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Enron Corp., Bethlehem Steel Corp. and Planet Hollywood International are a few of the latest bankruptcy casualties. As late as Nov. 30, 2001, a staggering 231 public companies with assets exceeding $182.5 billion filed for bankruptcy relief this year, a 30 percent increase over all of last year. See www.BankruptcyData.com. The attorney fees generated in large bankruptcy cases are also staggering, easily exceeding seven figures and sometimes even eight for the law firm representing the debtor. The competition among law firms hoping to represent debtors is intensifying as the size of the cases and the potential for enormous attorney fees increase. Yet how can a larger law firm assure the court that its attorneys do not represent any interest contrary to the debtor’s and that the firm is not biased? Conversely, how does a lawyer assure his law firm that the court will not order the disgorgement of fees already earned because a conflict was not disclosed? In the 1980s, larger law firms routinely shied away from representing debtors out of concern that these relationships might chill their representation of financial institutions, leasing companies and other entities frequently owed money by bankrupt companies. Besides, until 1984, the Bankruptcy Code precluded attorneys from representing both the debtor and a creditor, disqualifying most large firms from debtor representation because their substantial client bases invariably included at least one creditor. The code no longer disqualifies an attorney from representing a debtor “solely” because he represents a creditor, unless there is an objection and an “actual conflict of interest.” 11 U.S.C. 327(c). In examining a lawyer’s unrelated representation of a creditor, the court is concerned with the portion of the law firm’s revenues generated from the creditor and whether the law firm will be hesitant to “bite the hand” that feeds it. Lawrence P. King, Collier on Bankruptcy, Vol. 3 � 327.04[7][b] (15th ed. rev.) Thus, while current representation of a creditor is not a per se bar to retention, an actual conflict of interest or the appearance of impropriety are independent grounds for disqualification. Id. Indisputably, the door for debtor representation by large law firms is open, yet it is only slightly ajar because of the strict requirements of disinterestedness. The code mandates that attorneys for the debtor must be “disinterested” and must not hold or represent an interest adverse to the bankruptcy estate. 11 U.S.C. 327(a). The purpose of these requirements is to ensure impartiality in bankruptcy representation. Electro-Wire Prod. Inc. v. Sirote & Permutt P.C. ( In re Prince), 40 F.3d 356, 359 (11th Cir. 1994). The court may deny compensation or order disgorgement of fees paid if at any time during the representation counsel was not disinterested or held an interest adverse to the estate. 11 U.S.C. 328(c). The threat of not being paid for work performed or, worse, being forced to return monies already earned, is a lawyer’s nightmare, compelling a thorough understanding of the disinterestedness requirement and what constitutes an adverse interest. STRICTLY DEFINED The definition of disinterestedness is broad enough to include anyone who might have some interest or relationship that would even “faintly color the independent and impartial attitude” required of counsel. In re Keller Fin. Serv. of Fla. Inc., 248 B.R. 859, 892 (Bankr. M.D. Fla. 2000). The term “disinterested person” includes a person who is not an insider, director or an equity security holder of the debtor. 11 U.S.C. 101(14)(A)(D). The definition includes a “catch-all,” defining a disinterested person as someone who does not hold an interest “materially” adverse to the estate, a creditor or equity security holder “for any … reason.” 11 U.S.C. 101(14)(E). A counsel’s relationships with the debtor’s investment bankers must be examined to assure disinterestedness. 11 U.S.C. 101(14). For example, a law firm that represented an investment banker for a security of the debtor within three years of the filing lacks disinterestedness. Close relationships between counsel and insiders may preclude counsel from exercising independence-defeating disinterestedness. In re Keller Fin. Serv. of Fla. Inc., 248 B.R. at 895. Insiders include directors and officers of the debtor. 11 U.S.C. 101(31)(B). Equity security holders include shareholders in the debtor. 11 U.S.C. 101(17). Courts should not assume a “flexible approach” in determining disinterestedness. United States Trustee v. Price Waterhouse, 19 F.3d 138 (3rd Cir. 1994). Nor may bankruptcy courts apply their broad equitable powers to disregard the unambiguous statutory language of the code. Id. at 142. The term “adverse interest” is interpreted broadly as a person serving as attorney for a person possessing either an economic interest that would tend to decrease the value of the bankruptcy estate, or one that would create either an actual or potential dispute where the estate is a “rival” claimant. In re Prince, 40 F.3d at 361. An adverse interest also includes a predisposition of bias against the estate. In re Granite Partners L.P., 219 B.R. 22, 33 (S.D.N.Y. 1998). The requirements of disinterestedness and lack of adverse interest are policed through the code’s mandatory disclosure requirements. Prospective debtor’s counsel is required to disclose through a verified statement all its connections with the debtor, creditors and parties in interest. Fed. R. Bankr. P. 2014. The applicant must disclose all connections, not only those that rise to the level of a conflict. In re Granite Partners L.P., 219 B.R. at 35. Boilerplate statements are insufficient. Id. The applicant is charged with disclosing all facts that bear on his disinterestedness