Disclose (Publish) or Perish - Part II Post-employment Connections Issues and Disclosure Techniques
The "connections" search and disclosure obligation stems from Bankruptcy Rule 2014(a), which provides, as a condition of employment of "attorneys, accountants, appraisers, auctioneers, agents or other professionals," for debtors, official committees and otherwise—where the professional engagement must be approved by the court—disclosure of "all of the person's connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the U.S. Trustee or any person employed in the office of the U.S. Trustee." The information must also be verified by the person to be employed "to the best of the applicant's knowledge."
Once the employment application is filed together with appropriate disclosure information and approved, does the professional have an obligation to continue to monitor developments in the case and within his or her firm for either previous connections missed or future connections that might arise, and to make supplemental disclosures thereof? The answer is emphatically "yes," but you won't find it in the Bankruptcy Code or Rules. As articulated by Chief U.S. Bankruptcy Judge Stuart M. Bernstein:
Rule 2014(a) does not expressly require supplemental or continuing disclosure. See In re Caldor Inc., 193 B.R. at 176. Nevertheless, §327(a) implies a duty of continuing disclosure and requires professionals to reveal connections that arise after their retention [citations omitted]. "[T]he need for professional self-scrutiny and avoidance of conflicts of interest does not end upon appointment." Rome v. Braunstein, 19 F.3d at 57-58; accord, In re Unitcast Inc., 214 B.R. 979, 986 (Bankr. N.D. Ohio 1997). Continuing disclosure is necessary to preserve the integrity of the bankruptcy system by ensuring that the trustee's professionals remain conflict free.In re Granite Partners L.P., 219 B.R. 22, 35 (Bankr. S.D.N.Y. 1998).
The easiest case for supplemental disclosure arises when the initial connections search cannot be completed in time for the filing of the employment application. It may simply not be possible to know or feasible to discover all disclosable connections at the time the employment application must be filed with the court. For example, where employment as debtor's counsel is concerned, and where there is a need to maintain confidentiality regarding an imminent filing, a full "connections" inquiry among partners, key employees and staff at law or other professional service firms may be infeasible before the filing has become public knowledge.1 The best course of action in such cases is (a) include in the initial Rule 2014 affidavit a disclosure of any inquiries that could not be completed, why, and when it likely will be completed, and (b) promptly complete the inquiries and file a supplemental disclosure affidavit.
Supplemental disclosures are often a source of stress (which may explain why some are not made promptly or at all) because, however innocuous they may be, they draw attention from parties in interest and they present a risk of challenge to the professional's continued employment. The longer a case endures, the more likely that the number of parties in interest paying close attention to developments (with heightened self-interest) will grow larger. Indeed, in many chapter 11 cases, professional employment is approved with first-day orders at a time when the list of parties requesting notice is likely to be limited and a creditors' committee has not yet been appointed.
To mitigate this stress, regularize the timing of supplemental disclosure where the initial disclosure is based on incomplete information, and otherwise provide some level of employment protection for professionals; some judges in the U.S. Bankruptcy Court for the Southern District of New York have been following a practice of approving professional retention with the typical first-day orders on what is in substance an "interim" 30-day basis. Disclosure (including supplemental disclosure) can then be made to all parties who have requested notice and, if objections are filed, a further hearing can be held, after which the employment order can be made, in substance, "final."
An example of this practice, taken from an order in the chapter 11 cases of Loews Cineplex Entertainment Corp. (ch. 11 case nos. 01-40346 through 01-20582, U.S. Bankruptcy Court, Southern District of New York; Bernstein, C.J.), follows:
ORDERED that, pursuant to §§327 and 328 of the Bankruptcy Code and Bankruptcy Rule 2014, the debtors are authorized and empowered to retain and employ Fried Frank as their attorneys for 30 days, without prejudice to the debtors' right to present a proposed order, and serve the proposed order by notice of presentment2 on (i) the Office of the U.S. Trustee, (ii) O'Melveny & Myers LLP, counsel to Bankers Trust Co. as administrative agent for the debtors' pre-petition and proposed post-petition working capital facility, (iii) counsel to the official committee of unsecured creditors, if appointed, and (iv) all other parties that have filed a notice of appearance in these chapter 11 cases, approving the retention of Fried Frank for the remainder of these cases.
The order does not use the terms "interim" and "final," but rather approves the employment for a 30-day period. Unless the debtors (and the professionals) file and serve a further proposed order with supporting papers, the employment authorization will expire after 30 days. So the effect is the same as if those terms were used.
