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In a huge setback for Congoleum Corp., a federal appeals court has reversed a bankruptcy judge’s approval of the company’s “pre-packaged” bankruptcy plan after finding that one of the firms it hired suffered from conflicts of interest because it also represented plaintiffs with asbestos claims against Congoleum. In its 30-page opinion in In re Congoleum Corp., a unanimous three-judge panel concluded that Congoleum should not have hired Gilbert Heintz & Randolph of Washington, D.C., as “special counsel” to advise it on negotiating with asbestos claimants. The court concluded that GHR suffered from an incurable conflict of interest because it had acted as counsel for Congoleum in negotiating settlement arrangements with asbestos claimants represented by lawyers from another firm — Weitz & Luxenberg — who were co-counsel with GHR in insurance matters for the same claimants. As a result, the court held GHR “cannot meet the Bankruptcy Code’s requirement of disinterestedness” because its status as co-counsel with the Weitz firm prevented GHR “from being completely loyal to Congoleum’s interests.” The ruling is a victory for a group of insurance companies that would have been required under the bankruptcy plan to finance a $500 million trust that would allow Congoleum to put its asbestos liability behind it. Attorney Tancred V. Schiavoni of O’Melveny & Myers, who argued the appeal on behalf of the insurers, said the ruling could have a “direct impact” on a separate case currently on trial in the New Jersey Superior Court in which Congoleum is demanding contributions to the trust from about three dozen insurers. Schiavoni said the state court litigation has been on trial since August, but that the 3rd Circuit’s decision may end the case. At issue in the Superior Court case is whether the insurers have the right to control the litigation strategy in Congoleum’s asbestos cases. So far, Schiavoni said, the insurers have successfully defended Congoleum in numerous trials. But under the terms of the pre-packaged bankruptcy plan, the insurers would be forced to forego litigation and establish a hefty trust fund that would pay claimants on the basis of a “matrix,” with mesothelioma victims being paid $100,000 each; lung cancer victims getting $30,000; victims of “other cancers” receiving $10,000; and lesser payments going to those with “non-malignant” diseases. Now the 3rd Circuit has issued an opinion that is critical of U.S. Bankruptcy Judge Kathryn C. Ferguson’s decision to approve the plan, finding that she should have rejected it on the grounds of GHR’s conflict. “We do not approve of a bankruptcy court applying less than careful scrutiny to pre-petition procedures in pre-packaged plans,” Senior U.S. Circuit Judge Joseph F. Weis Jr. wrote. “For a court to approve a pre-packaged plan whose preparation was tainted with overreaching … would be a perversion of the bankruptcy process,” Weis wrote in an opinion joined by 3rd Circuit Judges Dolores K. Sloviter and Theodore A. McKee Jr. Pre-packaged bankruptcy reorganization plans, Weis said, “offer a means of expediting the bankruptcy process by doing most of the work in advance of filing.” But “that efficiency,” Weis said, “… must not be obtained at the price of diminishing the integrity of the process. In this case, it was not a proper exercise of the bankruptcy court’s discretion to fail to consider and appraise the conduct of the parties and counsel pre-petition.” Weis found that GHR had violated Rule 1.7 of the New Jersey Rules of Professional Conduct because, in the negotiation of the pre-packaged plan, it was simultaneously representing both Congoleum and asbestos claimants with interests adverse to Congoleum. GHR had a duty, Weis found, to limit Congoleum’s liability. Although the pre-packaged plan required the claimants to release Congoleum, Weis found that the release “was a limited one and applied only if proceeds were recovered from the insurance companies.” If the litigation against the insurers failed, Weis said, Congoleum “would be liable to the individual claimants for the amount of the settlements, thus pitting Congoleum against the individual claimants [GHR] represents as co-counsel with Weitz.” Lawyers for the insurers also complained that GHR suffered from a second conflict due to its 70 percent ownership of the Kenesis Group, a company hired by Congoleum to screen claimants. Weis agreed, finding that Congoleum had an interest in limiting the number