Proxy Games; Is It Merely an Unfair Advantage or an Ethical Violation to Serve as a Member of the Creditors’ Committee and Then Become Co-Counsel?

Competition among law firms to be selected as counsel to an Official Committee of Unsecured Creditor is notoriously stiff.  The financial rewards are substantial and work begets more work.  Every new engagement is another line in the pitch book, and one less for the competition.

The Local Rules of the Delaware bankruptcy court require out of state counsel to align with Delaware-barred counsel.  Accordingly, Committee formation meetings conducted in Delaware present an opportunity for Delaware firms to compete for the local role.  Delaware lawyers routinely meet with creditors before the Committee is formed, discuss the case, and present their credentials and hourly rates.  But after the Committee is formed, prospective Delaware counsel are ushered out of the Committee meeting room, the door is closed, and all marketing efforts come to an end.  Delaware counsel then wait patiently to hear which firm the Committee has selected to serve as its Delaware counsel.

But in at least two instances, Delaware firms have secured the role of Delaware counsel to the Committee by staying behind the closed door with the Committee members.[1] This was accomplished by a firm that first held a proxy for a creditor, and then served as an actual member of the Committee.  Using the proxy as a ticket to gain access, the firm later pivoted to become Delaware counsel to the Committee. This was a dubious practice at best and, at worst, unethical. 

Because Committee meetings are conducted in confidence, one can only speculate as to the alchemy involved in counsel transforming its role as Committee member to the more lucrative role of Delaware counsel to the Committee.  For counsel “trained in the art of persuasion,”[2] however, it is probably not that difficult. Perhaps by design, this only happens in cases where the decision to retain local counsel inexplicably is “deferred” for a couple of days. And if counsel is later questioned how the switch from creditor to Delaware counsel occurred, he or she can devise their own narrative.  As is often said, “The paper never refused the ink.” But whatever story is put forward, the selection of the proxy holding law firm as Delaware counsel most likely did not involve the competitive, market driven process that the Committee should insist govern every other aspect of the chapter 11 case. The Office of the United States Trustee, that self-styled “watchdog” of the public interest, appears not to be troubled by any of this and has not uttered as much as a low growl when this conduct is brought to its attention.   

The Delaware firms that have held a proxy, stayed in the Committee meeting room as a Committee member after the Committee was formed and then succeeded to become local counsel certainly have benefitted from an unfair advantage. Being in the room has obvious advantages; e.g., sitting with and befriending the Committee members, developing the trust and confidence of being a fellow fiduciary serving on the Committee, and discussing the case and adding to the “debate” in the selection of lead counsel.  For Delaware counsel waiting outside the Committee room, however, this only serves to confirm the old adage “Out of the room, out of the deal.” 

But it might be that counsel’s direct solicitation of the Committee as a client is a violation of Rule 7.3 of Delaware’s Rules of Professional Responsibility which provides:

A lawyer shall not by in-person, live telephone or real-time electronic contact solicit professional employment from a prospective client when a significant motive for the lawyer’s doing so is the lawyer’s pecuniary gain, unless the person contacted:  (1) is a lawyer; or (2) has a family, close personal, or prior professional relationship with the lawyer.

Del. Lawyer’s R. of Prof. Cond. 7.3. 

After the Committee was formed, the Delaware firms that held proxies must have asked (in-person or by phone) the Committee, a prospective client, to serve as its local counsel. The firms had no prior professional relationship with the Committee other than serving as one of its members. It is also not clear that a competitive (or any) process was run to select local counsel.  This stands in stark contrast to the selection of lead counsel where the Committee itself nominates several firms and invites them to come into the room to pitch for the role of lead counsel and a competitive process is run.

The ability of a Delaware law firm to have entrée to actual Committee members (while other Delaware law firms remain outside the room), and use that access to become Delaware counsel to the Committee is the unfortunate byproduct of lawyers trafficking in proxies, which have their own currency.  The Office of the United States Trustee should put an end to this practice.  If a law firm that holds a proxy is appointed to serve as a fiduciary on the Committee, it should not thereafter have any potential economic interest in the outcome of the voting to select professionals or serving on the Committee. To be clear, a law firm that goes into the room as a fiduciary should wear only that hat and should not later make itself available for the local counsel role. The opportunity for mischief is too great.