MALPRACTICE TRAPS: HOW TO AVOID THE SLEEPLESS NIGHTS AND THE MORNING AFTER

Transcription

MALPRACTICE TRAPS:
HOW TO AVOID THE SLEEPLESS NIGHTS
AND THE MORNING AFTER
John D. Penn*
Haynes and Boone, L.L.P.
201 Main Street, Suite 2200
Fort Worth, Texas 76102-3126
[email protected]
Clifton R. Jessup, Jr.
Patton Boggs, L.L.P.
2200 Ross Avenue, Suite 900
Dallas, Texas 75201
[email protected]
Honorable Ronald B. King
United States Bankruptcy Court
Western District of Texas
San Antonio, Texas
ADVANCED BUSINESS BANKRUPTCY LAW COURSE 1998
MAY 14-15, 1998
DALLAS, TEXAS
CHAPTER D
* Editor of materials contributed by all Presenters
TABLE OF CONTENTS
I.
DISCLOSURE FOR RETAINED PROFESSIONALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
A. Statutes and Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
B. Practical Advice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
C. Duty to Disclose Continues Throughout Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
D. Purpose of Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
E. Relationships with Parties in the Case Which Must be Disclosed?
-- How far does “all” really go? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
F. Consequences of. .Non-Disclosure
............................................................ 2
G. Benefits of Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
II. WHO IS THE CLIENT? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
A. Debtor / Debtor in Possession . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
B. Representing Creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
C. Representing Committees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
III. TRANSFERS IN THE ZONE OF INSOLVENCY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
A. Fresh Start vs. Head Start . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
B. Risks of Transfers During Financial Distress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
C. Exposure for Participation in Fraudulent Transfer or other
Fraudulent Pre-petition Conduct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
D. Words of Wisdom for Bankruptcy Counsel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
IV. CONFLICTS OF INTEREST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
A. Traditional Conflict Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
B. Law Firm Economics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
C. Actual v. Potential Conflicts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
D. Disinterestedness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
V. DEALING WITH RENEGADE CLIENTS AND ADVERSARIES . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
A. Duty to “Rat” on Client . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
B. Policing the Debtor in Possession . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
C. Policing the Conduct of Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
D. Duty to the Court . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
VI. DEADLINES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
A. General Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
B. Important Dates/Deadlines for Debtors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
C. Important Deadlines for Creditors/Trustees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
D. Removal Deadlines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
E. Non-bankruptcy Statutes of Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
F. Important Deadlines for Adversary Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
G. Important Deadlines for Appeals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
VII. FATAL OMISSIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
A. Unlisted Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
B. Failure of Unsecured Creditor to file Proof of Claim . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
C. Retention of Claims on Confirmation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
D. Adequacy of Notice to Parties Affected by Proposed Action . . . . . . . . . . . . . . . . . . . . . . . . . 22
VIII.
INVESTIGATION AND DISCOVERY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
A. Investigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
B. Discovery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
IX. PRE-FILING PLANNING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
A. The Business Debtor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
B. Engagement of Professionals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
C. Considerations Of Counsel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
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TABLE OF CONTENTS (Cont’d.)
D.
E.
F.
G.
H.
X.
Counseling the Business Debtor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Approaching Chapter 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Preparation of the Chapter 11 Petition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financing the Chapter 11 Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Planning for Operating Changes and Other Matters
to Implement Post-Petition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
I. Venue -- Tactical Analysis of Where to File . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
J. Beware the Risk of an Involuntary Proceeding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
K. Consider Efforts to Negotiate a Deal Pre-Filing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
L. Consider Pre-Packaged Chapter 11 Plan Alternative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
M. Planning for Compliance With Other Post-Petition Operating
Requirements: The United States Trustee Guidelines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
CAUTION IN PLEADINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
A. Judicial Estoppel and Property Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
B. Usury Exposure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
C. Rule 9011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
28
28
28
29
29
29
29
30
30
30
30
30
31
31
Excerpt from 1997 ALAS Loss Prevention Manual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Hypothetical Problem for Loss Prevention Seminiar on Bankruptcy-Related Claims . . . . . . . . . . . . . . 39
Discussion of Hypothetical Problem for Loss Prevention Seminiar on
Bankruptcy-Related Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
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Malpractice Traps: How to Avoid the Sleepless Nights and the Morning After
I.
DISCLOSURE FOR RETAINED
PROFESSIONALS
A. Statutes and Rule
1. 11 U.S.C. § 327(a) provides:
“Except as otherwise provided in this
section, the trustee, with the court's approval, may
employ one or more attorneys, accountants,
appraisers, auctioneers, or other professional
persons, 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. 11 U.S.C § 329(a) provides:
“Any attorney representing a debtor . . . ,
whether or not such attorney applies for
compensation under this title, shall file with the
court a statement of the compensation paid or
agreed to be paid, if such payment or agreement
was made after one year before the date of the
filing of the petition, for services rendered or to be
rendered in contemplation of or in connection with
the case by such attorney, and the source of such
compensation.”
3. Bankruptcy Rule of Procedure
2014 provides, in pertinent part:
“An order approving the employment of
attorneys, accountants, appraisers, auctioneers,
agents, or other professionals pursuant to § 327, §
1103, or § 1114 of the Code shall be made only
on application of the trustee or committee. . . .
The application shall state . . . to the best of the
applicant's knowledge, all of the person's
connections with the debtor, creditors, any other
party in interest, their respective attorneys and
accountants, the United States trustee, or any
person employed in the office of the United States
trustee. The application shall be accompanied by
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 person employed in the
office of the United States trustee.”
B. Practical Advice
If you think of a relationship that might raise
a question to anyone, disclose it.
C. Duty to Disclose Continues
Throughout Employment
1. Rome v. Braunstein, 19 F.3d 54,
59 (3rd Cir. 1994) stated:
“Thus, as soon as counsel acquires even
constructive knowledge reasonably suggesting an
actual or potential conflict, see id. at 839
(fiduciary duty of disclosure arises as soon as
D-1
counsel becomes ‘aware’ of facts), a bankruptcy
ruling should be obtained. See, e.g., In re Martin,
817 F.2d at 182 (‘There must be at a minimum
full and timely disclosure of the details of any
given arrangement. Armed with the knowledge of
all relevant facts, the bankruptcy court must
determine, case by case, whether [a conflict
exists].’)” (emphasis in original).
a. The Rome court did not
indicate how an attorney could both obtain a
ruling regarding a potential conflict of which the
attorney has only constructive knowledge.
b. A more interesting question is
how such a full disclosure (which would
necessarily name the other parties and / or their
counsel) could be filed in a public record while
preserving the attorney / client, work product and
other privileges.
2. In re Martin, 817 F.2d 175, 180
(1st Cir. 1987) described part of the job of the
bankruptcy court as:
“[E]xercising of its ongoing affirmative
responsibility to ‘root out impermissible conflicts
of interest’ under Bankruptcy Code §§ 327(a) and
328(c), the bankruptcy court must determine
whether any meaningful incentive to act contrary
to the best interests of the estate and its sundry
creditors -- an incentive to place the parties at
more an acceptable risk -- or the reasonable
perception of one.” (emphasis in original.)
D. Purpose of Disclosure
1. In re BH&P, Inc., 949 F. 2d
1300 (3rd Cir. 1991) (stated that full disclosure is
required to allow the evaluation of the issues at an
early stage of the proceedings).
2. In re Prudent Holding Corp., 153
B.R. 629, 631 (Bankr. N.D. Ill. 1993) (described
§ 327 as a “prophylactic provision designed to
insure that the undivided loyalty and exclusive
allegiance required of a fiduciary to an estate in
bankruptcy is not compromised or eroded.”).
3. In re Tinley Plaza Associates,
L.P., 142 B.R. 272 (Bankr. E.D. Ill. 1992)
(announced the self-evident proposition that the
court has “no duty to rummage through files or
conduct independent fact finding investigations in
order to determine whether prospective attorneys
are involved in actual or potential conflicts of
interest. Without strict enforcement of Rule
2014(a), the burden of fact finding would shift to
the court, wasting judicial resources that are better
utilized elsewhere.”).
E.
Relationships with Parties in the Case
Which Must be Disclosed? -- How far
does “all” really go?
1. Current Clients
a. Relationships with current
clients who are debtors, creditors or affiliates of
each must be disclosed.
b. 11 U.S.C. § 327 is absolutely
clear and unambiguous on this point.
2. Affiliates of Debtor(s) and
Creditors
a. “Affiliate” is defined in §
101(2) as:
(A) entity that directly or
indirectly owns, controls, or holds with power to
vote, 20 percent or more of the outstanding voting
securities of the debtor, other than an entity that
holds such securities - (i) in a fiduciary or agency
capacity without sole discretionary power to vote
such securities; or (ii) solely to secure a debt, if
such entity has not in fact exercised such power to
vote;
(B) corporation 20 percent or
more of whose outstanding voting securities are
directly or indirectly owned, controlled, or held
with power to vote, by the debtor, or by an entity
that directly or indirectly owns, controls, or holds
with power to vote, 20 percent or more of the
outstanding voting securities of the debtor, other
than an entity that holds such securities - (i) in a
fiduciary or agency capacity without sole
discretionary power to vote such securities; or (ii)
solely to secure a debt, if such entity has not in
fact exercised such power to vote;
(C) person whose business is
operated under a lease or operating agreement by
a debtor, or person substantially all of whose
property is operated under an operating agreement
with the debtor; or
(D) entity that operates the
business or substantially all of the property of the
debtor under a lease or operating agreement.
b. This is a very broad
definition.
3. Source of Client Referrals
Kornstein Veisz & Wexler (In re Re), 1997
WL 162918 (S.D. N.Y.) (had the court denying a
defendant’s motion for summary judgment as to a
breach of fiduciary duty based on the ethical
violations where the defendant firm referred cases
to the plaintiff’s attorney. In effect, failing to
reveal to a client that the employer he wished to
sue had referred some cases to this firm was
enough to defeat a summary judgment motion.).
D-2
4. Investments by the Professional or
Firm Being Employed
a. If judges are required to
annually disclose their personal investments (to
avoid conflicts), will they be sympathetic to
attorneys who do not list theirs as well?
b. See: Ray Warner, Of Grinches,
Alchemy and Disinterestedness: the
Commission’s Magically Disappearing Conflicts
of Interest. 5 AM. BANKR. INST. L. Rev., 423,
440 (discussing the possibility of being required to
disclose personal investments).
5. Former Clients
a. Texas Disciplinary Rule of
Professional Conduct 1.09.
b. An attorney cannot represent a
current client against a former client in the same or
substantially related matter or where current client
questions validity of work for former client.
F. Consequences of Non-Disclosure
1. Revoking Employment Order
a. The court can revoke order
authorizing employment if disclosures are
inadequate or misleading.
b. Without an order approving
employment, professional cannot be paid under §§
330 - 31.
2. Monetary Penalties are Available
for Inadequate Disclosure
a. All fees allowed under §§ 330
- 31 would be returned if the employment Order is
revoked.
b. Fees can be denied during the
period where a conflict exists.
i. In re EWC, Inc., 138
B.R. 276 (Bankr. W.D. Okla. 1992).
ii. In re Lewis, 113 F.3d
1040 (9th Cir. 1997).
iii. In re Smitty’s Truck
Stop, Inc., 210 B.R. 844 (B.A.P. 10th Cir. 1997).
iv. In re Hot Tin Roof, Inc.,
205 B.R. 1000 (B.A.P. 1st Cir. 1997).
v. In re Crivello, 205 B.R.
399 (E.D. Wis. 1997).
c. Harm from conflict need not be
shown for monetary penalties to be imposed.
i. In re Mehdipour, 202
B.R. 474 (Bankr. 9th Cir. 1996).
3. Criminal Penalties
a. 18 U.S.C. §§ 152 -- 157
i. 18 U.S.C. § 152. A
person who-...
(2) knowingly and
fraudulently makes a false oath or account in or in
relation to any case under title 11;
(3) knowingly and
fraudulently makes a false declaration, certificate,
verification, or statement under penalty of perjury
as permitted under section 1746 of title 28, in or
in relation to any case under title 11, shall be fined
not more than $5,000, imprisoned not more than
five years, or both.
ii. 18 U.S.C. § 155. Fee
agreements in cases under title 11 and
receiverships
Whoever, being a party in interest, whether
as a debtor, creditor, receiver, trustee or
representative of any of them, or attorney for any
such party in interest, in any receivership or case
under title 11 in any United States court or under
its supervision, knowingly and fraudulently enters
into any agreement, express or implied, with
another such party in interest or attorney for
another such party in interest, for the purpose of
fixing the fees or other compensation to be paid to
any party in interest or to any attorney for any
party in interest for services rendered in
connection therewith, from the assets of the estate,
shall be fined under this title or imprisoned not
more than one year, or both.
iii. 18 U.S.C. § 157.
Bankruptcy Fraud
A person who, having devised or intending to
devise a scheme or artifice to defraud and for the
purpose of executing or concealing such a scheme
or artifice or attempting to do so-(1) files a petition under
title 11;
(2) files a document in a
proceeding under title 11; or
(3) makes a false or
fraudulent representation, claim, or promise
concerning or in relation to a proceeding under
title 11, at any time before or after the filing of the
petition, or in relation to a proceeding falsely
asserted to be pending under such title,
shall be fined under this title, imprisoned not
more than 5 years, or both.
b. A Milbank Tweed partner
was convicted of misleading the bankruptcy court
in Bucyrus International, Inc. case. He will be
sentenced on May 19, 1998.
G. Benefits of Disclosure
1. The bankruptcy court has
ostensibly considered everything that was
disclosed and approved the employment.
D-3
a. Parties in interest can be
precluded from challenging disinterestedness based
on relationships that are disclosed.
b. The employment order will be
a final judgement and res judicata as to the matters
stated in the application.
2. Employment is a condition
precedent to being paid from the estate under §§
330 - 31.
II. WHO IS THE CLIENT?
A. Debtor / Debtor in Possession
1. When the Debtor Is an Individual
a. The individual is easier to
identify as the client.
b. The duties of a debtor in
possession and fiduciary of the estate can create
relationships that are not usually contemplated,
creating competing interests.
i. A subsequently appointed
trustee can waive the attorney client privilege under
appropriate circumstances.
ii. Depending upon the facts,
this could include the waiver of the privilege when
the debtor is an individual as well as an entity.
A) Trustee has the
debtor’s attorney/client privilege for corporations
and partnerships. Commodity Futures Trading
Comm’n v. Weintraub, 471 U.S. 343, 105 S.Ct.
1986, 85 LE2d 372 (1985); U.S. v. Campbell, 73
F.3d 44 (5th Cir. 1996).
B) Cases are split where
the debtor is an individual. In re Williams, 152
B.R. 123 (Bankr. N.D. Tex. 1992) (Trustee has
privilege); In re Hunt, 153 B.R. 445 (Bankr. N.D.
Tex. 1992); McLarty v. Gudenau, 166 B.R. 101
(E.D. Mich. 1994).
2. When the Debtor Is an Entity
a. Entities act solely through
representatives selected by the owners
(shareholders elect directors who name officers
who hire other employees).
b. The owner’s interests and
rights should control over those of management,
unless a debtor is insolvent and the debtor is
responsible to creditors (as are directors).
i. In re Dark Horse
Tavern, Inc., 189 B.R. 576 (Bankr. N.D. N.Y.
1995) (stated that the board of directors is vested
with the power to determine corporate policy and
conduct its activities).
ii. Dark Horse Tavern also
stated that the board has the authority to propose a
plan -- not the officers.
c. Estate assets should not be
consumed in corporate governance fights.
i. In re Marvel Ent.
Group., Inc., 209 B.R. 832 (D. Del. 1997) (held
that the automatic stay was not implicated by
shareholders’ exercising their corporate
governance rights).
ii. The breadth of the stay
indicates that the right to govern is not “property
of the estate.” Since governance would not be
protected by the stay, it would be difficult to argue
that current management being retained is an
appropriate use of limited funds.
d. Exception to General Rule.
An election of a board of directors can be enjoined
only if there is “clear abuse.” To show “clear
abuse,” existing management must show that the
proposed management has a willingness to risk
reorganization to try for a large share of the
equity.
3. When the Retainer Is Provided, or
Fees are Guaranteed, by a Non-Debtor
a. Retainers by non-clients are
not prohibited per se.
i. In re Missouri Mining,
Inc., 186 B.R. 946, 950 (Bankr. W.D. Mo. 1995)
(refused to revoke order authorizing employment
of debtor’s counsel because counsel was
disinterested even though the retainer was paid by
the debtor’s principal, who was also a creditor).
b. Some courts have removed
attorneys based on the source of the funds for their
retainers.
i. In re Rabex Amuru,
Inc., 198 B.R. 892, 897 -- 98 (Bankr. M.D.N.C.
1996) (granted a motion to remove counsel for the
debtor where the firm’s fees were paid by a
creditor).
ii. In re Hathaway Ranch
Partnership, 116 B.R. 208, 219 (Bankr. C.D.
Cal. 1990) (found that the payment by a third
party of the fees of counsel for the debtor created
an actual conflict of interest which warranted
disqualification).
iii. In re Crimson
Investments, N.V., 109 B.R. 397, 403 (Bankr. D.
Ariz. 1989) (denied all compensation and ordered
the return of the retainer that debtor’s counsel
received from the debtor’s two largest unsecured
creditors).
iv. In re WPMK, Inc., 42
B.R. 157, 163 (Bankr. D. Haw. 1984) (found that
receiving payments from sources other than the
debtor created a per se conflict of interest).
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v. In re Glenn Electric
Sales Corp., 89 B.R. 410 (Bankr. D. N.J.), aff’d,
99 B.R. 596 (D. N.J. 1988) (disqualified counsel
for the debtor on the ground of an appearance of
impropriety where the payor had announced that it
would be a likely plan proponent).
c. Texas Disciplinary Rule of
Professional Conduct 1.08(e) allows payments by
third parties only if the client consents, the third
party does not interfere with the attorney’s
professional judgment and confidentiality between
attorney and client is protected.
4. When Releases are Provided for
Non-Debtor Insiders
a. Many plans have provisions
for releases of claims against insiders, officers,
directors, shareholders and employees.
b. Arguing too forcefully or
threatening to destroy confirmation unless those
claims are released could expose debtor’s counsel
to a charge that the insiders are running the
company in such a away that the professionals are
working for the insider instead of the estate.
c. In re Humble Place Joint
Venture, 936 F.2d 814, 818 (5th Cir. 1991) (stated
that the personal liability of non-debtors [investors
in this case] is not “a legitimate concern of Chapter
11.”).
B. Representing Creditors
1. The Bankruptcy Code and Rules do
not require any disclosures when an attorney
represents only one creditor in a case.
2. When an attorney represents more
than one creditor in a case, the attorney must
disclose the relationships in accordance with
Bankruptcy Rule 2019.
C. Representing Committees
1. Representing a creditors committee
and individual creditor(s) is not prohibited per se -as long as there is no actual conflict.
2. 11 U.S.C. § 1103(a) states,
“Representation of one or more creditors of the
same class as represented by the committee shall
not per se constitute the representation of an
adverse interest.”
a. In re Whitman, 101 B.R. 37
(Bankr. N.D. Ind. 1989) (required the resignation
of counsel to the creditors committee where the
attorney also represented an undersecured creditor
that was also a member of the committee since the
attorney was representing both secured and
unsecured creditors in the same case).
b. In re Grant Broad, Inc., 71
B.R. 655, 663 (Bankr. E.D. Pa. 1987) (held that
the attorney for the creditors committee could not
represent individual unsecured creditors
attempting to force the debtor to assume certain
contracts and consequentially pay administrative
claims to those creditors.)
3. Preparing and filing claims for
committee members could pose problems.
a. A proof of claim is considered
the equivalent of a lawsuit against the debtor. In
re Simmons, 765 F.2d 547, 552 (5th Cir. 1985)
(“It has been said that the filing of a proof of
claim is tantamount to the filing of a complaint in
a civil action, and the trustee’s formal objection
to the claim, the answer.”) (citation omitted).
b. Preparing and filing claims
for committee members raises the question of
whether counsel is representing the individual
members instead of, or in addition to, the
committee as a whole.
4. Can participating in “beauty
contest” disqualify counsel
a. If confidential information is
exchanged for advice, an attorney/client
relationship can be created.
b. The committee would be a
“former client” in the same or a substantially
related manner requiring a resignation.
III. TRANSFERS IN THE ZONE OF
INSOLVENCY
A. Fresh Start vs. Head Start.
1. Purpose of Bankruptcy is To Give
Debtor a Fresh Start.
a. Discharge of Pre-Petition
Debts.
b. Federal Exemptions under 11
U.S.C. §522(d) (unless State has opted out of
federal exemptions under 11 U.S.C. §522(b)(1)).
c. State Exemptions (i.e.,
Homestead, Life Insurance, Annuities, etc.).
2. Actions taken prior to filing
bankruptcy may impact the debtor's bankruptcy
case.
3. Bankruptcy attorneys must
carefully advise clients of the potential
consequences of their pre-bankruptcy actions.
B. Risks of Transfers During Financial
Distress.
1. Avoidance of the Transfer as a
Preferential Transfer.
a. 11 U.S.C. §547(b) empowers
the trustee to avoid, with certain exceptions, any
transfer of an interest of the debtor in property-
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(1) to or for the benefit of a
creditor;
(2) for or on account of an
antecedent debt owed by the debtor before such
transfer was made;
(3) made while the debtor was
insolvent;
(4) made(A) on or within 90 days
before the date of the filing of the petition;
(B) between ninety days
and one year before the date of the filing of the
petition, if such creditor at the time of such transfer
was an insider;
(5) that enables such creditor
to receive more than such creditor would receive if(A) the case were a case
under chapter 7 of this title;
(B) the transfer had not
been made; and
(C) such creditor
received payment of such debt to the extent
provided by the provisions of this title.
b. Fifth Circuit Authority
Regarding Preferential Transfers.
i. Cullen Center Bank &
Trust v. Hensley (Matter of Hensley), 102 F.3d.
1411(5th Cir. 1997) (Creditor’s filing of judgment
lien pre-petition against oil and gas properties
formerly owned by debtor was preferential transfer
despite fact that properties had been conveyed to
trust for children’s benefit before lien was filed
because transfer to trust was fraudulent conveyance
and debtor had equitable interest in properties
transferred by judgment lien.)
ii. Electric City
Merchandise Co. v. Hailes (Matter of Hailes), 77
F.3d. 873 (5th Cir. 1996) (Individual pre-petition
transfers of less than $600 to a single garnishing
creditor could be aggregated, so as to remove
transfers from the “de minimis” exception (11
U.S.C. §547(c)(8)) to the trustee’s preference
avoiding power and to permit recovery of transfers
by the Chapter 13 trustee where the total amount of
wages garnished within 90 days preceding the
bankruptcy filing was greater than $600).
2. Avoidance of Transfer as a
Fraudulent Transfer.
a. 11 U.S.C. §548(a) empowers
the trustee to avoid any transfer of an interest of the
debtor in property..., that was incurred on or within
one year before the date of the filing of the petition,
if the debtor voluntarily or involuntarily-
(1) made such transfer ...with
actual intent to hinder, delay or defraud any entity
to which the debtor was or became, on or after the
date that such transfer was made..., indebted; or
(2)(A) received less than a
reasonably equivalent value in exchange for such
transfer...; and
(B)(i) was insolvent on the
date that such transfer was made...or became
insolvent as a result of such transfer....
b. 11 U.S.C. §548(b) empowers
the trustee to avoid any transfer of an interest of
the debtor in property...that was made...on or
within one year before the date of the filing of the
petition, to a general partner in the debtor, if the
debtor was insolvent on the date such transfer was
made or...became insolvent as a result of such ....
c. Fifth Circuit Authority
Regarding Fraudulent Transfers
i. A.M. Mancuso v. T.
Ishida USA, Inc. (In re Sullivan), 161 B.R. 776
(N.D. Tex. 1993). To determine whether actual
intent to defraud exists for purposes of 11 U.S.C.
§ 548(a)(1), Texas Courts may make inferences
from objective facts surrounding transfer. The
“badges of fraud” in TEX.BUS. & COM. CODE
§24.005(b) are often used as guidelines. They are
as follows:
(A) the transfer or
obligation was to an insider;
(B) the debtor retained
possession or control of the property transferred
after the transfer;
(C) the transfer or
obligation was concealed;
(D) before the transfer
was made , the debtor had been sued or threatened
with suit;
(E) the transfer was of
substantially all the debtor’s assets;
(F) the debtor
absconded;
(G) the debtor removed
or concealed assets;
(H) the value of the
consideration received by the debtor was
reasonably equivalent to the value of the asset
transferred or the amount of the obligation
incurred;
(I) the debtor was
insolvent or became insolvent shortly after the
transfer was made;
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(J) the transfer occurred
shortly before or shortly after a substantial debt
was incurred; and
(K) the debtor transferred
the essential assets of the businesses to a lien or
who transferred the assets to an insider of the
debtor.
ii. Texas Truck Insurance
Agency, Inc. v. Cure (Matter of Dunham), 110
F.3d 286 (5th Cir. 1997) (Sale of Chapter 7
debtor’s insurance business eight months before
bankruptcy petition was filed was fraudulent
transfer under 11 U.S.C. §548(a)(2) when
business sold for $160,000 plus interest and
experienced insurance expert valued business at
$200,000).
d. Charitable contributions may
also be avoided as fraudulent transfers. See
Morris v. Midway Southern Baptist Church (In
re Newman), 183 B.R. 239 (Bankr. D. Kan. 1995).
