Sometimes Complete Disclosure, Disinterestedness and an Approved Employment Application are Not Good Enough!

On August 24, 2015, Judge Lee, a Bankruptcy Judge in the Eastern District of California, disqualified the Estate’s general bankruptcy counsel even though counsel was properly employed under § 327(a). The Court found that counsel was a disinterested person within the meaning of the code and did not hold or represent an interest adverse to the estate. This is a wild (but proper) result because under California law, a client’s waiver or consent can cure these types of deficiencies and under Bankruptcy law, those defects cannot be cured!

So how is it that under Bankruptcy law, counsel was properly employed but had to be disqualified under California law?

California Rules of Professional Conduct (“State Rule”) § 3-310(E), relates to the representation of adverse interests and states:

“A member shall not, without the informed written consent of the client or former client, accept employment adverse to the client or former client where, by reason of the representation of the client or former client, the member has obtained confidential information material to the employment.”

The analysis under State Rule 3-310(E) in the bankruptcy context was addressed by Judge Bufford in In re Muscle Improvement, Inc., 437 B.R. 389 (Bankr. C.D. Cal. 2010). In that case, the subject attorney consulted twice with the prospective debtors regarding the filing of a personal bankruptcy petition, but she was not retained to do so. She then undertook the representation of the debtors’ primary creditor after the petition was filed by another attorney. Although the debtors had not retained the attorney, the debtors successfully disqualified that attorney from representing the adverse creditor because there was a “substantial relationship” between the debtors’ consultation with the attorney and the attorney’s subsequent representation of the creditor. That “substantial relationship” created an IRREBUTTABLE PRESUMPTION that confidential information had been divulged and, therefore, in light of the debtors’ objection, the attorney could not represent the party with adverse interests.

The public policy at issue here was explained in the Ninth Circuit case, Trone v. Smith, 621 F.2d 994 (9th Cir. 1980).

The interest to be preserved by preventing attorneys from accepting representation adverse to a former client is the protection and enhancement of the professional relationship in all its dimensions. . . . These Objectives require a rule that prevents attorneys from accepting representation adverse to a former client if the later case bears a substantial connection to the earlier one. Substantiality is present if the factual contexts of the two representations are similar or related.

Id. at 998

In the Ninth Circuit the relevant test for disqualification is whether the former “representation” (here, consultation) is “substantially related” to the current representation of Charlotte and her bankruptcy estate. In the course of the consultation, it does not matter whether or not confidential information has actually been exchanged.

[I]t is immaterial whether [the attorney] actually obtained confidential information in the course of her meeting with debtors’ agents. The two dispositive issues are whether the subject matter of their meetings is substantially related to the subject matter of this case and whether [the attorney’s] relationship with debtors was one in which confidential information would ordinarily be disclosed.

Muscle Improvement, Inc., 437 B.R. at 396.

The rule is necessary to, inter alia, implement canons of professional ethics:

Canon 1 (maintaining integrity and confidence in the legal profession);
Canon 4 (preserving confidences and secrets of a client);
Canon 5 (exercise of independent professional judgment);
Canon 6 (representing a client competently);
Canon 7 (representing a client zealously within bounds 61 the law);
Canon 9 (avoiding even the appearance of professional impropriety).

The court must consider whether the attorney was in a situation where the attorney was likely to receive confidential information. However, the court may not inquire as to that information, which would require disclosure of the very confidential information that is being protected. Instead, the “substantial relationship” test is used as a substitute.

Where there is a “substantial relationship” between the consultation with a potential client, and the subsequent representation of an adverse client, an irrebuttable presumption arises that confidential information has been exchanged and disqualification of the attorney is mandatory.

The case can be found here.


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