Opinion ID: 626316
Heading Depth: 2
Heading Rank: 1

Heading: Disqualifying Conflict of Interest

Text: On appeal, the Trustee's central argument is that the bankruptcy court erred in finding that A&R did not have a disqualifying interest. Specifically, the Trustee argues that A&R was not disinterested: (1) because GCA paid the bankruptcy retainer; (2) because of A&R's relationship with GCA; and (3) because A&R advised AIPC on how to characterize payments made to officers and directors several months prior to filing the bankruptcy petition. The Bankruptcy Code requires that a professional retained by the debtor in possession not hold or represent an interest adverse to the estate, and that the professional be disinterested. 11 U.S.C. § 327(a); In re W.F. Dev. Corp., 905 F.2d 883, 884 (5th Cir.1990). The term disinterested is defined in 11 U.S.C. § 101(14) as a person (1) who is not a creditor, an equity security holder, or an insider, (2) who is not and was not, within 2 years before the date of the filing of the petition, a director, officer, or employee of the debtor, and (3) who does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason. 11 U.S.C. § 101(14); W.F. Dev. Corp., 905 F.2d at 884. A party has an adverse interest to the estate if they: (1) [] possess or assert 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; or (2) [] possess a predisposition under circumstances that render such a bias against the estate. West Delta Oil, 432 F.3d at 356 (quotation marks omitted); see also In re AroChem Corp., 176 F.3d 610, 623 (2d Cir.1999) (same); In re Crivello, 134 F.3d 831, 835 (7th Cir.1998) (same). [7] The determination of an adverse interest must be made with an eye to the specific facts of each case. West Delta Oil, 432 F.3d at 356. The standards for finding a conflict are `strict' and attorneys engaged in the conduct of a bankruptcy case `should be free of the slightest personal interest which might be reflected in their decisions concerning matters of the debtor's estate or which might impair the high degree of impartiality and detached judgment expected of them during the course of administration.' West Delta Oil, 432 F.3d at 355 (quoting In re Consol. Bancshares, Inc., 785 F.2d 1249, 1256 & n. 6 (5th Cir.1986)). Under Section 328(c), [a] court may deny compensation for services provided by an attorney who holds such an adverse interest. West Delta Oil, 432 F.3d at 354-55; 11 U.S.C. § 328(c). A bankruptcy court is not required, however, to deny all compensation if an attorney has an adverse interest and is found to not be disinterested. West Delta Oil, 432 F.3d at 355 n. 22 (explaining that the rule is flexible because a bankruptcy court is one of equity); In re Prince, 40 F.3d 356, 359-60 (11th Cir.1994) (same); Gray v. English, 30 F.3d 1319, 1324 (10th Cir.1994) (same). As noted, the Trustee argues that A&R was not disinterested based on three different grounds. Two of these grounds focus on A&R's connections to GCA and we will consider them together. The most troubling aspect of A&R's relationship to GCA is obviously GCA's payment of the bankruptcy retainer. Courts have taken two approaches when deciding if payment of a bankruptcy retainer by a third-party is a disqualifying interest. Some courts have found that payment of a retainer by a third party is a per se disqualification, while other courts have held that the totality of the circumstances surrounding the retainer payment must be scrutinized before deciding if a disqualifying conflict exists. See In re Lotus Props. LP, 200 B.R. 388, 391-96 (Bankr.C.D.Cal.1996) (explaining both approaches). Although we have not formally adopted a test in this Circuit, we find that the per se approach is inconsistent with our decision in West Delta Oil. In that decision, we stated that the existence of a conflict should be determined with an eye to the specific facts of each case. West Delta Oil, 432 F.3d at 356; see also In re Harold & Williams Dev. Co., 977 F.2d 906, 909-10 (4th Cir.1992) (stating that judicially created per se rules for disqualifications are usually not appropriate). [8] Thus, we now adopt the totality of the circumstances approach for deciding whether third-party payment of a retainer creates a disqualifying interest. [9] The Trustee cites a number of actions taken by A&R that it argues shows that A&R felt loyalty to GCA due to the retainer. We will analyze each of these occurrences. First, the Trustee argues that A&R's role in negotiating the pre-petition lock-up agreement shows A&R's loyalty to GCA. It is undisputed that A&R acted as the debtors' counsel during the pre-petition negotiations with GCA. It is not clear, however, how A&R's role in this negotiation evidences any divided loyalties. It is common for a law firm to help its client negotiate a pre-petition agreement with a creditor and the bankruptcy process encourages such voluntary settlements. The Trustee also argues that A&R believed that it was bound by the retainer payment to favor GCA's claims. Loyalty to a third-party due to the payment of a retainer would obviously render a party not disinterested. See In re Big Rivers Elec. Corp., 355 F.3d 415, 434 (6th Cir. 2004) (stating that a professional would not be disinterested if payment by creditor was linked to providing favorable result to that creditor). There is some evidence in the record showing that A&R discussed submitting bankruptcy plans that were favorable to GCA. However, the evidence supporting the Trustee's contentions on this point can also be interpreted as simply showing that A&R was aware that confirmation of a plan would require GCA's support, and that the proposed plan must, therefore, be acceptable to GCA. The bankruptcy court found that the record more fairly supported this legitimate inference. We are in a poor position to second-guess that factual judgment, and we now hold that this factual finding is not clear error. United States v. Casteneda, 951 F.2d 44, 47 (5th Cir.1992) (stating that where two permissible views of the evidence are presented, the district court's choice between them cannot be clearly erroneous.). Third, the Trustee argues that A&R's divided loyalties are evidenced by its decision not to litigate GCA's secured claim. GCA's secured claim was based on its lien on AIPK's shares and on the assignment of CGC dividends from AIPK. Although there are grounds for questioning A&R's decision on this point, the