3. Conversion of Non-Exempt
Property to Exempt Property.
a. Legislative History to
Bankruptcy Reform Act of 1978. Both the House
and Senate Reports provide that "under current
law, the debtor will be permitted to convert nonexempt property into exempt property before the
filing of a bankruptcy petition . . . . The practice is
not fraudulent as to creditors and permits the
debtor to make full use of the exemptions to which
he is entitled under the law." S. Rep. No. 95-989,
at 76 (1978), reprinted in 1978, U.S.C.C.A.N.
5787, 5862; H.R. Rep. No. 95-595, at 361 (1977),
reprinted in 1978 U.S.C.C.A.N. 5963, 6317.
b. Despite the Legislative
History, an impermissible conversion of property
may occur if the debtor possessed actual intent to
hinder, delay, or defraud creditors.
c. The Continuing Concealment
Doctrine - Even though originally transferred
outside the one year period before filing, the
concealment of a secretly retained interest in
property may support an objection to discharge
under 11 U.S.C. § 727(a)(2). See, Beaubouef v.
Beaubouef (In re Beaubouef), 966 F.2d 1527,
1531 (9th Cir. 1992) (debtor concealed interest in
company), and Thibodeaux v. Olivier (In re
Olivier), 819 F.2d 550, 551 (5th Cir.1990)
(debtors concealed house by transferring title seven
years before filing bankruptcy ).
d. Cases vary widely as to what
constitutes actual intent to hinder, delay or defraud
creditors, even within the same jurisdiction. A
review of Fifth Circuit and other case law
demonstrates this fact.
i. Fifth Circuit Cases.
(A) First Tex. Sav.
Assoc., Inc. v. Reed (In re Reed), 700 F. 2d. 986
(5th Cir. 1983) (Chapter 7 debtor’s rapid
conversion of non-exempt assets to extinguish one
home mortgage and to reduce another four months
before bankruptcy after arranging with his
creditors to be free of payment obligations until
the following year alone was enough to constitute
fraud. The fraudulent intent was further shown by
the debtors' diversion of receipts from his
company into an account unknown to his creditors
and management consultant and his use of those
receipts to repay a loan which had been a vehicle
for the conversion.)
(B) NCNB Texas Nat’l
Bank v. Bowyer (In re Bowyer), 916 F.2d. 1056
(5th Cir. 1990) (Bowyer I) (Chapter 7 debtor’s
actions of spending $18,000 on travel and exempt
assets on eve of bankruptcy when debtor knew he
had financial troubles and who voluntarily
satisfied homestead mortgage 15 days pre-petition
went beyond allowable pre-bankruptcy planning.
This extrinsic evidence of intent to hinder and
delay creditors led the Fifth Circuit to reverse the
lower courts’ decisions to discharge the debtor’s
debts despite the fact there was no evidence of
actual intent to defraud the creditor).
(C)
NCNB Texas
Nat’l Bank v. Bowyer (In re Bowyer), 932 F.2d
1100 (5th Cir 1991) (Bowyer II) (On rehearing,
the Fifth Circuit held that it had not given the
lower courts proper deference in the first hearing.
This time the Court held that the Chapter 7 debtor
did not have requisite intent to hinder, defraud or
delay creditors to prevent discharge. Although
debtor had sold gold and used his savings to repair
his exempt residence, he and his wife had also
withdrawn $25,000 from their savings during this
time to make advance unscheduled payments on
their note. The Fifth Circuit held that such
behavior was incompatible with an intent to
default on the note and file a bankruptcy petition).
(D) Swift v. Bank of
San Antonio, 3 F.3d 929 (5th Cir. 1993)
(Chapter 7 debtor’s transactions with relatives,
which included prepaying alimony to ex-wife,
transferring insurance policies to son who, after
borrowing against them transferred funds back to
ex-wife who then loaned funds back to debtor who
gave her promissory note the day before
bankruptcy, and borrowing money from daughter
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in exchange for promissory notes secured by
debtor's interests in personal property were done
with the intent to hinder, defraud, delay or conceal
assets from his creditors justifying a denial of
discharge order 11 U.S.C. § 727(a)(2).
ii. Other cases.
(A) Norwest Bank Neb.,
N.A. v. Tveten (In re Tveten), 70 B.R. 529 (Bankr.
D. Minn. 1987), certifying questions to 402 N.W.
2d 551 (Minn. 1987), aff'd 82 B.R. 95 (D. Minn.
1987), aff’d, 848 F.2d, 871 (8th Cir. 1988)
(Debtor who was doctor sheltered $700,000.00 on
the advice of counsel by converting non-exempt
assets to exempt assets. The bankruptcy court
found this to be too much and concluded if the case
had been brought under Chapter 7, discharge
would have been denied under 11 U.S.C.
§727(a)(2)). The bankruptcy court’s decision was
affirmed by the United States District Court for the
District of Minnesota and by the United States
Court of Appeals for the Eighth Circuit.
(B) Panuska v. Johnson
(In re Johnson), 80 B.R. 953 (Bankr. D. Minn.
1987), aff'd, 101 B.R. 997 (D. Minn. 1988),
remanded by 880 F.2d 78, 84 (8th Cir. 1989).
Final disposition contained in 124 B.R. 290
(Bankr. D. Minn. 1991) (Debtor who was also
doctor sheltered $340,000.00. The bankruptcy
court held this was acceptable and the District
Court affirmed. The Eighth Circuit Court of
Appeals remanded holding that although the
portion of the doctor's exemption related to his
homestead was acceptable, there were questions of
fraud related to his purchase of exempt musical
instruments and annuities and life insurance. On
remand, the Bankruptcy Court found fraud because
neither the doctor nor his girlfriend could play any
of the instruments and the life insurance policy
bought shortly before filing was cashed in shortly
after filing and the money spent, that the Debtor
had the requisite fraudulent intent so that the
discharge would be denied under 11 U.S.C.
§727(a)).
e. General Trends Related to
Exemptions
i. Non-exempt assets
converted to a homestead have a better chance of
remaining exempt than those converted to any
other category of exemption.
ii. Conversion to exempt
assets which themselves may be readily converted
to cash are not likely to remain exempt and may
threaten debtor's discharge.
iii. Insolvency and an
imminent lawsuit or an existing judgment against
the debtor appears to support findings of intent to
hinder, delay or defraud creditors.
iv. Conversions close to the
filing date are more suspect than conversions
months or years before filing.
4. Prosecution for Bankruptcy Fraud
a. Even if a transfer is outside of
the one-year period before filing bankruptcy,
Debtor may still be convicted for bankruptcy
fraud under fraud statutes. See 18 U.S.C. §157.
b. United States v. West, 22
F.3d 586 (5th Cir. 1994), cert denied, 115 S.Ct.
584 (1994) (Debtor convicted for bankruptcy
fraud under 18 U.S.C. §157 for concealing assets
and for hiding proceeds from money laundering by
placing them into his girlfriend's account even
though event occurred outside of one year period).
C. Exposure for Participation in
Fraudulent Transfer or other Fraudulent Prepetition Conduct
1. Potential Consequences for the
Client.
a. Transfer avoided under 11
U.S.C. §§ 547 or 548.
b. Denial of Discharge under 11
U.S.C. § 727(a) or continuing concealment
doctrine.
c. Conviction for bankruptcy
fraud under 18 U.S.C. §157.
2. Consequences for Attorney
Advising Client.
a. Model Rule of Professional
Conduct 1.2(d) - Attorney shall not encourage or
assist client in conduct that attorney knows is
fraudulent.
b. Attorney who engages in prepetition asset planning which is found to be
fraudulent may be subjected to a malpractice
claim from the Debtor if the Debtor's discharge is
denied. See In re Tomailo, 205 B.R. 10, 13
(Bankr. D. Mass. 1997).
c. Attorney may face
malpractice action from Trustee alleging that
counsel assisted in structuring pre-petition
fraudulent transfers. See Eisenberg v. Resource
Dynamics, Inc. (In re Environmental Research
and Dev.), 46 B.R. 774 (S.D. N.Y. 1985).
D. Words of Wisdom for Bankruptcy
Counsel
1. It is not always possible to predict
during the pre-petition stage what transfers will
successfully be challenged as fraudulent. Make
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sure that all clients are advised with regard to the
possible consequences of their pre-bankruptcy
actions.
2. It is always a good idea to
memorialize representations made and advice given
during this period in writing and have the client
sign it. Protect yourself from the disgruntled client
who might later allege that “my attorney told me to
do it.”
IV. CONFLICTS OF INTEREST
A. Traditional Conflict Issues
1. Texas Disciplinary Rules of
Professional Conduct
a. Rule 1.06 Conflict of Interest:
General Rule:
“(a) A lawyer shall not
represent opposing parties to the same litigation.
“(b) . . .(c), a lawyer shall not
represent a person if the representation of that
person: (1) involves a substantially related matter
in which that person’s interests are materially and
directly adverse to the interests of another client of
the lawyer or the lawyer’s firm; or (2) reasonably
appears to be or become adversely limited by the
lawyers’ or law firm’s responsibilities to another
client or to a third person or by the lawyer’s or law
firm’s own interests.”
b. Rule 1.08 Conflict of Interest:
Prohibited Transactions
“(e) A lawyer shall not accept
compensation for representing a client from one
other than the client unless (1) the client consents;
(2) there is no interference with the lawyer’s
independence of professional judgment or with the
client-lawyer relationship; and (3) information
relating to representation of a client is protected as
required by Rule 1.05.”
c. Rule 1.09 Conflict of Interest:
Former Client
“(a) Without prior consent, a
lawyer who personally has formerly represented a
client in a matter shall not thereafter represent
another person in a matter adverse to the former
client: (1) in which such other person questions the
validity of the lawyer’s services or work product
for the former client; . . . (3) if it is the same or a
substantially related matter.
2. Multiple parties in same case
a. Multiple creditors
i. Disclosure and informed
consent
A. Texas Disciplinary
Rule of Professional Conduct 1.06
“(a) A lawyer shall
not represent opposing parties to the same
litigation. . . . (c), A lawyer shall not represent a
person if the representation of that person: (1)
involves a substantially related matter in which
that person’s interests are materially and directly
adverse to the interests of another client of the
lawyer or the lawyer’s firm; or (2) reasonably
appears to be or become adversely limited by the
lawyer’s or law firm’s responsibilities to another
client or to a third person or by the lawyer’s or law
firm’s own interests.”
B. Rule 2019 requires
counsel to file a disclosure when more than one
creditor is represented by the same counsel.
ii. Creditors with similar
claims
A. In re Calabrese,
173 B.R. 61, 63 (Bankr. D. Conn. 1994) (Court
sustained the trustee’s objection to the application
of committee’s counsel where the attorneys
represented secured creditors of the debtor in
unrelated matters).
B. In re Oklahoma
P.A.C. First Ltd. Partnership, 122 B.R. 387, 393
(Bankr. D. Ariz. 1990) (Court refused to permit a
firm’s attempt to simultaneously represent the
first and second lienholders on the same property,
holding that the zealous representation of both
clients was impossible.).
b. General and
limited partners
i. In re W.F. Dev. Corp.,
905 F.2d 883 (5th Cir. 1990) (Prohibited this
representation as a per se lack of
disinterestedness).
c. Creditor and special counsel
for the trustee / estate
i. This situation can arise
when debtor in possession refuses to pursue
litigation and party is appointed as representative
of estate; see Louisiana World Exposition v.
Federal Ins. Co., 858 F.2d 233, 247 (5th Cir.
1988);
ii. In re Durbin, 205 B.R.
17 (Bankr. D. N.H. 1997) (Court reduced the fees
of special counsel to the trustee who also
represented a creditor. After representing the
trustee in a case that was settled by the return of
some disputed assets to the trustee, counsel
attached the other assets for the benefit of his
creditor client. The fees were reduced because he
did not disclose his attachment actions and there
was a question of whether the assets could have
gone to the estate for the benefit of all creditors).
d.
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Competing bidders
i. Milbank Tweed v. Chan
Char Boon, 15 F.3d 537 (2nd Cir. 1994) (A firm
cannot represent two bidders interested in same
assets).
e. Estate and asset purchaser
i. Prohibited in Rome v.
Braunstein, 19 F.3d 54 (3rd Cir. 1994) and In re
Lee Way Holding Co., 100 B.R. 950 (Bankr. S.D.
Ohio 1989)`.
3. Multiple debtor affiliates
a. In re Global Marine, Inc.,
108 B.R. 998 (Bankr. S.D. Tex. 1987) (Court
permitted multiple debtor representation).
b. In re Interstate Distribution
Center Associates, (A), Ltd., 137 B.R. 826
(Bankr. D. Colo. 1992) (Court found that the
representation of the corporate debtor and its
related entities created an impermissible conflict of
interest which precluded approval as debtor’s
counsel).
B. Law firm economics
1. Other clients
a. The magnitude and scope of
any relationship might be relevant to determine if
the firm will “bite the hand” that is feeding it
elsewhere. Where representation of other party is
too pervasive or extensive, the firm is not
disinterested.
i. In re Amdura Corp., 193
B.R. 963 (Bankr. D. Colo. 1992) (The debtor’s
principal creditor was such a large client of the firm
that it could not be disinterested in dealing with the
creditor notwithstanding the offers to employ
special counsel or an examiner to investigate the
transactions between the debtor and creditor).
ii. In re American Printers
& Lithographers, Inc., 148 B.R. 862 (Bankr. N.D.
Ill. 1992) (The bank who had a large pre-petition
claim was an existing and large client of the firm
and, notwithstanding a waiver from the bank, the
firm was found to have a conflict of interest).
iii. In re Status Game Corp.,
102 B.R. 19 (Bankr. D. Conn. 1989) (Employment
was denied where proposed counsel for DIP
represented the debtor’s principal pre-petition and
post-petition secured lender).
iv. In re Unitcast, Inc., 214
B.R. 979 (N.D. Ohio 1997) (Compensation of
attorney, engaged as a business and financial
consultant, was reduced because of his extensive
relationship with purchaser proposed under plan of
reorganization, the full extent of which was
belatedly disclosed).
v. In re Lee Way Holding
Co., 100 B.R. 950, 962 (Bankr. S.D. Ohio 1989)
(Disqualifying debtor’s counsel and requiring
disgorgement where counsel represented creditor
pre-petition and post-petition).
b. Disqualifications usually
apply to clients and attorneys including clients
brought in through a lateral hire as Wilke Farr &
Gallagher learned recently. In re Granite
Partners, L.P., 1988 WL 105658 (Bankr. S.D.
N.Y.). A lateral partner brought a brokerage
house as a client in 1994 and the firm charged
them over $9 million in fees over 1995 & 1996.
The firm was retained by the Trustee to
investigate possible claims against brokerage
firms before the lateral partner joined. The firm
belatedly disclosed the relationship with the
brokerage house in 1997 and lost approximately
$2 million in compensation.
2. Potential clients (target clients).
In re Granite Partners, L.P., supra. The problem
was known when a prospective lateral partner was
recruited knowing that he was bringing Merrill,
Lynch as a primary (and very large) client.
3. Selection of chapter for filing case.
a. Some cases generate higher
fees than those filed under other chapters.
b. Counsel cannot place their
needs for cash flow ahead of the clients’ needs.
4. Timing of filing
a. Allowing time to pass after
payment of fees or other transfer before filing a
case.
C. Actual v. Potential Conflicts
1. In re Kendavis Industries, Inc.,
91 B.R. 742 (Bankr. N.D. Tex. 1988) (Court
stated that there is no such thing as a potential
conflict and that potential conflicts are really
actual conflicts.)
2. In re BH&P, Inc., 949 F.2d 1300
(3rd Cir. 1991) (Court required a case by case
analysis of the individual facts before the
determination of whether counsel is disqualified.)
3. In re Sauer, 191 B.R. 402, 408
(Bankr. D. Neb. 1995) (“Even the potential for
conflict or the mere appearance of impropriety
may constitute a disqualifying conflict of interest.
And professionals engaged in the conduct of a
bankruptcy estate should be free of the slightest
personal interest which might be reflected in their
decisions concerning matters of the debtor estate
or which might impair the high degree of
impartiality and detached judgment expected of
them. There should be no opportunity for the
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exercise of conflicting interests and no appearance
that dual loyalty may exist.”) (Citations omitted).
4. In re Leslie Fay Cos., Inc., 175
B.R. 525, 533 (Bankr. S.D. N.Y. 1994) ([W]hether
a professional has ‘either meaningful incentive to
act contrary to the best interests of the estate and
its sundry creditors -- an incentive sufficient to
place those parties at more than acceptable risk or
the reasonable perception of one.’ In other words,
if it is plausible that the representation of another
interest may cause the debtor’s attorneys to act any
differently than they would without that other
representation, then they have a conflict and an
interest adverse to the estate.”)
D. Disinterestedness
1. This is really a two part analysis of
a requirement of disinterestedness and not holding
an adverse interest to the estate.
2. In re Diamond Mortgage Corp. of
Ill., 135 B.R. 78, 94 (Bankr. N.D. Ill. 1990) (“By
judicial definition, however, ‘holding an adverse
interest to the estate’ has come to mean:
1. To possess or assert any economic
interest that would tend to lessen the value of the
bankruptcy estate or that would create an actual or
potential dispute in which the estate is a rival
claimant; or
2. To possess a predisposition under
circumstances that render such a bias against the
estate.
Since section 328(a) of the Bankruptcy Code tells
professionals to neither hold nor represent an
adverse interest during the period of their retention
by an estate under section 327, there is a distinction
between representing an adverse interest and
holding an adverse interest. One who represents
an adverse interest acts in the capacity of an agent
or attorney for individuals or entities holding such
adverse interests.”) (Citations omitted).
3. In re Marvel Entertainment
Group, Inc., Civil Action No. 97-638-RRM (Jan.
27, 1998) (Judge McKelvie held that the Chapter
11 trustee’s own firm was not disinterested because
it represented a major secured creditor in matters
unrelated to the Marvel proceedings even though
the creditor waived the conflict).
V. DEALING WITH RENEGADE CLIENTS
AND ADVERSARIES
A. Duty to “Rat” on Client
1. Texas Disciplinary Rule of
Professional Conduct 1.05
a. Rules requiring Confidentiality
of Information must be honored.
Professional Conduct 3.03
“If a lawyer has offered material evidence
and comes to know of its falsity, the lawyer shall
make a good faith effort to persuade the client to
authorize the lawyer to correct or withdraw the
false evidence. If such efforts are unsuccessful,
the lawyer shall take reasonable remedial
measures, including disclosure of the true facts.”
B. Policing the Debtor in Possession
1. When DIP Makes Questionable
Management Decisions:
a. In re Rivers, 167 B.R. 288
(Bankr. N.D. Ga. 1994) stated that the attorney
had a duty to advise the court if the debtor in
possession is incompetent thereby making a
reorganization unlikely.
b. In re United Utensils, Inc.,
141 B.R. 306, 309 (Bankr. W.D. Pa. 1992)
counsel for the debtor should have disclosed that
the DIP refused to pursue actions against insiders.
c. In re Davison, 79 B.R. 851,
859 (Bankr. W.D. Mo. 1987) saw the court deny
the fees of counsel for the DIP since he failed to
prevent the DIP from incurring additional debts.
2. DIP is Gambling with Estate
Assets:
a. Debtor is holding out for
unrealistic returns.
b. In re DN Associates, 144
B.R. 195, 220 (Bankr. D. Me. 1992) aff’d 160
B.R. 20 (D. Me. 1993) (Counsel is charged with a
‘duty of diligence’ and should be expected in
every reorganization to made a ‘seasoned
determination’ whether the debtor is capable of
achieving successful reorganization. Attorneys
will not be compensated for vain attempts to
resuscitate the debtor long after they should have
given up the ghost).
3. When the DIP is Disposing of
Assets
a. In re Sky Valley, Inc., 135
B.R. 925, 937-38 (Bankr. N.D. Ga. 1992) (dealt
with the debtor’s unauthorized use of funds and
required the debtor’s attorney to disclose the
unauthorized use to the court).
b. In re Brennan, 187 B.R. 135
(Bankr. N.D. N.J. 1995) (involved the debtor’s
attorney’s failure to advise the court of the
conversion of estate assets by the DIP).
4. When the DIP is Concealing
Assets
a. U.S. v. Dolan, 120 F.3d 856
(8th Cir. 1997) (involved an attorney who was
D-11
convicted of aiding and abetting the debtor’s
concealing assets [Ferrari and multi-million dollar
lawsuit settlement] by telling creditors that debtor
could not pay his debts even though he was aware
of those assets).
b. In re Ward, 894 F.2d 771,
776 (5th Cir. 1990) (dealt with the attorney’s
failure to disclose the debtor’s concealment of
assets).
c. Criminal liability arises under
18 U.S.C. §152 for knowingly and fraudulently
concealing property of the estate from the trustee,
and § 157 for bankruptcy fraud.
1. U.S. v. Simpson, 49 F.3d
138 (5th Cir. 1995).
2
U.S. v. Center, 853 F.2d
568 (7th Cir. 1988).
3. U.S. v. Knoll, 16 F.3d
1313 (2nd Cir. 1994).
4. U.S. v. Parkhill, 775 F.
2d 612 (5th Cir. 1985).
5. Procedure for Withdrawal
a. In re McNar, Inc., 116 B.R.
746 (Bankr. S.D. Cal. 1990) (required the attorney
to use the corporate “chain of command” to take
the issue to the person’s superiors and ultimately to
the board of directors).
b. In re T.S. Industries, Inc.,
125 B.R. 638 (Bankr. D. Utah 1991), In re Wilde
Horse Enters., Inc., 136 B.R. 830, 840 (Bankr.
C.D. Cal. 1991), In re Consupak, Inc., 87 B.R.
529, 548 -- 549 (Bankr. N.D. Ill. 1988) and In re
NRG Resources, Inc., 64 B.R. 643 (W.D. La.
1986) (required the attorney to counsel with the
debtor regarding its fiduciary duties and those
duties imposed by the Bankruptcy Code).
c. If the debtor insists upon
continuing with its course of action and not
complying with those requirements, counsel must
resign. In re Perez, 30 F.3d 1209, 1219 (9th Cir.
1994).
C. Policing the Conduct of Others
1. In re C.F. Holding, Inc., 164 B.R.
799 (Bankr. D. Conn. 1994) (Court reduced fee of
counsel by $250,000 for failing to advise the court
of the investment banker’s post-petition conflict).
2. In re Sky Valley, Inc., 135 B.R.
925, 937-38 (Bankr. N.D. Ga. 1992) (resulted in a
$40,000 reduction of fees to counsel for the DIP
for failing to supervise the DIP. The DIP engaged
in an auction of its real property, disbursing
proceeds, paying the real estate broker and
improving the real estate outside of the ordinary
course of business without obtaining court
approval for any of those actions).
3. In re Chas. P. Young Co., 145
B.R. 131 (Bankr. S.D. N.Y. 1992) (involved an
undisclosed insider relationship between the
debtor and a prospective purchaser which the
court held should have been disclosed by debtor’s
attorney).
4. In re Bidermann Indus. U.S.A.,
Inc., 203 B.R. 547 (Bankr. S.D. N.Y. 1997)
(where a conflict of interest prevented approval of
leveraged buy out of the debtor involving the
professionals).
D. Duty to the Court
1. Baker v. Humphrey, 101 U.S.
494, 502 (1879)
The legal profession is found wherever . . .
civilization exists. Without it society could not
well go on. But, like all other great
instrumentalities, it may be potent for evil as well
as good. Hence the importance of keeping it on
the high plane it ought to occupy. Its character
depends upon the conduct of its members. They
are the officers of the law, as well as the agents of
those by whom they are employed. Their fidelity
is guaranteed by the highest considerations of
honor and good faith, and to these is superadded
the sanction of an oath.
2. In re Ward, 894 F.2d 771 (5th
Cir. 1990) held that, as officers of the court,
attorneys have a duty to disclose any concealed
assets and probably must disclose any criminal
activity that occurred.
3. Trustees and judges are required to
report to the appropriate U.S. Attorney possible
crimes or that a criminal investigation should be
commenced with respect to a bankruptcy case.
The U.S. Attorney must then commence an
investigation and report the findings to the
bankruptcy judge.
Professional Conduct 3.03.