of claims approved that could not be shared by GHR as an owner of Kenesis. “To the extent that the claims were not valid, it was [GHR's] responsibility in representing Congoleum to see that they were rejected, even though it would be adverse to [GHR's] interests if those claims were pursued individually or were excluded from a ‘package’ offered to the insurers in settlement,” Weis wrote. “This was not a potential, but an actual conflict,” Weis wrote. Lawyers for GHR argued the potential conflicts were cured because the firm had secured waivers from both Congoleum and clients the firm had represented as co-counsel with Weitz. Weis disagreed, saying the evidence did not prove the Weitz firm had the authority “to issue waivers on behalf of the thousands of individual claimants it represented.” Although “concurrent conflicts” may be waived by clients, Weis found “the effect of a waiver, particularly a prospective waiver, depends upon whether the clients have given truly informed consent.” Such informed consent was lacking for GHR’s asbestos clients, Weis found. “Given the complexities of the bankruptcy proceeding and the ‘many hats’ worn by [GHR] throughout the pre- and post-petition process, we cannot conclude that the purported waivers [GHR] received from Weitz ‘on behalf of’ the individual clients constituted informed, prospective consent,” Weis wrote. Ferguson erred in approving Congoleum’s pre-petition hiring of GHR, Weis said, because she “relied on an unrealistic view that the insurance interests of the claimants and Congoleum were so closely aligned and so narrowly defined that there was no actual conflict of interest.” Weis found Ferguson’s error “was the result, to a great extent, of the court’s refusal to consider evidence about Gilbert’s activities in negotiating and preparing the plan before its filing. Those pre-petition activities were clearly separate from seeking a recovery from insurance companies after the claims were liquidated or from attempting to negotiate settlements with the insurers.” For Professor Lester Brickman of the Benjamin N. Cardozo School of Law, the 3rd Circuit’s ruling amounts to a personal vindication of criticisms he has been lodging for years. In testimony before a subcommittee in Congress in July 2004, Brickman specifically complained about Ferguson’s decision to approve Congoleum’s hiring of GHR because the firm suffered from a conflict that violated two provisions in Rule 1.7. In his written testimony, Brickman said, “The bankruptcy court’s decision in Congoleum is indicative of the lengths that bankruptcy courts will go to accommodate the interests of plaintiff lawyers in asbestos bankruptcies.” In a strongly worded conclusion, Brickman testified that “the asbestos bankruptcy practices I have described — coupled with some of the implementations of bankruptcy law in the bankruptcy courts, which cede near unbridled power to plaintiff lawyers — in my judgment, constitute an unprecedented assault on the integrity of the bankruptcy process.” In an interview Friday, Brickman said the 3rd Circuit’s decision “is the latest in a series of 3rd Circuit pronouncements essentially holding that the ‘business as usual’ approach in which bankruptcy courts had largely rubber-stamped plaintiffs lawyers’ effective control over asbestos bankruptcy proceedings — irrespective of the bankruptcy rules and conflicts of interest — is no longer to be tolerated.” That trend began, Brickman said, with the 3rd Circuit’s decision to disqualify U.S. District Judge Alfred M. Wolin from handling five major asbestos bankruptcies due to a “perception of bias” stemming from his consultation with court-appointed advisers who suffered from conflicts of interest. It continued, he said, with the December 2004 decision that rejected Combustion Engineering Inc.’s pre-packaged bankruptcy plan on the grounds that it was riddled with flaws. Read together with last week’s Congoleum decision, Brickman said, “what the court appears to be saying to bankruptcy and district court judges is: We want the statutes and bankruptcy rules complied with even though that will require a longer time period to resolve these bankruptcies.” Congoleum’s lawyer, Kerry A. Brennan of Pillsbury Winthrop Shaw Pittman in New York, said the company did not have any immediate comment on the court’s decision. GHR’s lawyers — Richard W. Hill and Rachel L. Diehl of McCarter & English’s Newark, N.J., office — could not be reached for comment.

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