An adroitly drafted liquidating trust will allow the chapter 11 debtor’s counsel to become adverse to the liquidating trust after plan confirmation.
That’s the teaching from a May 5 opinion by Delaware Bankruptcy Judge Brendan Linehan Shannon.
A private equity investor purchased a company that ended up in chapter 11 more than three years later. A large New York-based law firm served as counsel for the acquiror in the acquisition.
After the acquisition, the buyer’s law firm also became the counsel for the acquired company. In the retention agreement, the firm warned the soon-to-be debtor that the dual representation could give rise to conflicts. In the engagement agreement, the soon-to-be debtor agreed that the firm could represent the acquiror if conflicts were to arise between the debtor and the acquiror.
The debtor filed a chapter 11 petition and retained a different firm to be primary bankruptcy counsel. With court approval, the debtor also retained the acquiror’s firm as special corporate counsel.
Less than one year after filing, the debtor confirmed a chapter 11 plan, creating both a liquidating trust and a plan administrator. The liquidating trust was charged with pursuing claims belonging to the debtor. The debtor continued in existence after confirmation, with the plan administrator serving as the debtor’s sole governing authority. The debtor retained assets that were not transferred to the liquidating trust.
Shortly after the acquisition, the debtor had completed a $250 million refinancing that repaid debt incurred as part of the acquisition. After confirmation, the liquidating trustee sued the acquiror, contending that the $250 million recapitalization gave rise to allegedly fraudulent transfers. The acquiror retained its longstanding counsel, the big New York firm, as its counsel to defend the adversary proceeding.
Not long after the complaint was filed, the New York firm filed a motion to dismiss on behalf of the acquiror. Simultaneously, the liquidating trustee filed a motion to disqualify the defendant’s counsel. The liquidating trustee took the position that he had stepped into the shoes of the debtor, thereby disqualifying the New York firm because it had become adverse to its former client.
Judge Shannon denied the disqualification motion, but not based on the written waiver.
Judge Shannon began his analysis by saying that someone seeking disqualification bears a “heavy burden” because disqualification is a “drastic” and “extreme” remedy. However, he quickly dismissed notions that the liquidating trustee was seeking a tactical advantage because the trustee had moved quickly and had also raised his concerns even before filing the motion.
Judge Shannon laid out the governing ethical standards in Model Rule 1.9. Among other things, the rule prohibits a firm from becoming adverse to a former client in a substantially related matter. The “threshold question,” he said, “is whether the Trustee ‘stands in the shoes’ of [the debtor] and is in fact its successor.”
To divine the answer, Judge Shannon examined the plan. He noted that the debtor continued in existence and was represented after confirmation by the same firm that had been its general bankruptcy counsel. Moreover, the plan administrator was the debtor’s sole governing authority.
The plan went on to say that the debtor would have no interest in assets after confirmation that were transferred to the liquidating trust, including the fraudulent transfer claim. Furthermore, the plan said that the liquidating trustee would not be deemed to be holding its assets in trust for the debtor or the estate.
“Under this structure,” Judge Shannon said, the defendant’s counsel’s former client would be the plan administrator “to the extent there is a ‘former client.’”
In terms of caselaw one way or the other, Judge Shannon said it was “scant.” Cases finding a conflict typically have involved a chapter 7 trustee butting up against the debtor’s former counsel. He said that chapter 7 trustees are “statutorily and functionally distinguishable from the Liquidating Trustee.”
Standing for the proposition that the liquidating trustee was not the debtor’s counsel’s former client, Judge Shannon cited In re Abengoa Bioenergy Biomass of Kansas LLC, 2018 WL 1321951 (Bankr. D. Kan. 2018); and In re Las Uvas Valley Dairies, 648 B.R. 260 (Bankr. D.N.M. 2022). To read ABI’s report on Las Uvas, click here.
Judge Shannon characterized Las Uvas as “finding that while the debtor’s assets were assignable to the liquidating trust, the attorney-client relationship was not.”
Judge Shannon denied the motion to disqualify. Agreeing “with the reasoning in both Abengoa and Las Uvas,” he found “that the Liquidating Trustee here is not the former client of [the acquiror’s law firm].”
Footnote
The parties had extensively briefed and argued whether the waiver in the original engagement agreement was enforceable even if the liquidating trust were the firm’s former client. In a footnote, Judge Shannon said, “[T]he Court does not today reach the waiver argument.”
An adroitly drafted liquidating trust will allow the chapter 11 debtor’s counsel to become adverse to the liquidating trust after plan confirmation.
That’s the teaching from a May 5 opinion by Delaware Bankruptcy Judge Brendan Linehan Shannon.
A private equity investor purchased a company that ended up in chapter 11 more than three years later. A large New York-based law firm served as counsel for the acquiror in the acquisition.
After the acquisition, the buyer’s law firm also became the counsel for the acquired company. In the retention agreement, the firm warned the soon-to-be debtor that the dual representation could give rise to conflicts. In the engagement agreement, the soon-to-be debtor agreed that the firm could represent the acquiror if conflicts were to arise between the debtor and the acquiror.
The debtor filed a chapter 11 petition and retained a different firm to be primary bankruptcy counsel. With court approval, the debtor also retained the acquiror’s firm as special corporate counsel.