Some orders following this practice explicitly characterize the employment as "interim." For example, an "Interim Order Authorizing Retention of LeBoeuf, Lamb, Greene & MacRae L.L.P. as counsel to the debtors" in In re RSL Com Primecall Inc. (ch. 11 case nos. 01-11457 and 01-1469, U.S. Bankruptcy Court, Southern District of New York; Gropper, J.) entered April 3, 2001 provided:
ORDERED, that the debtors are authorized to employ and retain LeBoeuf as general and bankruptcy counsel, on an interim basis, nunc pro tunc to March 16, 2001, pursuant to the terms set forth in the application; and it is further
ORDERED, that on or before April 4, 2001, the debtors serve this order, together with the application and declaration, by first class mail, postage prepaid, upon the 20 largest creditors, counsel to the creditors' committee by hand and all parties having filed notices of appearance in these cases; and it is further
ORDERED, that objections, if any, to the retention of LeBoeuf becoming final must be...served in accordance with General Order M-182 or by first-class mail so as to be received no later than 5:00 p.m. on April 23, 2001...; and it is further
ORDERED, that if there are no objections to final retention of LeBoeuf that are timely filed and served by April 23, 2001, at 5:00 p.m., then the retention of LeBoeuf as bankruptcy and general counsel for the debtors in these cases shall be deemed final without need for a hearing or entry of a further order of this court; and it is further
ORDERED, that if objections are timely filed and served, a hearing in connection with the final retention...shall be held on April 30, 2001, at 10:00 a.m...
Conflicts of Interest vs. Conflicts of Independence. Conflicts of interest are generally easy to identify and monitor because most professional firms have good computerized systems in place for client and matter identification and searching. Any prospective new engagement should be checked against that database. This search should show whether the prospective client is now or has been previously represented by the firm, as well as show whether the firm is already involved in the new matter on behalf of another client. Simultaneous engagement by two or more clients in the same matter is a bright red flag of a potential conflict-of-interest problem.
A conflict of independence is more difficult to identify and monitor. A conflict of independence occurs when the professional firm's relationship with a party in interest, on matters completely unrelated to the bankruptcy case, rises to a level sufficient to create an appearance that the bankruptcy professional's independence in dealing with that party in interest in the bankruptcy case might be compromised. These types of conflict are readily identified when employment is first sought, assuming the professional has run a computer search of all parties in interest in the case. However, unless the bankruptcy professional has taken care to record not only the client names, but also the names of all parties in interest that were searched for "connections" disclosures, the creation of supplemental conflicts of independence may be overlooked.
Bankruptcy professionals must have systems in place to monitor for the possibility of further connections disclosures on a regular basis.
If the parties-in-interest list is input (even though such parties are not "clients"), then the firm's future engagement by a party in interest should result in a "hit" that will get to the attention of the bankruptcy professional, permitting the firm either to avoid accepting an engagement that might cause a conflict of interest or independence problem, or to accept the engagement while making the appropriate supplemental disclosure to the bankruptcy court in a timely manner.
Where parties in interest are clients of a professional firm on matters unrelated to the bankruptcy case, the question of whether the bankruptcy professional's independence will be affected is often answered with reference to the magnitude of the client business with the firm. Many disclosure affidavits include information about the amount of the firm's billings to the "connected" party, in absolute terms as well as a percentage of the firm's total revenues. There is no bright-line dollar value or percentage test for determining whether a professional may be compromised in his or her treatment of the party's claims in the bankruptcy context. Much depends on the views of the bankruptcy judge, and can be affected further by the anticipated magnitude of the claim that might be asserted by or against the party.
Suppose then that when the professional employment is approved, the court has considered that a secured creditor of the estate, with a relatively large claim, is a client of the firm representing the debtor, but only on one matter (tax, for example) involving under $100,000 in billings, and less than .01 percent of the firm's revenues.3 Concluding that this type of "connection" will not compromise the firm's independence in the bankruptcy case, the employment is approved. Subsequently, however, the secured creditor begins to hire the firm for other and larger matters. A few litigation matters here, some corporate matters there. The creditor may be a large institution, and the people making the decision to expand the business may well be unaware of the bankruptcy case. What was $100,000 in billings suddenly turns into several million dollars in billings, with a greater percentage of firm revenues.
Bankruptcy professionals must have systems in place to monitor for the possibility of further connections disclosures on a regular basis. The monitoring must extend in at least two directions: to the court dockets to find and search with respect to newly arriving interested parties who were not known to the professional earlier; and to the professional's firm to find and search with respect to new clients, or larger engagements for pre-existing clients, that might now be considered disclosable connections, or might require supplementing of a prior disclosure.