“(a) A lawyer shall not knowingly:
(1) make a false statement of material fact or law
to a tribunal; (2) fail to disclose a fact to a tribunal
when disclosure is necessary to avoid assisting a
criminal or fraudulent act; (3) in an ex parte
proceeding, fail to disclose to the tribunal an
unprivileged fact which the lawyer reasonably
believes should be known by that entity for it to
make an informed decision; (4) fail to disclose to
the tribunal authority in the controlling
jurisdiction known to the lawyer to be directly
adverse to the position of the client and not
D-12
disclosed by opposing counsel; or (5) offer or use
evidence that the lawyer knows to be false.
(b) If a lawyer has offered material evidence
and comes to know of its falsity, the lawyer shall
make a good faith effort to persuade the client to
authorize the lawyer to correct or withdraw the
false evidence. If such efforts are unsuccessful, the
lawyer shall take reasonable remedial measures,
including disclosure of the true facts.
(c) The duties stated in paragraphs (a) and (b)
continue until remedial legal measures are not
longer reasonably possible.”
E. Scorched earth litigation is prohibited
1. In re Dondi Properties Corp., 121
F.R.D. 284 (N.D. Tex. 1988).
2. In re Kendavis Indus., Inc. 91 B.R.
742 (Bankr. N.D. Tex. 1988).
VI. DEADLINES
A. General Information
1. “Under the Bankruptcy Code and
rules, creditors play a zero-sum game in which a
failure to navigate effectively through various
intricate procedures can mean total defeat.
Moreover, because such procedures are thought to
be necessary to protect the bankrupt and the
creditors, exceptions cannot be made every time a
creditor claims hardship. Frequent players in the
bankruptcy arena .... know this and are aware that
deadlines are important and should not be heard to
complain of unfairness except under the most
egregious circumstances.” Oppenheim, Appel,
Dixon & Co. v. Bullock (In re Robintech, Inc.),
863 F.2d 393, 398 (5th Cir. 1989) (citation
omitted), cert. denied, 493 U.S. 811, 110 S.Ct. 55
(1989). This section of the outline is intended to
be an overview of major deadlines that occur in
bankruptcy under the Bankruptcy Code and Rules.
All deadlines cannot be covered in a paper of this
size. The practitioner should also consult court
orders, local notices, and local rules with regard to
all deadlines, because they could change some code
and rule imposed deadlines or create their own
deadlines. In addition, the practitioner should
determine whether there is a filing fee associated
with a particular filing, so that a deadline is not
missed for want of a filing fee.
2. Although deadlines appear in
numerous bankruptcy code sections and rules, the
general rule for computing time is found at
Bankruptcy Rule 9006, which provides in part that
“[i]n computing any period of time prescribed or
allowed by these rules, or by the Federal Rules of
Civil Procedure made applicable by these rules, by
the local rules, by order of court, or by any
applicable statute, the day of the act, event, or
default from which the designated period of time
begins to run shall not be included. The last day
of the period so computed shall be included,
unless it is a Saturday, a Sunday, or a legal
holiday, or, when the act to be done is the filing of
a paper in court, a day on which weather or other
conditions have made the clerk’s office
inaccessible, in which event the period runs until
the end of the next day which is not one of the
aforementioned days. When the period of time
prescribed or allowed is less than 8 days,
intermediate Saturdays, Sundays, and legal
holidays shall be excluded in the computation.”
FED. R. BANKR. P. 9006(a).
a. Note that Bankruptcy Rule
9006 limits or reduces the permissible
enlargement or reduction of many time periods
under other rules. FED. R. BANKR. P. 9006(b), (c).
3. Mailbox Rule--Bankruptcy Rule
9006(f) provides that "[w]hen there is a right or
requirement to do some act or undertake some
proceedings within a prescribed period after
service of a notice or other paper and the notice or
paper other than process is served by mail, three
days shall be added to the prescribed period."
FED. R. BANKR. P. 9006(f).
a. Note that the mailbox rule
does not apply to those rules that require an act to
be done within a prescribed period of time other
than after service of a notice or other paper,
including-i. complaints objecting to
the debtor’s discharge, which must be filed not
later than sixty days after the first date set for the
§ 341(a) meeting of creditors (chapter 7), or not
later than the first date set for the hearing on
confirmation. FED. R. BANKR. P. 4004(a);
ii. complaints to determine
the dischargeability of a debt under § 523(c) in a
chapter 7, 11, or 12 case, which must be filed not
later than sixty days after the first date set for the
§ 341 meeting of creditors. FED. R. BANKR. P.
4007(c);
iii. proofs of claim in a
chapter 7, 12, or 13 case, which must be filed not
later than 90 days after the first date set for the §
341 meeting. FED. R. BANKR. P. 3002(c); In re
Robintech, Inc., 863 F.2d at 395-96 (concluding
that Rule 9006(f) does not extend the bar date by
three days just because the notice of the bar date is
served by mail, but that the rule instead applies
D-13
only when the "prescribed period" is fixed by the
date on which notice is served);
iv. notices of appeal, which
must be filed within ten days of the date of the
entry of the judgment, order, or decree appealed
from. FED. R. BANKR. P. 8002(a); Arbuckle v.
First Nat’l Bank of Oxford (In re Arbuckle), 988
F.2d 29, 31-32 (5th Cir. 1993) (holding that
Bankruptcy Rule 9006(f) does not extend the thirty
day time period for filing a notice of appeal);
v. exclusivity periods,
during which, with some exceptions, only the
debtor may file a plan for the first 120 days after
the date of the order for relief, 11 U.S.C. §
1121(b), and during which (if the debtor files a
plan within the first 120 days) the debtor has until
180 days after the order for relief to obtain
acceptance of the plan. 11 U.S.C. § 1121(c)(3);
vi. periods to assume
executory contracts or unexpired leases, which are
tied to either the date of the order for relief or the
date a plan is confirmed. 11 U.S.C. § 365(d).
4. Bankruptcy Rule 9014
provides that “[n]o response is required under this
rule unless the court orders an answer to a motion.”
FED. R. BANKR. P. 9014. Many courts, however,
have local rules requiring responses to motions
within a certain time. For example, in bankruptcy
court in the Western District of Texas, many
motions are filed with a "20-day negative notice."
W.D. TEX. BANKR. R. 9014(b). Local Court Rule
9014(c) provides that “[i]f no response in
opposition to a contested matter is received within
twenty (20) days after the date reflected in the
Certificate of Service, the Motion may be granted
without further notice or hearing.”
a. How does this 20-day negative
notice interact with the mailbox rule under Rule
9006(f)? See In re Barnhart, 134 B.R. 580, 583
(Bankr. W.D. Tex. 1991) (holding that if all parties
are served by mail, the mailbox rule will not apply
to motions subject to negative notice, so that a
response filed two days after the 20-day negative
notice deadline was untimely). When in doubt, file
early.
B. Important Dates/Deadlines for
Debtors
1. Schedules and Statements of
Financial Affairs: Unless an extension of time is
granted, a debtor is required to file schedules and
statements of financial affairs within 15 days of
the order for relief. 11 U.S.C. § 521; FED. R.
BANKR. P. 1007.
2. First meeting of creditors (§ 341
meeting) is held-a. in chapter 7 and chapter 11
cases, no fewer than 20 days and no more than 40
days after the order for relief. FED. R. BANKR. P.
2003(a);
b. in a chapter 13 case, no fewer
than 20 days and no more than 50 days after the
order for relief. FED. R. BANKR. P. 2003(a).
3. Plan Deadlines:
a. In an ordinary chapter 11
case, there is no particular deadline within which a
plan must be filed and confirmed. However,
inability to effectuate a plan is grounds for
conversion of a chapter 11 case to chapter 7, or
dismissal. 11 U.S.C. § 1112(b)(2).
b. Exclusivity periods: Subject
to certain exceptions, only the debtor may file a
plan for the first 120 days after the date of the
order for relief. 11 U.S.C. § 1121(b). If the
debtor files a plan within the first 120 days, he has
until 180 days after the order for relief to obtain
acceptance of the plan. 11 U.S.C. § 1121(c)(3).
c. The exclusivity periods may
be reduced or increased "for cause" if the request
is made before the expiration of the exclusivity
period. 11 U.S.C. § 1121(d). The exclusivity
periods do not apply if a chapter 11 trustee is
appointed under § 1104. 11 U.S.C. §§ 1104,
1121(c)(1). If the exclusivity periods expire or do
not apply, any party in interest may file a plan. 11
U.S.C. § 1121(c).
d. If the debtor is a "small
business" as defined in 11 U.S.C. § 101(51C) and
elects to be considered a small business, the
debtor's exclusivity period for filing a plan is 100
days after the order for relief. 11 U.S.C. §
1121(e)(1). If that exclusivity period expires, all
plans must be filed within 160 days after the
order for relief. 11 U.S.C. § 1121(e)(2).
e. When a chapter 11 plan is
filed, it must be accompanied by a disclosure
statement. 11 U.S.C. § 1125; FED. R. BANKR. P.
3016(b). The court must hold a hearing to
determine whether the disclosure statement
contains "adequate information" concerning the
debtor and the plan. 11 U.S.C. § 1125(b); FED. R.
BANKR. P. 3017(a). The hearing on the disclosure
statement shall be held on not less than 25 days'
notice to parties in interest. FED. R. BANKR. P.
3017(a). After approval of the disclosure
statement, the court will provide notice to the
creditors of the date and time of the plan
confirmation hearing, and the deadlines to vote on
D-14
the plan and to object to the plan. FED. R. BANKR.
P. 3017(c), (d).
f. In the Western District of
Texas, the deadline to object to a chapter 13 plan
will be set forth in the Notice of Commencement of
Case. Official Bankruptcy Form 9.
C. Important Deadlines for
Creditors/Trustees
1. Objections to Exemptions: The
trustee or any creditor may file objections to a
debtor’s claimed exemptions within 30 days after
the conclusion of the first meeting of creditors or
the filing of any amendment to the list or
supplemental schedules unless, within such period,
further time is granted by the court. FED. R.
BANKR. P. 4003(b).
a. Creditors may seek extensions
of time to object to the exemptions. FED. R.
BANKR. P. 4003(b). Note that this can be a trap for
the unwary, however, because Bankruptcy Rule
4003(b) provides that the deadline is firm unless
"within such period" further time is granted by the
court. FED. R. BANKR. P. 4003(b). The Supreme
Court has interpreted this language to mean that,
unless a court order extending the deadline to
object is actually obtained prior to the expiration of
the deadline, there can be no extension of the
deadline and the debtor's exemptions are
unassailable. Taylor v. Freeland & Kronz, 503
U.S. 638, 643-44, 112 S.Ct. 1644, 1648-49
(1992). This is so even if the debtor had no
colorable claim to the exemptions. Id. If a creditor
feels the need for an extension of time to object to
the exemptions, it would be most prudent to seek
an extension as soon as possible, and if the
deadline is looming, seek an expedited hearing for
extension of the deadline.
2. Objections to Discharge:
a. A complaint objecting to a
debtor’s discharge under § 727(a) shall be filed-i. in a chapter 7 case, not
later than 60 days following the “first date set” for
the first meeting of creditors. FED. R. BANKR. P.
4004(a). This time period cannot be reduced. FED.
R. BANKR. P. 9006(c)(2). Note that the deadline is
60 days from the first date set for the first
meeting of creditors, as opposed to the deadline for
objecting to exemptions being 30 days after the
conclusion of the meeting of creditors. See FED.
R. BANKR. P. 4004(a), 4003(b);
ii. in a chapter 11 case, not
later than the first date set for hearing on
confirmation of a plan. FED. R. BANKR. P.
4004(a). This time period cannot be reduced.
FED. R. BANKR. P. 9006(c)(2).
b. Extensions of time to file
complaints objecting to discharge can be obtained.
FED. R. BANKR. P. 4004(b). The standard for
obtaining an extension is "for cause." Id. As long
as the motion for extension is made prior to the
deadline for objecting to discharge, the motion for
extension is timely. Id. This time period does not
appear to be eligible for enlargement by a postdeadline motion under Bankruptcy Rule
9006(b)(1). FED. R. BANKR. P. 9006(b)(3). Cf.
FED. R. BANKR. P. 4003(b) (requiring
procurement of extension order for objection to
exemptions prior to deadlines). Of course, if the
motion for extension of time to object to discharge
is filed shortly before the deadline, the creditor
could lose valuable rights if he has a meritorious
objection to discharge but cannot show good cause
for the extension.
3. Revocation of Discharge:
a. Even if no creditors timely
object to discharge and a discharge is obtained, in
some instances, a debtor's discharge may be
revoked. 11 U.S.C. §§ 727(d), 1328(e).
b. The deadline to file an
adversary proceeding to revoke the debtor's
discharge depends on the grounds for revocation.
i. If the grounds for
revocation are under 11 U.S.C. § 727(d)(1)
(discharge obtained through fraud), the action
must be filed within one year after the discharge
is granted. 11 U.S.C. § 727(e)(1).
ii. If the grounds for
revocation are under 11 U.S.C. § 727(d)(2)
(failure to report acquisition of property of the
estate) or 727(d)(3) (debtor's refusal to testify),
the deadline is the later of one year after the
granting of discharge or the date the case is
closed. 11 U.S.C. § 727(e)(2).
iii. If a chapter 13 discharge
is procured by fraud, the adversary proceeding to
revoke the discharge must be filed within one
year after the discharge was granted. 11 U.S.C. §
1328(e).
4. Objections to Dischargeability of
Particular Debts:
a. The deadline for filing
objections to dischargeability of a debt depends on
the grounds for objection.
b. A complaint to determine the
dischargeability of any debt pursuant to § 523(c)
must be filed not later than 60 days following the
first date set for the first meeting of creditors.
D-15
FED. R. BANKR. P. 4007(c). This deadline is
usually set forth in the Notice of Commencement of
Case. Official Bankruptcy Form 9. Section 523(c)
provides that, unless an objection to discharge is
filed by the deadline for the following types of
debts, the debtor automatically gets a discharge for
these debts:
i. § 523(a)(2) (fraud, false
pretenses, and false financial statements);
ii. § 523(a)(4) (fraud or
defalcation while acting in a fiduciary capacity,
embezzlement, or larceny);
iii. § 523(a)(6) (debts for
willful or malicious injury by the debtor to another
entity or to the property of another entity); and
iv. § 523(a)(15) (property
settlement debts in connection with a divorce or
separation agreement).
c. A creditor may seek an
extension of the deadlines to file an objection to
dischargeability under § 523(c) “for cause.” FED.
R. BANKR. P. 4007(c). Like a motion to extend the
time to object to the discharge, a motion for
extension of time to object to dischargeability
under § 523(c) must be made before the deadline
has expired. FED. R. BANKR. P. 4007(c).
d. A complaint to determine
dischargeability under any other subsection of §
523 may be filed "at any time." FED. R. BANKR.
P. 4007(b). Thus, objections to dischargeability for
the following types of debts are not subject to the
deadline of Rule 4007(c):
i. § 523(a)(1) (taxes);
ii. § 523(a)(3) (unscheduled
debts);
iii. § 523(a)(5) (alimony or
support);
iv. § 523(a)(7) (government
fines);
v. § 523(a)(8) (student
loans);
vi. § 523(a)(9) (driving while
intoxicated);
vii. § 523(a)(10) (previously
waived discharge);
viii. § 523(a)(11), (12)
(federal depository institutions fraud and failure to
maintain capital);
ix. § 523(a)(13) (Title 18
restitution);
x. § 523(a)(14) (debts
incurred to pay non-dischargeable taxes);
xi § 523(a)(16) (condo/coop fees);
xii. § 523(a)(17) (debts for
filing fees and costs); and
xiii. § 523(a)(18) (support
debts owed to a state or municipality).
e. A case that has been closed
may be reopened without the payment of an
additional filing fee for the purpose of filing a
complaint of the types immediately above (non-§
523(c)) to determine dischargeability. FED. R.
BANKR. P. 4007(b).
5. Reaffirmation Agreements:
a. A reaffirmation agreement
must be made before the granting of a discharge.
11 U.S.C. § 524(c)(1). However, reaffirmation
agreements may be rescinded without penalty at
any time prior to discharge or within 60 days after
the agreement is filed with the court, whichever
occurs later, by giving notice of rescission to the
holder of the claim. 11 U.S.C. § 524(c)(2), (c)(4).
b. If the court holds a hearing on
the reaffirmation agreement, the motion for
approval of the agreement shall be filed before or
at the hearing. FED. R. BANKR. P. 4008.
6. Proof of Claims Deadline--The
Claims Bar Date:
a. In a chapter 11 case, a proof
of claim is "deemed filed" in the amount scheduled
if the creditor's claim is listed in the schedules and
is not scheduled as disputed, unliquidated, or
contingent. 11 U.S.C. § 1111(a); FED. R.
BANKR. P. 3003(b)(1).
i. If a claim in a chapter 11
case is not scheduled, or is scheduled as disputed,
unliquidated, or contingent, a proof of claim will
be required in order for the creditor to participate
in a distribution. 11 U.S.C. §§ 501, 1111; FED.
R. BANKR. P. 3003(c)(2). Also, if the chapter 11
creditor disagrees with the amount or
classification of the claim as scheduled, he should
file a proof of claim; otherwise, his claim stands
as scheduled. The filing of a creditor's proof of
claim in chapter 11 supersedes the debtor's
scheduling of the claim and is prima facie proof of
the validity and amount of the claim. FED. R.
BANKR. P. 3003(c)(4), 3001(f).
ii. In a chapter 11 case, the
deadline to file proofs of claims is fixed by the
court. FED. R. BANKR. P. 3003(c)(3). This
deadline usually appears in the Notice of
Commencement of Case. Official Bankruptcy
Form 9. The chapter 11 claims bar date may be
extended "for cause shown." FED. R. BANKR. P.
3003(c)(3). What if a chapter 11 creditor does not
D-16
file a proof of claim or obtain an extension of time
to file a proof of claim before the claims bar date?
The United States Supreme Court has provided
guidance in Pioneer Investment Services v.
Brunswick Associates Ltd. Partnership, 507 U.S.
380, 113 S.Ct. 1489 (1993). In Pioneer, a chapter
11 creditor missed the claims bar date and then
filed a motion for relief from that deadline.
Pioneer, 507 U.S. at 384, S.Ct. at 1492. Relying
on Bankruptcy Rule 9006(b)(1), the Court held
that a post-expiration enlargement of the time
could be allowed in a chapter 11 case when the
failure to act was due to "excusable neglect." In
Pioneer, the court stated the following as bearing
on excusable neglect: “[T]he determination is at
bottom an equitable one, taking account of all
relevant circumstances surrounding the party's
omission. These include, as the Court of Appeals
found, the danger of prejudice to the debtor, the
length of the delay and its potential impact on
judicial proceedings, the reason for the delay,
including whether it was within the reasonable
control of the movant, and whether the movant
acted in good faith.” Pioneer, 507 U.S. at 395,
113 S.Ct. at 1498 (footnote omitted).
iii. In addition to the
Bankruptcy Rules concerning when claims must be
filed, confirmed chapter 11 plans may contain
deadlines to file claims, and creditors will be bound
by these deadlines regardless of whether they
accepted the plan. 11 U.S.C. § 1141(a).
b. There is no deemed filing of a
proof of claim by scheduling in a chapter 7 or 13,
however. Under those chapters, in order to be an
allowed claim and receive a distribution, a proof of
claim must be filed, 11 U.S.C. §§ 501, 502; FED.
R. BANKR. P. 3002(a)(proof of claim required for
claim to be allowed), with the following
exceptions:
i. Bankruptcy Rule 1019(3)
(pre-conversion proof of claim);
ii. Bankruptcy Rule 3003
(chapter 11 deemed filed claims);
iii. Bankruptcy Rules 3004
(proofs of claims filed by debtor or trustee; and
iv. Bankruptcy Rule 3005
(proofs of claims filed by co-debtors).
c. If the proof of claim is filed in
a chapter 7 case after the claims bar date, it is a
tardily filed claim and will be placed in a lower
priority for payment. 11 U.S.C. § 726(a)(2). In
the typical chapter 7 bankruptcy, general unsecured
claimants with timely filed proofs of claim usually
do not receive full payment; therefore, tardy filing
of a proof of claim usually means no distribution
for that claimant.
d. The time for filing a proof of
claim in a chapter 7, 12, and 13 is not later than
90 days after the first date set for the first
meeting of creditors. FED. R. BANKR. P. 3002(c).
This deadline is also usually set forth in the Notice
of Commencement of Case. Official Bankruptcy
Form 9.
i. However, a proof of
claim filed by a governmental unit is timely filed if
it is filed not later than 180 days after the date of
the order for relief. Rule 3002(c)(1). Also, the
court may extend the time for filing a proof of
claim by an infant or incompetent person or the
representative of either. FED. R. BANKR. P.
3002(c)(2).
ii. Note that Bankruptcy
Rule 9006(b)(1) does not apply to deadlines under
Bankruptcy Rule 3002(c) (deadline for chapter 7
proofs of claim). Fed. R. Bankr. P. 9006(b)(3);
Pioneer, 507 U.S. at 389, 113 S.Ct. at 1495
(noting that the excusable neglect standard of Rule
9006(b)(1) governs late filings of proofs of claim
in Chapter 11 cases, but not in Chapter 7 cases).
7. Stay Relief Deadlines:
a. Once a motion for relief from
stay under § 362(d) is filed, the court may
schedule a preliminary hearing and then a final
hearing, or may consolidate the preliminary
hearing and the final hearing. 11 U.S.C. § 362(e).
The stay terminates automatically with respect to
a motion for relief from stay of any act against
property of the bankruptcy estate within 30 days
of the filing of the motion for relief, unless an
exception applies. 11 U.S.C. § 362(d). The
exceptions are:
i. the court may order the
stay continued beyond 30 days from the filing of
the motion, pending the conclusion of a final
hearing, if there is a reasonable likelihood that the
party opposing the motion will prevail;
ii. if the hearing is a
preliminary hearing, then the final hearing must be
concluded within 30 days of the conclusion of the
preliminary hearing, unless the 30-day period is
extended with the consent of the parties or for a
specific time which the court finds is required by
compelling circumstances. 11 U.S.C. § 362(e).
b. If the debtor is a single asset
real estate debtor as defined in 11 U.S.C. §
101(51B), and a motion for relief from stay under
11 U.S.C. § 362(d) is filed by a creditor with a
lien on the real estate, the stay will terminate
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unless the debtor has filed a plan of reorganization
within 90 days of the order for relief or the debtor
has commenced monthly interest payments to
secured creditors as prescribed by section
362(d)(3)(B). 11 U.S.C. § 362(d)(3).
i. The court may extend this
period for cause. 11 U.S.C. § 362(d)(3).
c. Other milestones resulting in
expiration of the stay include the following:
i. the stay of acts against
property of the estate expires when the property is
no longer property of the estate. 11 U.S.C. §
362(c)(1).
ii. the automatic stay expires
when the case is closed. 11 U.S.C. § 362(c)(2)(A).
iii. the automatic stay expires
when the case is dismissed. 11 U.S.C. §
362(c)(2)(B).
iv. the automatic stay expires
when a discharge is granted or denied in individual
chapter 7 cases or in cases under chapter 9, 11, 12,
or 13. 11 U.S.C. § 362(c)(2)(C).
8. Executory Contracts and
Unexpired Leases:
a. Deadlines to act depend on
whether the case is a chapter 7 or 11, whether real
property leases are residential or nonresidential,
and whether personal property leases are business
or consumer in nature. The most commonly
occurring deadlines under § 365 are as follows:
i. In a chapter 7 case, an
executory contract or unexpired lease of residential
real property or of personal property of the debtor
not assumed by the trustee within 60 days after the
order for relief is deemed rejected, unless the court
orders otherwise. 11 U.S.C. § 365(d)(1).
ii. In a chapter 9, 11, 12, or
13 case, an executory contract or unexpired lease of
residential real property or of personal property of
the debtor may be assumed or rejected by the
trustee any time before the confirmation of a plan,
but the court may order a specific deadline within
which the trustee must determine whether to
assume or reject. 11 U.S.C. § 365(d)(2).
iii. Under any chapter, if the
debtor is a lessee of nonresidential real property,
the lease must be assumed or rejected by the trustee
within 60 days of the order for relief, or the lease is
deemed rejected and the premises must be
immediately surrendered to the lessor. 11 U.S.C. §
365(d)(4). The court may extend this deadline "for
cause, within such 60-day period." Id.
iv. In the case of an
unexpired lease of nonresidential real property, the
debtor's obligations are to be timely performed by
the trustee from and after the order for relief until
the lease is assumed or rejected. 11 U.S.C. §
365(d)(3). The court may extend, for cause, the
time for performance of any such obligation that
arises within 60 days after the order for relief, but
the time for performance shall not be extended
beyond such 60-day period. 11 U.S.C. §
365(d)(3).
v. In a chapter 11 case, the
obligations first arising on or after 60 days after
the order for relief of a debtor under an unexpired,
non-consumer personal property lease shall be
timely performed by the trustee unless the court
orders otherwise. 11 U.S.C. § 365(d)(10).
