Opinion ID: 1189498
Heading Depth: 1
Heading Rank: 11

Heading: The Legal Standard for Removal of Trustees

Text: The standard for removal of a trustee due to a conflict of interest under § 324 has not been formalized in the Ninth Circuit. Nationally, there are three approaches in the case law to which we will look for guidance. As noted, some of these cases involve attorneys and other professionals, not trustees. Some courts will not remove the trustee unless there is actual injury to the estate or fraud. See In re Freeport Italian Bakery, Inc., 340 F.2d 50, 54 (2d Cir.1965) (actual conflict of interest and fraud). Such harm may simply be the loss of creditor confidence to the point that discord threatens the estate. 3 Collier, supra, ¶ 324.02, at 324-5. Thus, these courts will consider the best interests of the bankruptcy estate. If it would suffer more from the discord created by the present trustee than would be suffered from a change of administration, the removal of the trustee is necessarily the better solution. Baker v. Seeber (In re Baker), 38 B.R. 705, 708 (D.Md.1983) (quoting Freeport Italian Bakery, 340 F.2d at 55); see also In re Microdisk Inc., 33 B.R. 817, 819 (D.Nev.1983). Another approach is per se disqualification if an individual is determined to be not disinterested, typically under the plain terms of §§ 101(14)(A)-(D), without analyzing the effect of any such conflict on the estate. The majority of courts applying this standard do so on the theory that the court cannot use its equitable powers to disregard unambiguous statutory language. See, e.g., Michel v. Fed'd Dep't Stores, Inc. (In re Fed'd Dep't Stores, Inc.), 44 F.3d 1310, 1318-19 (6th Cir.1995), Cf. Movitz v. Baker (In re Triple Star Welding, Inc.), 324 B.R. 778, 790 (9th Cir. BAP 2005) (noting, in a case involving the attorney for the estate, that the court cannot approve employment of a person who is not disinterested); First Interstate Bank of Nev., N.A. v. CIC Inv. Corp. (In re CIC Inv. Corp.), 175 B.R. 52, 56 & n. 4 (9th Cir. BAP 1994) (holding, in a case involving professionals but not a trustee, that a court must follow the unambiguous language of §§ 327(a) and 101(14). but reserving judgment in regards to an attorney with a claim arising solely from services rendered in the bankruptcy case). The Fourth, Sixth and Eighth Circuits have adopted a per se rule in disqualifying attorneys who are not disinterested. See Harold & Williams Dev. Co. v. U.S. Trustee (In re Harold & Williams Dev. Co.), 977 F.2d 906, 909-10 (4th Cir.1992) (but holding that the congressionally established per se rules are carefully delineated and narrowly tailored); Childress v. Middleton Arms, L.P. (In re Middleton Arms., L.P.), 934 F.2d 723, 725 (6th Cir. 1991); and Pierce v. Aetna Life Ins. Co. (In re Pierce), 809 F.2d 1356, 1362-63 (8th Cir.1987). The last approach, formulated by the First and Third Circuits, holds that there is no bright-line rule, but that each case must be judged in the perspective of the particular case and the facts presented. 3 Collier, supra, ¶ 327.04[2][a][I], at 327-35. These courts apply a non-exhaustive list of factors to determine whether a conflict of interest, even if it arises under § 101(14), is sufficient for removal or disqualification because of a potential for a materially adverse effect upon the estate. See In re Martin, 817 F.2d 175, 182 (1st Cir.1987) and BH & P Inc., 949 F.2d at 1313, as clarified in In re Marvel Entm't Group, Inc., 140 F.3d 463, 476-77 (3d Cir. 1998). Both of these cases, which are relied upon by Dye, deserve closer scrutiny. Martin involved a debtor's attorney who duly disclosed that he had taken a mortgage in the chapter 11 debtor's real property, prepetition, in order to secure his fees. The case was then converted to chapter 7 and the attorney sought to enforce the mortgage. The bankruptcy court denied his motion because, according to the plain language of § 101(14)(A) and the disinterested requirement of § 327(a), the attorney was a creditor, and therefore not disinterested. Id. at 177. On appeal, the First Circuit rejected this par se approach as a literalistic reading [which] defies common sense and must be discarded as grossly overbroad. Martin, 817 F.2d at 180. It adopted a full panoply of events and elements test to determine whether such conflict of. interest was materially adverse to the estate and creditors, and elucidated a non-exhaustive list of factors to consider. Id. at 182. The First Circuit then remanded the case for such an analysis. Some of those factors, which are relevant to our case, include the likelihood that a potential conflict might turn into an actual one, the influence the conflict might have in subsequent decisionmaking, and how the matter is perceived by creditors and other parties in interest. Id. In a 1991 case, the Third Circuit was similarly faced with making a per se decision, viz., the removal of a trustee because he represented multiple debtors and therefore was a creditor, under § 101(14)(A) by virtue of having filed claims against the related estates. See BH & P, 949 F.2d at 1310. It opined that it would be unfair and unsound from a standpoint of administrative efficiency and economy to disqualify a trustee on that basis alone, and that such an interpretation of the Code was overbroad. Id. at 1310. First, the Third Circuit correctly reasoned that § 101(14)(A) was inapplicable because it was intended to disqualify only creditors with personal claims and those holding prepetition adverse interests, not trustees having claims against the estate solely in a representative capacity. See Tevis v. Wilke, Fleury, Hoffelt, Gould & Birney, LLP (In re Tevis), 347 B.R. 679, 688 (9th Cir.BAP2006) (To represent an adverse interest means to serve as an attorney for an entity holding such an adverse interest.) Second, it adopted Martin and held that the inquiry as to whether the single trustee in jointly administered estates with interdebtor claims had a materially adverse interest should be evaluated prospectively on a case-by-case basis, by an examination of the full panoply of events and elements. BH & P, 949 F.2d at 1312-13. The Third Circuit concluded that the disputed nature of the proofs of claim and the need for advocacy of the competing interests was a materially adverse potential or actual conflict of interest. Id. at 1313. It therefore affirmed the bankruptcy court's removal of the trustee and his attorneys. Id. at 1313-14. Appellees concede, in their responsive brief, that the proper analysis for our case is the Martin full panoply of events and elements or totality-of-circumstances test. In addition, Dye encourages the panel to adopt BH & P's approach, and suggests the use of several additional factors which she has gleaned from the case law. [10] We agree with this approach to the extent that the question of materiality is addressed in the disinterestedness determination. Whether an interest is materially adverse necessarily requires an objective and fact-driven inquiry. See Rus, Miliband & Smith, APC v. Yoo (In re Dick Cepek, Inc.), 339 B.R. 730, 739-40 & n. 10 (9th Cir. BAP 2006) (holding that where no per se disqualification exists, the inquiry into whether the professional holds interests adverse to the estate, is disinterested or otherwise is impaired by conflict of interest (actual or potential) is necessarily case- and fact-specific.); In re Guy Apple Masonry Contr'r, Inc., 45 B.R. 160, 166 (Bankr.D.Ariz.1984) (analyzing all the evidence to decide whether an actual conflict of interest due to dual representation was materially adverse). [11] We also generally agree that a court should apply a totality-of-circumstances analysis in determining other causes for removal under § 324. We do not subscribe to a rigid application of factors, however, but view them as aids for the court's discretionary review.