Multiple Debtor Representation

While the court was not at all critical of debtors' counsel, recognizing the lack of any objection to its multiple representation for years, the court concluded that 'changed circumstances' created conflicts that could not be avoided. Noting that 'the presence of inter-company claims between debtors represented by the same counsel does not automatically warrant the disqualification of that counsel,' the court used a 'fact-driven approach' to decide how to remedy the conflict. Id. at 672-673. Rather than disqualifying debtors' counsel outright as counsel for the affected debtors, the court reached the practical result of precluding counsel from actively participating in the inter-debtor disputes. In an effort to strike just the right balance, the court made an unusual distinction, noting that counsel could 'continue to act as a facilitator to privately try to assist the creditor groups ' to reach a settlement' but would 'have to refrain from 'going public'; from being an advocate for either side; and from taking any steps that might be regarded by any of the feuding parties as tilting the playing field.' Id. at 673.

This decision illustrates how courts have tried to find ways to satisfy the limits on professional retention set by the Bankruptcy Code, as well as state ethical rules, while not crippling the reorganization process with endless sets of attorneys. On one hand, it is obvious that a law firm cannot litigate or negotiate against itself on behalf of different clients, even if they are members of the same corporate enterprise. On the other hand, a system in which the 231 separate Adelphia entities were each required to be represented by separate counsel would collapse under its own weight. To better understand the challenge of navigating through this minefield of conflicts, it is necessary to consider both the underlying legal framework and the case law that has developed to deal with it.

The Framework

Debtors' counsel must meet the two-pronged test of 11 U.S.C. ' 327(a) ' counsel must be 'disinterested' (as defined by ' 101(14)) and must 'not hold or represent an interest adverse to the estate.' While disinterestedness seems to focus on the personal interests of the person involved (eg, as a creditor, equity holder, or insider), the adverse interest prong makes it clear that debtors' counsel may not represent an interest adverse to the estate of each debtor it is representing. The latter prohibition is softened by ' 327(c), which precludes disqualification of debtors' counsel solely because that counsel represents a creditor, as long as there is no objection. If there is an objection, however, the court must disapprove that counsel's employment if there is an actual conflict of interest. Rule 2014, F.R.B.P., requires initial disclosure of all of counsel's 'connections' with the debtor and any other parties in the case, including their attorneys and accounts, as well as all personnel in the United States Trustee's office. For a large firm in a large case, identification and disclosure of all of these 'connections' can be a daunting task.

Of course, co-existing with the Code's restrictions on conflicts are the state ethical rules that bind all practicing lawyers. Rule 1.7 of the ABA Model Rules of Professional Conduct imposes the basic prohibition of conflicts, that '[a] lawyer shall not represent a client if the representation of that client will be directly adverse to another client' and that '[a] lawyer shall not represent a client if the representation of that client may be materially limited by the lawyer's responsibilities to another client.' The only exceptions require consent, and in the fiduciary, multi-party context of bankruptcy cases conflict waivers are not a viable option.

Taken together, these limits frequently clash with the distinct advantages of multiple debtor representation in bankruptcy cases ' efficiency, economy, and coordination of the common interests of debtors and creditors. Courts have generally tried to avoid rigid black and white applications of the conflict restrictions and have instead examined the facts of each case and found ways to balance these competing interests.

No Per Se Rule

While courts have tended to strictly apply the requirement of disinterestedness, they have been more flexible in applying the adverse representation restriction. The more rigid approach, represented by cases such as In re Lee, 94 B.R. 172 (Bankr. C.D. Cal. 1988) (imposing a presumption of impropriety of multiple debtor representation in certain circumstances), and In re Ginco, Inc., 105 B.R. 620 (D. Colo. 1988) (applying the restriction literally and rejecting a 'wait and see' approach) have given way to a fact-intensive analysis that provides debtors' counsel with more flexibility.