9. Preference Deadlines:
a. Generally speaking, a
preference occurs when a creditor improves his
position vis-a-vis other creditors via a transfer of
an interest of the debtor in property during either a
90-day or one-year period prior to the bankruptcy
filing, depending on the status of the creditor. See
11 U.S.C. § 547. The elements of a preference are
listed in 11 U.S.C. § 547(b).
b. Preferences have a
"reachback" period, that is, the time period prior
to the filing of the bankruptcy petition when a
transfer could be a preference.
i. An otherwise
preferential transfer made on or within 90 days of
the filing of the bankruptcy can be avoided by the
trustee. 11 U.S.C. § 547(b)(4).
ii. If the preferred creditor
at the time of the transfer was an insider to the
debtor as defined in 11 U.S.C. § 101(31), the
reachback period is one year prior to the filing of
the bankruptcy petition. 11 U.S.C. § 547(b)(4).
iii. There is also a statute of
limitations for filing preference actions. A
preference claim may not be commenced after a
case is closed or dismissed. 11 U.S.C. §
546(a)(2). Also, a preference action may not be
commenced after the later of 2 years after the
entry of an order for relief or one year after the
appointment or election of the first trustee if such
appointment or election occurs before 2 years
after the entry of the order for relief. 11 U.S.C. §
546(a)(1).
10. Fraudulent Transfer Deadlines:
a. Generally speaking,
fraudulent transfers occur when the debtor
transfers property to another either with actual
intent to hinder, delay, or defraud creditors or for
less than reasonably equivalent value while the
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debtor is insolvent. See generally TEX. BUS. &
COM. CODE ANN. § 24.001 et seq (also known as
the Uniform Fraudulent Transfer Act or "UFTA");
11 U.S.C. § 548.
b. In bankruptcy, the trustee can
file an action to avoid fraudulent transfers. 11
U.S.C. § 548. The bankruptcy code provides that
the reachback period for fraudulent transfers under
§ 548 is on or within one year before the date of
the filing of the bankruptcy petition. 11 U.S.C. §
548(a).
c. The trustee also has the powers
of a hypothetical creditor, which allows the trustee
to use the state fraudulent transfer law as well. 11
U.S.C. § 544. Under state law, different types of
fraudulent transfers have different periods within
which an action must be commenced. TEX. BUS. &
COM. CODE ANN. § 24.010. Most of these
deadlines under UFTA use the date of "transfer" as
the anchor date. The time when a transfer is
deemed made is defined at UFTA section 24.007.
TEX. BUS. & COM. CODE ANN. § 24.007.
i. A cause of action for
fraudulent transfer under UFTA section
24.005(a)(1) (transfers made with actual intent to
hinder, delay, or defraud a creditor) is extinguished
unless an action is brought within the later of (1)
four years after the transfer was made, or (2) one
year after the transfer could have reasonably been
discovered by the claimant. TEX. BUS. & COM.
CODE ANN. § 24.010(a)(1).
ii. A cause of action for
fraudulent transfer under UFTA section
24.005(a)(2) or 24.006(a) (transfers for less than
reasonably equivalent value while the debtor was
insolvent, about to be insolvent, or insolvent as a
result of the transfer) is extinguished unless it is
brought within four years of the transfer. TEX.
BUS. & COM. CODE ANN. § 24.010(a)(2).
iii. If the fraudulent transfer
is based on "insider preference" grounds of UFTA
section 24.006(b), the fraudulent transfer action is
extinguished unless it is brought within one year
after the transfer. TEX. BUS. & COM. CODE ANN. §
24.010(a)(3).
iv. UFTA section 24.010(b)
extends some of these time periods due to legal
disabilities. TEX. BUS. & COM. CODE ANN. §
24.010(b).
d. A fraudulent transfer action
may not be commenced in bankruptcy after the
earlier of-i. the later of 2 years after
the entry of an order for relief or one year after the
appointment or election of the first trustee if such
appointment or election occurs before 2 years
after the entry of the order for relief; or
ii. the time the case is
closed or dismissed. 11 U.S.C. § 546(a).
9. Reclamation Claims:
a. A seller of goods who sells
and delivers goods to a debtor in the ordinary
course of the seller’s business while the debtor is
insolvent may reclaim such goods pursuant to
section 2.702(b) of the UCC only if the seller
demands in writing reclamation of such goods
before 10 days after receipt of such goods by the
debtor, or if such 10-day period expires after the
bankruptcy petition is filed, before 20 days after
receipt of such goods by the debtor. 11 U.S.C. §
546(c)(1).
D. Removal Deadlines
1. Proceedings for which there is
bankruptcy court jurisdiction under 28 U.S.C. §
1334 may be removed. 28 U.S.C. § 1452(a). The
procedure for bankruptcy removal is found at
Bankruptcy Rule 9027. FED. R. BANKR. P. 9027.
Removal is initiated by filing a notice of removal
with the clerk for the district and division within
which is located the state or federal court where
the civil action is pending. FED. R. BANKR. P.
9027(a)(1). Time deadlines for filing removal
notices depend on whether the civil action is
pending when the bankruptcy case is commenced
or whether the civil action is commenced after the
bankruptcy case has been filed. See FED. R.
BANKR. P. 9027(a).
a. If the civil action is pending,
and then a bankruptcy is filed, the notice of
removal may be filed only within the longest of
(1) 90 days after the order for relief (2) 30 days
after entry of an order terminating a stay, if the
claim has been stayed under § 362, or (3) 30 days
after a trustee qualifies in a chapter 11 case, but
not later than 180 days after the order for relief.
FED. R. BANKR. P. 9027(a)(2).
b. If a civil action is filed while a
bankruptcy case is pending, the notice of removal
may be filed with the clerk only within the shorter
of (1) 30 days after receipt, through service or
otherwise, of a copy of the initial pleading setting
forth the claim or cause of action sought to be
removed, or (2) 30 days after receipt of the
summons if the initial pleading has been filed with
the court but not served with the summons. FED.
R. BANKR. P. 9027(a)(3).
2. Once the notice of removal is filed,
the remover must "promptly" serve all parties to
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the removed action with a copy and must file a
copy of the notice of the removal with the court
from which the action was removed. FED. R.
BANKR. P. 9027(b), (c).
3. Any party who has filed a pleading
in connection with a removed claim (other than the
remover) must file and serve a "core/non-core"
statement in the removed proceeding within 10
days after the notice of removal is filed; that is, a
statement that the proceeding is either "core" or
"non-core" and, if the proceeding is non-core,
whether the party consents or does not consent to
the entry of final orders or judgments by the
bankruptcy court. FED. R. BANKR. P. 9027(e)(3).
4. The deadline for answers to actions
removed to bankruptcy court is found at
Bankruptcy Rule 9027(g). First, the rule provides
that the adversary proceeding rules of "Part VII"
(that is, Bankruptcy Rules 7001-87) apply. FED.
R. BANKR. P. 9027(g). If the defendant in a
removed action has not already answered, the
answer (under the adversary rules) must be filed
within the longest of these three periods:
E. Non-bankruptcy Statutes of
Limitations
1. When a debtor files bankruptcy,
causes of action, whether filed or not, owned by the
debtor become property of the debtor's bankruptcy
estate, and the trustee has the authority to file suit.
See, e.g., American Nat'l Bank of Austin v.
MortgageAmerica Corp. (In re
MortgageAmerica Corp.), 714 F.2d 1266, 127677 (5th Cir. 1983) (noting that a corporation's trust
fund action, upon bankruptcy, passes to the trustee,
who may then enforce the claim); 11 U.S.C. § 323.
2. The bankruptcy code gives the
trustee more time to bring the action if the statute
of limitations is nearing the end when the
bankruptcy is filed. Section 108(a) provides that
the trustee may bring such an action by the end of
the limitation period (including any suspension of
the period occurring on or after the case is filed), or
before two years after the order for relief,
whichever is later. 11 U.S.C. § 108(a).
3. Section 108(b) is a similar
provision dealing with when the trustee may take
actions other than filing suit, such as filing a
pleading, demand, notice, etc. Section 108(b)
provides that, so long as the period to act has not
expired before the filing of the bankruptcy petition,
the trustee may act before the later of (1) the end
of the period, including any suspension of the
period occurring on or after the commencement of
the case, or (2) 60 days after the order for relief.
11 U.S.C. § 108(b).
4. Section 108(c) gives creditors
extensions of time to take actions. The automatic
stay, of course, enjoins creditors from filing suit
on pre-petition claims. 11 U.S.C. § 362(a)(1).
Upon discharge, section 524 enjoins creditors
from filing suit or otherwise collecting on
discharged debts. 11 U.S.C. § 524(a)(2).
a. What if the bankruptcy case is
dismissed prior to a discharge and limitations on a
state cause of action has run in the meantime?
Section 108 provides that limitations does not
expire until the later of (1) the limitations period,
including any suspension of the period occurring
on or after the commencement of the case, or (2)
30 days after notice of termination or expiration
of the automatic stay. 11 U.S.C. § 108(c).
F. Important Deadlines for Adversary
Proceedings
1. All of the deadlines found in the
7000 series of the Federal Rules of Bankruptcy
Procedure are well beyond the scope of this
article. For an exhaustive review of all deadlines
both in the bankruptcy case and in adversary
proceedings, see NORMAN L. PERNICK,
BANKRUPTCY DEADLINE CHECKLIST (2d ed.
1996). In order to give the readers a head start,
however, please note that answers to adversary
complaints are due within 30 days after the
“issuance” of the summons (not necessarily 30
days after the service of the summons). FED. R.
BANKR. P. 7012.
G. Important Deadlines for Appeals
1. Appeals from an appealable order
or judgment of the bankruptcy court are initiated
by the filing of a Notice of Appeal filed with the
clerk of the bankruptcy court. FED. R. BANKR. P.
8001(a), 9001(3) (defining clerk as the
bankruptcy clerk, if one has been appointed). The
Notice of Appeal must conform to an Official
Bankruptcy Form, and it must be filed and served
within 10 days of entry of the order or judgment
to be appealed. FED. R. BANKR. P. 8001(a)
(official form), 8004 (service of notice of appeal),
8002(a) (ten-day filing requirement).
a. Note that the deadline is ten
days from the entry of the bankruptcy court order,
not ten days from the mailing of the bankruptcy
court order to the prospective appellant, and that
the three day mailbox rule does not apply.
Arbuckle v. First Nat'l Bank of Oxford (In re
Arbuckle), 988 F.2d 29, 31-32 (5th Cir. 1993).
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b. The ten-day Notice of Appeal
deadline is jurisdictional, and an untimely filing
will result in dismissal of the appeal. See, e.g., In
re Arbuckle, 988 F.2d at 32 (affirming the district
court's determination that it lacked appellate
jurisdiction over the debtors' appeal when the
debtors filed their Notice of Appeal eleven days
after entry of the bankruptcy court's order); In re
Slimick, 928 F.2d 304, 306 (9th Cir. 1990)
(affirming the BAP's dismissal when notice of
appeal filed five months after entry of order).
2. Certain timely filed motions
suspend the time period for filing a Notice of
Appeal until entry of an order disposing of them.
FED. R. BANKR. P. 8002(b). These are-a. motions to amend or make
additional findings of fact;
b. motions to alter or amend
judgment;
c. motions for new trial; or
d. motions for relief from a
judgment or order if the motion is filed no later
than 10 days after the entry of the judgment. FED.
R. BANKR. P. 8002(b).
3. Extensions of time to file a Notice
of Appeal for a period not to exceed 20 days from
the original deadline, or 10 days from the date of
entry of the order granting the motion, whichever
is later, can be obtained by filing a request for an
extension before the deadline to file the Notice of
Appeal. FED. R. BANKR. P. 8002(c). However,
with a showing of excusable neglect, on certain
types of orders and judgments, an extension for
filing a Notice of Appeal after the Notice of Appeal
deadline may be sought if the request is made not
later than 20 days after the Notice of Appeal
deadline. Id.
4. Within 10 days after filing the
Notice of Appeal, the appellant must file with the
bankruptcy clerk and serve on the appellee a
designation of the items to be included in the record
and a statement of issue to be presented. FED. R.
BANKR. P. 8006.
a. Within 10 days after the
service of the appellant's designation of record and
issues on appeal, the appellee may file and serve a
designation of additional items to be included in the
record. Id.
5. After the bankruptcy clerk receives
all the designations of record, the bankruptcy clerk
transmits a copy of the record to the district court.
FED. R. BANKR. P. 8007(b). The district clerk then
"dockets" the appeal by entering the appeal in the
district clerk's docket and giving prompt notice to
the parties of the date on which the appeal was
docketed. Id. The appellant's brief is then due to
be filed and served within 15 days after
docketing. FED. R. BANKR. P. 8009(a)(1).
a. The appellee's brief is due to
be filed and served within 15 days after the
service of the appellant's brief. FED. R. BANKR. P.
8009(a)(2).
b. The appellant's reply brief
may be filed and served within 10 days after
service of the appellee's brief. FED. R. BANKR. P.
8009(a)(3).
c. If a motion is made in an
appeal, a response to the motion (other than a
motion seeking a procedural order) must be filed
within seven days after service of the motion, a
time period that may be shortened and extended.
6. A judgment of the district court on
a bankruptcy appeal is automatically stayed for 10
days after entry, unless otherwise ordered. FED.
R. BANKR. P. 8017(a). Appeal deadlines beyond
the district court are beyond the scope of this
article.
VII.
FATAL OMISSIONS
Unlisted Claims
1. 11 U.S.C. §521(1) requires a
debtor to file a list of creditors, and unless
the court orders otherwise, a schedule of
assets and liabilities, a schedule of current income
and current expenditures, and a statement of the
debtor’s financial affairs.
2. 11 U.S. C. §523(a)(3) provides
that a debt will be excepted from discharge if the
debt is neither listed nor scheduled under section
521(1) with the name, if known to the debtor, of
the creditor to whom such debt is owed in time to
permit a creditor to file a timely proof of claim or
in time for a creditor to seek a determination of
dischargeability of a debt under §§523(a)(2),
(a)(4), or (a)(6) unless the creditor had notice or
actual knowledge of the bankruptcy case.
a. If the debtor knows that the
debt has been transferred from the original
creditor to a new creditor, the new creditor must
be listed. Birkett v. Columbia Bank, 195 U.S.
345, 25 S. Ct. 38, 49 L.Ed. 231 (1904), aff’g 174
N.Y. 112, 66 N.E. 652 (1903).
b. The correct address of the
scheduled creditors must be listed if known. See
FED. R. BANKR. P. 1007(a). If the address is
unknown, the debtor should expressly state this in
the list or schedules.
A.
D-21
i. Failure to list the correct
address when known may cause the debt not to be
discharged. See In re Springer, 127 B.R. 726
(Bankr. M.D. Fla. 1991).
ii. Listing the address of a
parent company found in the telephone book is not
adequate when debtor could easily reference own
files to find correct address. See Faden v.
Insurance Co. of North America (In re Faden),
96 F. 3d. 792 (5th Cir. 1996).
c. Under 11 U.S.C.
§523(a)(3)(A), the only requirement is that the
creditor be listed in time to permit that creditor to
receive notice of the case in time to file a timely
proof of claim. The Bankruptcy Court may,
however, reserve the right to deny a discharge when
there is evidence that the debtor failed to list the
creditor or debt due to intentional design, fraud, or
improper motive. Negligence is not enough. See
Stone v. Caplan (In re Stone), 10 F.3d. 285 (5th
Cir. 1994).
d. Factors the Fifth Circuit
suggests that courts examine to determine whether
a debt is dischargeable under 11 U.S.C. §523(a)(3)
(Robinson Factors):
i. the reasons the debtor
failed to list the creditor;
ii. the amount of disruption
that would likely occur;
iii. the prejudice suffered by
the listed creditors and the unlisted creditor in
question.
e. The exception - An unlisted
claim will be discharged if the unlisted creditor had
notice or actual knowledge of the bankruptcy case.
i. Mere constructive notice
or imputed knowledge is not enough. See Small
Bus. Admin. v. Bridges, 894 F.2d 108 (5th Cir.
1990).
ii. Examples of Actual
Knowledge or Notice
(A) Knowledge through
receipt of responsive pleadings.
(B) Verbal
communication.
(C) Knowledge through
reading newspaper.
iii. Burden of proof to show
actual notice is on debtor. In re Faden, 96 F.3d
792 (5th Cir. 1996).
B. Failure of Unsecured Creditor to file
Proof of Claim
1. 11 U.S.C. §501(a) provides that a
creditor may file a proof of claim.
a. Filing Proof of Claim is
permissive, not mandatory.
b. For claimants, however, the
filing of a proof of claim with limited exceptions
may be a prerequisite to allowance of the claim as
a claim on the assets of the bankruptcy estate. See
I.B.M. v. Fernstrom Storage and Van Co. (In re
Fernstrom Storage and Van Co.), 938 F.2d.
731(7th Cir. 1991).
c. Filing a proof of claim may be
a prerequisite to vote in the election of a trustee in
a Chapter 7 or Chapter 11 Bankruptcy Case. See
11 U.S.C. §§ 702(a), 1104(b), FED. R. BANKR. P.
2003(b)(3).
d. Untimely proofs of claim may
be disallowed. See, 11 U.S.C. §502(b)(9).
C. Retention of Claims on Confirmation
1. 11 U.S.C. §1141(b) specifies that
except as otherwise provided in the plan or the
order confirming the plan, the confirmation of a
plan vests all of the property of the estate in the
debtor.
2. 11 U.S.C. §1123 (b)(3)(B)
provides that a Chapter 11 plan may provide for
the retention and enforcement by the debtor, by
the trustee, or by a representative of the estate
appointed for such purpose, of any claim or
interest belonging to the estate.
3. The ability of a party to enforce a
claim once held by the bankruptcy estate is limited
to that which is retained under the terms of the
confirmed plan. See In re MAKO, Inc., 120 B.R.
203 (Bankr. E.D. Okla. 1990).
a. A retention provision in a
Plan requires specific and unequivocal language
of reservation.
i. Language that a party had
“the right to prosecute or defend any other such
litigation” and that it “may appear as the real
party in interest in any pending or later instituted
contested or adversary proceeding filed herein”
was not specific enough to confer on the party the
right to bring avoidance actions after
confirmation. Id. at 209. See also Paramount
Plastics, Inc. v. Polymerland, Inc. (In re
Paramount Plastics Inc.), 172 B.R. 331 (Bankr.
W.D. Wash. 1994).
D. Adequacy of Notice to Parties
Affected by Proposed Action
1. Bankruptcy Rule of Procedure
2002 contains the requirements for certain notices
to creditors, equity security holders, United States,
and the United States Trustee.
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a. The Courts are split with
regard to the consequences when a party does not
receive notice.
i. The Fifth Circuit and the
Ninth Circuit place upon the creditor who knows of
the bankruptcy case the duty to inquire as to
matters concerning the bankruptcy, including time
limitations. See Neely v. Murchison, 815 F.2d.
345 (5th Cir. 1987); Lompa v. Price (In re Price),
79 B.R. 888 (Bankr. 9th Cir. 1987), aff’d, 871
F.2d. 97 (9th Cir. 1988).
ii. The Tenth and Eleventh
circuits hold that actual notice by the party does not
negate the statutory notice requirement and it does
not place a duty on creditors to inquire regarding
time limitations for filing claims or objecting to
discharge and dischargeability. See In re Herd,
840 F.2d. 757 (10th Cir. 1988); Spring Valley
Farms, Inc. v. Crow (In re Spring Valley Farms,
Inc.), 863 F.2d. 832 (11th Cir. 1989).
b. Failure to raise the issue
of defective notice at the trial or hearing results in
waiver of the defect. See Ninety Two Eighty One
Shore Road Owners Corp. v. Seminole Realty,
Inc. (In re Ninety Two Eighty One Shore Road
Owners Corp.), 187 B.R. 837 (E.D. N.Y. 1995).
VIII.
INVESTIGATION AND
DISCOVERY IN CONTESTED MATTERS
A. Investigation
1. Review Clients’ files
a. Review “check register” to
identify payments and dates: A debtor who pays a
creditor by regular check and who wishes to avoid
exposing that creditor to preference liability should,
before filing bankruptcy, be careful to determine
whether the drawee bank has honored the check.
See Barnhill v. Johnson, 503 U.S. 393, 112 S.Ct.
1386 (1992) (holding that a debtor’s payment by
regular check that was delivered to the transferee
on the 92nd day before the bankruptcy petition was
filed, but that was not honored by the drawee bank
until the 90th day before the petition, was a transfer
within the 90-day preference period of §
547(b)(4)(A): “For payment by ordinary check,
therefore, a “transfer” . . . occurs [pursuant to the
UCC] on the date of honor, and not before.”).
2. Lien Searches
a. General--An attorney for a
party to a bankruptcy case may expose himself to
malpractice claims by failing to discover liens on
property. The following is a non-exhaustive and
nonexclusive list of possible locations to conduct
lien searches.
b.
Personal Property and
Fixtures--UCC
i. The UCC generally
governs the perfection of consensual security
interests in personal property and fixtures. The
proper place to file (and therefore search for) a
security interest is-A) when the collateral is
consumer goods not covered by a certificate of
title, in the office of the county clerk in the county
of the debtor’s residence or if the debtor is not a
Texas resident, then in the office of the county
clerk in the county where the goods are kept. TEX.
BUS. & COM. CODE ANN. § 9.401(a)(1).
B) when the collateral is
timber to be cut or is minerals or the like or
accounts arising from the sale of oil or gas or
when the financing statement is filed as a fixture
filing and the collateral is goods which are or are
to become fixtures, then in the office of the county
clerk in the county where a mortgage on the real
estate would be filed or recorded. TEX. BUS. &
COM. CODE ANN. § 9.401(a)(2).
C) in all other cases, in
the office of the Secretary of State. TEX. BUS. &
COM. CODE ANN. § 9.401(a)(3).
ii. Beware of certain
unrecorded perfected security interests, including-A) a purchase money
security interest in consumer goods, which is
automatically perfected upon attachment. TEX.
BUS. & COM. CODE ANN. § 9.302(a)(4).
B) a security interest in
letters of credit and advices of credit, goods,
instruments, money, negotiable documents or
chattel paper, which may be perfected by
possession. TEX. BUS. & COM. CODE ANN. §§
9.302(a)(1), 9.305.
C) a temporary
perfected security interest in instruments,
certificated securities, or documents without
delivery under section 9.304 or in proceeds under
section 9.306. TEX. BUS. COM. CODE ANN. §
9.302(a)(2).
c. Motor Vehicles
i. Except for motor
vehicles held as inventory by a person in the
business of selling motor vehicles, a person may
perfect a security interest in a motor vehicle that is
the subject of a first or subsequent sale only by
recording the security interest on the certificate of
title pursuant to the Transportation Code. TEX.
TRANSP. CODE ANN. § 501.111.
d. Real Property
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i. Judgment liens--An
abstract of judgment, when properly recorded and
indexed, if the judgment is not then dormant,
constitutes a lien on the real property of the
defendant located in the county in which the
abstract is recorded and indexed, including real
property acquired after such recording and
indexing. TEX. PROP. CODE ANN. § 52.001.
ii. Mechanic’s, Contractor’s,
or Materialman’s liens--Except for liens arising
from residential construction projects, a person
claiming a mechanic’s, contractor’s, or
materialman’s lien must file an proper affidavit
with the county clerk of the county in which the
property is located. TEX. PROP. CODE ANN. §
53.052.
iii. Other liens under the
Texas Property Code--The Texas Property Code
also provides for landlord’s liens, hospital liens,
liens against mineral property, and other liens. See
TEX. PROP. CODE ANN. §§ 54.001-70.306.
iv. Environmental
A) Texas -Environmental remediation costs for which a
responsible person is liable to the state constitutes
a lien in favor of the state on the affected real
property and on the rights to the property. TEX.
HEALTH & SAFETY CODE ANN. § 361.194(a). The
lien attaches at the time an affidavit is recorded and
indexed in the county where the real property is
located. Id. § 361.194(b). The lien is not
enforceable against prior security interests unless
the holder of the prior security interest had or
reasonably should have had actual notice or
knowledge that the property was the subject of a
clean-up action or that the state has incurred cleanup costs. Id. § 361.194(g).
B) Federal-Environmental remediation costs, damages to
natural resources, and costs of health assessments
for which a responsible person is liable to the
United States shall constitute a lien in favor of the
United States upon all real property and rights to
such property which belong to the responsible
person and are subject to or affected by a removal
or remedial action. 42 U.S.C. § 9607(l)(1). The
lien, which shall be filed in the office of the county
clerk in the county in which the real property
subject to the liens is situated, is not enforceable
against prior, properly perfected security interests
in the real property. 42 U.S.C. § 9607(l)(3); TEX.
