In Robbye R. Waldron v. Adams & Reese, L.L.P. (In re American International Refinery, Inc.), the Fifth Circuit Court of Appeals recently upheld the fee award to bankruptcy counsel to the debtor, notwithstanding that such counsel was indirectly paid a pre-bankruptcy retainer by a secured creditor of the debtor. The Court did, however, affirm the bankruptcy court’s decision to have the law firm disgorge a portion of its fees, based on certain non-disclosures in counsel’s retention application.
Qualifications as Counsel
Section 327(a) of the Bankruptcy Code requires that a law firm retained by a debtor not “hold or represent an interest adverse to the estate” and that the law firm be “disinterested.” The term “disinterested” is defined in section 101(14) of the Code as a person (1) who is not a creditor, an equity security holder, or an insider; (2) who is not and was not, within 2 years before the date of the filing of the petition, a director, officer, or employee of the debtor; and (3) who does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason.
The Fifth Circuit has previously held that a party has an adverse interest to the estate if the party (a) possesses or asserts any economic interest that would tend to lessen the value of the bankruptcy estate or that would create either an actual or potential dispute in which the estate is a rival claimant; or (b) possesses a predisposition under the circumstances that render such a bias against the estate. See In re W.F. Dev. Corp., 905 F.2d 883, 884 (5th Cir. 1990).
If an attorney is retained and it later turns out that she had an adverse interest, section 328(c) of the Code provides that a court may deny compensation for services provided by such attorney. The Fifth Circuit noted, however, that a bankruptcy court is not required to deny all compensation if an attorney has an adverse interest and is found not to be disinterested.
At the time of its bankruptcy, American International Refinery was a public corporation, with various affiliates and subsidiaries. The debtor refined, produced and marketed oil and engaged in oil and gas exploration in Kazakhstan. One of the debtor’s principal assets was a gas concession in a gas field in Kazakhstan. Prior to the bankruptcy, the debtor sold 85% of its interests in this gas concession, which required one of the debtor’s largest creditors, GCA Strategic Investment Fund Limited, to release its security interests in these assets.
In the fall of 2004, American International Refinery filed bankruptcy in the Western District of Louisiana. After confirmation of its chapter 11 plan, the liquidating trustee appointed under the plan brought a lawsuit against debtor’s counsel, seeking, among other things, disgorgement of all the attorneys fees awarded ($678,936). The trustee also alleged that, in participating in certain pre-bankruptcy transactions with GCA (albeit representing the debtor), debtor’s counsel committed willful misconduct, fraud and breach of fiduciary duty. All the claims centered around counsel’s alleged decision not to challenge GCA’s secured claims post-bankruptcy.
To support his contention, the liquidating trustee complained that debtor’s counsel did not disclose that (a) it represented the debtor in pre-bankruptcy negotiations with GCA, pursuant to which counsel drafted an assignment agreement transferring certain interests of the debtor to GCA and (b) GCA had loaned money to one of the debtor’s subsidiaries, which, in turn, was used to pay debtor’s counsel pre-bankruptcy retainer. The trustee claimed that these pre-bankruptcy transactions created a conflict over the treatment of GCA’s secured claims, which was challenged by other parties in the bankruptcy case.
The bankruptcy court ultimately dismissed all the fraud and breach of duty claims on summary judgment but left the trustee with the disgorgement claim. After a bench trial, the bankruptcy court sanctioned counsel $135,000 for not disclosing various connections it had to the debtor and its creditors. The Court, however, left most of the award of the fees to debtor’s counsel untouched, finding that debtor’s counsel did not have a disqualifying adverse interest based on the trustee’s allegations. On appeal, the Fifth Circuit ultimately affirmed the holding of the bankruptcy court.
The Fifth Circuit’s holding was not about a debtor’s counsel having an adverse interest to the debtor’s bankruptcy estate. Rather, it turned on counsel’s failure to disclose certain pre-bankruptcy transactions with the debtor’s creditors. Indeed, as was the case in American International Refinery, it is not uncommon for a debtor’s counsel to represent the debtor in certain pre-bankruptcy negotiations with secured creditors or for the debtor to borrow funds from a secured lender to pay a pre-bankruptcy retainer. Neither of these instances creates an adverse interest to a bankruptcy estate. However, following the maxim that honesty is the best policy, the Fifth Circuit’s opinion underscores that debtor’s counsel should make thorough disclosures at the outset of a bankruptcy representation.