This disqualification case of the week arose in bankruptcy court, in which some of the most daunting conflict of interest and disqualification issues arise.  Bankruptcy practice is frequently difficult and complex in this regard in part because the Bankruptcy Code and Rules can complicate the common law disqualification framework and because the status of creditors varies significantly (as does the approach that firms and courts take to conflicts between debtors and creditors and between creditors and creditors).  As it turns out, however, this case was uncharacteristically simple.  An associate represented the debtor-in-possession in a Chapter 11 bankruptcy, and essentially two secured creditors had claims to virtually all of the debtor’s assets.  The firm representing one of the secured creditors gave the associate a job offer, which the associate accepted on March 11, 2015.  The associate failed to disclose the accepted offer to his supervising attorney until April 20, 2015.  Furthermore, “[b]etween March 11, 2015 and June 5, 2015, [the associate] continued to sign and file all pleadings on behalf of the Debtors.”[1]  It was during this time that the debtor and creditors entered into a settlement agreement, divvying up the debtor’s previously liquidated assets among the secured creditors and stipulating to dismiss the bankruptcy case.  On June 5, the associate moved to withdraw (without disclosing the conflict), and on June 15, the supervising attorney “filed a Supplement to Application for Employment of Attorneys [under 11 U.S.C. 327], for the first time informing the Court of [the associate]’s acceptance of an employment offer with [the secured creditor’s law firm].”  The U.S. Trustee in response filed a motion to disqualify and to deny all compensation to the debtor’s firm.

The court first recited the relevant standards in the Bankruptcy Code and Rules.  Section 327(a) provides that “the trustee, with the court’s approval, may employ one or more attorneys . . . that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee’s duties under this title.”[2]  Bankruptcy Rule 2014(a) also imposes on attorneys a continuing duty of disclosure through “a verified statement of the person to be employed setting forth the person’s connections with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States trustee, or any other person employed in the office of the United States trustee.”[3]  The court then noted that “accepting a position at a law firm representing one of the largest creditors in a case where one represents the debtor must be disclosed, [and] . . . the connections between the firms and the parties at a minimum created the appearance of impropriety.”  The court therefore concluded that, “under § 327(a) and Rule 2014(a), there is no question [the associate] and his firm . . . had the fiduciary duty and responsibility to disclose [the associate]’s move to [the secured creditor’s firm]. It is also undisputed [they] failed to do so for over three months. The failure to disclose the connection between [the associate] and [the creditor’s firm] warrants denial and disgorgement of fees and expenses.”   The court proceeded to penalize the associate’s former firm by denying all compensation for work done on and after March 11, 2015 (the date on which the associate had secretly accepted the offer of employment), even though the supervising attorney did not know about the conflict until over a month later.[4]  The court refused to disqualify the firm, however, reasoning in essence that the associate “created the conflict here, and he has left” the debtor’s firm (and the creditor’s firm has apparently been screening the associate since his arrival).

The full opinion is available here: In re US Bentonite, Inc. (Bankr. Wyo. Sept. 3, 2015).

[1]           Among other sources of ethical guidance, the associate could have instead reviewed this new ABA article, which summarizes an associate’s disclosure and related obligations when negotiating and accepting employment with an adverse firm.

[2]           The court also cited Section 328(c), which gives the court discretion to “deny allowance of compensation for services and reimbursement of expenses of a professional person employed under section 327 or 1103 of this title if, at any time during such professional person’s employment under section 327 or 1103 of this title, such professional person is not a disinterested person, or represents or holds an interest adverse to the interest of the estate with respect to the matter on which such professional person is employed.”

[3]           As an extreme application of Bankruptcy Rule 2014, attorney John Gellene was convicted and sent to prison in part for submitting less-than-truthful 2014 declarations concerning his firm’s representation of creditors. See United States v. Gellene, 182 F.3d 578 (7th Cir. 1999); Milton C. Regan, Jr., Eat What You Kill: The Fall of a Wall Street Lawyer (U. Mich. Press 2006).

[4]           Presumably, the firm quickly knew that it would be receiving a haircut because the court’s opinion begins as follows: “Attorneys are legal professionals. As a condition to practicing law in Wyoming, attorneys must affirmatively swear to ‘support, obey and defend the Constitution of the United States and the Constitution and laws of the State of Wyoming, and [to] faithfully and honestly and to the best of [their] ability discharge the duties of an Attorney and Counselor at Law.’ The duty of candor and honesty underscore this oath, and safeguard the judicial process. In this self-policing profession, truthfulness and disclosure are imperative. As a result, attorneys bear the risks associated with non-disclosure, even when the non-disclosure was the result of temporary lapses of judgment.”