The Case-by-Case Analysis

While far from uniform, the case law addressing conflicts (in multiple debtor and other contexts) has established several principles that have gained wide acceptance:

• Multiple debtor representation is not judged under a per se rule, but must be evaluated on a case-by-case basis. See, e.g., In re Interwest Business Equipment, Inc., 23 F.3d 311 (10th Cir. 1994); In re BH&P Inc., 949 F.2d 1300 (3d Cir. 1991).
• The court should use its discretion in considering conflicts 'to determine whether the efficiency and economy which may favor multiple representation must yield to competing concerns affecting fairness to all parties involved and protection of the integrity of the bankruptcy process.' BH&P, 949 F.2d at 1316; see also Harold & Williams Development Co., 977 F.2d 906 (4th Cir. 1992) (court should weigh potential conflicts against potential advantages); In re Coal River Resources, Inc., 321 B.R. 184 (W.D.Va. 2005) (factual analysis of inter-debtor conlficts required).
• The existence of inter-debtor claims does not necessarily disqualify common debtors' counsel. Interwest; BH&P; In re Global Marine, Inc., 108 B.R. 998 (Bankr. S.D. Tex. 1987).
• The appearance (as opposed to existence) of a conflict may not require disqualification. In re Marvel Entertainment Group, Inc., 140 F.3d 463, 476 (3d Cir. 1998). But see In re Martin, 817 F.2d 175, 180 (1st Cir. 1987) ('Section 327 is intended ' to address the appearance of impropriety as much as its substance').
• Disapproval or disqualification is not always required. Global Marine, 108 B.R. at 1004 (special counsel for particular matters); Adelphia, 336 B.R. at 673 (limitation on taking active role in specific inter-debtor disputes).
• Disclosure is essential. BH&P, 949 F.3d at 1317 ('It is not . . . the obligation of the bankruptcy court to search the record for possible conflicts of interest. That obligation belongs to the party who seeks employment by the estate ' '); In re Roberts, 75 B.R. 402 (D. Utah 1987).

Potential vs. Actual Conflict

Some would debate whether there is any ethical difference between a potential conflict and an actual conflict. See Ginco, 105 B.R. at 621-622 (potential conflicts equally disqualifying). Nevertheless, in attempting to accommodate the competing interests in the bankruptcy system, courts have drawn a distinction between actual conflicts and those that are only potential. The unique nature of bankruptcy proceedings, in which the interaction of a multitude of interests is often impossible to predict in advance, almost requires such a distinction.

While courts recognize that an actual conflict normally requires disqualification, they are inclined to commit the evaluation of potential conflicts to the discretion of the court. Marvel Entertainment, 140 F.3d at 477; BH&P, 949 F.2d at 1317. The determination of whether a potential conflict requires disqualification (or some other remedy) necessarily requires a fact intensive analysis. See Martin, 817 F.2d at 182 (in the context of evaluating a secured retainer agreement, 'the court should consider the full panoply of events and elements'). As stated by the Adelphia court, '[i]nterests are not considered 'adverse' merely because it is possible to conceive a set of circumstances under which they might clash.' 336 B.R. at 672, quoting In re Leslie Fay Companies, Inc., 175 B.R. 525, 532 (Bankr. S.D.N.Y. 1994). As another court colorfully put it, 'horrible imaginings alone cannot be allowed to carry the day.' Martin, 817 F.2d at 183.

In evaluating potential conflicts, both counsel and the court must take care to recognize the source of potential conflicts and anticipate the likelihood that they will mature into interests that actually conflict. Of course, the line between potential and actual conflicts is not always a clear one, and the line may shift over time. Thus, the Adelphia court had no problem with multiple representation by debtors' counsel until circumstances changed and objections were raised. 336 B.R. at 672. But as that court also noted, conflicted counsel must be cautious to avoid any actions that might amount to 'tilting the playing field.' Id. at 673.

Timing of Conflict Resolution

Ideally, counsel for multiple debtors would identify all of the potential conflicts arising from such representation, anticipate the future development of those conflicts, and limit representation of the debtors accordingly from the outset. In cases of any complexity, however, this is beyond the capability of any practitioner, no matter how careful. Moreover, overreacting to potential conflicts might tend to discourage multiple representation to the extent that cases could not be filed in any kind of an efficient, cost-effective manner. Therefore, counsel must thoroughly perform due diligence at the outset of the engagement, but the task does not end there. Counsel should be attuned to developing conflicts as the case proceeds and be prepared to resolve them in advance of the inevitable objections by antagonistic parties. It is likely that courts will be appreciative of counsel's taking the initiative to raise and resolve conflict issues as they develop, to avoid the complications that inevitably result in trying to deal with such matters after the fact.

