. City
Nat'l. Bank & Trust Co., 312
U.S. 262 (1940), where the Supreme Court held that reasonable compensation
to a professional serving in a bankruptcy case requires loyal,
disinterested service and that when a professional serves two masters,
compensation should be denied. In often quoted language, the Supreme Court
stated:

[T]he incidence of a particular conflict of interest
can seldom be measured with any degree of certainty. The bankruptcy court
need not speculate as to whether the result of the action was to delay
action where speed was essential, to close the record of past transactions
where publicity and investigation were needed, to compromise claims by
inattention where vigilant assertion was necessary, or otherwise to dilute
the undivided loyalty owed to those whom the claimant purported to
represent. Where an actual conflict of interest exists, no more need be
shown in this type of case to support a denial of compensation.
</blockquote>

Woods, 312 U.S. at 268. See, also, Wolf v. Weinstein,
372 U.S. 633, 641 (1963) ("a fiduciary may not receive compensation
for services tainted by disloyalty or conflict of interest."); Mosser v. Darrow, 341 U.S.
267, 271 (1951) ("Equity tolerates in bankruptcy trustees no interest
adverse to the trust. This is not because such interests are always
corrupt, but because they are always corrupting.").

"[I]t is well established that
conflict-of-interest rules are more strictly applied in the bankruptcy
context than in other areas of the law, at least insofar as professionals
retained by the estate are concerned. The strict approach maintains the
integrity of the bankruptcy process...and assures counsel's undivided
loyalty to the client." In re Rusty Jones
Inc., 134 B.R. 321, 346 (Bankr. N.D. Ill.
1991). Accord, In re Plaza Hotel Corp., 111 B.R. 882, 883 (Bankr. E.D. Cal. 1990) ("Literal
enforcement of [Rule 2014(a)] is required to assure its vitality in
combating the evils against which it is aimed."), aff'd., 123 B.R. 466
(B.A.P. 9th Cir. 1990). That conflicts of interest in the bankruptcy
context are taken seriously, and rightly so, begs the question of whether
disclosures that are required by a literal application of the unambiguous
language set forth in Rule 2014(a), but that would not evidence or tend to
evidence any disabling conflicts of interest, are appropriately required of
professionals serving bankrupt estates. The balance of this article focuses
on this issue.

"Courts have recognized three broad categories
of 'connections'—financial, business and personal that
must be disclosed pursuant to Rule 2014." Bowles, C.R.
"Chip" Jr., "Disclosing Connection and Relationships
under Rule 2014," 2001 ABI Journal LEXIS 72 (April 2001) (hereafter "Straight &
Narrow"). In his thoughtful article, Mr. Bowles notes that
"courts are increasingly requiring" professionals to disclose
personal connections, but that the "full range" of these
connections "has not been fully developed." His article
addresses several cases in which courts considered the extent of required
disclosures.

Inadequate disclosure alone is sufficient to warrant
denial of all fees sought. See, e.g., In re
Georgetown of Kettering Ltd., 750 F.2d 536 (6th
Cir. 1984); In re EWC Inc., 138 B.R. 276, 280 (Bankr. W.D. Okla. 1992) ("Violation of
the disclosure rules alone is enough to disqualify a professional and deny
compensation, regardless of whether the undisclosed connections or fee
arrangements were materially adverse to the interests of the estate or were
de minimis.");
In re Saturley, 131
B.R. 509, 516-17 (Bankr. D. Maine 1991) ("Anything less than the full
measure of disclosure leaves counsel at risk that all compensation may be
denied."). Therefore, prudent
professionals—understandably—err on the side of caution and
disclose far more than is (or should be) required, for fear of ending up
having served pro bono. See Crivello, supra, 134 F.3d at 836; Park-Helena,
supra, 63 F.3d at 882 ("Even a
negligent or inadvertent failure to disclose fully relevant information may
result in a denial of all requested fees.").