PROP. CODE ANN. § 14.002(b).
a. Tax Lien Filings
i. Federal
A) A federal tax lien,
which arises after a taxpayer’s failure to pay
delinquent taxes after demand, attaches to a
delinquent taxpayer’s property, real and personal,
upon assessment of the tax liability. 26 U.S.C. §§
6321-22.
B) Perfection of a
federal tax lien is governed by § 6323, which
provides that a federal tax lien is not valid against
third-party creditors until a proper notice is filed.
26 U.S.C. § 6323(a).
C) Section 6323(f) of
the IRC and sections 14.001-.002 of the Texas
Property Code govern the place of filing of federal
tax liens. 26 U.S.C. § 6323(f); TEX. PROP. CODE
ANN. 14.001-.002.
1) Real
Property -- federal notices of tax liens shall be
filed in the office of the county clerk in the county
in which the real property subject to the liens is
situated. TEX. PROP. CODE ANN. § 14.002(b).
2) Personal
Property -- federal notices of tax liens shall be
filed (1) if the person against whose interest the
lien applies is a corporation or a partnership
whose principal executive office is in the state, in
the office of the secretary of state; (2) in all other
cases, in the office of the county clerk in the
county where the person against whose interest the
lien applies resides at the time of filing of the
notice of lien. TEX. PROP. CODE ANN. §
14.002(c).
ii. Texas
a. On January first of
each year, a tax lien attaches to property to secure
the payment of all taxes, penalties, and interest
imposed for the year on the property, whether or
not the taxes are imposed in the year the lien
attaches. The lien exists in favor of each taxing
unit having power to tax the property. TEX. TAX
CODE ANN. § 32.01(a).
b. The tax lien is
perfected on attachment and, with only one
exception for manufactured homes, perfection
requires no further action by the taxing unit. TEX.
TAX CODE ANN. § 32.001(c).
c. A tax lien may not,
however, be enforced against a buyer in the
ordinary course of business of personal property
who does not have actual notice of the lien or, if
the property is a manufactured home, does not
have constructive notice of the lien. TEX. TAX
CODE ANN. 32.03(a).
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1) Secured creditors
beware: In Central Appraisal District of Taylor
County v. Dixie-Rose Jewels, Inc., 894 S.W.2d
841 (Tex. App.--Eastland 1995, no writ), the court
held that a bank that did not qualify as a buyer in
the ordinary course of business had a lien on the
debtor’s personal property that was inferior to the
lien of the county appraisal district’s lien, even
though the district had given no notice to the bank
of the lien or of delinquent taxes, had not taken any
action to file a notice of the lien, and had not taken
any action take possession of the property before
the bank began to foreclose.
3. Requirements for Filing an
Involuntary Petition:
a. An attorney representing a
creditor that is considering filing an involuntary
petition against a debtor should be careful to
review the requirements of § 303 of the Bankruptcy
Code. Failure to comply with that section which
results in the petition being dismissed without the
consent of all parties may result in an award to the
debtor of costs and reasonable attorney’s fees
(against any petitioner) or even proximate damages
caused by the filing and punitive damages (against
bad-faith petitioners). 11 U.S.C. § 303(i). Among
the more important requirements are the following:
i. Eligible Debtor--An
involuntary petition may be filed only under
chapters 7 and 11, and only if the debtor qualifies
for relief under those chapters. An involuntary
petition may not be filed against farmers, family
farmers, or corporations that are not moneyed,
business, or commercial corporations. 11 U.S.C. §
303(a).
ii. Holder Requirements--If
the debtor has fewer than 12 “holders” (those
holding claims--or an indenture trustee representing
the holder--that are not contingent as to liability
and are not subject to a bona fide dispute, and
excluding certain interested parties), one or more
petitioning holders with claims aggregating at least
$10,000 in unsecured debt are needed. 11 U.S.C. §
303(b)(2). If the debtor has 12 or more holders,
three or more petitioning holders with claims
aggregating at least $10,000 in unsecured debt are
needed. 11 U.S.C. § 303(b)(1).
A) “A claim is
contingent as to liability if the debtor's legal duty to
pay does not come into existence until triggered by
the occurrence of a future event and such future
occurrence was within the actual or presumed
contemplation of the parties at the time the original
relationship of the parties was created.” Subway
Equip. Leasing Corp. v. Sims (In re Sims), 994
F.2d 210, 220 (5th Cir.1993) (quoting In re All
Media Properties, Inc., 5 B.R. 126, 133 (Bankr.
S.D. Tex.1980), aff'd, 646 F.2d 193 (5th
Cir.1981)), cert. denied, 510 U.S. 1049, 114
S.Ct. 702, 126 L.Ed.2d 669 (1994).
B) To determine
whether a claim is subject to a bona fide dispute,
the court must determine whether there is an
objective basis for either a factual or a legal
dispute as to the validity of the debt. In re Sims,
994 F.2d at 220-21.
iii. Deadbeat
Requirement--Petitioning holders in a timely
controverted involuntary case usually must show
that the debtor is generally not paying such
debtor’s debts as such debts become due unless
such debts are subject to a bona fide dispute. 11
U.S.C. § 303(h)(1).
A) Factors the court
must consider in determining whether debtor was
generally not paying its debts as such debts
became due, justifying the filing of an involuntary
petition in bankruptcy, include the number of
unpaid claims, the amount of such claims, the
materiality of nonpayment, and the debtor's
overall conduct in its financial affairs. In re
Arriola Energy Corp., 74 B.R. 784, 790 (S.D.
Tex. 1987); In re Norris, 183 B.R. 437, 456-57
(Bankr. W.D. La. 1995).
B. Discovery
1. Attorneys should be familiar with
the various methods of discovery available in
bankruptcy proceedings. A brief outline of those
methods and some limitations on each are set forth
below.
a. First Meeting of Creditors (§
341 Meeting)
i. Within a reasonable time
after the order for relief, the debtor must appear
and submit to examination under oath at a first
meeting of creditors convened and presided over
by the United States trustee. 11 U.S.C. §§ 341,
343.
ii. Creditors, an indenture
trustee, any trustee or examiner in the case, or the
United States trustee may examine the debtor. 11
U.S.C. § 343. The court may not attend this
meeting. 11 U.S.C. § 341(c).
iii. “[T]he primary purpose
of the first meeting of creditors is to provide the
creditors with the opportunity to gather
information on any point that may affect their
interest, including, of course, the possibility of
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fraudulent transfers or other conduct that might
suggest that an objection to the discharge is in
order.” Allegheny Int’l Credit Corp. v. Bowman,
60 B.R. 423, 425 (S.D. Tex.1986).
A) “Facts related to an
allegedly nondischargeable debt are well within the
scope of a Section 341 examination. However, due
to time constraints and the number of parties in
interest often in attendance, a debtor's Section 341
examination rarely presents a sufficient opportunity
for an individual creditor to fully explore all
underlying facts of potential dischargeability.”
People’s Bank v. Poirier (In re Poirier), 214 B.R.
53, 58 (Bankr. D. Conn. 1997).
iv. Scope of the Examination
at the § 341 meeting: The examination of the
debtor at the § 341 meeting “may relate only to the
acts, conduct, or property or to the liabilities and
financial condition of the debtor, or to any matter
which may affect the administration of the debtor’s
estate, or to the debtor’s right to a discharge.”
FED. R. BANKR. P. 2004(b). In a chapter 11, 12, or
13 case, the examination “may also relate to the
operation of any business and the desirability of its
continuance, the source of any money or property
acquired or to be acquired by the debtor for
purposes of consummating a plan and the
consideration given or offered therefor, and any
other matter relevant to the case or to the
formulation of a plan.” Id.
v. In a chapter 7 case, the
business of the § 341 meeting may also include the
election of a trustee or of a creditors’ committee.
FED. R. BANKR. P. 2003(b)(1).
b. Bankruptcy Rule 2004
Examination
i. Any “party in interest”
may seek a court order for the examination of “any
entity.” FED. R. BANKR. P. 2004(a). The debtor
may be examined pursuant to this rule. FED. R.
BANKR. P. 2004(a), (d). Some courts, however,
have local rules that allow a party to give written
notice of a proposed 2004 examination, and if no
response is timely served, the examination is
deemed ordered by the court. See, e.g., W.D. TEX.
BANKR. R. 2004(b), (c).
ii. Scope: Same as that for
the examination of the debtor at the § 341 meeting,
as set forth above, except that the examination may
extend beyond the debtor to include third parties
who have had dealings with the debtor. FED. R.
BANKR. P. 2004(b). Unlike the examination at the
§ 341 meeting, the 2004 examination is not
presided over by the United States trustee.
iii. "The purpose of a Rule
2004 examination is to show the condition of the
estate and to enable the Court to discover its
extent and whereabouts, and to come into
possession of it, that the rights of the creditor may
be preserved." In re Express One Int’l, No. 9541189, 1998 WL 100520, at *1 (Bankr. E.D. Tex.
Jan. 12, 1998) (quoting In re Coffee Cupboard,
Inc., 128 B.R. 509, 514 (Bankr. E.D. N.Y.
1991)). Courts have labeled the 2004
examination a “fishing expedition.” In re
Wilcher, 56 B.R. 428, 433 (Bankr. N.D. Ill.
1985).
iv. The attendance of an
entity at the examination and the production of
documents may be compelled in the manner
provided in Bankruptcy Rule 9016 (which
incorporates Federal Rule 45) for attendance of
witnesses at a hearing or trial. FED. R. BANKR. P.
2004(c).
v. Because Rule 2004
offers fewer procedural safeguards than the
discovery provisions of the Federal Rules of Civil
Procedure, once an adversary proceeding or a
particular contested matter is under way,
discovery sought in furtherance of litigation is
subject to the Federal Rules rather than the
broader bounds of Rule 2004. In re Valley Forge
Plaza Assoc., 109 B.R. 669, 674-75 (Bankr. E.D.
Pa. 1990) (citing, inter alia, In re Paramount
Publix Corp., 82 F.2d 230, 233 (2d Cir.1936); In
re Kipp, 86 B.R. 490, 491 (Bankr. W.D.
Tex.1988)).
c. Federal Discovery Rules
i. Bankruptcy Rules 702637 incorporate Rules 26-37 of the Federal Rules
of Civil Procedure, respectively, into adversary
proceedings. Bankruptcy Rule 9014 makes these
rules (with the exception of Rule 27, concerning
use of depositions before action or pending
appeal) applicable in contested matters as well.
FED. R. BANKR. P. 9014. Therefore, in addition to
examinations pursuant to § 343 or Rule 2004, an
attorney in an adversary proceeding or contested
matter may also employ the ordinary discovery
procedures including-A) depositions, FED. R.
BANKR. P. 7028-32;
B) interrogatories, FED.
R. BANKR. P. 7033;
C) production of
documents and things and entry upon land, FED.
R. BANKR. P. 7034;
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D) physical and mental
examination of persons, FED. R. BANKR. P. 7035;
and
E) requests for
admissions, FED. R. BANKR. P. 7036.
ii. Civil Rule 26, which
governs the general scope of discovery, allows
discovery of information that is relevant to the
subject matter of the pending action or which is
reasonably calculated to lead to the discovery of
admissible evidence. FED. R. CIV. P. 26(b)(1).
A) “The key phrase in
this definition--’relevant to the subject matter
involved in the pending action’--has been construed
broadly to encompass any matter that bears on, or
that reasonably could lead to other matter that
could bear on, any issue that is or may be in the
case.” Oppenheimer Fund, Inc. v. Sanders, 437
U.S. 340, 351, 98 S.Ct. 2380, 2389 (1978).
B) Civil Rule 26(a)
requires disclosure, without the necessity of a
formal discovery request, of certain information
including information on individuals likely to have
discoverable information, relevant documents and
things in a person’s control, computation of
damages, and certain insurance agreements. FED.
R. CIV. P. 26(a). Rule 26(a), however, expressly
allows districts to opt out of the mandatory
disclosure requirement. Id.
d. Lists, Schedules, Statements,
and Reports
i. Inexpensive sources of
information about the debtor and the debtor’s
affairs include the list of creditors and equity
security holders, schedule of assets and liabilities,
schedule of current income and current
expenditures, statement of financial affairs,
statement of intention, and trustee or debtor in
possession reports. 11 U.S.C. § 521(1); FED. R.
BANKR. P. 1007, 2015.
2. Discovery: To Use or Not to Use?
a. The decision to employ
discovery or go without it sometimes may be
determined by the amount of time available to the
attorney. Many hearings, such as cash collateral
hearings, are set on shortened notice, and formal
discovery may not be possible. Moreover, as in
nonbankruptcy practice, failure to conduct
discovery is not necessarily negligence as a matter
of law. American Int’l Adjustment Co. v. Galvin,
86 F.3d 1455, 1461 (7th Cir. 1996) (“[W]e are
extremely wary of holding that pre-trial discovery
is required as a matter of law. . . . [W]e are
reluctant to encourage the practice of ‘defensive
law.’ Of course, this does not mean that failure to
conduct discovery will never constitute legal
malpractice as a matter of law. Nevertheless, it
will be the rare exception.”) (citation omitted).
b. On the other hand, an attorney
who neglects to conduct discovery and in the
process fails to gather information necessary for
his client’s claims or defenses may get himself or
his client sanctioned, which in turn may lead to a
malpractice claim. See People’s Bank v. Poirier
(In re Poirier), 214 B.R. 53, 58-59 (Bankr. D.
Conn. 1997) (“Procedural devices affording
discovery, including Rule 2004 Examinations and
the ability to notice and conduct depositions, were
enacted to guarantee the orderly, efficient and fair
administration of justice. . . . After the period had
passed within which the Plaintiff could have, and
in this case should have, conducted a Rule 2004
Examination or deposition of the Debtors, its
claims were no longer ‘substantially justified’
[under § 523(d)] since an inquiry would have
served to inform a reasonable litigant of the
untenable nature of its claims. In essence, the
Court concludes that the Plaintiff’s presumed
failure to conduct discovery by oral deposition or
Rule 2004 Examination of the only critical
witness prior to trial tolls and terminates whatever
‘special circumstances’ protection it enjoyed by
virtue of the ‘unexplained’ nature of the Disputed
Charges.”).
IX. PRE-FILING PLANNING
A. The Business Debtor
1. Identify the Legal Nature of the
entity and its business.
2. Identify business problems and
cause of business failure, such as:
a. Continuing increase in
overhead costs.
b. Obsolete production methods.
c. Increase in competition.
d. Acquisition of unprofitable
subsidiaries.
e. Lack of working capital.
f. Declining sales.
g. Increased operating costs and
overhead.
h. Excessive dividends and
withdrawals compared to earning record.
i. Decline in net profits and
lower return on invested capital.
j. Poor financial reporting and
planning.
k. Absence of key management.
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l. Fraud and dishonesty.
3. Counsel will often find that
management does not recognize the causes of the
business’s trouble. In some instances, management
will not see the trouble until it is too late. Often
management has neglected the record keeping or
even deserted the business.
4. Counsel must be ready to suggest
new management if necessary, reduction of fixed
costs, if possible, institution of economies,
generation of cash flow, adjusting sales or
adjustment of production, and how to deal with
creditor pressure.
B. Engagement of Professionals
1. Debtor’s counsel
2. Financial Advisors
3. Accountants
4. Special counsel
5. Issues to discuss, include:
a. Payment of pre-filing fees and
retainers;
b. Representation of multiple
debtors in related cases by a single firm.
i. The representation of
entities with potentially conflicting interests does
not necessarily constitute a conflict of interest;
there must be an actual conflict of interest to justify
an attorney's disqualification or denial of
compensation. See In re Global Marine, Inc.,
108 B.R. 998 (Bankr. S.D. Tex., 1987).
ii. Texas Disciplinary Rule
of Professional Conduct 1.06 provides that an
attorney may represent multiple parties if:
(1) the lawyer reasonably
believes the representation of each client will not be
materially affected; and
(2) each affected or
potentially affected client consents to such
representation after full disclosure of the existence,
nature, implication and possible adverse
consequences of the common representation and
the advantages involved, if any.
C. Considerations Of Counsel
1. Counsel must find and examine
with care the following:
a. The history of the business
with emphasis on earnings.
b. Cause of its present
difficulties.
c. Business prospects with
evaluation of the market, competition, and
competency of present management.
2. The availability of new capital,
particularly working capital.
3. An honest appraisal of the
liquidation value of the business’s assets.
4. An analysis of the business’s
liabilities, secured, unsecured, taxes, wages,etc.
5. The attitude of the principal
secured creditors and suppliers toward the
business.
D. Counseling the Business Debtor
1. Realistic alternatives.
a. Possible out-of-court
extension or workout with creditors.
b. A reorganization under
Chapter 11.
c. Liquidate
i. Out of Court
ii. Chapter 7
E. Approaching Chapter 11
1. There must be a reasonable
prospect that the Debtor can effectively
reorganize. Chapter 11 is a continual arrangement
between the Debtor and its creditors. Such
arrangement is a combination of pre-bankruptcy
and post-bankruptcy negotiation and postbankruptcy protection and planning.
2. Rehabilitation will work if you find
that within a reasonable period of time that the
business will be able to:
a. Gain the confidence of the
principal secured creditors and suppliers;
b. Correct management’s
mistakes;
c. Reduce fixed charges;
d. Eliminate burdensome
maturity dates;
e. Acquire working capital;
f. Acquire long-term financing;
g. Establish sound fiscal
policies;
h. Eliminate non-productive
activities;
i. Obtain competent
management.
F. Preparation of the Chapter 11
Petition
1. Petition packet.
a. Petition with Debtor’s
Declaration and Exhibit A to Official Form
Number 1, if Debtor is a corporation.
b. List of Creditors holding the
20 largest unsecured claims with addresses and
amounts, excluding insiders and governmental
units and including holders of secured claims to
the extent that their unsecured claims may be
among the 20 largest.
D-28
c.
d.
e.
List of equity security holders.
Statement of financial affairs.
Schedule of assets and
f.
Board of Directors resolution
liabilities.
(if applicable).
g. Any matrix complying with
local bankruptcy rules.
h. Filing fee.
2. First-day pleadings.
a. Agenda for Presentation of
First Day Orders and Related Pleadings.
b. Applications/Declarations for
retention of professionals.
c. Motion for use of cash
collateral.
d. Motion authorizing payment of
pre-petition wages and employee benefits.
Sections 363(b) and 105(a) of the Bankruptcy
Code Authorizing Accelerated Payment of PrePetition Wages, Salaries, and Other Compensation,
Employee Benefits, and Reimbursable Employee
Expenses.
e. Motion to honor accrued
employee benefits.
f. Application/declaration
authorizing retention of professionals in ordinary
course of business.
g. Motion authorizing
maintenance of pre-petition bank accounts, cash
management system, use of existing books and
records.
h. Motion for joint administration
or substantive consolidation of related cases.
i. Motion authorizing payment of
essential trade creditors.
j. Motion to assume key
executory contracts.
G. Financing the Chapter 11 Case
1. Building a war chest pre-filing.
2. Preparation of short term and long
term cash forecasts.
a. Assessing internal cash needs.
b. Ability to realize cash from
assets.
3. Sources of financing, including DIP
financing and use of cash collateral.
a. Identify potential lenders.
b. Commitment letter/
documentation pre-petition.
c. Credit review.
4. Uses of financing.
a. Post-petition operations.
b. Funding for the plan, to meet
proposed treatment of claims and feasibility
requirement.
H. Planning for Operating Changes and
Other Matters to Implement Post-Petition
1. Consider significant operating
changes to be implemented post-petition, and
whether such matters require commencement prepetition, e.g.
a. Closures.
b. Other employee layoffs.
c. Major marketing or sales
decisions.
d. Talking to suppliers, trade
creditors and customers pre-filing to soften the
impact or surprise of the filing.
2. Obtaining possession of assets of
the debtor held by third parties, e.g.
a. Goods in transit.
b. Possessory security interests.
3. Executory contract and lease
analysis.
a. Consider quick rejections -- to
avoid accrual of administrative claims.
b. Consider quick assumptions - to provide assurance to key customers or
government agencies.
c. Non-assumability of
financing arrangements.
d. 60-day limit for assumption
or rejection of lease of non-residential real
property.
4. Preference and fraudulent
conveyance analysis.
I. Venue -- Tactical Analysis of Where
to File
1. Forum shopping in general -benefit and burdens.
2. Avoidance of negative local
publicity, where a foreign jurisdiction is available.
3. Prospect of local sympathy for a
filing in the home jurisdiction.
4 Taking advantage of or avoiding
adverse lines of legal authority on key issues.
5. Convenience of the parties,
including long distance travel to and from court .
6. Availability of professionals in
certain districts.
7. Standards for allowable
compensation for professionals in certain districts.
J. Beware the Risk of an Involuntary
Proceeding
1. Consider the advantages and
disadvantages of involuntary proceedings.
D-29
a. Eliminates the time available
to consider all of the other items in this outline, to
increase the prospects for a successful chapter 11.
b. Petitioning creditors may select
a venue for the case which is not the debtor’s
preferred location, subject to the debtor’s right to
seek change of venue.
2. Consider negotiating pre-filing
forbearance agreements with active creditors to
lessen the risk of an involuntary filing.
K. Consider Efforts to Negotiate a Deal
Pre-Filing
1. Talk to the secured lenders -- both
about the treatment of their secured claims under a
plan of reorganization and the possibility of
arranging DIP financing.
2. Consider creating and negotiating
with unofficial committees of creditors and interest
holders.
a. Bondholders
b. Equity holders
c. Issues to consider:
i. Forbearance agreements
ii. Term sheet regarding
treatment and recoveries under pre-negotiated plan.
3. Consider talking to other parties
pre-filing.
a. Significant trade creditors
b. Lessors and landlords
c. Key suppliers
d. Key customers
e. Issues to discuss
i. What should you tell such
parties about the prospect of bankruptcy?
ii. Securities law,
bankruptcy law and fraud concerns: to what extent
can you discuss terms of contemplated plan of
reorganization and solicit acceptances pre-filing?
L. Consider Pre-Packaged Chapter 11
Plan Alternative
1. Consider treatment of trade
creditors and holders of contingent claims, and
other problems in pre-packing the plan.
2. Corporate law and securities law
issues.
3. Solicitation of acceptances.
M. Planning for Compliance With Other
Post-Petition Operating Requirements: The
United States Trustee Guidelines
1. Prepare or obtain:
a. Proof of insurance.
b. Tax Returns/unaudited
Financial Statements.
c. Projected Operating Statement
for first 30 days post-filing.
d. Proof of establishment of DIP
bank accounts.
e. Copies of trust agreements.
f. Copies of applications to
employ professionals.
X.
CAUTION IN PLEADINGS
A. Judicial Estoppel and Property
Valuation
1. Should parties be concerned about
being judicially estopped from estimating the
value of collateral at a different value than that
previously asserted by the party earlier in the
case? See Ergo Science, Inc. v. Martin, 73 F.3d
595, 598 (5th Cir.1996) ("The doctrine of judicial
estoppel prevents a party from asserting a position
in a legal proceeding that is contrary to a position
previously taken in the same or some earlier
proceeding."); In re Woolley’s Parkway Ctr., 147
B.R. 996, 1001 (Bankr. M.D. Fla. 1992) (noting
that the doctrine of judicial estoppel “prevents a
party from playing ‘fast and loose’ with the
judicial system.”).
2. Although a party cannot
disassociate itself from the evidence it presented
at the earlier hearing, most courts have concluded
that judicial estoppel usually does not apply to
valuation of property in a bankruptcy case. See,
e.g., In re Victorian Park Assoc., 189 B.R. 147,
149-50 (Bankr. N.D. Ill. 1995) (rejecting a
creditor’s argument that the debtor should be
judicially estopped from applying a different value
at confirmation than at the prior lift-stay hearing:
“This position is ridiculous since a key variable
affecting the value of real property is time.”); In
re Woolley’s Parkway Ctr., 147 B.R. at 1001
(concluding that “general statements of the law on
judicial estoppel . . . have no relevance and
applicability to valuation of property in a case
under Title 11 . . . .”); cf. First Federal Sav. &
Loan Ass’n of Rochester v. Kelley (In re
Kelley), 163 B.R. 27, 33-34 (Bankr. E.D. N.Y.
1993) (concluding that a mortgagee was not
judicially estopped from asserting that a
deficiency judgment might arise from a state-court
foreclosure; noting that the value of property may
decline between the valuation for lift-stay
purposes and later valuations).
3. In an extreme case, however, where
a drastic difference in a proposed valuation is
attributed by a party to a “mistake” in the prior
valuation, a court may apply judicial estoppel. In
D-30
re J.F.K. Acquisitions Group, 166 B.R. 207, 21011 (Bankr. E.D. N.Y. 1994) (applying judicial
estoppel where the debtor asserted a $10 million
valuation (estimation of secured claim for plan
purposes) only ten months after its previous
valuation of $30 million (for lift-stay purposes),
which it claimed was a “mistake”).
B.