Prevention vs. Damage Control

Identifying, anticipating, and resolving potential conflicts is difficult, but not nearly as difficult as facing disqualification or, even worse, denial of compensation, long after a case is filed, because of conflicts. Therefore, debtors' counsel must invest the necessary time and effort in dealing with conflict issues at the very beginning of the case. A thorough system of dealing with conflicts in multiple debtor cases would include at least the following steps:

• Identify all conflicts among the debtor entities, actual or potential, before even undertaking the engagement. Inter-debtor conflicts that are sufficiently clear and unavoidable may demand separate counsel for the affected debtors. It is far better to start the case that way than to attempt damage control after the fact.
• Evaluate the inter-debtor relationships and the likely conflicts that might arise during the course of the case. This will require some careful analysis and an attempt, to some extent, to predict the future. Nevertheless, it is essential. In cases involving dozens or even hundreds of debtors, this will be no small task, but it cannot be avoided.
• Anticipate how the case dynamics might play out over time. This will include consideration of creditor groups that may have strongly differing interests involving the various debtor entities. Counsel must recognize that these case dynamics cannot be controlled by the debtors and can be pushed in any number of directions by the creditors.
• Disclose all potential conflicts, no matter how unlikely they seem to come to fruition. While disclosure is not a panacea, it will help get conflict issues resolved early and greatly reduce counsel's risk of incurring the wrath of creditors and the court.
• Monitor potential conflicts as the case progresses. Identifying and deal-ing with conflicts as soon as they become apparent, by disclosure and by proposing means of dealing with them, such as the use of special counsel, can minimize the otherwise unpleasant consequences of being caught in a conflict.
• Be Realistic about the nature and significance of conflicts. Counsel should never underestimate the seriousness of conflicts but, at the same time, should remain realistic and practical, to avoid overreacting. In this way the proper balance of interests in the system can be maintained.

Jack L. Smith is a partner at Holland & Hart LLP in Denver. A member of this newsletter's Board of Editors, he may be reached at [email protected].

The complex structure of modern corporate entities presents unique challenges when it comes time for a Chapter 11 filing. In addition to facing the fundamental questions of whether Chapter 11 is the right course, when it should be filed, and what the ultimate reorganization strategy should be, management and its counsel must grapple with how to manage a multiple debtor filing. For example, which entities should file? How should the filings be timed? How can the separate interests and obligations of each entity be respected and yet be coordinated in such a way as to make reorganization of the overall enterprise manageable from a practical standpoint? The widely accepted approach is to implement an essentially simultaneous filing on behalf of most or all of the entities in the corporate family. In the interest of efficiency and cost control, a single set of debtors' counsel most often represents all the filing entities, with each of the individual cases jointly administered under a common umbrella.

The Adelphia Dilemma

Both the efficiencies and complexities of multiple debtor representation by a single law firm are illustrated in a recent decision by the Bankruptcy Court for the Southern District of New York in the Adelphia Communications cases. In one of the more spectacular corporate crises in recent years, Adelphia, the large communications and entertainment conglomerate beset by financial distress and scandal, plunged into Chapter 11 with petitions filed by the corporate parent and 230 related entities, all of which were represented by a single law firm in joint administration of all of the cases. After working the cases for over 3 years, debtors' counsel became the target of a motion to disqualify by a creditor group, based primarily on the inter-debtor disputes among certain of the debtor entities. In In re Adelphia Communications Corp., 336 B.R. 610 (Bankr. S.D.N.Y. 2006) the court considered the inescapable conflicts between the interests of various debtors (and their creditors) and came up with a practical solution to the problem.

While the court was not at all critical of debtors' counsel, recognizing the lack of any objection to its multiple representation for years, the court concluded that 'changed circumstances' created conflicts that could not be avoided. Noting that 'the presence of inter-company claims between debtors represented by the same counsel does not automatically warrant the disqualification of that counsel,' the court used a 'fact-driven approach' to decide how to remedy the conflict. Id. at 672-673. Rather than disqualifying debtors' counsel outright as counsel for the affected debtors, the court reached the practical result of precluding counsel from actively participating in the inter-debtor disputes. In an effort to strike just the right balance, the court made an unusual distinction, noting that counsel could 'continue to act as a facilitator to privately try to assist the creditor groups ' to reach a settlement' but would 'have to refrain from 'going public'; from being an advocate for either side; and from taking any steps that might be regarded by any of the feuding parties as tilting the playing field.' Id. at 673.