<h4>The Dilemma</h4>

Rule 2014's "all...connections"
clause is overbroad. Even those professionals that make voluminous
disclosures of wildly irrelevant "connections" probably do not
comply with the literal requirement of disclosure of "all
connections" as required by Rule 2014(a). Literal compliance with the
unambiguous language in Rule 2014(a) requires disclosures that are
unnecessary for a determination of a professional's fitness to act
for an estate. Nor is it even possible for a conscientious professional to
comply in any but the most mundane and tiny cases. Most cases of any size
would require huge or even impossible disclosures that would defeat the
intended purpose of the Rule. Simply stated, Rule 2014(a), in its present
form, is overbroad. And despite the best efforts of some courts, the rule
of reason they espouse is impossibly vague and, accordingly, of little
practical utility.

What is a "connection" with a creditor?
In any large prospective chapter 11 case, counsel preparing the schedules
will learn that the debtor-to-be will be listing dozens of utility
companies, national or international equipment or real property lessors and
other companies with whom the law firm has had prior dealings. Is it
necessary for a law firm that hopes to represent the chapter 11 debtor to
disclose that, for example, in a chapter 7 bankruptcy case 10 years before
in which the law firm represented the trustee, one of the creditors was
AT&T, which happens also to be a creditor in the current case? What if,
in a case concluded 10 years earlier, this law firm actually represented
AT&T but has had no assignment from that company since? What if the law
firm knows that Local Attorney A will be representing the bank, that Local
Attorney B will be representing the municipality and that Local Attorney C
will be representing a tort claimant in the new case? Should the law firm
disclose every case that it ever had in which A, B or C (all well-respected
busy bankruptcy lawyers) were involved? What about the golf dates they
shared, the meetings and conferences they attended, and the fact that they
are on the same bench/bar liaison committee? Are these not all
"connections"? If not, then how is that term defined?

Professionals are not even likely to know of all
"connections" they may have that they could be required to
disclose. How does a certifying professional really know who all the
parties in interest in a case will be, let alone the attorneys and
accountants for the yet-to-be-determined parties in interest? For example,
what if, unknown to the certifying lawyer, another attorney in the law firm
seeking to be employed by the debtor-in-possession (DIP) happens to
personally use the services of an accountant who is himself involved in the
case? This non-disclosure, under a literal interpretation and application
of Rule 2014(a)—and recall that some courts have said that one must
comply with the literal terms of the Rule (see,
e.g., Plaza Hotel, supra, 111 B.R. at
883)—would trigger disqualification and denial of fees. Following
this example, the fear of being disqualified or having compensation denied
might prompt a professional to make blanket or boilerplate disclosures of
any and all accounting firms with which she, her firm and any of its other
personnel do business. Even worse, because there is no real way for a law
firm filing its initial disclosures to know which lawyers and accountants
the (perhaps thousands of) creditors may retain (or have already retained)
to assist them in the soon-to-be-filed chapter 11 case, a cautious lawyer
could reasonably conclude that the law firm's disclosure should
include a boilerplate recitation of all connections with all known lawyers
and accountants wherever located.

<blockquote><blockquote>
<hr>
<big><center>
[O]ver-disclosure resembles the overproduction of documents that has long been condemned in the course of litigation discovery: Somewhere in the midst of all the disclosures, there might be something relevant.
</center></big>
<hr>
</blockquote></blockquote>

This over-disclosure resembles the overproduction of
documents that has long been condemned in the course of litigation
discovery: Somewhere in the midst of all the disclosures, there might be
something relevant. Thus, the literal terms of the vaguely worded Rule
2014(a), combined with the ever-more-draconian application of the
"death penalty" for perhaps minor slip-ups, tend to dilute the
purpose of the Rule in the first place.

Another disturbing trend that flows inexorably from
the unduly strict application of an unduly vague rule is the strategic use
of immaterial nondisclosure to disqualify competent opposing counsel.
Parties in, or that anticipate, conflict with the client of the putative
counsel have been known to oppose retention based on the counsel's
failure to disclose immaterial connections. Worse, such parties may even
contest (or blackmail counsel by threatening to contest) counsel's
fees based on the counsel's failure to disclose immaterial
connections. This is another unhealthy side effect of courts' overly
strict interpretation of a rule that, at least textually, knows no
boundaries. The rule virtually begs for courts to impose not a strict
interpretation, but a rule of reason.