Usury Exposure
1. A person who contracts for,
charges, or receives interest at a rate greater than
that permitted by law is subject to certain usury
penalties. TEX. FIN. CODE ANN. §§ 302.001,
305.001-.005. Should an attorney worry about
“charging” usurious interest rates in a pleading?
Although the answer at one time was unclear,
recent cases have answered the question “no.”
a. George A. Fuller Co. of
Texas v. Carpet Serv., Inc., 823 S.W.2d 603, 606
(Tex. 1992) (“[W]e hold that a demand for
prejudgment interest contained in a pleading does
not make the pleader liable for statutory usury
penalties if the pleading seeks the recovery of
unlawful prejudgment interest.”).
b. Sage Street Assoc. v.
Northdale Constr. Co., 863 S.W.2d 438, 440
(Tex. 1993) (holding that the constitutional
proscriptions on usurious interest govern only
lending and credit transactions and do not apply to
the rate of prejudgment interest set by a court).
c. D&S Kingsway Ventures v.
Texas Capital Bank--Richmond, N.A., 882
S.W.2d 573, 575 (Tex. App.--Houston [14th
Dist.] 1994, no writ) (rejecting the argument that a
bank’s first amended petition to recover on a
defaulted note constituted a “charge” of usurious
interest because the petition did not reflect a credit
for the amount the bank received at the
foreclosure: “A pleading by itself, even if it
contains a claim for usurious interest, ‘does not
constitute a “charge” of usurious interest for
purposes of the Texas usury statue.’”) (citing
George A. Fuller Co.).
d. Federal Sav. & Loan Ins. v.
Kralj, 968 F.2d 500, 504 (5th Cir. 1992) (“[I]f
the underlying documents are not usurious, then
irrespective of the type of interest demanded in the
pleadings, imposing a penalty for usury, based
solely on a demand made in a pleading or
interrogatory answer, does nothing to fulfill the
purpose of usury laws, which is to correct abusive
practices in consumer and commercial credit
transactions.”).
2. A demand letter from an attorney,
on the other hand, could constitute a usurious
charge of interest. See George A. Fuller Co., 823
S.W.2d at 605 (concluding that “[a] charge must
be communicated to the debtor. The
communication need not be direct, as long as the
charge is ultimately demanded from the debtor.”).
C.
D-31
Rule 9011
1. Bankruptcy practitioners should be
aware of the pitfalls involved in signing, filing, or
advocating any pleading or paper in a bankruptcy
court. Effective December 1, 1997, Rule 9011
again substantially mirrors the “revised” Rule 11 of
the Federal Rules of Civil Procedure. Rule 9011,
as amended, provides in part that “[e]very petition,
pleading, written motion, and other paper, except a
list, schedule, or statement, or amendments thereto,
shall be signed by at least one attorney of record in
the attorney's individual name. A party who is not
represented by an attorney shall sign all papers.”
2. Rule 9011 also provides that “[b]y
presenting to the court (whether by signing, filing,
submitting, or later advocating) a petition,
pleading, written motion, or other paper, an
attorney or unrepresented party is certifying that to
the best of the person's knowledge, information,
and belief, formed after an inquiry reasonable
under the circumstances,-a. it is not being presented for
any improper purpose, such as to harass or to
cause unnecessary delay or needless increase in the
cost of litigation [the “improper purpose prong”];
b. the claims, defenses, and other
legal contentions therein are warranted by existing
law or by a non-frivolous argument for the
extension, modification, or reversal of existing law
or the establishment of new law [the “frivolousness
prong”];
c. the allegations and other
factual contentions have evidentiary support or, if
specifically so identified, are likely to have
evidentiary support after a reasonable opportunity
for further investigation or discovery; and
d. the denials of factual
contentions are warranted on the evidence or, if
specifically so identified, are reasonably based on a
lack of information or belief.” FED. R. BANKR. P.
9011(b).
3. Examples of unreasonable inquiries,
factually inaccurate assertions, and unwarranted
legal arguments under the frivolousness prong
include-a. failing to investigate whether a
client had a prior bankruptcy case dismissed within
the preceding 180 days in response to a motion for
relief from the automatic stay. Moran v. Frisard
(In re Ulmer), 19 F.3d 234, 237-38 (5th Cir.
1994). See 11 U.S.C. § 109(g)(2) (prohibiting a
second bankruptcy petition if, within 180 days
preceding the second petition, the prior case was
voluntarily dismissed following the filing of a
motion for relief from the automatic stay);
b. failing to investigate whether
a client is eligible to participate in the selection of
a Chapter 7 trustee before voting on behalf of the
client for that proposed trustee. Masunaga v.
Stoltenberg (In re Rex Montis Silver Co.), 87
F.3d 435, 439-40 (10th Cir. 1996);
c. failing to investigate whether
a claim is valid before filing an objection to claim.
In re Medical One, Inc., 68 B.R. 150, 152
(Bankr. M.D. Fla. 1986);
d. failing to read an entire
statute before relying on it. Findlay v. Banks (In
re Cascade Energy & Metals Corp.), 87 F.3d
1146, 1151 (10th Cir. 1996);
e. asserting that a bankruptcy
judge should be disqualified after witnessing all of
the judge’s alleged misconduct yet failing to allege
facts which, even if proven, would support
disqualification. Reserve Management, Inc. v.
Jacobson (In re Jacobson), 47 B.R. 476, 477-78
(D. Colo. 1985);
f. asserting inaccurate and
misleading information in a statement of affairs.
Caldwell v. Unified Capital Corp. (In re
Rainbow Magazine, Inc.), 77 F.3d 278, 282-83
(9th Cir. 1996);
g. arguing that the United States
Trustee has no standing to object to an attorney’s
fees. Hayes & Son Body Shop, Inc. v. United
States Trustee, 124 B.R. 66, 68 (W.D. Tenn.
1990);
h. arguing--after submitting to
the court the text of a statute with relevant and
limiting portions omitted--that a statute applies to
the facts of a case when it clearly does not. In re
Cascade Energy & Metals Corp., 87 F.3d at
1151.
4. The improper purposes listed
in the rule are not exclusive. Examples of
improper purposes include-a. filing a document for the
central purpose of delaying or avoiding state
foreclosure proceedings. McGahren v. First
Citizens Bank & Trust Co. (In re Weiss), 111
F.3d 1159, 1171 (4th Cir. 1997), cert. denied,
118 S.Ct. 369 (1997);
b. filing a “flood” of
objections to claims to cause creditors to
relinquish valid, enforceable claims rather than
incurring the legal costs required to respond to
the objections. In re Medical One, Inc., 68 B.R.
150, 151-52 (Bankr. M.D. Fla. 1986);
D-32
c. filing a collateral attack
on a bankruptcy court sale order for the purpose of
intimidating the purchaser. Valley Nat’l Bank of
Arizona v. Needler (In re Grantham Bros.), 922
F.2d 1438, 1443 (9th Cir. 1991), cert. denied, 502
U.S. 826, 112 S.Ct. 94 (1991).
5. An objective standard of
reasonableness applies to determine whether a
signatory acts with an improper purpose and
whether the signatory’s pre-filing inquiry was
sufficient. In re Weiss, 111 F.3d at 1170-71;
Mapother & Mapother, P.S.C. v. Cooper (In re
Downs), 103 F.3d 472, 481 (6th Cir. 1996);
Silverman v. Mutual Trust Life Ins. Co. (In re
Big Rapids Mall Assocs.), 98 F.3d 926, 930 (6th
Cir. 1996). This determination should be based not
upon the bankruptcy court’s hindsight, but instead
upon what was reasonable at the time the document
was filed. In re Downs, 103 F.3d at 481 (citing
McGhee v. Sanilac County, 934 F.2d 89, 93 (6th
Cir. 1991)); In re Big Rapids Mall Assocs., 98
F.3d at 930; Glatter v. Mroz (In re Mroz), 65 F.3d
1567, 1572 (11th Cir. 1995). Factors considered
in this determination include-a. the amount of time in
which to research the facts of the case;
b. the amount of information
available about the client’s business;
c. whether other
professionals were consulted;
d. what the clients told the
attorney and whether the attorney was justified in
believing the client;
e. any other relevant factual
detail. In re Downs, 103 F.3d at 481; In re Big
Rapids Mall Assocs., 98 F.3d at 930.
6. Whereas sanctions were
mandatory for Rule 9011 violations before
December 1, 1997, sanctions under the revised
Rule 9011 are discretionary. Compare FED. R.
BANKR. P. 9011(a) (pre-revision) (providing that
“the court shall impose . . . an appropriate
sanction” for documents signed in violation of the
rule) (emphasis added) with FED. R. BANKR. P.
9011 (current) (providing that the court "may . . .
impose an appropriate sanction" for violations of
Rule 9011) (emphasis added).
7. If Rule 9011 is violated, the
court may impose sanctions on the attorney, law
firm, or party that violated the rule. FED. R.
BANKR. P. 9011(c). The sanctions should be
limited to what is sufficient to deter future
offending conduct and may include nonmonetary or
monetary sanctions. FED. R. BANKR. P.
9011(c)(2).
EXCERPT FROM 1997 ALAS LOSS
PREVENTION MANUAL
Copyright © 1998
Attorneys’ Liability Assurance Society, Inc.
A Risk Retention Group
Reprinted with Permission
Lawyer Liability in Bankruptcy Practice
by Brian J. Redding and Mark E. Gralen
[Revised from the January 1995 issue of the
ALAS Loss Prevention Journal]
Introduction
As we note in our introductory message for
this edition of the Journal, this is a "theme" issue,
in which we explore areas of practice that
historically have not been a serious problem for
ALAS Member Firms, but cause us concern for
the future. In a sense this article, which explores
lawyer liability problems in the bankruptcy
practice, is out of place, because the "future"
concerns trial we set out to predict in this issue
have already begun to cause losses in bankruptcyrelated claims. That is, however, a very recent
phenomenon.
In the fall of 1993 one of the authors spoke
on a panel at the annual meeting of the National
Conference of Bankruptcy judges. In connection
with that speech we reviewed ALAS bankruptcy
related claims as of November 30, 1992. Those
claims offered little indication that bankruptcy
practice was dangerous. Claims classified as
bankruptcy-related totaled less than $5 million in
incurred loss and less than 7% of ALAS' total
incurred loss. Most claims were garden-variety
negligence claims, with the most prominent being
claims arising from failure to perfect a security
interest (often through allegedly defective UCC
filings) in pre-bankruptcy transactions, causing a
later loss when the creditor lost its priority during
bankruptcy proceedings. Notwithstanding this
rather unremarkable historical loss record, we
predicted at the 1993 meeting of the National
Conference of Bankruptcy judges that bankruptcy-
D-33
related claims were likely to be a future problem
area for large law firms. Our reasoning included
the following:
A) Historically, the most serious problem
for large law firms (including ALAS Member
Firms) has been "aiding and abetting", i.e., the
claim that a client has engaged in wrongdoing (e.g.,
fraud, misrepresentation, breach of fiduciary
obligation, etc.) and that the defendant lawyer
providing legal services aided the wrongdoing.
Frequently, the serious claims have been
exacerbated by allegations of conflict of interest.
The root causes of these claims are generally: 1)
representation of dishonest or incompetent clients;
2) engaging in a representation that raises conflict
of interest issues, e.g., by failing to recognize
potential conflicts or by failing to dispel any
ambiguity about the identity of the lawyer's client,
particularly in a transactional setting; and, 3)
failure to investigate a deal (or the client's conduct)
when "red flags" arise suggesting the possibility
that something is amiss.
B)
Bankruptcy is a setting where dishonest
or incompetent clients are not unknown.
C) Bankruptcy is also a setting where
conflict of interest problems are increasingly
prevalent. Yesterday's bankruptcy boutique is
today's bankruptcy department in a large fullservice law firm that represents thousands of
clients that present potential conflicts in any large
bankruptcy. Moreover, today conflict of interest
analysis must survive scrutiny under both the
provisions of the Bankruptcy Code and under
relevant provisions of the ethics rules. Frequently,
today's bankruptcy judge comes from outside the
bankruptcy practice and is likely to disapprove of
representations challenged on conflicts grounds,
even though those representations would have
passed muster five or ten years ago.
D)
The typical "aiding and abetting"
claim asserted in a variety of other contexts-in
particular those involving failed financial
institutions-fits well in the bankruptcy setting.
E)
The Department of Justice
announced last year (at the NCBJ Annual Meeting,
among other places) that it intends to expand
substantially its efforts in the investigation and
prosecution of criminal bankruptcy fraud. We
warned lawyers that an increase in the number of
criminal prosecutions for bankruptcy fraud, (e.g.,
involving fraudulent conveyances) would probably
result in a corresponding increase in civil suits,
e.g., by trustees or creditors, against the lawyers
that “papered" the transaction giving rise to the
criminal prosecution (whether or not those lawyers
were actually culpable).
Our prediction that bankruptcy practice
would become more dangerous was admittedly
speculative. Unfortunately, our speculation has
proved to be accurate. In preparation for this
article we reviewed, as of late summer, 1994, all
of ALAS' reserved claims categorized as
"bankruptcy" claims. Currently, that category
accounts for more than $60 million in incurred
loss, which is approximately 5 % of ALAS' total
incurred loss. That is a dramatic increase in loss
incurred in the past two years.
Some explanation of these figures is
necessary. First, some of the conduct giving rise
to these claims occurred years ago. Second,
several of the severe claims might fairly be
characterized as other than bankruptcy. For
example, a claim by investors for securities fraud
brought against a bankruptcy debtor and his
lawyers could be characterized as either a
securities claim or a bankruptcy claim. Several
significant claims of that type have contributed to
the incurred loss figures referred to above. We
have classified them as bankruptcy claims, but
others might disagree. Similarly, many of the
"failure to perfect" claims against ALAS Member
Firms could be characterized as involving
commercial law or "UCC" claims. Again, we have
characterized them as bankruptcy claims.
Whatever their classification, the severity of these
claims justifies increased scrutiny by ALAS
Member Firms of their representation of debtors
and creditors, both before and after filing of a
bankruptcy petition.
Time and space limitations preclude
detailed scrutiny of all of ALAS' bankruptcyrelated claims. We will, however, briefly survey
those areas that we believe currently present the
most serious problems.
Fraud
In terms of incurred toss, ALAS' most
significant problems are fraud claims. Included in
that category is any claim that a lawyer is legally
D-34
responsible for injury caused by a client's fraud
because the lawyer aided the fraud through
supportive legal services. Some of these claims
might be characterized as garden-variety securities
law claims. Many, however, are fraudulent
conveyance claims, brought either under the
bankruptcy laws or under the Uniform Fraudulent
Conveyance Act. The circumstances giving rise to
these claims vary significantly. All, however,
involve classic fraudulent transfer allegations, i.e.,
that the debtor conveyed property in a business
transaction and received inadequate consideration
in return. If the transaction is pre-petition, it was
allegedly done "in contemplation of bankruptcy," or
while the debtor was "insolvent." In each instance
the lawyer allegedly knew "or should have known"
of the inadequacy of the consideration and
allegedly papered the deal to aid the debtor in
defrauding creditors. Frequently the transfers are
to persons or entities related in some way to the
debtor. Often it appears that the lawyer had no
knowledge that the consideration was less than fair
value for the property transferred. That does not
always protect the lawyer from suit.
How does a business lawyer avoid such
claims? There is no perfect answer. Sometimes
diligence above and beyond normal standards may
be the only way to avoid being sued. Asking
questions and investigating may be necessary, at
least where circumstances suggest that fraudulent
conveyance issues are potentially lurking behind a
transaction (e.g., the sale of a plant or subsidiary to
an affiliated company by a corporation facing
severe financial difficulties). ALAS' recent
experience indicates that in the absence of
increased visor by business and bankruptcy
lawyers, more claims of this type are likely to
surface in coming years.
Conflicts of Interest
Conflicts of interest have always been a
major lawyer liability problem for ALAS and its
Member Firms. Losses from claims involving
conflicts have increased substantially in the past
two years. (See the September 1994 issue of this
Journal, p. 2.) That trend is present in ALAS'
bankruptcy claims, as well. Claims resulting
primarily from conflicts now represent more than
10% of ALAS' $60 million in incurred loss in
bankruptcy claims. Conflicts are also causing
problems in bankruptcy practice outside the ALAS
group.
There are two major categories of conflict
problems in bankruptcy claims: 1) conflicts of
interest arising from pre-bankruptcy conduct -e.g., conflicts arising from alleged multiple
representation in a pre-filing transaction that
allegedly causes injury to the debtor (and the
bankruptcy estate); and 2) conflicts of interest
allegedly arising from the conduct of a law firm in
representing a debtor or creditor in a bankruptcy
proceeding.
ALAS' incurred loss in bankruptcy
matters comes primarily from alleged conflicts
from the first category-alleged conflicts arising
from multiple representations in business
transactions that precede the debtor's bankruptcy
petition. In most cases causing ALAS to incur
losses, a claim has been made that the ALAS
lawyer represented the debtor and others in a
transaction and failed to fully protect the debtor,
allegedly as a result of the lawyer's conflict.
Frequently the transaction involved related entities
that were friendly at the time of the transaction but
became adverse after the transaction caused
economic harm to one or more of them. We
discussed the problems arising from alleged
multiple representations in business transactions
in a previous issue of this Journal. We won't
repeat that discussion, but we urge bankruptcy
lawyers (and all other transactional lawyers in
ALAS Member Firms) to refer to that discussion.
(See the September 1994 issue of this Journal, pp.
2-5.) We will repeat our warnings of the
importance of defining carefully the identity of the
parties that you represent, and those you don't
represent (i.e., the "I'm not your lawyer" letter). It
is also crucial to understand and explain to your
client the ethical implications of accepting
representation of multiple parties to a transaction
(e.g., under Model Rule 2.2).
The second category of conflict problems
in bankruptcy-those arising from the
representation of a client in the bankruptcy
proceeding-was discussed in the May 1994 issue
of this Journal, pp. 21-24. [This article now
appears as Section VI.C. of Tab III.B. of this
Manual.] We will not repeat that discussion here,
but bankruptcy lawyers should be familiar with
the problems discussed in that article. We note
here only the following general points:
1)
Bankruptcy courts appear to be
subjecting possible conflicts to closer scrutiny
D-35
than in years past. Remember, conflicts must pass
muster under both the bankruptcy rules and the
Rules of Professional Conduct governing lawyers
in the relevant jurisdiction. It is possible that a
conflict will pass scrutiny under the bankruptcy
rules, but not under the ethics rules, and vice-versa.
One important measure in bankruptcy proceedings
is to fully disclose all possible conflicts to the
court. Bankruptcy courts tend to deal particularly
harshly with undisclosed conflicts. Failure to
disclose prior relationships with other parties
playing roles in the bankruptcy may result in
disqualification or loss of fees. A prominent New
York law firm spent a substantial portion of 1994
fighting attempts by a U.S. trustee to obtain
disqualification and disgorgement orders against
the firm (New York Times, November 11, 1994, p.
C2). Ultimately, the firm forfeited substantial fees.
The danger of such motions is present in any
situation where bankruptcy counsel fails to reveal a
relevant relationship to other parties in the
proceedings.
2)
Yesterday's bankruptcy boutique
is often today's bankruptcy group in a large fullservice law firm having thousands of clients. Many
bankruptcy practitioners are not used to living with
the substantial foreclosure of opportunity that
occurs because existing clients of the firm are, at
least theoretically, adverse to a party the lawyer
represents in the bankruptcy proceedings.
3)
Today, finessing a conflict of
interest is more likely than in years past to generate
a claim that the quality of a lawyer's representation
was adversely affected by the conflict.
These factors, taken together, make it
imperative that bankruptcy lawyers pay strict
attention to conflict of interest issues. Early
consultation with your firm's loss prevention
partner, or a member of the firm's ethics
committee, is important.
Failure to Perfect Security Interests
ALAS' Bankruptcy Claims Arising From
Perfection Problems
Until recently, ALAS' bankruptcy-related claims
experience for failure to perfect security interests
was unremarkable. While ALAS has always had
claims involving perfection failures, in 1992
incurred losses in this area arising from bankruptcy
cases were not alarming. In the last two years,
however, ALAS has seen increased exposure in
this area. Incurred losses from perfection failures
in bankruptcy cases are now almost $10 million.
Significantly, both the frequency and severity of
claims in this area have accelerated even with the
recent decline in the number and dollar volume of
corporate Chapter 11 bankruptcy filings.
How do perfection problems arise? The
typical commercial finance practitioner at an
ALAS firm knows how to perfect a security
interest, both in terms of the substantive law and
the mechanics. The primary source of perfection
problems is not substantive mistakes, but filing
errors, erroneous or inadequate descriptions of
collateral, or other mistakes by inexperienced
paralegals, junior attorneys or attorneys
inexperienced in secured transactions. Often, the
preparation and filing of the UCC statements is
viewed as a mechanical task which is left to the
paralegal or the junior associate because the
partner is occupied negotiating the loan covenants,
representations and warranties, and collateral
ratios. By the time the deal gets to closing, the
partner may be under pressure to stay within a fee
cap or budget (or may already have exceeded it).
This only increases the incentive to "delegate"
mechanical tasks such as the actual filing of the
UCC-l's.
While there is nothing wrong with
delegation, the inexperienced paralegal or
associate may not understand the significance of
what he or she is reviewing, absent partner
supervision. The result is that easily correctable
problems are missed, and everybody goes on to
the next project. Often the file is not reexamined
until the company either has filed bankruptcy or is
about to file. At that point, the lender and the law
firm find themselves unable to correct the
problem. A claim against the law firm is the
inevitable result.
The best known "failure to perfect" claim
against a law firm resulted from a now famous
typographical error resulting in a ship mortgage
being filed with an amount denominated as
$92,885, instead of $92,885,000. Shortly after
the mistaken filing, the debtor filed for
bankruptcy. Both the debtor and another secured
creditor sought to limit the erroneously filed
security interest to $92,885. This "$93 million
typo" resulted in enormous trouble and expense to
D-36
everyone involved. The creditor-client ultimately
succeeded in partly reforming the mortgage, but
years of litigation resulted, and the client alleged
that it had suffered $30 million in damage from the
mistake. It filed malpractice claims against three
law firms. See Prudential Insurance Co. v.
Dewey, Ballantine, Bushby, Palmer & Wood, 170
A.2d 108, 573 KNESSET 981 (N.Y. App. 1991).
Claims against two firms were settled, with the
third claim being dismissed. See Prudential
Insurance Co. v. Dewey, Ballantine, Bushby,
Palmer & Wood, 80 N.Y.2d 377, 590 KNESSET
831 (1992).
Preventing Perfection Problems
Based on our claim experience, we suggest
a number of steps ALAS firms can take to reduce
their exposure in these matters:
1.
Increase oversight and training for
paralegals and associates in commercial finance
transactions. Finns should take steps to ensure
proper oversight and training other employees who
are doing the mechanical work in these deals. They
are the ones who will most often prevent -- or
create -- a major perfection problem. In particular,
the responsible partner or other attorney should
personally review any UCC statements (including
exhibits) that are filed in any transaction, and
should personally review the results of UCC filings
and/or post-closing searches. Lawyers also need to
keep abreast of the law in this area, which is
constantly evolving.
2.
Try to structure the mechanics of
transactions co minimize the risks of human error.
Anything that can be done to make filing mistakes
less likely is a positive step. One partner in an
ALAS firm suggests that, if possible, one uniform
exhibit describing the collateral in a secured loan
transaction should be used for the loan agreement,
the security agreement, the UCC filing, and other
documents. This approach minimizes the risk of
error in multiple re-creations of collateral
descriptions.
3.
Make sure experienced commercial finance
lawyers are involved or at least consulted in
secured loans or workouts. Malpractice problems
often occur when a lawyer ventures outside of his
or her area of expertise. Perfection of security
interests is no different. The best way to avoid
perfection problems is to obtain the advice of
experienced counsel in collateralizing any loan.
4.
Recognize the risks of reliance on third
parties. The use of outside vendors to file UCC
statements and to do UCC searches is a reality in
today's secured lending environment. In any
malpractice claim, however, the claimant will
often allege that the lawyers were responsible for
the accuracy of the vendor's work. For example,
title policies often contain broad bankruptcy
exclusions that purport to absolve the title
company of responsibility if a security interest is
avoided in bankruptcy. Lawyers using outside
services should carefully review their work and
make sure those services are responsible for their
own errors and those of their agents.
5.
Put it in writing. Clients should be
advised in writing of what types of collateral they
have obtained, what their priorities are with
respect to other creditors, and whether any clear
risks to enforceability or perfection exist. Absent
timely and clear written advice, lawyers are at the
mercy of creative memories of the loan officer or
in-house counsel, who often will say that he or she
relied completely on outside counsel and assumed
everything was completely secured.
6.
Do post-closing searches. Many lawyers
do UCC searches after a closing to ensure that all
filings have been property made. This is a
laudable practice from a loss prevention
standpoint, but its utility will be sharply
diminished unless experienced lawyers review the
results of the post-closing searches carefully. The
fact that a financing statement was filed will not
prevent that statement from being avoided in
bankruptcy if the collateral description or the
debtor's name is incorrect. Literal accuracy in
financing statements is likely to be increasingly
important in the future as more states convert to
computerized filing systems that require literal
searching.