and cannot usurp the court’s function by unilaterally choosing which connections impact disinterestedness. Id. An attorney’s inadvertent failure to disclose still warrants denial of compensation. In re Florida Peach Corp. of Amer., 110 B.R. 589 (Bankr. M.D. Fla. 1990). CRITICAL CONFLICT CHECKS Obviously, a firm’s conflict-check system provides the basis for assuring adequate disclosure. Assuming that all larger firms use a database that includes the names of clients, adverse and related parties, it is counsel’s job to run the necessary names through the database for matches. Performing a conflict check involving thousands, perhaps tens of thousands of names where shareholders are involved, may take several days, or in some cases weeks, as a conflict specialist generally checks up to 60 names per hour. Initially, the names of the debtor and its affiliates, directors, investment bankers, creditors and adverse parties must be checked against the database. Some firms maintain a database of the stock portfolios of their attorneys, making information concerning a counsel’s ownership of the debtor’s stock — a prohibited relationship — readily available. As “hits” are identified, the nature of the relationship must be thoroughly examined, sometimes a time-consuming task, entailing contacting the attorney currently handling a matter for the client, as well as the potential bankruptcy counsel, to determine if disinterestedness can be overcome. Finally, the conflict check must be updated before the filing, and supplemented after the filing. A more difficult task is identifying which relationships taint the firm’s independent judgment or suggest bias. A firm might represent a creditor in securities and employment matters and have no involvement in the issues surrounding the creditor’s claim against the debtor. Yet, the creditor’s legal work generates substantial revenues and some of the firm’s members have close personal relationships with members of the creditor’s board. Or, a member of the firm plays golf once a week with the debtor’s chairman, and their families vacation each winter in Colorado. The determination of whether these relationships taint disinterestedness must be made by the court after the nature of these relationships is fully disclosed at the inception of the case. In a blustery opinion, the 11th U.S. Circuit Court of Appeals vacated a district court decision affirming the bankruptcy court’s award of compensation to a law firm that failed to disclose accurately the nature of the services it performed on behalf of the debtor and his spouse. In re Prince, 40 F.3d at 356. The services included orchestrating the debtor’s transfer of property valued at $600,000 to his spouse for little or no consideration. The 11th Circuit held that the bankruptcy court abused its discretion in allowing the award where the law firm could not possibly qualify as a disinterested person, reasoning that the impartiality requirements of the code would be rendered meaningless if any fees were awarded. Id. at 361. An expansive discussion of the interplay between disinterestedness and disgorgement is contained in In re Keller Fin. Serv. Inc. That case involved a debtor’s law firm that failed to supplement its disclosure affidavit. The affidavit should have revealed its connections with potential plaintiffs in suits against brokers resulting from the plaintiff’s purchase of certain notes of the debtors. In re Keller, 243 B.R. at 809. Although the possibility existed that the lawsuits might trigger indemnity claims against the debtors, grounds did not exist to deny compensation because the representation began after the trustee was appointed. Id. at 814. In the landmark case of In re Leslie Fay Co., 175 B.R. 525 (Bankr. S.D.N.Y. 1994), Weil Gotshal & Manges failed to disclose its relationships with individual members of the debtor’s audit committee that had an interest in the outcome of the debtor’s investigation into accounting irregularities. The failure to disclose deprived the court of the “meaningful opportunity” to approve or disapprove the law firm’s application for employment. Id. at 538. The law firm was assessed the costs of the investigation into its disinterestedness (approximately $800,000) and was precluded from handling new matters in the case. The court declined to order disgorgement of all fees, although the remedy is available where disinterestedness is lacking. Id. at 539. Similarly, in In re Granite Partners, a firm’s failure to disclose its representation of a broker dealer who was also the target of an investigation into wrongdoing, warranted disallowance of compensation. 219 B.R. at 22. Law firms must perform extensive conflict checks at the commencement of the case and must fully disclose any relationships with the debtor and its affiliates, creditors, shareholders, investment bankers, targets of investigations and insiders, thereby providing the court with a meaningful opportunity to approve or disapprove of the retention. The disclosure must be supplemented if questionable relationships arise after the filing. Unfortunately, lawyers cannot guarantee that their firms will not be required to disgorge fees. If the firm’s conflict database is flawed, the disclosure may also be flawed. One omission may result in a defective database causing a failure to discover a prohibited relationship, and may result in fee disgorgement. Joanne Gelfand is of counsel to the Boca Raton, Fla. office of Akerman Senterfitt, where she specializes in bankruptcy and creditors’ rights. Ms. Gelfand can be contacted at [email protected]. Rodolfo Pittaluga is a shareholder in the Miami office, where he heads the firm’s bankruptcy and creditors’ rights department. He can be contacted at [email protected].

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