The Debtor or Trustee Control the Privileges of an Independent Audit Committee

Writing what may be his last opinion, Bankruptcy Judge Kevin J. Carey of Delaware parsed a split of authority before concluding that a liquidating trustee may compel counsel for an independent audit committee to turn over almost all of its files.

Judge Carey is stepping down from the bench on August 31 after 19 years of service as a bankruptcy judge. He was a bankruptcy judge in Philadelphia for five years before transferring his flag to Delaware.

The Audit Committee’s Investigation

Before bankruptcy, the debtor corporation formed an independent audit committee that hired a law firm and forensic accountants. The committee was tasked with investigating senior management’s financial reporting. Later, the company filed a chapter 11 petition when the inability to produce audited financial statements caused a default on secured credit facilities.

Before bankruptcy, shareholders commenced a class action lawsuit alleging the issuance of false or misleading financial statements. The audit committee’s professionals presented their conclusions to the debtor and the Securities and Exchange Commission several months into the chapter 11 case. The debtor paid the audit committee’s professionals $6.3 million for their work.

The company confirmed a liquidating chapter 11 plan that conveyed all of the debtor’s claims and rights of action to a liquidating trust. The liquidating trustee demanded that the audit committee’s professionals turn over their files. The law firm declined to turn over documents that it claimed to be covered by the attorney/client and work-product privileges.

The Split of Authority

In his June 20 opinion, Judge Carey began the analysis with C.F.T.C. v. Weintraub, 471 U.S. 343, 105 S. Ct. 1986 (1985), where the Supreme Court held that a corporation’s bankruptcy trustee has the power to waive the corporation’s attorney/client privilege. He explained why the high court “determined that the trustee’s control of the corporate debtor’s attorney-client privilege would be consistent with the policies of the bankruptcy laws.” Were it otherwise, a trustee could not carry out the duty of investigation if former management controlled the privilege.

However, the law firm contended that the audit committee was a separate, independent body with its own privileges to which the trustee did not succeed.

There is a split of authority among district judges in the Southern District of New York, Judge Carey said. The more recent case allowed a trustee to recover privileged documents from an audit committee, while an earlier case did not.

Judge Carey adopted the reasoning of the more recent Southern District case, saying that “it is appropriate to extend the Supreme Court’s analysis in Weintraub and recognize that the trustee appointed as the representative of a corporate debtor controls the privileges belonging to the independent committee established by the corporate debtor.”

The analysis was not over. Did the transfer of the privileges extend to the work-product privilege, not just the attorney/client privilege?

Judge Carey followed a third decision from the Southern District of New York holding that a firm may not invoke the work-product doctrine to withhold documents from a client or former client, given that the client paid for the creation of the materials.

But wait, there’s more! Judge Carey cited the Delaware Chancery Court for pointing out a split of authority about a firm’s duty to release files to a client or former client. The majority require production of the entire file, while the minority require the lawyer to produce only the end product.

Judge Carey decided to follow the Delaware Chancery Court’s policy of requiring the production of everything, subject to limited exceptions for documents intended for internal law office review and use.

Judge Carey therefore directed the audit committee’s counsel to turn over everything “except for those items that are firm documents intended for internal law office review and use.” He only allowed the firm to withhold documents with “counsel’s mental impressions.” He required the firm to turn over draft legal and factual memoranda, even if they were only circulated within the firm. He also required counsel to turn over communications between the lawyers and individual audit committee members.