Although nonprecedential, a December 21 opinion shows how the Third Circuit will not excuse nonbankruptcy lawyers from the rigors of disclosure under Sections 327 and 320. The Court of Appeals upheld disqualification and the imposition of monetary sanctions of disgorgement against special counsel for a chapter 11 debtor.
The circuit court’s opinion deserves greater weight because its author was Circuit Judge Thomas L. Ambro.
The Successive Disclosure Violations
In the first of two opinions about one year apart, Bankruptcy Judge John T. Dorsey of Delaware imposed a $55,000 sanction on the debtor’s special counsel for failing to disclose that it was actually two law firms doing business under a fictitious name, and thus was sharing compensation without disclosure.
In his first opinion, Judge Dorsey declined to impose more severe sanctions because they were not bankruptcy lawyers and thus were “not accustomed to the stringent disclosure requirements mandated by the Bankruptcy Rules.” NNN 400 Capital Center LLC v. Wells Fargo Bank NA (In re NNN 400 Capital Center LLC), 18-50384, 2019 BL 388754 and 2019 BL 298715, 2019 Bankr. Lexis 2485 (Bankr. D. Del. Aug. 9 and Oct. 9, 2019). To read the ABI report, click here.
After the first sanction, Judge Dorsey ordered the lawyers to file accurate disclosures, but the new disclosures turned out to be inaccurate, too. After two days of hearings, Judge Dorsey found that the lawyers failed to disclose a fee-sharing arrangement with a “finder” hired to obtain financing for the debtor. In addition, he found that the lawyers had caused the debtor to pay the finder’s expenses without court approval. On top of that, Judge Dorsey also found that the lawyers failed to disclose that they had represented one of the debtor’s largest unsecured creditors.
Finding that the lawyers’ testimony “lacks all credibility,” Judge Dorsey ruled that the failure to disclose the representation of the creditor violated Section 327(e) and Bankruptcy Rule 2014. He also found a disclosure violation with regard to the fee-sharing arrangement. In addition, he said that the nondisclosure of the fee-sharing agreement violated Section 327(e) and Rule 1.8(a) of the Model Rules of Professional Conduct.
Judge Dorsey disqualified the firm from representing the debtor. Within 30 days, he ordered the firm to disgorge fees paid or to be paid, and directed the firm to refund $11,400 in expenses paid to the finder. He said that the fee-sharing agreement “itself” rendered the firm ineligible to serve as special counsel. See In re NNN 400 Capital Center LLC, 619 B.R. 802 (Bankr. D. Del. Sept. 4, 2020). To read ABI’s report, click here.
When six months had passed and the lawyers had not made the required payments, Judge Dorsey held them in contempt. The lawyers appealed all of the orders. After the district court affirmed, the lawyers appealed to the Third Circuit.
Affirmance in the Circuit
Judge Ambro said that the lawyers made “a host of challenges” to disqualification, but “none is persuasive.” In one short paragraph, he nixed the idea that the pre-bankruptcy fee-sharing agreement “did not need to be disclosed under Section 329 of the Bankruptcy Code.”
Judge Ambro rejected five more arguments, each in one paragraph.
With regard to contempt, the lawyers contended they were deprived of due process by not having been given a second hearing to explain why they had not paid previous sanctions. After the first hearing, the lawyers filed a declaration saying they were “incapable of complying.”
Judge Ambro saw no error by having no second hearing, because the compliance defense “would have been futile.”
Affirming the district court’s judgments that affirmed the rulings of the bankruptcy court, Judge Ambro ended his opinion with a paragraph to be quoted far and wide:
Courts must be able to rely on full and true disclosures to do their job properly. And while all parties are entitled to have their claims fairly heard, courts have scarce resources to meet the many pressing demands put on them. We expect attorneys to appreciate these realities.
Although nonprecedential, a December 21 opinion shows how the Third Circuit will not excuse nonbankruptcy lawyers from the rigors of disclosure under Sections 327 and 320. The Court of Appeals upheld disqualification and the imposition of monetary sanctions of disgorgement against special counsel for a chapter 11 debtor.
The circuit court’s opinion deserves greater weight because its author was Circuit Judge Thomas L. Ambro.
In the first of two opinions about one year apart, Bankruptcy Judge John T. Dorsey of Delaware imposed a $55,000 sanction on the debtor’s special counsel for failing to disclose that it was actually two law firms doing business under a fictitious name, and thus was sharing compensation without disclosure.