This decision illustrates how courts have tried to find ways to satisfy the limits on professional retention set by the Bankruptcy Code, as well as state ethical rules, while not crippling the reorganization process with endless sets of attorneys. On one hand, it is obvious that a law firm cannot litigate or negotiate against itself on behalf of different clients, even if they are members of the same corporate enterprise. On the other hand, a system in which the 231 separate Adelphia entities were each required to be represented by separate counsel would collapse under its own weight. To better understand the challenge of navigating through this minefield of conflicts, it is necessary to consider both the underlying legal framework and the case law that has developed to deal with it.

The Framework

Debtors' counsel must meet the two-pronged test of 11 U.S.C. ' 327(a) ' counsel must be 'disinterested' (as defined by ' 101(14)) and must 'not hold or represent an interest adverse to the estate.' While disinterestedness seems to focus on the personal interests of the person involved (eg, as a creditor, equity holder, or insider), the adverse interest prong makes it clear that debtors' counsel may not represent an interest adverse to the estate of each debtor it is representing. The latter prohibition is softened by ' 327(c), which precludes disqualification of debtors' counsel solely because that counsel represents a creditor, as long as there is no objection. If there is an objection, however, the court must disapprove that counsel's employment if there is an actual conflict of interest. Rule 2014, F.R.B.P., requires initial disclosure of all of counsel's 'connections' with the debtor and any other parties in the case, including their attorneys and accounts, as well as all personnel in the United States Trustee's office. For a large firm in a large case, identification and disclosure of all of these 'connections' can be a daunting task.

Of course, co-existing with the Code's restrictions on conflicts are the state ethical rules that bind all practicing lawyers. Rule 1.7 of the ABA Model Rules of Professional Conduct imposes the basic prohibition of conflicts, that '[a] lawyer shall not represent a client if the representation of that client will be directly adverse to another client' and that '[a] lawyer shall not represent a client if the representation of that client may be materially limited by the lawyer's responsibilities to another client.' The only exceptions require consent, and in the fiduciary, multi-party context of bankruptcy cases conflict waivers are not a viable option.

Taken together, these limits frequently clash with the distinct advantages of multiple debtor representation in bankruptcy cases ' efficiency, economy, and coordination of the common interests of debtors and creditors. Courts have generally tried to avoid rigid black and white applications of the conflict restrictions and have instead examined the facts of each case and found ways to balance these competing interests.

No Per Se Rule

While courts have tended to strictly apply the requirement of disinterestedness, they have been more flexible in applying the adverse representation restriction. The more rigid approach, represented by cases such as In re Lee, 94 B.R. 172 (Bankr. C.D. Cal. 1988) (imposing a presumption of impropriety of multiple debtor representation in certain circumstances), and In re Ginco, Inc., 105 B.R. 620 (D. Colo. 1988) (applying the restriction literally and rejecting a 'wait and see' approach) have given way to a fact-intensive analysis that provides debtors' counsel with more flexibility.

The Case-by-Case Analysis

While far from uniform, the case law addressing conflicts (in multiple debtor and other contexts) has established several principles that have gained wide acceptance:

• Multiple debtor representation is not judged under a per se rule, but must be evaluated on a case-by-case basis. See, e.g., In re Interwest Business Equipment, Inc., 23 F.3d 311 (10th Cir. 1994); In re BH&P Inc., 949 F.2d 1300 (3d Cir. 1991).
• The court should use its discretion in considering conflicts 'to determine whether the efficiency and economy which may favor multiple representation must yield to competing concerns affecting fairness to all parties involved and protection of the integrity of the bankruptcy process.' BH&P, 949 F.2d at 1316; see also Harold & Williams Development Co., 977 F.2d 906 (4th Cir. 1992) (court should weigh potential conflicts against potential advantages); In re Coal River Resources, Inc., 321 B.R. 184 (W.D.Va. 2005) (factual analysis of inter-debtor conlficts required).
• The existence of inter-debtor claims does not necessarily disqualify common debtors' counsel. Interwest; BH&P; In re Global Marine, Inc., 108 B.R. 998 (Bankr. S.D. Tex. 1987).
• The appearance (as opposed to existence) of a conflict may not require disqualification. In re Marvel Entertainment Group, Inc., 140 F.3d 463, 476 (3d Cir. 1998). But see In re Martin, 817 F.2d 175, 180 (1st Cir. 1987) ('Section 327 is intended ' to address the appearance of impropriety as much as its substance').
• Disapproval or disqualification is not always required. Global Marine, 108 B.R. at 1004 (special counsel for particular matters); Adelphia, 336 B.R. at 673 (limitation on taking active role in specific inter-debtor disputes).
• Disclosure is essential. BH&P, 949 F.3d at 1317 ('It is not . . . the obligation of the bankruptcy court to search the record for possible conflicts of interest. That obligation belongs to the party who seeks employment by the estate ' '); In re Roberts, 75 B.R. 402 (D. Utah 1987).

