ack in 2001, I contributed a two-part article for this column on techniques for uncovering disclosable Bankruptcy Rule 2014 "connections" and determining whether, to what extent and how to disclose these connections when seeking court approval for professional retentions.¹ Although one might believe that the dangers of failing to disclose connections are by now well-known in the bankruptcy community, as well as the cardinal principle "when in doubt, disclose," it is remarkable that there continue to be prominent examples of failures that uniformly provoke the response, "what were they thinking?" Three recent failures of this sort—each of which involve allegations of undisclosed financial interests by law firms (or their partners) in the fees earned by other firms or persons in chapter 11 cases—are the subject of this column: the law firm Boies Schiller & Flexner's connection with a document-management firm called Amici LLC in the Adelphia Communications case, the law firm Traub, Bonacquist & Fox's connection with the president and CEO of the debtor in the eToys case, and the law firm Gilbert Heintz & Randolph's ownership of the company hired to review and process asbestos claims in the ACandS case.

To recap some general principles: The "connections" search-and-disclosure obligation stems from Bankruptcy Rule 2014(a), which provides that as a condition of employment, "attorneys, accountants, appraisers, auctioneers, agents or other professionals" for debtors, official committees and otherwise where the professional engagement must be approved by the court must disclose "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." The Bankruptcy Code does not define (or limit) "connections," which makes its determination a matter of subjective judgment on a case-by-case base. In addition, it has been established through case law and practice (but again, not in the Code or Rules) that professionals have a continuing obligation to monitor developments in the case and within their firms for connections that might arise and to make supplemental disclosures.²

In many cases, it will be clear whether a "connection" should be disclosed. However, there is an enormous gray area of "connections" that lend themselves equally to rationales for disclosure as well as nondisclosure, creating an ethical tension between the duty to disclose and the subconscious desire to conceal (or simply ignore) information. The thesis of these columns in 2001 was that such stress and ethical conflict were most apparent where arguably innocuous connections could, if disclosed, present the risk that a professional's employment will be challenged. In such situations, whether by conscious design or not, the temptation to resist disclosure and avoid jeopardy to the engagement must be overwhelming. Perhaps the obvious is too glib: Once the argument and rationale between disclosure and nondisclosure can be resolved either way, disclosure should be the only outcome. The following cases seem to support that conclusion.

In re Adelphia Communications Corp.

In the most recent and high-profile example of how a failure to disclose connections can spark serious consequences, Boies Schiller & Flexner LLP, serving as debtors' special litigation counsel in the chapter 11 cases of Adelphia Communications Corp., came under fire for failing to disclose its relationship with Amici LLC, a document-management firm also retained in Adelphia's bankruptcy cases.³ Shortly after Boies Schiller was retained by the debtors, the firm recommended the retention of Amici without disclosing that two partners and an associate at Boies Schiller, along with other family members related to name partner David Boies and another Boies Schiller partner, held indirect interests of more than 25 percent in Amici through intermediate companies. The lead Boies Schiller attorney for Adelphia is reported to have said that he did not disclose these relationships to Adelphia or its management (or by affidavit to the court and parties in interest) because he was unaware of them at the time Amici was retained, and that the lack of disclosure was "inadvertent" and did not harm Adelphia's value in bankruptcy.

While these circumstances only recently came to light, the repercussions for Boies Schiller were swift. Within the first few months, counsel for parties adverse to the litigation involving the Boies Schiller firm in the Adelphia case⁴ and other Boies Schiller clients (according to David Boies, six to eight other Boies Schiller clients also use Amici's services) questioned the firm's integrity and handling of its litigation. As these complaints illustrate, the costs of failing to disclose are often high because they implicate the professional's judgment and provide litigation opportunities for disgruntled parties in interest to exploit the failure. The consequences can also be far more concrete, however, than damage to the professional's reputation and litigation headaches.

In August 2005, after it learned about the previously undisclosed connections, Adelphia itself requested that Boies Schiller resign its by-then three-year engagement as special counsel. Boies Schiller's lead attorney in Adelphia stated in response: "We resigned because we were asked to resign," not because of improper activity.⁵ However, an unanswered question lingers: Would the firm have been disqualified from representing the debtors or otherwise penalized with disgorgement or other sanctions had it not resigned?

It appears that Adelphia's request was but the first step toward seeking disgorgement of the substantial fees that Adelphia had paid to both Boies Schiller and Amici. Amici reportedly received approximately $7 million in fees, and when Boies Schiller filed its final fee application on Oct. 3, 2005, it sought final approval for roughly $30 million in fees and expenses, of which around $23 million had already been paid over the course of the cases.⁶ The hearing on Boies Schiller's final fee application has been adjourned indefinitely, presumably while the underlying facts of the late disclosure are further investigated.