Monitoring the court dockets should be relatively easy to accomplish. New parties are typically identified through notices of appearance or motions. Although a search through a firm's conflicts computer system can be done every time a new party is introduced, it might be reasonable and less burdensome to run such a search periodically (e.g., every two weeks), with the previous two weeks' parties listed. Care should be taken not to allow too long a period of time to elapse between searches, though what is too long will depend on the particular case and parties involved. As soon as it is learned that a newly-identified party has a connection of any kind with the professional, a supplemental disclosure affidavit under Rule 2014 should be filed and served on all parties who have requested notice (as well as the usual core group of U.S. Trustee, the debtor, the creditors' committee, etc.).
If the connection rises to the level of a conflict of interest, the mere filing of a supplemental disclosure is insufficient. In such cases, the professional should proactively raise the issue with the court and parties in interest. If it is not clear whether the conflict creates an employment disqualification or not, the professional should file a supplemental employment motion and seek the court's approval for continued employment.
Regular monitoring within the professional firm itself is somewhat more cumbersome, but most large firms have conflict clearance computer systems that can assist with the monitoring with appropriate information inputs. To illustrate how this might work, consider a recurring problem for supplemental connections disclosures: the case of the after-acquired client. In this example, assume that at the outset of a bankruptcy case, the professional firm ran a computer search and otherwise made inquiry of partners and selected employees regarding connections with a list of 100 parties in interest then known. The results were memorialized in a Rule 2014 affidavit, with any discovered connections being disclosed. A month later, the firm acquires as a new client a company that was on the original list of 100. It wasn't a connection before, but now it has become one. The engagement is not related to the bankruptcy case, but is a disclosable connection.4 How do those responsible for the bankruptcy case find out about it in an timely manner?
One way is to repeat the computer search with the original list (expanded as appropriate to include new parties in interest) on a fairly frequent basis. However, it may be more effective (and automated) to input the list to the computer system as though all the names on the list were clients, with instructions to be contacted in the event of any "hits." That way, when the after-acquired client's name is input, as a preliminary to accepting the engagement (to check for conflicts), there will be a "hit" that will get to the attention of the bankruptcy people who must make the disclosure.
Some readers may view this computer monitoring and information inputting for supplemental disclosures to be tedious or burdensome. They should consider well the consequences of not doing so. In Granite Partners, the law firm hired to represent a trustee in an investigation of potential estate claims against certain broker-dealers filed an initial disclosure affidavit revealing that it had "'client relationships' with various (unidentified) creditors and broker-dealers, but the affidavit did not disclose what this meant." 219 B.R. at 28. The affidavit also disclosed that the firm "may have represented parties in interest in the past and may again in the future in matters unrelated to the estate." Id. at 38. One of the client broker-dealers of the law firm was Merrill Lynch, one of the parties to be investigated. The bankruptcy court concluded that the "clear import of the [disclosure affidavit] is that [the law firm] did not currently represent any parties in interest or broker-dealers, and hence, that [it] did not have an existing client relationship with Merrill Lynch." Id.
But what made the matter much worse is that the Merrill Lynch business with the law firm, which accounted for approximately $225,000 in fees on five matters during the year before the law firm's retention in the bankruptcy case, grew in the next two-and-a-half years to 400 matters accounting for more than $9 million in fees. At no time during that period had the law firm made a supplemental disclosure of the growing relationship with this "connection." The information was revealed only after the investigation was concluded and final fee applications were filed. Under these circumstances, the court concluded that the law firm's "concurrent representation of the trustee and Merrill Lynch created the appearance that its independent judgment and impartiality might be compromised." Id. at 36. Although the court noted that there was "no evidence that [the law firm] failed to discharge its duties in a thoroughly professional manner," it believed that "the investigation and final report [was] tainted." Id. at 42.
In its final fee application, the law firm sought total fees of $4,666,970.92, of which $2,093,700.45 was attributable to the claims investigation of the broker-dealers. As a sanction, the court denied every penny of the fees attributable to the investigation, 15 percent of the fees attributable to the non-investigative aspects of the case ($385,990.57) and the costs associated with a pre-hearing investigation by a fee examiner ($257,079.11). A pro rata disallowance of expenses was also ordered.5
2 Under the notice-of-presentment procedure, the final order can be signed without a hearing if no objections are timely made, and a hearing is held only if such objections are made. Return to article
3 It might also be appropriate for that client to give a waiver of any conflict objection it might assert to a challenge to its claim, or other adverse action by the firm in the bankruptcy case. Return to article
5 There were a number of other facts that influenced the court, including the law firm's acknowledgment that it had requested from Merrill Lynch a prospective waiver to permit the firm to investigate and bring appropriate claims against Merrill Lynch, and that Merrill Lynch had declined to give such a waiver in writing. Thus, it cannot be said that the severity of the sanction was based solely on the failure to make a supplemental disclosure. The full text of the opinion is recommended as an excellent summary of the law on conflicts, disinterestedness and disclosure. Return to article