Screening for Conflicts Is Particularly Important in Booming Lateral Market

Lateral movement among law firm partners and associates has boomed. In 2020, the number of associates moving firms was up 149% and the number of partners moving was up almost 43%. [1] In 2021, the number of lawyers switching firms was up 111% over 2020. [2] And the lateral market for bankruptcy lawyers is no stranger to the boom, despite bankruptcy filings having sat at record low numbers over the past few years. [3]

Bankruptcy cases are, however, on the rise. With all the movement over the past two years, it is critical for bankruptcy lawyers and firms to remember ethical and professional rules that require screening for conflicts after hiring. And it is equally important to put those rules into practice. A recent case from the United States Court of Appeals for the Third Circuit provides one example of how a law firm and a newly hired bankruptcy partner properly followed and implemented those rules, specifically Rule 1.10(a)(2) of the American Bar Association’s Model Rules of Professional Conduct. [4]

After filing a chapter 11 case, a debtor’s liquidating trust sued the debtor’s parent companies, asserting fraudulent conveyance and alter-ego claims. [5] And during the bankruptcy, a partner at the law firm serving as debtor’s counsel moved to the law firm representing the trust. [6] Before switching firms, that partner had participated in the firm’s initial pitch to serve as debtor’s counsel, as well as negotiated the engagement letter, drafted several motions, received emails with the debtor, attended conferences with the debtor, and had appeared in the case on the debtor’s behalf. [7]

The new firm, however, began implementing its conflicts-screening process from the start. [8] The firm began by screening the partner’s cases and clients, and also established an ethical wall that was erected on the partner’s first day at the new firm. [9] Among other things, the new firm:

• Prohibited all attorneys and staff from being involved in the bankruptcy case if not assigned specifically to the case;
• Prevented excluded attorneys and staff from accessing records and other information related to the case;
• Had the partner acknowledge her compliance with the screen and required her to periodically certify her compliance;
• Gave the partner no compensation that resulted from the firm’s representation of the trust; and
• Advised the Debtor of the employment on the partner’s first day, which notice explained the procedure for the screening and ethical wall and advised that review of the procedure may be available before a tribunal.
• [10]

Nonetheless, the Debtor moved to disqualify the partner’s new firm from representing the trust. The bankruptcy court, however, denied the Debtor’s motion, and the Third Circuit affirmed.

In affirming the bankruptcy court’s decision, the Third Circuit noted that the ABA’s Model Rules of Professional Conduct governed disqualification, which had been expressly adopted by the bankruptcy court’s local rules. [11]

Model Rule 1.9 sets out the general rule on direct conflicts of interests, prohibiting a lawyer that has formerly represented a client in a matter from “represent[ing] another person in the same or a substantially related matter in which that person’s interests are materially adverse to the interests of the former client.” Model Rule 1.10(a), in turn, sets out the rule governing imputed conflicts after a lawyer switches firms, which provides that no lawyer at a firm “shall knowingly represent a client when any one of them practicing alone would be prohibited from doing so by Rules 1.7 or 1.9….” Obviously, the partner at issue was prohibited from participating in her new firm’s representation of the trust. But was her conflict imputed to the new firm, conflicting out the new firm and all its attorneys? Not according to the bankruptcy court and Third Circuit. Rule 1.10(a)(2) includes an exception that cuts off the general rule of imputed conflicts where effective screening is put in place. Model Rule 1.10(a)(2)’s exception allows a new firm and its lawyers to continue representation if:

(i) the disqualified lawyer is timely screened from any participation in the matter and is apportioned no part of the fee therefrom; (ii) written notice is promptly given to any affected former client to enable the former client to ascertain compliance with the provisions of this Rule . . . ; a statement of the firm’s and of the screened lawyer’s compliance with these Rules; a statement that review may be available before a tribunal; and an agreement by the firm to respond promptly to any written inquiries or objections by the former client about the screening procedures; and (iii) certifications of compliance with these Rules and with the screening procedures are provided to the former client by the screened lawyer and by a partner of the firm, at reasonable intervals upon the former client’s written request and upon termination of the screening procedures.

The Debtor attempted to argue that a “special circumstances” exception should apply to Model Rule 1.10(a)(2). But the Third Circuit rejected that argument, as the language of the ABA’s Model Rules include no such exception. Because the partner and her new firm followed Model Rule 1.10(a)(2), her new firm and its lawyers were not disqualified from representing the trust.

With the boom in lateral movement since 2020 and the recent uptick in bankruptcy filings, the rules governing conflicts of interest, screening, and disqualification are perhaps more relevant now than ever. And In re Maxus Energy Corporation serves as an excellent primer for bankruptcy lawyers, law firms, and judges to follow should the issue arise.