In January 2006, the U.S. Trustee's Office and the Adelphia fee committee (later joined by Adelphia and the committees of unsecured creditors and equity-holders) sought the appointment of a special examiner to explore Boies Schiller's alleged conflicts of interest and fees. Thus, in an ironic twist of events, from the failure to timely disclose ownership connections in a firm involved in document production services for the debtors (disclosures that arguably would not have imperiled Boies Schiller's engagement as special counsel), the firm that had been hired by Adelphia to seek recovery of funds from the parties that had been responsible for Adelphia's accounting scandals⁷ became the subject of investigation into its own alleged cover-up. Adelphia and the creditors' committee supported the Justice Department's request, adding that they would carry out their own investigation if the request were denied.⁸

At the hearing on the motion for appointment of a special examiner, the court began by stating, "I think everybody can and should take it as a given that the inquiry will take place." The only issue, the court indicated, was whether this inquiry into the underlying facts was best achieved by means of a special examiner or by discovery taken by the parties. The court agreed with Boies Schiller that appointment of an examiner was inappropriate because §1104 of the Code required that such appointments be made to conduct an investigation of the debtor and not its counsel. Furthermore, the court expressed concern that the examiner's fees would exceed the $350,000 cap initially set for the investigation, and indicated that Boies Schiller's pending fee application provided the incentive and the means for opposing parties to take discovery while doing so more cheaply. In denying the appointment of an examiner, the court stated, "This case already has enough fiduciaries. It does not need to spend another $350,000 to accomplish ends that already can be easily addressed in what I believe to be a much more efficient and economical matter." The debtors, creditors' committee and fee committee, the court stated, "have all of the incentive they need to litigate vigorously against [Boies Schiller], and [Boies Schiller] has all the incentive it needs to litigate vigorously to clear its name. That is what the adversary process is all about." The court then granted leave to the parties to seek discovery on Boies Schiller's fees and ethical violations, and added that it would "not foreclose any discovery by any of [Boies Schiller's] opponents on any matter."

In re eToys Inc.

A recent 56-page decision handed down by Judge Mary F. Walrath on Oct. 4, 2005, in the eToys Inc., et al. bankruptcy case⁹ raises issues similar to the disqualification and disgorgement issues implicated by the Boies Schiller case.

According to the findings of fact, shortly after the law firm of Traub, Bonacquist & Fox LLP (TB&F) was retained as counsel for the unsecured creditors' committee, Paul Traub, a partner at TB&F, recommended turnaround specialist Barry Gold to the debtors as a restructuring executive. After conducting interviews with Gold, the debtors hired him and he assumed the positions of president and chief executive officer. Neither Traub nor Gold, however, had disclosed that just a month before eToys had filed for bankruptcy, they had formed a joint venture to provide marketing inventory control and asset-disposition services to distressed companies. TB&F lent funds to the joint venture, which were used to pay compensation to Gold. Moreover, although TB&F and the joint venture maintained separate books and records, TB&F provided office space, administrative services and personnel to the joint venture, for which it was reimbursed.

Traub and Gold's business relationship came to light when an eToys shareholder who was surfing the Internet stumbled on information related to the joint venture. Following this, another shareholder and an administrative claimant each moved for removal, disgorgement and sanctions for violating Bankruptcy Rule 2014 and Code §327(a). The U.S. Trustee also became involved, initially seeking disgorgement of the entire $1.6 million TB&F had received from the debtors, but later reaching a settlement that provided for the disgorgement of $750,000.

Judge Walrath found that TB&F had a direct relationship with Gold that it failed to disclose, but that disqualification was not warranted even though sanctions would result in the form of disgorgement under the U.S. Trustee settlement. The court began by examining Gold and TB&F's involvement in several bankruptcy cases together, either retained by the same or adverse parties, stating that it was not only not unusual, but inevitable, that professionals and turnaround specialists would work on the same cases. However, the court found that TB&F's failure to disclose that it had retained Gold as a consultant in several other cases violated its ongoing duty to disclose "all connections a professional may have with the other parties in the case."

The court then turned to the consequences of this failure. The court began by noting that a "[f]ailure to disclose may result in disallowance of fees or disqualification, even if the failure was negligent and not willful." On the issue of disqualification, the court turned to §1103(b) for the standards of retention applicable to counsel for the creditors' committee. Section 1103(b) provides that "an attorney...employed to represent a committee under §1102...may not, while employed by such committee, represent any other entity having an adverse interest in connection with the case." An adverse interest is "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." The court found that TB&F did not have an adverse interest because the joint venture (as opposed to Gold) had not been involved in the case, and even if it had, TB&F (as opposed to Traub) did not have an interest in the joint venture. Although the relationship raised an "appearance of a conflict," the court concluded that this was not an actual conflict warranting disqualification. However, on the issue of fees, the court approved the settlement with the U.S. Trustee, in part because it furthered the deterrent goal of a sanction.

In re ACandS Inc.