testimony at trial indicated that A&R considered whether to dispute these claims and decided that the costs of litigation were not in the best interests of the estate, particularly given that the debtors were already litigating Halifax's claims. In its analysis, the bankruptcy court considered the same arguments as are currently presented on appeal, and it found that there was no evidence that A&R's decision was affected by loyalty to GCA. Again, this factual finding is supported by evidence in the record and it is, therefore, not clearly erroneous. See Fairley v. Hattiesburg, Miss., 584 F.3d 660, 673 (5th Cir.2009) (`If the district court's account of the evidence is plausible in light of the record viewed in its entirety, the court of appeals may not reverse ...' (quoting Anderson v. City of Bessemer, 470 U.S. 564, 573, 105 S.Ct. 1504, 84 L.Ed.2d 518 (1985))). Finally, and most suspiciously, the Trustee offers evidence showing that A&R drafted a motion for relief from stay on behalf of GCA during the bankruptcy. The bankruptcy court found, however, that this letter did not evidence any favoritism or loyalty to GCA. Instead, the bankruptcy court credited testimony from Dean Ferguson, who was A&R's lead attorney on the bankruptcy, that A&R prepared the draft as part of a strategy to help overcome a stalemate in negotiations between GCA and the Equity Committee. Even though the circumstances surrounding the drafting of this motion are strange, we again hold that the bankruptcy court's factual findings on this issue are not clearly erroneous. Ferguson's explanation for the drafting is reasonable, and the bankruptcy court did not err in crediting his testimony on this point. See Fairley, 584 F.3d at 673. Thus, we find that this evidence does not show that A&R's loyalty to the debtors was compromised. Overall, given the factual findings made below, we agree with the bankruptcy court that GCA's payment of the retainer did not create an adverse interest or show that A&R was not disinterested. The facts of this case are not nearly as egregious as those in West Delta Oil, where we found that special counsel for the debtor had an adverse interest because they were actively plotting to harm the estate for their own benefit. 432 F.3d at 357-58. In that case, the attorneys for the debtor attempted to surreptitiously purchase the debtor though an outside investor, while also suppressing other bids to artificially depress the purchase price. Id. at 349-53. We held that disgorgement of all fees was required due to the profound nature of the conflict. Id. at 358. While some of the actions of A&R appear suspicious, this case does not present a totality of the circumstances as egregious as West Delta Oil, and we agree with the bankruptcy court that the relationship between GCA and A&R does not rise to the level of a disqualifying conflict requiring the disgorgement of fees. See AroChem, 176 F.3d at 628 (stating that a bankruptcy court's conclusions on a conflict of interest should be accorded deference); In re Martin, 817 F.2d 175, 182 (1st Cir.1987) (same). Here, unlike in that case, there is no evidence that A&R took action contrary to the interests of the estate or gave legal advice that was colored by loyalty to a third party. Accordingly, we decline to reverse the bankruptcy court's ruling on this issue. In addition to A&R's relationship to GCA, the Trustee separately argues that A&R possessed a disqualifying interest because of its previous representations of the debtors. Specifically, the Trustee argues that A&R's role in the Bridge transaction prevented it from offering objective legal advice to the debtors. The bankruptcy court found that A&R did not have a conflict because A&R's role in these transactions was limited to a neutral escrow agent. In January 2004, AIPK transferred eighty-five percent of its shares of CGC to Bridge in exchange for $5 million. A significant portion of the sale price was used to pay the wages and benefits of AIPC's officers. The bankruptcy court's determination that A&R's role was limited to a neutral escrow agent is incorrect based on the testimony at trial. Rather, the testimony showed that A&R, in addition to acting as an escrow agent, also advised AIPC on the accounting treatment of these payments, and counseled AIPC that the payments should be labeled retention payments for future services. Given this factual error, we must now, therefore, determine whether A&R's legal advice on these payments created a disqualifying conflict. Although under Section 1107(b) of the bankruptcy code, a professional is not disqualified for employment under section 327 of this title by a debtor in possession solely because of such person's employment by or representation of the debtor before the commencement of the case, 11 U.S.C. § 1107(b), courts have held that the nature of the representation can still create a disqualifying conflict under Section 327(a), such as where the attorney may be required to review his own legal work in the course of the bankruptcy action. See, e.g., In re Ressler Hardwoods & Flooring, Inc., 2010 WL 2342497, at  (Bankr. M.D.Pa. June 8, 2010); In re Granite Sheet Metal Works, Inc., 159 B.R. 840, 841-49 (Bankr.S.D.Ill.1993). We agree with these cases that earlier legal work can require disqualification of counsel under certain circumstances. See West Delta Oil, 432 F.3d at 355 (stating that an attorney should be free from the slightest personal interest which might be reflected in their decisions concerning matters of the debtor's estate or which might impair the high degree of impartiality and detached judgment expected of them .... (quotation marks omitted)). Although recognizing such conflict is possible, we do not think that the record supports finding one here. As noted by the Trustee, the wages and benefits paid to AIPC's officers and directors may have been avoidable because they were paid close in time to the bankruptcy filing. Nonetheless, the Trustee points to no evidence in the record indicating that A&R's advice on the treatment of these claims was clouded. Instead, the record shows that A&R counseled against disputing these claims because, in its judgment, the potential benefit to the estate was outweighed by the expense of litigating the claims. Although obviously not ideal or best practice, A&R's previous relationship to the debtors is also insufficient to constitute a disqualifying interest.