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In the matter of In re Premier Farms, L.C., a bankruptcy judge for the Northern District of Iowa refused to allow a major law firm to represent a debtor in a Chapter 11 case solely because of the law firm’s unrelated representation of a bank that was the largest creditor in the case. BACKGROUND As one of its “first day motions,” the debtor sought retention of a large law firm that had been rendering pre-petition bankruptcy advice to the debtor under a substantial retainer. The application disclosed that the law firm for two years had provided (and presumably would continue to provide) services to a major bank in matters unrelated to the bankruptcy case. The bank in question was the largest creditor in the case, holding a security interest in both tangible and intangible assets of the debtor. In support of its application, the law firm presented waivers of any conflict from both the debtor and the bank and further disclosed (without specifying dollar amounts) that during the last two years, revenues from its representation of the bank represented much less than one percent of the firm’s total revenue in each year. Several unsecured creditors objected to the debtor’s application to have the firm serve as debtor’s counsel, alleging a conflict interest which should disqualify the law firm from serving. The bankruptcy court, while stating that the law firm is “well qualified to act as attorney for [the debtor] in all aspects of the bankruptcy case,” nevertheless agreed with the objectors and denied the application. APPLICABLE CODE PROVISION The bankruptcy court zeroed in on the applicable code provisions: “Pursuant to 11 U.S. Code 1107(a), premier, as debtor-in-possession, has the rights and powers of a trustee serving in a Chapter 11. A trustee may employ one or more attorneys “that do not hold or represent an interest adverse to the estate, and that are disinterested persons.” Section 327 also provides that “in a case under Chapter 11 of this title, a person is not disqualified for employment under this section solely because of such person’s employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.” The bankruptcy statute defines a “disinterested person.” The definition, in relevant part, states that a disinterested person “does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor of an investment banker specified in subparagraph (B) of (C) of this paragraph, or for any other reason.” The bankruptcy court began by noting that the code does not define or state what it means to hold or represent an adverse interest, but noted: “The statute does not define or state what is means to hold or represent an adverse interest. The meaning has been developed by case law. An interest adverse to the estate has been defined in Re Envirodyne Industries Inc., as “any economic interest that would tend to lessen the value of the bankruptcy estate or that would create either an actual or potential dispute in which the estate is a rival claimant” or it is a “predisposition under circumstances that render such a bias against the estate.” The court then concluded that under the circumstances of the case, the law firm had a “predisposition to bias in favor of [the bank],” which constituted both an adverse interest and evidence that it was not disinterested. In the same paragraph, the court also found that because creditors had objected, the court has discretion to disqualify an attorney because of a potential conflict. The relevant language of the opinion is as follows: “I find and conclude that [the law firm] has an adverse interest and is therefore not disinterested, because it has a predisposition to bias in favor of bank. Bank is a client. It has been one for at least nearly two years. There is an exception from disqualification which might permit a law firm to represent a trustee or debtor-in-possession despite the firm’s employment by a creditor. “But this exception applies only if no creditor objects and there is no actual conflict of interest. In this case, a creditor, JBD Pork, et al., has objected, and I find there is a potential, if not actual, conflict. Although there is a per se disqualification for an actual conflict of interest, the court in its discretion, may disqualify an attorney that has a potential conflict.” Thus, in a single short paragraph, the bankruptcy court found disqualifying adverse interest, disqualifying lack of disinterestedness and disqualifying potential conflict of interest, all predicated upon the court’s conclusion that the law firm had a “predispositon bias in favor of [the bank]” because of its ongoing representation of the bank in unrelated matters. COURT’S REASONING ON BIAS The court assumed the importance of the bank to the law firm as one of its clients or on the relatively de minimis percent of total firm revenue generated by the bank and focused on the leverage that the bank had in the bankruptcy case and the court’s perception of the difficulty that the law firm would have in zealously representing the debtor in matters involving its regular bank client. The court’s reasoning was as follows: “Bank is the largest creditor, and the only creditor scheduled to have a security interest in property of the debtor. Bank is not merely one of a number of creditors holding general unsecured claims. The debtor-in-possession’s law firm must deal with bank’s bankruptcy counsel. The issues to be evaluated and possible raised and litigated are numerous and important. They include consideration of and possible challenge to the validity and extent of bank’s liens, the adequate protection of bank’s lien, objection to or subordination of the bank’s claim, plan treatment, and stay litigation.” While acknowledging a debtor should not be deprived of its choice of counsel except in rare cases and that the court should not disqualify counsel for a mere appearance of impropriety, citing In re Marvel Entertainment Group Inc., it nevertheless felt that disqualification was appropriate under the circumstances. “Nonetheless, premier is entitled to zealous representation by its attorney in this case. I believe that there is legitimate and real concern that [the law firm's] attorney-client relationship with bank could detrimentally affect the firm’s zealous representation in this case. Premier may well be a one-time client of the law firm. It is obvious that bank has not been. In short, [the law firm] might be affected in this handling of the case by a desire not to make a regular client angry. Also, there must be no concern in the minds of other creditors that bank is receiving favored treatment from debtor because debtor’s counsel represents the bank,” the court wrote. There is a case authority for my decision to disqualify [the law firm]: Matter of Status Game Corp.; contra, In re Dynamark Ltd. [The law firm] could have cured the problem by ceasing its representation of bank. It did not. It is my view that [the law firm's] attorney-client relationship with bank, one of the most significant, if not the most significant, creditors in this case, creates a potential if not actual conflict of interest for the law firm. Such conflict should result in its disqualification as counsel for the debtor-in-possession.” And, apparently for good measure, the bankruptcy court also denied the application of the law firm’s attorney to appear pro hac vice! COMMENT Since the bankruptcy court cited only other bankruptcy court decisions in support of its view of disqualification of counsel under � 327 (a) under these circumstances, it would appear that at least so far as published opinions from the bankruptcy court’s research showed, similar disqualifications are not common. The court’s opinion, in holding that the law firm was not disinterested because it had an “adverse interest,” did not, however, find that it had any adverse economic interest in the bankruptcy case itself, but rather, because of an unrelated attorney-client relationship (albeit perhaps minimal in dollar terms) nevertheless had a disqualifying “predisposition” to prefer the bank client’s economic interest in the case to those of the debtor. Regrettably, the opinion does not reflect whether or to what extent an evidentiary hearing occurred, and, if customary practice obtained, it likely did not. Accordingly, the reader is left with the bankruptcy court’s inference or presumption (but stated as a finding and conclusion) that such a predisposition to bias favoring the bank existed, not merely that there was an appearance of impropriety. It should also be noted that the court was unmoved by the proffer of waivers from both the debtor and the bank and engaged in no discussion in its opinion as to the effectiveness or lack of effectiveness of the waivers as an antidote to or a mitigating circumstance with respect to any predisposition of bias. If the holding of this court is followed by other courts facing similar circumstances, it will be virtually impossible for a large law firm, over objection, to serve as counsel for a debtor or debtor-in-possession whenever an established client of the firm (e.g. a bank) has a significant interest adverse to the debtor in the bankruptcy case, even though that client is separately represented in the case and even though the debtor and the client each have waived conflict. In short, if objection is raised, a law firm’s ongoing but unrelated representation of a major creditor can, in the court’s discretion, be presumed to be evidence and therefore to constitute a disqualifying potential conflict arising from the predisposition of the firm to favor the regular client over the debtor in the case. If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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