A third case illustrates the lingering effects that an undisclosed business connection may have on bankruptcy counsel's representation later in the case. The story begins with the pre-petition engagement of Gilbert Heintz & Randolph (GH&R) in December 2001 to negotiate the settlement of asbestos-related injury claims against ACandS Inc. (ACandS), an insulation contracting company that had installed products containing asbestos. During the pre-petition period, the debtors employed as a claims reviewer a company called the Kenesis Group LLC in which GH&R held a 70 percent interest. In a further pre-petition arrangement about which the debtors were apparently unaware, the bulk of the work was subcontracted to another company called Clearing House LLC for a payment by Kenesis to Clearing House of two-thirds of Kenesis' fees (a flat fee of $3 million). Kenesis later agreed to purchase Clearing House. This work continued upon the bankruptcy filing of ACandS, but inexplicably Kenesis did not file a retention application until nine months later, and Clearing House never filed a retention application. In August 2003, the bankruptcy court denied Kenesis' retention application for failing to disclose its compensation-sharing arrangement with Clearing House. As a result, the court ordered Kenesis to disgorge $2.4 million of the original $3 million paid to Kenesis.

A year later, in June 2004, a partially secured creditor with an unliquidated asbestos personal-injury claim filed a motion seeking to disqualify GH&R as special counsel and disgorging fees it had earned to date in the case. The motion argued that GH&R—which, in addition to holding a 70 percent interest in Kenesis, had a named partner serving as the chairman of the board of Kenesis and shared offices with Kenesis—failed to disclose the financial connections and background that had led to the rejection of Kenesis' retention application. Combined with allegations that GH&R was conflicted because it represented many asbestos claimants against their insurance companies, the movant argued that GH&R had a pecuniary interest in, and "some degree of influence over," the granting of claims against ACandS, which had been handled by Kenesis and Clearing House. Following the issuance of a court-mandated opinion by an ethics expert (which did not address GH&R's relationship with Kenesis) and oral argument, the court ultimately rejected the motion, ruling in favor of GH&R. As in the other cases discussed above, arguably none of these consequences, much less the collateral litigation and aggravation, would have occurred had the financial interests been disclosed in a timely manner.

In each case, a law firm being engaged for a debtor had a financial interest in another provider of services. In each of these cases, it can be argued that the financial interest motivated the law firm to recommend or otherwise facilitate the engagement of the other providers. In addition, in each of these cases there was financial benefit to the principal law firms from the work being simultaneously performed by the service providers in whom they had a financial interest. Perhaps these are merely examples of negligence in the process of discovering connections. Each of the firms may have lacked the computer and inquiry tools needed for the lawyers principally engaged in the bankruptcy matter to learn of their firm's or partners' financial interests in other service providers. If we stop there, then we can at least conclude that firms lacking inquiry processes to discover connections such as these act in grave peril of their reputations and fee recoveries.

If the connections were in fact known to responsible parties and deliberately not disclosed, then what were they thinking?

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Footnotes

1 Richman, Michael P., "Disclose (Publish) or Perish, Part I: Connections Discovery and Disclosure Techniques," ABI Journal, Vol. XX, No. 5, June 2001; Richman, Michael P., "Disclose (Publish) or Perish, Part II: Post-employment 'Connections' Issues and Disclosure Techniques," ABI Journal, Vol. XX, No. 7, September 2001.

2 See In re Granite Partners, L.P., 219 B.R. 22, 35 (Bankr. S.D.N.Y. 1998).

3 In re Adelphia Communications Corp., et al., Case No. 02-41729 (REG) (Bankr. S.D.N.Y.). Boies Schiller also failed to disclose at the time of its retention, but later did disclose, that other partners and associates owned indirect interests in Echelon Group LLC, another company retained in the cases to perform document reproduction functions. Recently, it has been suggested that a third company, Legal Scientific Analysis Group, is owned by Boies Schiller partners and their relatives. On the subject of disclosure, the author's firm has been serving as counsel to the Bank of Montreal in the Adelphia cases, as well as counsel to some other creditors and an accounting firm (some of which involve the author's work as a lawyer personally), and Kenneth Noble, one of the author's partners, first uncovered Boies Schiller's undisclosed connections and questioned them in court. However, as emphasized in note 1, supra, the author's comments here in the context of connections disclosures in the bankruptcy context are personal and academic in nature, and should not be attributed to the firm, its partners nor any of its clients.

4 For example, Cravath Swaine & Moore, which represented a party adverse to Adelphia, filed letters with the court charging, among other things, that Amici provided it with irrelevant "garbage pages" that included phone directories, cookbooks, menus, travel brochures and shoe catalogs, resulting in unnecessarily high charges.

5 "National Briefing," Washington Post at D02 (Aug. 31, 2005).

6 The fee application also indicated that Boies Schiller had not received any payments from Adelphia since January 2005, leading some to speculate that Boies Schiller's relationship with Adelphia had "soured...before the Amici situation came to light." See Lin, Anthony, "News in Brief: Boies Schiller Files Final Application for Adelphia Fees," N.Y.L.J. 1, Oct. 6, 2005, at 1.

7 Parloff, Roger, "Boies Firm Says: Where's the Beef?," CNNMoney.com (Feb. 6, 2006), at money.cnn.com/2006/02/06/news/newsmakers/ boies2_fortune/.

8 "Adelphia Seeks Federal Probe of Its Former Law Firm," AP DataStream (Feb. 2, 2006).

9 In re eToys Inc., et al., Case No. 01-706 (MFW), slip. op. (Bankr. D. Del. Oct. 4, 2005).