The following hypothetical demonstrates the scope and application of §327(a) to competing neighboring urban hospitals: Two nonprofit hospitals are separated by three miles in a densely populated low-income urban community. Holy Mackerel sits at one end of Main Street while Baruch Gefilte is at the other. Both are suffering financial difficulties.
Recently, Baruch Gefilte commenced a chapter 11 proceeding with the intent of selling its assets under § 363 of the Bankruptcy Code. Before the bankruptcy filing, Holy Mackerel made an unsuccessful out-of-court bid for the assets of Baruch Gefilte, but Holy Mackerel is no longer interested in pursuing that bid. Shmuley O’Malley, a talented bankruptcy attorney who represented Holy Mackerel in its out-of-court restructuring has been asked by some of the unsecured creditors of Baruch Gefilte to pitch the Baruch creditors’ committee. Can O’Malley represent Holy Mackerel in its out-of-court restructuring while simultaneously representing the chapter 11 creditors’ committee of neighboring Baruch Gefilte?
Section 327(a) provides for the retention of professional persons “that do not hold or represent an interest adverse to the estate.”[1] Because of the phrase “hold or represent,” if an attorney’s client has an adverse interest to the bankruptcy estate, then the attorney will similarly be disqualified. And what is holding an “adverse interest?” As the case law provides, it is “possessing or asserting any economic interest that would tend to lessen the value of the bankruptcy estate.”[2]
Hospitals, unlike many other businesses in this Internet age, have markets that are regionally and geographically limited. Furthermore, neighboring hospitals compete with each other not only for patients, but for physicians, physician practice groups, state licensure for lucrative programs, and—particularly in urban settings—for state and federal charitable dollars. In states such as New York and New Jersey where published state policy seeks to reduce “over-bedding” in urban areas, they also compete for “essentiality” (i.e., the state’s favor if they are determined to be “essential” to protecting the urban poor). If a neighboring hospital fails, the remaining hospital in the urban area will become more “essential” in the eyes of the state to serving an underprivileged population. As a result, the surviving hospital becomes a stronger candidate for financial support.
Outside of the health care arena, in Marvel Entertainment, the Third Circuit has held that a trustee’s firm’s representation of the senior secured lender in an unrelated matter would not prohibit his retention on “adverse interest” grounds where he submitted two letters to the court: (1) a waiver letter between his firm and the secured lender permitting direct litigation against the secured lender by the firm and (2) a letter terminating in all respects the attorney-client relationship between the secured lender and the firm.[3] In the hypothetical, unlike the facts in Marvel Entertainment, O’Malley has no intention of giving up his representation of Holy Mackerel.
O’Malley therefore relies on El Comandante to support his quest. There, debtor’s counsel’s current client in other matters, First Bank, issued a commitment letter to a bidder for the debtor’s assets. If the bid was successful, then debtor’s counsel’s client, First Bank, would have been the funding source for the acquisition. The district court, affirming the bankruptcy court, found no conflict because “First Bank was not a party in interest even though it had a…loan commitment.”[4] First Bank was “a mere observer of the proceeding waiting to see if their [sic] potential client would need the credit offered.”[5] In short, representing a vendor to a bidder would not create a conflict for debtor’s counsel.
So, can O’Malley simultaneously represent Holy Mackerel and the Baruch Gefilte committee? In the author’s view, O’Malley cannot concomitantly represent both Holy Mackerel in its restructuring and Baruch’s creditors’ committee. A directly competing neighboring hospital that pre-petition made a bid for the debtor’s assets thereby possesses an economic interest “adverse” to the interest of the debtor. Unlike the facts in El Comandante,O’Malley’s client is not “once removed,” i.e., a vendor to a bidder and a “mere observer.” Because his client is the bidder/competitor itself, O’Malley cannot therefore meet the requirements of § 327(a). This conclusion is dictated not only by Holy Mackerel’s pre-petition bid, but also by the extensive level of competition among neighboring hospitals.
Bottom Line
When insolvency counsel is put in the same position as O’Malley, he or she must recognize the employment requirements established under § 327(a), along with the time, expense and delay that could be occasioned by a disqualification motion. In the end, counsel should prudently decide that discretion is a better part of valor and politely decline to pitch the case.