Rethinking Rule 2014: Are Your Disclosures Adequate?

In disclosing your firm’s connections with the debtor and its creditors when applying for employment under §327, how far do your disclosures go? Do you merely provide a list of those creditors your firm represents, or has represented, with little additional information? If you only provide the names of the creditors and a general statement that the matters are unrelated to the pending bankruptcy case, you may be risking both disqualification and later disgorgement of fees.

On February 18, 2014, the Eastern District of New York in KLG Gates LLP v. Brown, Case No. 13-CV04972 (ADS) (USDC ED NY 2014) affirmed in part, denied in part, and remanded to the bankruptcy court, its decision to disqualify the debtor’s attorneys for an undisclosed conflict of interest and disgorgement of attorney fees pursuant to a motion filed more than three years after the case was commenced and two years after the plan was confirmed. Prior to the bankruptcy filing, the debtor’s attorneys met and consulted with the debtor’s general counsel, its president and CEO, and its vice-president and CFO, regarding a possible management buyout either pre-bankruptcy or under a §363 sale.  The decision was ultimately made to proceed with the bankruptcy filing and §363 sale at which the insiders would form a company to offer the stalking horse bid.  Upon filing the case, the debtor’s attorneys disclosed in their application for employment that they represented or had represented 483 of the debtor’s 1,250 creditors, including the agents for certain of the debtor’s secured lienholders, PNC and Wilmington Trust, in matters unrelated to the bankruptcy case.  No distinction was made between current and former clients, nor was any information given regarding any specific matters.

At the auction for the debtor’s assets, the insiders’ company was the successful bidder for most of the assets; however, its financing fell through and the assets were ultimately sold to PNC, the next-highest bidder.  Almost one year after the sale, the debtor’s plan was confirmed, under which a liquidating trust was formed to succeed to the remaining assets of the debtor’s estate.  The liquidating trust then retained the debtor’s attorneys to pursue affirmative actions on behalf of the trust.

Almost a year later, one of the debtor’s insiders filed a motion to disqualify the debtor’s attorneys from representing the liquidating trust, alleging that the attorneys had represented both the insiders and the debtor pre-petition in an effort to help the insiders obtain the debtor’s assets in bankruptcy.  In ruling on the motion, the bankruptcy court disqualified the debtor’s attorneys, finding (1) an undisclosed, pre-petition attorney-client relationship with the insiders, and (2) failure to make the required Rule 2014 disclosures regarding the insiders and also the attorneys’ relationships with significant creditors in the case, ordering the attorneys to disgorge $100,000 of the fees received.  Of significant note was the fact that the lawyer with primary responsibility for the debtor’s case was the same attorney who was personally involved in representing PNC and Wilmington Trust in both the Enron and Delphi bankruptcy cases, which fact was not disclosed.

On appeal, the District Court agreed with the bankruptcy court that the attorneys’ disclosures were inadequate, including failure to disclose the debtor’s counsel’s personal involvement with the debtor’s creditors in unrelated matters; but holding that the insiders had waived any claim regarding a conflict of interest by waiting three years to bring the disqualification motion.  The case was remanded to the bankruptcy court to rule on the disqualification issue.

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