7.
Upon discovering a problem, deal with It.
In many cases involving a failure to file or an
erroneous filing of a financing statement,
malpractice exposure can be avoided if a
corrective action is taken. If the lender is not an
"insider" of the debtor, the lender's security
interest usually will not be avoidable if the
bankruptcy petition is filed more than 90 days
after the corrective filing. ALAS has had claims
D-37
where such corrective filings have eliminated a law
firm's malpractice exposure. ALAS encourages its
member firms to consult with ALAS in these
situations.
Most of the steps suggested above apply to
virtually any kind of client representation.
However, ALAS firms should realize that, in
today's environment, proper perfection of security
interests in collateral is not only good lawyering
but also effective loss prevention. Hopefully,
careful attention to potential problems at the front
end of these transactions will avoid malpractice
exposure in subsequent bankruptcy cases.
Negligent Bankruptcy Advice or
Litigation Services
As more ALAS firms have become
involved in bankruptcy work, ALAS has seen an
increasing number of claims alleging negligent
bankruptcy-related advice or services. Despite the
increasing number of matters, the severity of losses
in this area remains relatively low. Some of the
trends in recent claims, however, are a cause for
concern.
Bankruptcy practice, particularly the
representation of corporate debtors, often involves
not only litigation, but many different types of
transactions, such as securities offerings, asset
sales or real estate deals, and advice on corporate,
environmental, labor, ERISA, tax and other issues.
ALAS has had a number of bankruptcy-related
claims in which lawyers allegedly have given
incorrect advice on areas of substantive law outside
of their expertise. ALAS has also had a few claims
arising from alleged mistakes by transactional
attorneys representing clients in bankruptcy court.
These claims suggest that straying outside one's
expertise is particularly dangerous in bankruptcy
settings, where adverse parties are on the spot to
review each move the bankruptcy lawyer makes
and the lawyer's client is frequently looking to
obtain financial aid from any available source. To
avoid problem in this area, firms should maintain
open lines of communication between transactional
lawyers and bankruptcy lawyers so that they are
utilized as needed.
ALAS also has had claims where
disappointed clients have accused bankruptcy
lawyers of overstating their expertise, promising
results that were not achieved, or otherwise failing
to live up to expectations. Often these claims
seem to be driven by client anger over the law
firm's fees or its efforts to collect them. These
claims to date have not caused substantial toss to
ALAS, but they have been expensive to defend.
ALAS has already advised its firms that it is
usually a bad idea to sue a client for unpaid legal
fees. The same goes for heavy-handed collection
tactics in bankruptcy cases.
ALAS also has had several negligence
claims arising from the nature of bankruptcy
practice itself, which often involves extreme time
pressures and numerous deadlines. For example,
in Chapter 7 cases, many of these deadlines are set
automatically by the Bankruptcy Code or Rules,
such as the time within which to assume or reject
unexpired leases or executory contracts (60 days
after the order for relies; the time within which to
file objections to discharge (60 days after the first
date set for the meeting of creditors under Section
341 of the Bankruptcy Code); and the time within
which to file proofs of claim (90 days after the
first date set for the Section 341 meeting). (In
Chapter 11 cases, in contrast, several of these
deadlines are set by the court). Bankruptcy also
has different rules for appeals, the most notable of
which is that a notice of appeal must be filed
within 10 days of final judgment, rather than 30
days. The Bankruptcy Reform Act of 1994 adds
to the deadline pressure with accelerated time
deadlines for "small business" and "single asset"
bankruptcies, and a new 30-day limit for
concluding the final hearing on a motion for relief
from the automatic stay.
ALAS' claims experience in these areas
suggests that the following loss prevention
technique are particularly useful in the bankruptcy
practice:
1.
Use a calendar. An effective
calendaring system is essential in
bankruptcy
representations. Deadlines should be input at the
outset of a representation, not delayed pending
further developments. The calendar also must be
updated continuously as the bankruptcy case
progresses.
D-38
routinely grant a motion to receive notice of all
proceedings to any attorney representing a party in
interest.
3.
Review the schedules, statement
of financial affairs, and docket sheet. If an
attorney is retained to represent a party in a
pending bankruptcy case, the attorney should
review the debtor's schedules and statement of
financial affairs, and, most importantly, the docket
sheet. These documents will summarize case
developments and identify other parties and their
counsel (for conflicts purposes). The docket sheet
also will enable the attorney to determine whether
any orders have been entered affecting the client's
interests.
4.
Put it in writing. Lawyers should
report developments in writing to clients (many of
whom distrust the bankruptcy process and, by
implication, the lawyers involved) and reach a clear
understanding in writing about the scope of the
lawyer's responsibilities. For example, if a client
wants to save fees by filing its own proof of claim,
as often happens, that decision should be
memorialized in writing, with clear instructions as
to the deadline. Written communications not only
will help defeat an effort to blame a lawyer for a
client's mistakes, but also will minimize the
potential for a serious fee dispute, which may
escalate into a full-blown claim.
5.
Do not be reactive. Finally,
lawyers should consider taking early affirmative
action to enforce clients' rights, rather than taking a
reactive approach to the bankruptcy process. Many
bankruptcy attorneys attempt to craft case specific
strategies which sometimes involve attempts to
negotiate solutions to disputes before resorting to
litigation. If the strategy fails, the lawyer may be
subjected to second guessing of legitimate tactics
by other participants in the bankruptcy process.
Accordingly, lawyers should consider filing
available motions or other necessary pleadings
before engaging in negotiations. If a different
strategy is advisable (as it often may be), attorneys
should contemporaneously document the reasons
for that strategy, with notice to the client in writing.
Conclusion
2.
File a Motion to Receive Notice.
Bankruptcy lawyers should make sure they receive
notice of important developments and court
orders. In most bankruptcy cases, courts will
The future is here. ALAS' recent claims
experience indicates that representation of debtors
and creditors, before or after the filing of a
bankruptcy petition, is becoming increasingly
dangerous from a lawyer liability standpoint. The
only way to deal with the problem is increased
diligence on the part of lawyers in ALAS Member
Firms. What does increased diligence mean? It
means increased scrutiny of prospective
bankruptcy clients -- a client that was dishonest
prior to bankruptcy isn't likely to change spots
afterward. It means increased diligence in
papering transactions for financially troubled
businesses. It means increased attention to
conflict of interest issues by bankruptcy lawyers,
both before and after the filing of a petition. It
means increased attention to detail and better
partner supervision in documenting secured
transactions and perfecting security interests. It
means better quality control, including greater use
of specialists within your firm in representing
parties to a bankruptcy proceedings. If all that is
done, the recent trend in bankruptcy-related claims
can be reversed.
Hypothetical Problem for Loss Prevention
Seminar on Bankruptcy-Related Claims
D-39
million), but U.S. Widget paid Premium Widget in
cash.
Although an in-house lawyer for U.S.
Widget kept track of the deal, he did not attend the
closing. Doonesbury, the partner in Premium
Widget's law firm, drafted the closing documents
and handled the closing.
Doonesbury knew that Rich was on both
sides of the deal and viewed these assets as
Premium Widget's "crown jewels." Doonesbury
also knew there was some connection between Rich
and the appraiser whose price was chosen.
Premium Widget had just been hit with a large
judgment in a contract dispute and had some
significant potential exposure to products liability
claims. Despite misgivings about the deal and
Premium Widget's future prospects, however, the
lawyers took some comfort in the comments of the
press and securities analyses. They thought the
deal would give Premium Widget badly needed
cash to pay its bills. They also believed that U.S.
Widget would have a better chance to develop the
new widget with its greater cash reserves.
Issues.
By Brian J. Redding, Mark E. Gralen
and Randolph J. Haines
Background
Premium Widget Corporation is a manufacturer of
luxury widget. Before 1994, Premium Widget
was controlled by its 25% shareholder, IM Rich.
Rich is also a 25% shareholder of another widget
manufacturer, U.S. Widget Corp., a larger
company with a much broader product line.
Premium Widget sells widget through subsidiary
dealerships. Premium Widget's banks require the
dealers to sign financing and collateral agreements
for loans to Premium Widget.
I. The Asset Transfer
Facts. In 1992 Premium Widget, under Rich's
direction, sold a plant and related assets to U.S.
Widget. Premium Widget had used the plant to
manufacture a state-of-the-art widget that, after
years of investment, had just started to make
money. Before the sale, Rich commissioned three
appraisals of the assets. The parties chose the
lowest of the three for the purchase price ($25
1.
Is this transaction a fraudulent
transfer? What kind of fraudulent transfer (actual
or constructive)?
2.
What exposure do the lawyers
have for fraudulent transfers involving their
clients?
3.
What problems are posed by
Doonesbury's dominant role in the closing? Does
this role make the fraudulent transfer problem
worse?
II. The Perfection Problem
Facts. When it sold the plant, Premium Widget
also refinanced its $50 million revolving line of
credit. Outside counsel for the First National
Bank, the new lead tender, and in-house counsel
knew that, in the future, U.S. Widget Credit Corp.
(USWCC) would finance Premium Widget's
acquisition of widget in exchange for purchase
money security interests. However, the lead
partner did not discuss collateral priorities with inhouse counsel, whom she considered a nuisance.
In-house counsel assumed the bank would be senior
to USWCC because the bank's UCC statements
would be filed first.
The lead partner negotiated an
outstanding loan agreement, with excellent
covenants, collateral ratios, representations and
warranties. However, she became occupied on
other deals as the closing on this one approached.
She therefore delegated the filing of the UCC-1
financing statements to a mid-level associate. The
associate's primary experience had been in real
estate. True to his background, he was focused on
complicated issues involving title and leasehold
mortgages in the Premium Widget deal.
Accordingly, the associate delegated the personal
property collateral issues (which he disliked
anyway) to a paralegal.
Working by himself, the paralegal did not
understand that the UCC in Premium Widget's
home state required both a "local" county filing
and a "central" filing with the Secretary of State.
The paralegal also did not understand the
significance of the term "accounts receivable" and
took the collateral description from the wrong
place in the loan documents. As a result, he filed
the UCC statements only with the Secretary of
State and did not include the term "accounts
receivable." The paralegal ordered post-closing
searches, but he was the only one to review the
results, so he did not catch the mistakes.
By 1994, Premium Widget was in
desperate financial condition, hit hard by a luxury
tax and increased competition from foreign
manufacturers. The company had completely
dissipated the proceeds of the 1992 asset sate.
Accordingly, Premium Widget began workout
talks with its secured tenders. Premium Widget
also began considering bankruptcy.
When workout talks began, the bank
transferred the loan to its Special Workout Group,
which discovered the lack of a UCC filing in the
county. The bank's outside lawyers fixed their
mistake by immediately filing with the county the
same UCC statement used before. However,
neither the bank nor its counsel realized the
accounts receivable description problem.
Issues. 1.
Putting aside the substantive
mistakes, what problems do you see in the way the
bank's lawyers handled this assignment? What
should they have done differently?
D-40
2.
What exposure does the bank's
law firm have for failing to file the UCC statements
locally at the county level? What defenses might
the firm have? Does the corrective filing solve the
problem?
3.
What will be the likely result of a
priority fight between the bank and USWCC?
How will the firm's exposure be affected by that
result?
III. Disclosure in the Bankruptcy
Facts. In workout negotiations, creditors were
willing to allow Premium Widget to survive as a
going concern, although with substantial
restrictions on operations and a new CEO chosen
by the creditors. However, Premium Widget's law
firm, the same one that had handled the asset sale,
persuaded Premium Widget to break off the
negotiations and to file a Chapter 11 bankruptcy
petition. Doonesbury assured Rich that a quick
reorganization would allow Premium Widget to
reject all of its burdensome leases and emerge
intact under existing management, with Rich's
share holdings unaffected.
Before planning the bankruptcy,
Doonesbury insisted that Premium Widget pay his
firm's unpaid fee balance of $150,000, which
included some billings at premium rates, and a
$100,000 retainer. At Rich's direction, Premium
Widget paid $175,000 and U.S. Widget paid
$75,000. (The firm had done some work on a tax
project for U.S. Widget that was on hold pending a
ruling from the IRS). After depositing the fee
payments, Doonesbury decided to wait to file
Premium Widget's bankruptcy petition until after
the 90-day preference period under the Bankruptcy
Code expired.
Shortly after Doonesbury received the fee
payments, the bank made its corrective county
UCC filing. Four months after the fee payments,
American Widget Corp. and several other
unsecured creditors filed an involuntary bankruptcy
petition against Premium Widget. Before filing the
petition, counsel for American Widget screened the
debtor in their conflict check, but did not screen
Premium Widget's secured lenders. The firm
therefore did not realize that First National Bank
was a client of one of its branch offices.
In light of its existing plans, Premium
Widget consented to the bankruptcy filing.
Doonesbury filed an affidavit in support of his
firm's motion for court approval of its
employment as counsel to Premium Widget as
debtor-in-possession. The affidavit did not
disclose the fee payments by Premium Widget and
U.S. Widget, nor did it disclose the firm's tax
project for U.S. Widget. The court granted the
motion.
Issues. 1.
Was it wrong for Doonesbury to
insist on payment of the firm's past due bills and
on a retainer for the bankruptcy?
2.
What if anything was wrong with
the way the firm dealt with the fee payments in the
bankruptcy? What is the consequence of not
disclosing the payments and the connection with
U.S. Widget?
3.
Is there a problem with the firm
deciding to wait until the preference period passed
before filing the bankruptcy petition? What if this
was done with the clear approval of the client?
4.
How is this likely to play out in
the bankruptcy proceeding?
IV. Malpractice in the Bankruptcy
Facts. In the Chapter 11, improvements in certain
local real estate markets made some of the leases
quite favorable to Premium Widget. However,
Doonesbury, as DIP counsel, was preoccupied in
the early days of the bankruptcy with ensuring
utility service and with cash collateral and DIP
financing, and did not focus on lease issues. He
assumed that assumption of the teases could be
dealt with at any time before confirmation of the
plan under Section 365 (d) (2) of the Code, just as
with executory contracts.
Doonesbury eventually reached agreement
with the bank on a cash collateral and DIP
financing order. The bank's outside counsel,
fearful of the reaction of the judge, decided on his
own (without consulting with bank in-house
counsel) not to include in the order a waiver of the
debtor's right to "surcharge" the collateral for
administrative expenses under Section 506(c) of
the Bankruptcy Code. The bank's counsel also did
not include a "cross-collateralization" provision
which would have secured the pre-petition loan
D-41
with post-petition collateral. Counsel was
concerned that this tactic, expressly disapproved by
some courts, would anger the debtor-oriented
judge, causing him to make other, more harmful
changes to the agreed order.
Meanwhile, other creditors were having
problems of their own in the Premium Widget
bankruptcy. Both USWCC and American Widget
missed the proof of claim bar date. The court set
the bar date early in an order mailed to the business
addresses of creditors rather than to their counsel.
Outside counsel for USWCC was not concerned
about the bar date because USWCC's loan officer
said he would "take care of' the proof of claim, and
outside counsel believed USWCC was fully
secured anyway. American Widget's counsel never
got the bar date order from his client. However, he
could have discovered the bar date on his own by
filing a motion to receive notice in the bankruptcy
or by checking the docket sheet.
Issues. 1. Is there a problem with the way
Doonesbury approached the lease issue?
2.
What about the bank's counsel's
approach to the cash collateral/DIP financing
order?
3.
What exposure do USWCC and
American Widget's counsel have for missing the
bar date? What argument does American Widget
have for avoiding disallowance of its proof of
claim? Is there a reason why USWCC would not
want to file a proof of claim?
V. Disqualification and Disgorgement
Facts. Despite his success on the cash
collateral/DIP financing order, Doonesbury was not
immune from the problems besetting other counsel.
Throughout the bankruptcy, he was worried about
his pre-petition advice to Premium Widget not to
settle a products liability class action for $10
million. For Premium Widget, this was a
significant sum, but one the company could have
handled at the time. Premium Widget turned the
deal down on Doonesbury's advice that the
company could do better by litigating.
Although the court refused to certify a
class action, Doonesbury's litigation strategy forced
the company to turn over some incriminating
documents. In the first of the individual cases to go
to trial, the plaintiffs obtained a $250,000 verdict
against Premium Widget, defended by
Doonesbury's firm. However, in the next case,
handled by local counsel, the court ruled that the
suit was barred by Premium Widget's compliance
with a federal regulation covering the design
defect in question. Doonesbury felt vindicated by
this result, but became worried when he read the
appeal brief. The brief persuasively argued that
the federal regulation did not preempt the tort
claim and that the incriminating documents raised
significant triable issues about Premium Widget's
conduct.
Doonesbury's reaction to the appeal brief
was shared, although in a different way, by Brash
Fearless, the counsel for the unsecured creditors'
committee. After reading the brief, Brash &
Fearless decided to investigate the pre-petition
relationship between Premium Widget and
Doonesbury's firm. In a Rule 2004 examination
of Premium Widget's CFO, Brash & Fearless
found out about the pre-petition fee payments to
the firm and the firm's relationship with U.S.
Widget.
Brash & Fearless immediately filed a
motion seeking an order disqualifying
Doonesbury's firm as DIP counsel and requiring
the firm to disgorge all fees paid to it as DIP
counsel, including the $100,000 retainer. The
motion not only excoriated Doonesbury's firm for
violating the disclosure requirements of
Bankruptcy Rule 2014 and Section 329 of the
Code, but also made veiled references to alleged
malpractice by the firm in the handling of the class
action. The committee also sought leave to file a
preference action against Doonesbury's firm for its
pre-petition fee payments, arguing that the firm
was an "insider" of Premium Widget and therefore
was subject to the one-year preference period.
After a hearing, the court granted the motion to
disqualify and granted the committee leave to file
the preference action. The court set the request
for disgorgement for a later evidentiary hearing.
Issues. 1.
Was the court's disqualification
decision correct? Why?
2.
What is the likely result on the
disgorgement issue? Does the court have any
discretion on the issue?
VI. Reorganization
D-42
Facts. Eventually, Premium Widget confirmed a
reorganization plan that paid off secured claims by
selling some of Premium Widget's remaining assets
to U.S. Widget (the only cash buyer) and by
distributing stock in a smaller, reorganized
Premium Widget to trade creditors and product
liability claimants. Based on a valuation of the
stock at confirmation, the plan would only pay 20%
of unsecured creditor claims, and trade creditors
faced significant dilution if products liability claims
were enlarged by a reversal on the tort appeal.
Counsel for American Widget, a dominant
unsecured creditor, strongly supported the plan, as
did new counsel for the DIP and Brash & Fearless.
The plan provided no recovery for the estate's
potential claims against U.S. Widget and Rich.
However, under the plan, U.S. Widget paid the fees
and expenses of all estate professionals, including
new DIP counsel and Brash & Fearless.
Three weeks after confirmation, dissenting
bondholders' special federal appellate counsel filed
a notice of appeal. A week later, in the tort case
against Premium Widget, the appellate court
reversed, ruling that there was no federal
preemption bar to the suit and reopening all of the
individual cases based on the same design defect.
The appellate court also reversed the trial court's
denial of the class certification motion. The ruling
had two effects. First, under the Premium Widget
plan, pre-petition products liability claimants who
obtained judgments or settlements from Premium
Widget would receive additional distributions of
stock in the reorganized company. Second,
Premium Widget now faced new claims alleging
post-petition injuries based on the same theory.
Analysts predicted exposure in the new cases could
eventually cause Premium Widget to file a second
bankruptcy.
Several months later, Premium Widget
filed a malpractice suit against Doonesbury's firm,
alleging negligence in Doonesbury's advice not to
settle the tort claims on a class basis and further
negligence in the discovery and trial of the first tort
case. Doonesbury's firm filed a motion to dismiss
on the ground that the claim was barred by
principles of res judicata and judicial estoppel
because of Premium Widget's failure to schedule it
in the reorganization plan.
Issues. 1.
What are the malpractice
consequences of Doonesbury's
motion to dismiss for (1)
Doonesbury's firm; (2) Premium
Widget's second DIP counsel;
and (3) creditors' committee
counsel?
2.
Does American Widget's counsel
have any exposure for supporting
a reorganization plan that paid
off the secured claim of the
bank?
3.
Do Premium Widget's second
DIP counsel and creditors'
committee counsel have any
exposure for supporting a plan in
which U.S. Widget paid their fees
in full?
4.
Does bondholders' counsel face
exposure on the appeal of the
confirmation order?
Discussion of Hypothetical Problem for Loss
Prevention Seminar
on Bankruptcy-Related Claims
DISCUSSION OF ISSUES
I. Asset Transfer
Issue. 1.
Is this transaction a fraudulent
transfer? What kind of fraudulent
transfer (actual or constructive)?
Discussion. It is not clear whether this
transaction constitutes a fraudulent transfer. What
is clear is that a trustee, or creditors committee,
might assert that the transfer is actually, or
constructively, fraudulent and that the claim would
not be treated as frivolous by most bankruptcy
judges.
still in effect in approximately 10 states), or the
Uniform Fraudulent Transfer Act (adopted in 1984
and in effect in approximately 30 states).
The legal test, whether under the
Bankruptcy Code, or state law, is similar. A
transfer is actually fraudulent if made with actual
intent to hinder, delay or defraud creditors.1*
Absent proof of actual intent to hinder creditors, a
transfer may be deemed constructively fraudulent if
made without "fair consideration" or "reasonably
equivalent value" (we shall generically refer to
these tests as "fair value") if, immediately after the
transfer, the debtor was "insolvent," or left with
('unreasonably small assets" or "unreasonably
small capital" or where the transferor intends to, or
believes it will, incur debts beyond its ability to
pay. The difference between actual and
constructive fraud may not be as significant as one
would think, since actual fraud (i.e., intent to hinder
creditors) may be proved by circumstantial
evidence. Moreover, under, e.g., the UFTA, if the
so-called "badges of fraud" are present, actual
fraud may be presumed.
Issue. 2. What exposure do lawyers have for
fraudulent transfers involving their clients?
Discussion. The last step in the chain is that some
courts have held that lawyers may be liable for
aiding and abetting transfers that are actually
fraudulent. See, e.g., McElhanon v. Hing, 151
Ariz. 386, 728 P. 2d 256 (Ariz. App., 1985),
modified on other grds, 151 Ariz. 403, 728 P. 2d
273 (1986). Even in jurisdictions not expressly
recognizing this principle, lawyers may be sued for
allegedly aiding and abetting a breach of fiduciary
duty. See, e.g., Feinberg v. Carter, 652 F. Supp.
1066, 1082 (S.D. N.Y. 1987); Heckmann v.
Ahmanson, 168 Cal. App. 3d 119, 127, 214 Cal.
Rptr. 177 (2nd Dist. 1985). (While we don't agree
1
There are several potential sources of law
available to attack pre-petition transfers of
property as fraudulent. A trustee (or DIP) may
attack a conveyance made within a year of the
bankruptcy petition under §548 of the Bankruptcy
Code. Attacks on pre-petition transfers may also
be made, pursuant to §544 of the Code, under
State laws. The primary state laws applicable to
this situation are versions of the Uniform
Fraudulent Conveyance Act (adopted in 1918 and
D-43
Under state law there may be "standing"
issues as to which creditors may raise a "fraudulent
transfer" claim as to a particular transaction (e.g.,
present as opposed to future creditors). While this
may present defenses in a particular situation, for
the purposes of this discussion (i.e., loss
prevention) they are not of overwhelming
significance and we will generally omit discussion
of them.
that these cases correctly state the law, or that they
should apply to lawyers representing their clients,
plaintiffs' lawyers will argue that they should be
applied to the conduct of transactional lawyers).
Applying these principles to the
hypothetical, we see several problems in fending
off a fraudulent transfer claim. First, the sale of
the plant was for the lowest of the three
appraisals. Second, it was made to an affiliated
company, i.e., an entity that, because of Rich's
ownership interests, might be considered an
insider. Moreover, because Premium Widget had
just been hit with a large judgment, another
"badge of fraud" is present. The factual argument
that Rich was trying to preserve the "crown jewel"
of his production facilities, thus advantaging
himself and hindering creditors, could strike a
chord with the trier of fact. On the other hand, the
deal raised cash for Premium Widget, and may
have been superior in that respect to the other
offers. We cannot tell from the hypothetical
whether the transfer was for fair value (using the
lowest appraisal is not helpful), or whether the
transfer left Premium insolvent in an accounting
sense (valuing existing assets and liabilities,
including contingent liabilities, is an "iffy"
proposition). It would appear, however, that,
given the nature of the contingent liabilities and
the sequence of events, there is room for a creative
lawyer representing creditors to make arguments
(presumably aided by (‘experts’) that at least
create a litigable controversy, and a lawyer
liability risk, for our friend Mr. Doonesbury.
