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Use of Conflicts Counsel Will Not Overcome an Actual Conflict of Interest

By: Stephanie Kenn

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Section 327 of the Bankruptcy Code governs the employment of professional persons in bankruptcy cases.[1] In order to gain court approval, counsel must (1) “not hold or represent an interest adverse to the estate,” and (2) be a “disinterested person.”[2] Further, § 327(c) states that, “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 an actual conflict of interest.”[3]

In In re WM Distribution, Inc., a bankruptcy court in New Mexico refused to allow a law firm to simultaneously represent both a debtor and a second company because the companies’ close working relationship created a disqualifying conflict of interest.[4] The debtor, WM Distribution, a cigarette distribution company, had a close working relationship with STM, another cigarette distribution company.[5] Indeed, STM was the largest unsecured creditor of WM Distribution, holding 50% of WM Distribution’s total debt.  In addition, the two companies had common ownership, shared employees, and were covered by some of the same insurance policies.[6]         STM filed a chapter 11 bankruptcy petition in September of 2016, in which the Davis Firm represented the company.[7] Subsequently, WM Distribution filed a chapter 11 bankruptcy petition and the Davis Firm sought approval for its employment as WM Distribution’s general bankruptcy counsel.[8]  Donald Packingham, the majority shareholder of STM, then moved to terminate the firm’s representation of STM because the firm’s involvement in both companies’ bankruptcy and business reorganizations created a conflict of interest.[9] The Davis Firm argued that there was no actual conflict of interest and that any potential conflict could “be cured by hiring separate conflicts counsel to represent WM Distribution on those matters for which an actual conflict exists.”[10] The court rejected these defenses, finding multiple actual conflicts of interest related to the firm’s simultaneous representation of these companies.[11] The court explained that the companies’ daily operations were so entangled that the area of adverse interests between the two debtors reached into their reorganization efforts.[12] In fact, the adverse interests involved were “central to their respective reorganization efforts,” and because of this, the use of conflict counsel was not a practical solution.[13]

Section 327(c) is a limited exception to (a)’s requirements and deals with situations where an otherwise qualified counsel is disqualified solely because of its representation of both a debtor and a creditor in bankruptcy proceedings. However, subsection (c) cannot be read independently from subsection (a). Thus, in order to meet the requirements of subsection (c) and have no actual conflict of interest, counsel must also meet the requirements of (a). The Bankruptcy Code does not define what an “actual conflict of interest” is, but courts often have broad authority to find a conflict under § 327(c).[14] Such determinations are made on a case-by-case basis.[15] The court in WM Distribution held that the two companies’ interests were “such that retention of independent conflicts counsel poses too great a risk that the Davis Firm would nevertheless be unable to give each debtor its undivided loyalty and provide to each debtor untainted advice and assistance in furtherance of their fiduciary responsibilities.”[16] In determining whether a conflict existed, the court emphasized the attorney-client relationship and the fiduciary duty owed to the client by the attorney.[17] The court explained that in this situation, counsel would not be able to fulfill its duty to one debtor without sacrificing its duty to the other.[18] By focusing on the fiduciary duties owed by an attorney to its client, the court aligned the underlying policy of subsection (c) with those underlying subsection (a).[19]     

   


[1] 11 USC § 327 (2012).

[2] 11 USC § 327(a).

[3] 11 USC § 327(c).

[4] In re: WM Distribution, Inc., 571 B.R. 866, 874 (Bankr. D.N.M. 2017). The court refused such representation despite the offer of using conflicts counsel.

[5] See id.

[6] See id.

[7] See id.

[8] See id. at 870.

[9] See id. at 869. Packingham’s daughter, Donna Woody, was a 10 percent shareholder of both WM Distribution and STM. She also managed both companies and ran their daily operations. Woody argued in favor of the Davis Firm’s representation. See id. at 868.

[10] Id. at 872.

[11] See id. at 873.

[12] See id. at 874.

[13] Id.

[14] See In re 7677 E. Berry Ave. Assocs., L.P., 419 B.R. 833, 843 (Bankr. D. Colo 2009). Subsection (c) is “commonly referred to as the ‘catch-all clause.’”

[15] See BH & P Inc., 949 F.2d 1300, 1315 (3rd Cir. 1991).

[16] In re: WM Distribution, Inc., 571 B.R. at 873 (“[S]uch use of conflicts counsel is not appropriate where the adverse interests of the debtors represented by the same general bankruptcy counsel are central to the reorganization efforts of either debtor . . . or where the adverse interests are so extensive that each debtor should have its own independent . . . counsel.”).  

[17] See id. at 874.

[18] See id. at 874 (“STM and WM Distribution need separate counsel to advise the companies as to what is in the best interest of each company regarding their continuing business relationship so each company can best formulate its chapter 11 plan.”).

[19] Rome v. Braunstein, 19 F.3d 54, 58 (1st Cir. 1971) (holding that the statutory requirements under §327(a), “disinterestedness and no interest adverse to the estate[,] serve the important policy of ensuring that all professionals appointed pursuant to section 327(a) tender undivided loyalty and provide untainted advice and assistance in furtherance of their fiduciary responsibilities.”).