<h4>Recent Cases Fail to Provide Clear Guidance</h4>

In his article, Mr. Bowles frames the following issue
directly pertinent here: "Is there such a thing as a de minimis connection?"
Straight & Narrow, *15. Acknowledging case law that repeats the widely
accepted proposition that all connections, no matter how small, must be
disclosed, Mr. Bowles states that the actual holdings of these cases
"clearly indicate" that the omitted disclosures "were, in
most cases, material to a determination of whether a professional could be
employed." Id. As an example, he cites the leading case of Rusty Jones, supra, 134 B.R. at
346, which states that what must be disclosed are connections that are
related to a pending bankruptcy case or could "reasonably have an
effect on the attorney's judgment in the case."

In Rusty Jones, the court explained that "[t]he purpose of disclosure
is to permit the court to determine whether the attorney is disqualified or
whether further inquiry is needed before making that determination.
Therefore, the decision about what to disclose is not left to the
prospective attorney 'whose judgment may be clouded by the benefits
of the potential employment.'" Id. at 345. After recognizing that Rule 2014(a) requires
disclosure of "all connections," the Rusty Jones court, in apparent
recognition of the scope of connections that would have to be disclosed
based on a literal application of the language in Rule 2014(a), stated:

This is not to say that every possible
connection need be disclosed by [a
professional]. Rule 2014 does not require a
[professional] to dredge up every past connection, however remote, that he
or she ever had with the parties in interest in the case... What is
important are connections that presently exist or recently existed between the [professional] and parties in interest, and also past connections of business or personal nature
that are either related to the bankruptcy proceedings or could reasonably
have an effect on the [professional's] judgment in the case.
</blockquote>

Id. (Emphasis added.)

The formulation set forth in Rusty Jones has been widely followed. See, e.g., Kagan v. Lopez (In re San Juan Hotel Corp.), 239 B.R. 635, 647 (BAP 1st Cir. 1999) ("Although an
attorney need not disclose every past or remote connection with every party
in interest, he must disclose those presently or recently existing, whether
they are of business or personal in nature, which could reasonably have an
effect on the attorney's judgment in the case."), aff'd., 230 F.3d 1347 (1st
Cir. 2000); Sabre Intern., supra, 289 B.R. at 426 ("For while retention under §327
is only limited by interests that are 'materially adverse,'
under Rule 2014, 'all connections' that are not so remote as to
be de minimis must
be disclosed."). Nevertheless, as Mr. Bowles noted, neither Rusty Jones nor any other
decision "clearly define[s]" what connections could
"reasonably affect" an attorney's judgment. Straight
& Narrow, *16.

In a recent decision, one court made an attempt to
clarify the standard. According to the court in In re Molten Metal Technology Inc.,
289 B.R. 505, 511-12 (Bankr. D. Mass. 2003), two questions must be asked in
determining whether non-disclosure should have any bearing on the allowance
of a professional's application for compensation and reimbursement:
Was the subject matter a "relevant" consideration, i.e., one that could reasonably
have an effect on the attorney's judgment, and if so, did the subject
give the firm an "interest adverse to the debtor or the estate with
respect to the matter on which such attorney is to be employed?" Id. In a footnote, the court
further clarified that, in framing this two-part inquiry, it did not mean
to suggest that compensation should be affected only if both inquiries were
answered in the affirmative, but that the second inquiry helped define the
extent to which the connection, and its non-disclosure, should affect the
firm's compensation. Id. at 512 n.13. This formulation is hardly a template for
a practicing attorney to follow in determining when a distant
"connection" is so remote as to be non-disclosable.

According to Collier on Bankruptcy:

<blockquote>
The term "connection" is an unfortunate
one. Arguably, two people are "connected" if they serve
together on a charitable board or are even friends. Nevertheless, the
courts usually maintain that the requirement to disclose connections will
be strictly construed. In bankruptcy practice, there are often numerous
"connections" among professionals due to the fact that
professionals will interact in many cases. No court has yet suggested that the
requirement of disclosure includes listing all such relationships. The
"connections" cited by the courts run to fee-sharing
arrangements and the like that might affect the court's decision to
approve the employment.

