Nettlesome Neighbors: When Can Non-Client Outsiders Challenge Retentions

Many lawyers may have dealt with a challenging neighbor in their personal lives, but it is fair to say that few have dealt with a difficult neighbor challenging their retentions in their professional lives. However, the U.S. Bankruptcy Court for the Southern District of Alabama recently addressed such a scenario in In re Breland,[1] where the neighbor of a debtor objected to the bankruptcy estate’s retention of litigation counsel by alleging that the counsel had a conflict of interest, even though the neighbor was neither a current nor former client of the counsel, nor a party in interest in the bankruptcy proceeding.

In In re Breland, the bankruptcy court made short work of the neighbor’s objection on standing grounds, highlighting how bankruptcy courts often address the issue of who has standing to object to the retention of counsel by the estate. The fact pattern in In re Breland also provides an interesting backdrop to examine the different bases, such as disinterestedness, that interested parties in a bankruptcy proceeding have to challenge the retention of counsel by a debtor or other estate representative.

Background

Charles Breland and Fred Killian owned adjacent plots of land in the city of Fairhope, Ala. Breland, a real estate developer, hoped to fill in wetlands located on his plot of land as the first step in a real estate development project. When the City of Fairhope issued a stop work order to prevent Breland from advancing his project, Breland filed suit in state court to enjoin the order (the “Fairhope litigation”). Breland hired Blackburn & Conner P.C. to represent him in the lawsuit. Killian, who had strenuously opposed Breland’s development efforts, twice tried unsuccessfully to intervene in the Fairhope litigation in order to oppose the relief sought by Breland, but his motions were denied.

            During the pendency of the Fairhope litigation, Breland commenced a chapter 11 bankruptcy proceeding in the U.S. Bankruptcy Court for the Southern District of Alabama, which eventually resulted in the appointment of a chapter 11 trustee. Shortly following his appointment, the chapter 11 trustee filed an application to retain Blackburn as counsel in the Fairhope litigation in an effort to maintain continuity of representation, and the bankruptcy court granted the chapter 11 trustee’s request.

            A month after the retention order was entered, the neighbor, Fred Killian, filed a motion for reconsideration. Specifically, Killian alleged that Blackburn had a conflict of interest because, in addition to representing the Breland estate in the Fairhope litigation, the firm also represented the county commission of the county in which Fairhope was located. Killian alleged that the interest of the county commission and the city were aligned as the result of a purported “partnered relationship” that he believed placed Blackburn in the position of representing two clients in the same litigation whose interests were adverse in violation of Rule 1.7 of the Alabama Rules of Professional Conduct. Blackburn opposed Killian’s motion on two grounds: (1) that Killian lacked standing to raise the alleged conflict of interest, and (2) that the interest of the estate and of the county commission were not “directly adverse” and therefore did not give rise to a conflict under Rule 1.7.

Bankruptcy Court’s Ruling: Outsiders Lack Standing

Based on the plain language of Rule 1.7 of the Alabama Rules of Professional Conduct, the bankruptcy court held that “[t]his Rule places the onus of conflict determination on the attorney and his client, prohibiting outsiders from interloping in the attorney/client relationship.”[2] Thus, in order to have standing to seek disqualification, a party must show that (1) it is a current client of the attorney, and (2) its interests conflict with the interests of the other client or with the interest of the attorney.[3] As Killian was neither a former nor current client of Blackburn, he did not fall within the designated class of persons under Rule 1.7 that could permissibly raise a conflict of interest. This conclusion was further supported by the fact that both of Blackburn’s clients (the county commission and the chapter 11 trustee) did not raise any objection to the purported conflict.[4]

The bankruptcy court’s decision might have been motivated by Killian’s litigious history. Specifically, the bankruptcy court noted that the bar to allowing strangers to attorney/client relationships to raise conflict challenges was supported by sound policy considerations. Quoting In re Employment Discrimination Litig. Against Alabama, the court stated: “Because a motion for disqualification is such a ‘potent weapon’ and ‘can be misused as a technique of harassment,’ the court must exercise extreme caution in considering it to be sure it is not being used to harass the attorney sought to be disqualified, or the party he represents.”[5]

Although the lack of standing was sufficient to dismiss Killian’s objection, the bankruptcy court also noted that Killian had failed to show that the interests of the bankruptcy estate were directly adverse to the interests of the county commission within the meaning of Rule 1.7.[6] First, the county commission was not actually a party to the Fairhope litigation. Second, Killian had failed to provide any evidence that the interests of Fairhope and the county commission were actually aligned as a result of the “partnered relationship.”[7]

