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A federal appeals court has overturned a Delaware bankruptcy court’s order requiring Philadelphia-based law firm Pepper Hamilton to “disgorge” nearly $140,000 in fees it had already been paid and denying its final petition for more than $65,000 in fees. The unanimous three-judge panel found that the bankruptcy court had abused its discretion when it denied the fees due to Pepper Hamilton’s alleged failure to disclose to the court an employment restriction that could have led to its forced withdrawal from the case. The decision in In Re: Olsen Industries Inc. focuses on a provision in the Bankruptcy Code that allows the court to limit compensation to a lawyer who at any time “is not a disinterested person, or represents or holds an interest adverse to the interests of the estate.” But the appeals court said the bankruptcy court limited Pepper Hamilton’s fees not on a finding of an actual adverse interest, but “the possibility” that the lawyers would take an adverse position. Although the firm failed to “explicitly disclose” the terms of its employment restriction to the bankruptcy court, the appeals panel found that the firm’s actions “were sufficient to satisfy the requirements of Bankruptcy Rule 2014(a).” Pepper Hamilton’s client, T. Frederick Jackson Inc., was an electrical contracting company, wholly owned by Olsen Industries, the debtor. In 1977, Jackson and Olsen had agreed to indemnify Fidelity & Deposit Co., which provided its payment and performance surety bonds, for all losses in connection with any bond issued by F&D for Jackson. Jackson defaulted on a bond in 1982 for electrical work on the Marriott Marquis in New York City. The general contractor, Morse Diesel, demanded that F&D remedy the default, but F&D refused. Over the next 11 years, the parties litigated the dispute in the federal courts in New York. Since Jackson did not have funds to litigate, F&D paid its fees. In 1993, Jackson hired Pepper Hamilton, but the firm did not approve of the existing fee indemnity agreement between F&D and Jackson. Because F&D was paying the fees, the firm refused to be placed in a position where Jackson could direct the firm to represent it in a suit against F&D. Attorney Kenneth Cushman drafted an engagement letter to Olsen that said the firm would not represent Jackson in any matter adverse to F&D and that Jackson would agree that the firm could share attorney-client confidences with F&D. The letter explicitly stated that F&D would be paying the fees and that Jackson had agreed that if its bills were not timely paid, the firm “has a right to withdraw as counsel.” Then, in October 1994, Olsen filed for bankruptcy protection under Chapter 11, and Pepper Hamilton was appointed as lead counsel. Pepper attorney Francis J. Lawall attached an affidavit to the application that disclosed that its fees were being paid by F&D, but did not mention the restriction that said the firm would not represent Jackson in any matter adverse to F&D. During the bankruptcy proceedings, Olsen and the Pepper lawyers disagreed on some issues relating to the Morse Diesel litigation. After the verdict in that case was upheld on appeal, the firm withdrew from the bankruptcy. In January 1997, the firm applied for a final fee of more than $65,000, but Jackson filed an objection, saying the firm had failed to disclose its connection to F&D to the court. The bankruptcy court found that the firm’s non-disclosure became “problematic” in March 1995 when “the possibility that the debtor would take a position adverse to the interests of F&D … changed from merely conceptual to actual.” At that point, the bankruptcy court said, the Pepper firm was required to disclose the restriction to the court. Finding that the non-disclosure was intentional, the court disallowed the seventh fee petition and ordered disgorgement of $139,960, representing all fees dating back to March 1995. Now the 3rd Circuit has ruled that Pepper is entitled to all its fees. The panel found that while the bankruptcy court’s finding was correct that Pepper had failed to disclose the restrictions to the court, the real issue was whether “Pepper’s failure to disclose was legally so significant as to run afoul of Bankruptcy Rule 2014(a).” Senior U.S. Circuit Judge Ruggero J. Aldisert said the bankruptcy court also got it right in finding that Pepper’s employment restriction “did not create an actual conflict of interest.”‘ Aldisert said the lower court erred in disallowing fees due to non-disclosure in light of “the possibility” of a conflict. The firm had disclosed in its initial application that F&D was funding the case and that it would withdraw if F&D failed to pay, Aldisert said, and the lower court’s order appointing the firm as lead counsel specifically provided that it could resign if F&D did not pay. “Pepper’s disclosure was sufficient under Rule 2014(a) because the firm notified the court in its application for employment that F&D was paying the debtor’s legal bills,” Aldisert wrote. Aldisert said the bankruptcy court “can be presumed to have been aware not only of the limitations that this arrangement placed on Pepper, but also that, in these circumstances, where Pepper was involved from early on, and was carrying on complex construction litigation (which was the sole asset of the estate), it was not realistic that any other law firm would take on the job of being counsel on a contingent basis, or on a non-contingent basis without a similar limitation.” As a result, Aldisert said, the bankruptcy judge’s denial of the final fee petition and disgorgement order “was an abuse of discretion.” The Pepper firm, he said, “is entitled to full compensation for all of the applied-for fees associated with its representation of Jackson.” Aldisert was joined by Chief U.S. Circuit Judge Edward R. Becker and visiting Senior U.S. District Judge William C. O’Kelley of the Northern District of Georgia. Pepper Hamilton was represented in the appeal by attorneys David T. Sykes, Mark J. Packel and Lauren Lonergan Taylor of Philadelphia-based Duane Morris & Heckscher. Attorney Pace Reich of Elkins Park, Pa., represented T. Frederick Jackson Inc. in a cross-appeal that said the lower court had erred by not ordering complete disgorgement of all fees.

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