A requirement that a professional disclose all
instances of involvement in cases with other professionals could be
burdensome. However, the failure to disclose any
connection will be at the
professional's risk. While serious omissions warrant
disqualification of the professional or a reduction, denial or disgorgement
of compensation, or even more creative remedies, a court has broad
discretion to determine whether the disclosure at issue justifies remedial
measures at all.
</blockquote>

King, Lawrence P., 9 Collier on Bankruptcy, ¶2014.05, at 2014-7
through 2014-8 (15th ed. rev. 2003) (citations omitted) (italics in
original, but underscore is added).

The above-quoted language from Collier and the above-cited cases
suggest that there is a theoretical limit on the disclosures required where
the connections are so "remote" as to be de minimis, or are at least
insufficient to warrant a finding that they could "reasonably
affect" a professional's judgment. But they fail to describe a
method for determining when one is approaching that limit. Moreover, these
authorities, otherwise consistent with the approach suggested in this
article, seem inconsistent with the unambiguous language used in Rule
2014(a) requiring disclosure of "all connections." See United States v. Ron Pair Ent., 489 U.S. 235, 241 (1989) (if the language of a statute is plain,
courts should enforce the statute according to its terms); Caminetti v. United States, 242
U.S. 470, 485 (1917) (same). Likewise, Collier states that "[p]rofessionals may not make unilateral
determinations regarding the relevance of particular connections, or that
certain connections to the debtor are too insignificant to disclose. All
connections must be disclosed." 1 Collier
on Bankruptcy, ¶8.05 at 8-60
(citations omitted). Well, if there is some limit on the disclosures
required but that limit is not one for the disclosing party to determine,
the logical result is that there is no limit on what must be disclosed.

This conundrum is graphically shown by the Bennett Funding case, discussed
by Mr. Bowles in Straight & Narrow. As courts frequently have done on
this subject, the court in Bennett Funding spoke out of both sides of its mouth. First, the court
stated that "it is critical to the integrity of the bankruptcy
process that disclosure of material facts which relate to disinterestedness be timely and
thorough." Bennett Funding, supra, 226 B.R. at 334. Then, a mere two paragraphs later, it
chastised the trustee for his having made repeated determinations of what
was material to disclose and what was not. Quoting
In re Granite Partners L.P., 219 B.R. 22, 35
(Bankr. S.D.N.Y. 1998), the court warned that a professional "cannot
usurp the court's function by choosing, ipse
dixit, which connections impact
disinterestedness [i.e., which facts are "material"] and which do not." Bennett Funding, supra, 226
B.R. at 335. So, it seems, a professional preparing to disclose its
connections must disclose only material information, but, when doing so,
may not make the decision about what is material and what is not.

<h4>Clarify the Rule</h4>

For there to be a real, practical remoteness limit on
the need to disclose connections, the better course would be to amend the
Rule. The loose cannon 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" must be substantially revised. The Rule
should state either that only certain types of connections must be
disclosed or it should delegate to the U.S. Trustee the duty to
promulgate—much as it has done with the task-based billing project
and fee application guidelines—the types of disclosures that would
constitute a safe harbor. The fees of a professional who completely and
honestly discloses the connections designated by the amended Rule, or the
resulting U.S. Trustee guidelines, would not be subject to disallowance
and disgorgement.

Without such common-sense, practical, easy-to-follow
guidelines, more and more otherwise honest professionals will become caught
in the trap of the unfairly vague aspirational pronouncement in Rule
2014(a) requiring professionals to disclose "all connections"
or will over-disclose to the benefit of no one and the detriment of the
true purpose of the Rule.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> See In re Crivello, 134
F.3d 831, 836 (7th Cir. 1998) ("[C]ounsel who fail to disclose timely
and completely their connections proceed at their own risk because failure
to disclose is sufficient grounds to revoke an employment order and deny
compensation."). <a href="#1a">Return to article</a>

Journal Authors

Arthur J. Spector

Paul A. Avron

Journal Date

Wednesday, December 1, 2004 - 12:00

Bankruptcy Rule

2004