The Broader Standing Debate

The ruling in In re Breland is consistent with the majority view that non-clients lack standing to challenge the retention of professionals by a debtor or estate representative on conflict-of-interest grounds. This position “is premised on the understanding that Rule 1.7 is intended to protect the interests of persons harmed by the conflict, thus, they are the proper parties to seek disqualification.”[8] These cases themselves are part of the larger body of case law finding that non-clients lack standing to challenge the retention of counsel on conflict-of-interest grounds.[9]

            On the other hand, some bankruptcy courts have conferred standing on non-clients to seek a counsel’s disqualification. These “courts have recognized an exception to the general rule limiting standing to clients or former clients in cases where the ethical breach so infects the litigation that it impacts the moving party’s interest in a just and lawful determination of the claims.”[10] Further, many bankruptcy courts have found that even if the non-client raising the objection lacks standing itself, the bankruptcy court has an independent duty to disqualify an attorney to preserve public trust in the administration of justice and the integrity of the legal system.[11] Courts outside the bankruptcy context often look to the ethical rules for guidance, but usually determine disqualification motions based on the perceived effect of conflicts on the fairness and integrity of the proceedings over which they preside.

As in In re Breland, a bankruptcy court will most likely find that a non-client lacks standing when the alleged conflict of interest is minor, indirect, driven by a litigation position, or not well documented. However, if the alleged conflict of interest can be shown to be more serious, the bankruptcy court may find that the non-client has sufficient standing to raise a challenge or may itself independently review the retention.

Beware of Disinterestedness

            It is interesting to consider whether Killian’s objection might have been successful if he had been a creditor in the underlying bankruptcy proceeding as opposed to an entirely uninterested party. In addition to abiding by the relevant state professional responsibility codes, bankruptcy practitioners must also abide by § 327 of the Bankruptcy Code, which only permits the retention of “disinterested” professionals by a debtor or estate representative.[12] This heightened standard in evaluating conflicts was written into the Bankruptcy Code to protect debtors and their creditors from attorneys whose interest may conflict with that of the bankruptcy estate. The Bankruptcy Code defines “disinterested person” as a person that

(A) is not a creditor, an equity security holder, or an insider;

(B) is not and was not, within 2 years before the date of the filing of the petition, a director, officer, or employee of the debtor; and

(C) does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason.[13]

Any interested party, including a creditor, has standing to raise a disinterestedness objection under § 1109 of the Bankruptcy Code.

The definition of “disinterested person” under § 101(14) of the Bankruptcy Code “overlaps with the adverse interest requirement of section 327(a), creating a single test for courts to employ when examining conflicts of interest.”[14] The term “adverse interest” is not defined in the Bankruptcy Code but has been defined by bankruptcy courts to include “any interest or relationship, however slight, that would even faintly color the independence and impartial attitude required by the Code and Bankruptcy Rules.”[15] Although courts have distinguished between actual and potential conflicts, the recent trend “elides the distinction and focuses on the concerns of divided loyalties and affected judgments.”[16] Bankruptcy courts apply the disinterestedness standard rigorously to the retention of professionals.

If he were a creditor of the Breland estate, Killian would have had standing and could have argued that the potential alignment of interest between Fairhope and Baldwin County, although not technically a directly adverse conflict under Rule 1.7 of the Alabama Model Rules, might still raise a serious question of the law firm’s disinterestedness. The fact that neither the county commission nor the city objected would be irrelevant. The relevant consideration would be whether there was more than a de minimis possibility that the estate’s counsel might be tempted to pull some punches in the Fairhope litigation because of his relationship with the adverse parties. The lack of standing in In re Breland and the disputed information presented foreclosed any further inquiry into that possibility.

Author Information

A Hughes Hubbard & Reed partner for more than 35 years, James B. Kobak, Jr has had a long and varied career. He serves as lead counsel to the trustee for the Securities Investor Protection Act (SIPA) liquidations of Lehman Brothers Inc. and MF Global Inc., and has served in similar roles for other liquidations almost from the inception of the SIPA statute. Mr. Kobak litigates in many forums at every level, including state and federal courts, from bankruptcy court to the U.S. Supreme Court, and is an active arbitrator. He has lectured and written widely, particularly on antitrust and intellectual property matters; has taught substantive antitrust and intellectual property courses at leading law schools for nearly two decades; and is a former president of the New York County Lawyers Association.