Issue. 3.
What problems are posed by
Doonesbury's dominant role in
the closing? Does this make the
fraudulent transfer problem
worse?
Discussion. Doonesbury's dominant role in the
closing presents further problems. While
Doonesbury probably believes (and will contend)
that he represented only Premium Widget, and
that U.S. Widget was represented by in-house
counsel, lawyers for the creditors (or a trustee if
one is appointed) will contend otherwise. They
will argue that Doonesbury was a "lawyer for the
deal," represented both sides in the transaction and
breached his fiduciary obligation to Premium
Widget by aiding (or conspiring with) Mr. Rich in
his attempts to transfer assets to U.S. Widget. If
U.S. Widget is successfully sued as recipient of a
D-44
fraudulent conveyance, it would not be surprising
to see a lawyer liability suit against Doonesbury
alleging that he represented both sides in the
transaction, had a conflict of interest and failed to
protect U.S. Widget's interests.
This scenario, where a lawyer believes he
represents one party to a transaction, but
circumstances make it appear that he may have
acted as a lawyer for the deal, is a very serious
lawyer liability problem for ALAS and its Member
Firms. A number of the case studies discussed at
the main loss prevention program at the 1995
ALAS Annual General Meeting involved this
problem. In some of those cases, a letter sent to all
participants in the transaction defining precisely the
parties that the lawyer did, or did not, represent
would have aided the defense of the malpractice
case. In the absence of these steps, it is likely that
conflict of interest issues will complicate the
defense of any claims brought against Doonesbury
for aiding and abetting a breach of fiduciary duty
by officials of his client (i.e., the alleged fraudulent
transfer) .
Loss Prevention. How should ALAS Member
Firms deal with this problem? First, you need to
increase the awareness of the firm's transactional
lawyers to the increased risk of documenting
transactions for clients that are facing hard
economic times. If your firm's bankruptcy lawyers
are involved, they're probably aware of the risk
presented by transactions that raise fraudulent
transfer issues. Corporate lawyers, although aware
of the law generally on these matters, may be less
sensitive to the risk than bankruptcy lawyers.
Being aware of the problem doesn't solve
it, however. The transactional lawyer faced with
these facts probably ought to:
1)
advise the client of the applicable
fraudulent transfer law, and document your
advice;
2)
make sure the client has a reasonable basis
to support its claim that the transaction is
not a fraudulent transfer;
3)
look out for red flags-facts that impeach
the accuracy of the client's position; and
4)
if you are convinced the transfer may be
actively or constructively fraudulent,
consult your firm's ethics committee to
determine your obligations under
applicable law.
Very recently, two well-known, non-ALAS
firms (headquartered in New York) were among
the defendants named in a $2.1 billion RICO
claim filed in the Keene Corp. bankruptcy
proceedings. (See, Lawyers Sued In Bankruptcy,
The National Law journal, June 26, 1995, P. A6.)
The RICO Claim was based upon alleged
fraudulent conveyances related to an LBO, and
subsequent asset transfers, involving Keene Corp.
and Baimco Corp. Apparently, one of the law
firms was sued for aiding and abetting the alleged
scheme, even though they advised their client of
the dangers presented by the applicable fraudulent
transfer law. Id. This case is substantially larger
than any of the fraudulent conveyance cases
pending against ALAS Member Firms. In a
dramatic way, it illustrates the problems such
cases present for the defendant law firm. Whether
or not there is any validity to the claim, the firms
against whom such claims are filed face long,
troublesome and distracting litigation, often spend
all of their self-insured retention, and could face
claims exceeding their policy limits, all because of
the circumstances surrounding pre-petition
transactions. It is worth considerable care to
avoid being named a defendant in this type of
litigation.
II. The Perfection Problem
Issue. 1.
Putting aside the substantive
mistakes, what problems do you
see in the way the bank's lawyers
handled this assignment? What
should they have done
differently?
Discussion. We see at least three problems with
the way the bank's outside counsel handled this
assignment. First, they failed to communicate
with their client. A frank discussion of collateral
priorities with in-house counsel, preferably in
writing, would have disabused in-house counsel of
the notion that the bank would be senior to
USWCC in all respects. See UCC 9-312(3)
(perfected purchase money security interest in
inventory has priority over an earlier-filed security
interest in the same inventory and identifiable cash
proceeds). It is not clear from the hypothetical
whether the bank actually relied on in-house
D-45
counsel's mistaken view of priorities in extending
the loan. By failing to communicate, however,
outside counsel put themselves at the mercy of the
hindsight memories of in-house counsel and the
bank's loan officers, who in today's climate will
likely be quick to blame outside counsel for a
perfection problem.
The second problem is delegation without
supervision. The hypothetical illustrates a
recurring problem, which is the remarkable lack of
high-level attention paid to the actual filing of UCC
statements to perfect security interests. In this
case, the lawyers delegated the UCC work to an
associate inexperienced in commercial finance, and
then delegated again to a paralegal, who,
understandably, was not versed in the intricacies of
the UCC in Premium Widget's home state and did
not understand the significance of a county filing.
The lawyers also put the paralegal in the position
of describing the collateral on his own from loan
documents. These facts (which are more common
sources of claims than readers may assume)
highlight the need for clear instructions and
adequate review of the work of paralegals and
associates in UCC transactions.
Another way to solve the problem would
be adequate review of the post-closing UCC
searches. Here the paralegal ordered the searches,
but no attorney reviewed them. One doubts
whether the paralegal or the lawyers involved had
any notion that failing to do so might create a
seven-figure malpractice problem for the law firm
down the road.
Issue. 2.
What exposure does the bank's
law firm have for failing to file the
UCC statement locally at the
county level? What defenses
might the firm have? Does the
corrective filing solve the
problem?
Discussion. Before the corrective filing, the bank's
law firm appeared to face possible exposure for
failing to file at the county level, although liability
for damages is another matter entirely. The UCC is
a "notice" filing system, in which the filing rules
are designed to provide objective notice to other
parties considering whether to extend credit to a
borrower. [See Official comment 2 to UCC Section
9-402.1 In this case, the firm may have an
argument that a reasonable "searcher" would search
the UCC records in the Secretary of State's office
in addition to the county office, and thus would be
put on notice of the bank's lien. The UCC also
provides that a good faith filing "made in an
improper place or not in all of the places required
by" the UCC is nevertheless effective as to
persons who have actual knowledge of the
contents of the financing statements. UCC
Section 9-401(2). However, the latter defense
may be unavailable against a bankruptcy trustee
or debtor-in-possession occupying the status of a
"hypothetical lien creditor" under Section 544(a)
of the Bankruptcy Code. See Barkley Clark, The
Law of Secured Transactions under the Uniform
Commercial Code, ¶ 2.12[3] (Warren, Gorham &
Lamont 1993).
Does the corrective filing solve the
problem? We believe the answer is probably yes
with respect to collateral correctly described in the
original filing with the Secretary of State, as long
as Premium Widget does not file bankruptcy
within 90 days of the corrective filing.2 Thus, the
lawyers here may have avoided a significant
portion of their exposure by promptly addressing
the problem when they discovered it, rather than
letting it fester or hoping it would go away.
Unfortunately, however, since they did not correct
the collateral description, some exposure may
remain. See the discussion in response to
Question #3 below.
Issue. 3.
What will be the likely result of a
priority fight between the bank
and USWCC? How will the
firm's exposure be affected by
that result?
Discussion. As discussed in response to Question
#1 above, the bank would have been junior to
USWCC on inventory and identifiable cash
proceeds even if the UCC filing had been handled
perfectly. The problem here is that the corrective
county filing did not correct the tack of a precise
“accounts receivable” description in the UCC
statement. Thus, the bank may be subordinate to
USWCC in accounts receivable and nonidentifiable cash proceeds. Both items could be
significant pieces of collateral in an insolvent
business.
The firm's exposure, however, depends on
how bad the misdescription was. The UCC only
requires that a financing statement describe
collateral "by item or type" and provides that
financing statements are effective even if they
contain "minor errors which are not seriously
misleading." See UCC 9-402(l), (8). There are
numerous cases going both ways on whether these
requirement are satisfied by collateral descriptions
that do not contain precise UCC terminology. See
Barkley Clark, supra, 11112.09, 2.10.
At the very least, however, a potentially
inadequate collateral description that does not
match up exactly with the loan agreement is likely
to be challenged in today's bankruptcy climate,
where debtors, trustees, and unsecured creditors
committees commonly attack secured creditors on
whatever grounds are available to obtain additional
funds or negotiating leverage. Defending any such
claim, regardless of whether it succeeds, is
expensive and difficult for a law firm.
III. Disclosure in the Bankruptcy
Issues. 1.
Was it wrong for Doonesbury to
insist on payment of the firm's
past due bills and on a retainer for
the bankruptcy?
2.
What if anything was wrong with
the way the firm dealt with the fee
payment in the bankruptcy? What
is the consequence of not
disclosing the payments and the
connections with U.S. Widget?
2
Note, however, a trap for the unwary if
the loan is guaranteed by an insider of the debtor.
In that instance, one commentator has argued that
the 1994 amendments to the Bankruptcy Code,
intended in part to overrule the "Deprizio" line of
cases permitting recovery of preferences within a
year of bankruptcy on loans guaranteed by
insiders, would not immunize the avoidance of a
security interest on collateral in the debtor's
possession. See Josephson, The Deprizio
Override, Business Law Today, p.38 (May/June,
1995).
D-46
Discussion. There is nothing wrong with a
bankruptcy lawyer insisting on payment of a firm's
past due bills and a retainer for undertaking
representation of a debtor in possession in a
bankruptcy case. It is essential, however, for a
bankruptcy lawyer to disclose those payments in
accordance with the Bankruptcy Code and rules in
order to avoid the embarrassing and costly
problems of disqualifications and disgorgement.
In this case, the payments, by themselves,
were not necessarily inappropriate. The problem
arises from the way that Doonesbury dealt with
them in the bankruptcy. Bankruptcy Rule 2014
requires that counsel for the debtor in possession
file an application describing any proposed
arrangement for compensation and all of the
attorneys' connections with the debtor, creditors,
and any other parties in interest. The disclosure of
connections with other parties is necessary to
determine whether counsel is "disinterested," as
required by Section 327 of the Code. Similarly,
Section 329 of the Bankruptcy Code and
Bankruptcy Rule 2016(b) require that a person
representing a debtor in a case under Chapter 1 1
file with the court a statement of compensation
paid or agreed to be paid for any services within a
year of the bankruptcy filing, and the source of the
compensation. Section 329(b) allows the court to
order the return any payment deemed to be beyond
the reasonable value of such services.
Unfortunately, Doonesbury has not
disclosed the payments by Premium Widget or
U.S. Widget, nor has he disclosed his firm's other
work for U.S. Widget. He also has not filed the
statement required by Section 329 of the Code.
With proper disclosure of these matters
Doonesbury probably would not have had to
worry about the fee payments, except perhaps the
premium amount of the billings. Whether
Doonesbury's firm would have been deemed not
"disinterested" in light of the other work for U.S.
Widget is perhaps a closer question. However,
most courts would probably be inclined to give
Doonesbury's firm the benefit of the doubt as long
as the other work was fully disclosed, since the
other work was unrelated and not even active at
the time. Because of the lack of any disclosure
here, however, Doonesbury's firm faces
substantial risk of disqualification and
disgorgement.
Issues. 3.
Is there a problem with the firm
deciding to wait until the
preference period passed before
filing the bankruptcy petition?
D-47
What if this was done with the
clear approval of the client?
4.
How is this likely to play out in
the bankruptcy proceeding?
Discussion. The problem with deciding to wait is
that the firm put its own interests ahead of its
client's interests. If the bankruptcy had been
promptly filed after the payments were made, the
bank's corrective filing probably would have been
avoidable as a preference. As it stands, however,
Doonesbury's decision to delay the filing of the
petition apparently has allowed the bank to shore
up its collateral position to the detriment of
Premium Widget and its unsecured creditors.
Doonesbury may not have known this might
happen; indeed, he probably believed that the delay
simply would not affect Premium Widget one way
or the other. Doonesbury's subjective belief,
however, will not prevent exposure to malpractice
liability, especially when the client is prejudiced.
Could Doonesbury wait to file the petition
with clear disclosure and consent of the client?
Because Doonesbury delayed the filing to benefit
himself and his firm, this appears to be a Model
Rule 1.7(b) conflict. It may be consentable, but
only if Doonesbury is able to make full disclosure
of the potential adverse consequences of delaying
the filing of the petition. Here, there may have
been no way of knowing that the bank had a
perfection problem, so Doonesbury may not even
have been able to disclose it in a consent letter.
Doonesbury has set himself on a
dangerous course by not disclosing his pre-petition
fee payments and by apparently trying to insulate
those payments by delaying the filing of the
petition. When these kinds of tactics emerge in
bankruptcy cases, other estate parties engage in
attack upon counsel to advance their own clients'
agendas. These attacks, not to mention harsh
opinions from bankruptcy courts on matters of
disqualification, increasingly serve as the
centerpiece of subsequent malpractice claims
against bankruptcy counsel.
IV. Malpractice in the Bankruptcy
Issue. 1.
Is there a problem with the way
Doonesbury approached the lease
issue?
Discussion. Doonesbury's approach to the lease
issue is a problem. Section 365(d)(4)of the
Bankruptcy Code provides that an unexpired lease
of nonresidential real property is deemed rejected
unless assumed within 60 days of the bankruptcy
petition. By simply assuming that commercial
leases are dealt with in the same way as other
leases and executory contracts, Doonesbury
missed a specific Code provision with a specific
deadline.
Doonesbury's mistake on the lease issue does
not necessarily translate into damage liability.
Any malpractice claimant would need to
demonstrate the extent to which the unassumed
leases were more valuable than leases at current
market rates for comparable locations. Moreover,
there may be no damage exposure if the leased
operations are discontinued or sold in the
bankruptcy process.
Readers may have noticed that
Doonesbury, the same lawyer who was closing
pre-petition corporate deals with Premium
Widget, is now acting as bankruptcy counsel for
Premium Widget. This may explain his mistake
on the time deadline for assumption of commercial
leases. As stated in our January 1995 article on
this subject in the Journal, ALAS has had a
number of claims in which lawyers have strayed
outside their expertise in bankruptcy-related
settings (these include both bankruptcy lawyers
becoming involved in non-bankruptcy subject
areas, and vice versa). Several of these claims
have involved scenarios not totally dissimilar to
this hypothetical.
Issue. 2. What about the bank's counsel's
approach to the cash collateral/DIP
financing order?
Discussion. Bank counsel made a judgment call
here that his client's interests would be
jeopardized by including a cross-collateralization
provision and a Section 506(c) waiver. These
types of discretionary decisions, for which lawyers
historically have enjoyed fairly broad immunity,
are increasingly being challenged today. In this
case, the bank's counsel is probably at somewhat
greater risk by failing to include a Section 506(c)
waiver. Such provisions have become quite
common and not including the waiver may expose
the lender's collateral to hundreds of thousands of
dollars in administrative expenses.
D-48
Bank counsel's decision not to include a
cross-collateralization provision is less
problematic, since some courts have expressly
disapproved cross-collateralization, at least as to
cash collateral. In re Saybrook Mfg. Co., 963 F.2d
1490 (11th Cir. 1992). Nevertheless, counsel
might still be at risk if there is no controlling
authority on the cross-collateralization issue in the
circuit where the bankruptcy case is pending, or if
the judge herself, despite counsel's fears, has not
definitively spoken on the issue.
Since discretionary decisions need to be
made all the time in bankruptcy, often under severe
time constraints, readers might wonder whether
anything can really be done to avoid these types of
claims. One method of minimizing claims from
such judgment calls is to document the reasons for
them. In this case, a simple letter explaining the
reasons for not seeking a Section 506(c) waiver or
cross-collateralization may seem like a small thing
at the time. Yet it would be a powerful defense
exhibit in any subsequent malpractice claim, and
may even allow the lawyer to obtain summary
judgment.
Another way for lawyers to protect
themselves is to ask at the outset of negotiations
for things such as a Section 506(c) waiver or crosscollateralization, even if the lawyer is willing to live
without them. You may obtain valuable
concessions from other parties in return. At the
very least, if another party refuses to give on these
points, the lawyer will not appear to have ignored
them, but rather to have conceded them in the
normal give and take of negotiations.
Lawyers should also consider the possible
benefits of promptly filing motions to enforce a
client's rights before negotiations begin or even
while negotiations proceed. Although there are
often very solid reasons for not following this
approach, a judge's decision to deny relief is often
easier to explain in hindsight than never making the
request in the first place.
Issue. 3.
What exposure do USWCC's
counsel and American Widget's
counsel have for missing the bar
date? What argument does
American Widget have for
avoiding disallowance of this
proof of claim? Is there a reason
why USWCC would not want to
file a Proof of Claim?
Discussion. Both USWCC's counsel and
American Widget's counsel face possible exposure
for missing the proof of claim bar date. Congress
may have made matters worse with recent
amendments to the Bankruptcy Code, effective
October 22, 1994, expressly disallowing most
untimely filed claims. See 11 U.S.C. Section
502(b)(9)(1994).
In USWCC's case, counsel will defend
and may prevail by arguing that the client
undertook to file the proof of claim. However,
unless that division of responsibility is clearly
documented, there may well be an issue of fact
precluding summary judgment, since clients have
a way of remembering the division of
responsibilities differently when a claim is deemed
time-barred. This is particularly true where, as
here, outside counsel has not notified the client of
the bar date or explained the consequences of
failing to file the proof of claim.
It is possible that USWCC might not
want to file a proof of claim to avoid submitting to
bankruptcy court jurisdiction. The time for
addressing those issues, however, is before the bar
date, not through hindsight rationalization.
American Widget's counsel likely will
escape exposure because the filing of the
involuntary petition will be sufficient to constitute
an "informal" proof of claim In re Wilbert Winks
Farm, Inc., 114 B.R. 95 (E.D. Pa. 1990). Even
so, however, American Widget's counsel may lose
this representation, and future representations,
because of the cost and embarrassment of having
to establish that the involuntary filing was an
informal proof of claim.
Both of these filing problems could have
been avoided by several bankruptcy practice
techniques that are also good loss prevention
steps: establishing a calendar at the outset of any
bankruptcy representation; filing a motion to
receive notice in any bankruptcy case in which a
lawyer represents a party; and reviewing the
bankruptcy court docket sheet, the schedules and
the statement of financial affairs at the outset of
any bankruptcy representation.
D-49
Failing to file a proof of claim does not
necessarily translate into automatic damage
liability for either set of lawyers. Under some
situations, a party can claim "excusable neglect"
and seek to have a late proof of claim deemed
timely filed. Pioneer Inv. Services Co. v.
Brunswick Associates, L.P., 507 U.S. 380, 113 S.
Ct. 1489, 1493 (1993). Other courts have held,
prior to the 1994 Bankruptcy Code amendments,
that certain priority claims are not disallowed if
they are tardily filed because, inter alia, Section
502(b) of the Code does not enumerate
"untimeliness" as a ground for disallowance of
claims. In re Pacific Atlantic Trading Co., 33
F.3d 1064 (9th Cir. 1994); In re Vecchio, 20 F.3d
555 (2d Cir. 1994).
V. Disqualification and Disgorgement
Issues. 1.
Was the court's disqualification
decision correct? Why?
2.
What is the likely result on the
disgorgement issue? Does the
court have any discretion on the
issue?
Discussion. While the bankruptcy judge's decision
seems a bit precipitous, the Doonesbury firm may
have been at risk on this motion in other
bankruptcy courts, as well. Our experience has
been that bankruptcy courts may be slightly more
lenient than a typical ethics committee in deciding
conflict of interest issues, so long as debtor's
counsel has fully disclosed the factual basis
surrounding possible conflict situations. Most
bankruptcy judges, however, react adversely when
debtor's counsel has failed to disclose arguably
relevant facts. Here, we're not quite sure what the
disclosure affidavit reveals, but it didn't disclose
the facts surrounding the fee payments, and those
should have been disclosed. The facts concerning
the delay in filing the petition, and the clear conflict
the firm had in advising the DIP concerning
potential malpractice claims against itself, raise
serious issues. While these facts may seem
somewhat exaggerated, recent months have seen
motions for disqualification and/or disgorgement
granted by bankruptcy judges against firms within
and outside of the ALAS membership, sometimes
accompanied by scathing criticism of the firm.
Obviously, the courts have substantial discretion
on these issues, but courts seem increasingly
willing to grant such motions.
VI.
Issue. 1.
Reorganization
What are the malpractice
consequences of Doonesbury's
motion to dismiss for (1)
Doonesbury's firm; (2) Premium
Widget's second DIP counsel;
and (3) creditor's committee
counsel?
Discussion. Doonesbury's motion is arguably
well-founded. Failure to schedule a claim, identify
it in a disclosure statement, or preserve it in a plan
of reorganization, has been held to preclude the
reorganized debtor from asserting the claim at a
later time. See, e.g., Eubanks v. FDIC, 977 F.2d
166 (5th Cir. 1992). See also, e.g., Monarch Life
Insurance Co. v. Ropes & Gray, 65 F.3d 973 (lst
Cir. 1995). By failing to preserve the claim, the
final order of the bankruptcy court operates as an
adjudication having collateral estoppel or res
judicata effect against the debtor. In reality, the
doctrine is based on judicial estoppel concepts,
i.e., it's not fair to allow the debtor to not schedule
a claim (shielding it from creditors) and later
benefit by asserting that claim. Obviously, while
this doctrine helps Doonesbury's firm, it creates
problems for the second DIP firm and creditors'
committee counsel. Depending on how obvious
the claim was, and what, if any, tactical
considerations led these law firms to not assert the
claim, it is possible that a dismissal on res judicata
grounds could lead to subsequent malpractice
cases being filed against the second DIP firm
and/or counsel for the creditors committee.
Bankruptcy lawyers need to know that failure to
schedule claims can result in losing those claims
through assertion of a res judicata, collateral
estoppel or judicial estoppel defense, and could
lead to later lawyer liability claims.
Moreover, the bank was a client of the firm on
unrelated matters and American's counsel failed to
disclose that fact to American Widget. Most ethics
lawyers would concede there is a serious issue as to
whether a rule 1.7(b) conflict existed, requiring the
firm to disclose to American Widget that the
secured lender was a valued client of the firm on
unrelated matters, and to obtain American Widget's
consent. Many ethics lawyers would also argue
that Model Rule 1.7(a) required consent of the
secured tender to allow the law firm to represent
American Widget. That is, they would argue that
American Widget's interests were "directly
adverse" to those of the secured lender within the
meaning of Model Rule 1.7(a).
Issue. 3
Does American Widget's counsel
have any exposure for supporting
a reorganization plan that paid
off the second claim of the bank?
Discussion. American Widget's counsel certainly
has exposure, though it's far too early to know
how that situation will eventually play out.
American Widget's counsel supported a plan that
paid its client 20 cents on the dollar, while failing
to challenge the secured lender's claim, even
though there was an arguable defect in part of that
claim (the description of the collateral).
Do Premium Widget's second DIP
counsel and creditors' committee
counsel have any exposure for
supporting a plan in which U.S.
Widget paid their fees in full?
Discussion. That fact was undoubtedly disclosed.
Without more it might not be a serious problem.
When added to the problems with the plan, it is an
additional factual element suggesting these law
firms may have had a Model Rule 1.7(b) conflict in
advising on the reorganization plan. This fact will,
most likely, be used by counsel filing any
malpractice case as an additional argument to
support the contention that DIP counsel and
creditors committee counsel "pulled their punches"
in not filing an action attacking the allegedly
fraudulent conveyance. As was noted in several
different sessions at the 1995 AGM, conflicts of
interest continue to be one of ALAS' biggest lawyer
liability problems. An alleged conflict can
frequently turn a weak malpractice claim into a
viable one.
Issue. 4.
Issue. 2
D-50
Does bondholders counsel face
exposure on the appeal of the
confirmation order?
Discussion. Yes. The appeal had a 10-day time
limit. Failure to perfect the appeal is arguably
negligent. Of course, part of any successful
malpractice claim based on failure to perfect an
appeal, is proof of the likelihood of a successful
appeal. (Hopefully, bondholders counsel will not
have written a letter describing the likelihood of
success on appeal in unrealistically glowing terms.)
Failing to effect a timely filing because counsel was
unaware of specialized filing deadlines is becoming
a problem. ALAS Member Firms have several
pending claims involving failure to effect timely
filing of various documents in bankruptcy
proceedings. It's not always clear why this occurs.
Sometimes we suspect it results from the
unsupervised work of associates. Sometimes we
suspect it occurs because bankruptcy litigation is
being conducted by lawyers not totally familiar
with the bankruptcy rules. Just as certain
litigation conducted in bankruptcy proceedings
may require nonbankruptcy specialists, ALAS
Member Firms need to remain aware of the
specialized nature of bankruptcy proceedings and
the need for attention to the special requirements
of those proceedings.
D-51

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