Potential vs. Actual Conflict

Some would debate whether there is any ethical difference between a potential conflict and an actual conflict. See Ginco, 105 B.R. at 621-622 (potential conflicts equally disqualifying). Nevertheless, in attempting to accommodate the competing interests in the bankruptcy system, courts have drawn a distinction between actual conflicts and those that are only potential. The unique nature of bankruptcy proceedings, in which the interaction of a multitude of interests is often impossible to predict in advance, almost requires such a distinction.

While courts recognize that an actual conflict normally requires disqualification, they are inclined to commit the evaluation of potential conflicts to the discretion of the court. Marvel Entertainment, 140 F.3d at 477; BH&P, 949 F.2d at 1317. The determination of whether a potential conflict requires disqualification (or some other remedy) necessarily requires a fact intensive analysis. See Martin, 817 F.2d at 182 (in the context of evaluating a secured retainer agreement, 'the court should consider the full panoply of events and elements'). As stated by the Adelphia court, '[i]nterests are not considered 'adverse' merely because it is possible to conceive a set of circumstances under which they might clash.' 336 B.R. at 672, quoting In re Leslie Fay Companies, Inc., 175 B.R. 525, 532 (Bankr. S.D.N.Y. 1994). As another court colorfully put it, 'horrible imaginings alone cannot be allowed to carry the day.' Martin, 817 F.2d at 183.

In evaluating potential conflicts, both counsel and the court must take care to recognize the source of potential conflicts and anticipate the likelihood that they will mature into interests that actually conflict. Of course, the line between potential and actual conflicts is not always a clear one, and the line may shift over time. Thus, the Adelphia court had no problem with multiple representation by debtors' counsel until circumstances changed and objections were raised. 336 B.R. at 672. But as that court also noted, conflicted counsel must be cautious to avoid any actions that might amount to 'tilting the playing field.' Id. at 673.

Timing of Conflict Resolution

Ideally, counsel for multiple debtors would identify all of the potential conflicts arising from such representation, anticipate the future development of those conflicts, and limit representation of the debtors accordingly from the outset. In cases of any complexity, however, this is beyond the capability of any practitioner, no matter how careful. Moreover, overreacting to potential conflicts might tend to discourage multiple representation to the extent that cases could not be filed in any kind of an efficient, cost-effective manner. Therefore, counsel must thoroughly perform due diligence at the outset of the engagement, but the task does not end there. Counsel should be attuned to developing conflicts as the case proceeds and be prepared to resolve them in advance of the inevitable objections by antagonistic parties. It is likely that courts will be appreciative of counsel's taking the initiative to raise and resolve conflict issues as they develop, to avoid the complications that inevitably result in trying to deal with such matters after the fact.

Prevention vs. Damage Control

Identifying, anticipating, and resolving potential conflicts is difficult, but not nearly as difficult as facing disqualification or, even worse, denial of compensation, long after a case is filed, because of conflicts. Therefore, debtors' counsel must invest the necessary time and effort in dealing with conflict issues at the very beginning of the case. A thorough system of dealing with conflicts in multiple debtor cases would include at least the following steps:

• Identify all conflicts among the debtor entities, actual or potential, before even undertaking the engagement. Inter-debtor conflicts that are sufficiently clear and unavoidable may demand separate counsel for the affected debtors. It is far better to start the case that way than to attempt damage control after the fact.
• Evaluate the inter-debtor relationships and the likely conflicts that might arise during the course of the case. This will require some careful analysis and an attempt, to some extent, to predict the future. Nevertheless, it is essential. In cases involving dozens or even hundreds of debtors, this will be no small task, but it cannot be avoided.
• Anticipate how the case dynamics might play out over time. This will include consideration of creditor groups that may have strongly differing interests involving the various debtor entities. Counsel must recognize that these case dynamics cannot be controlled by the debtors and can be pushed in any number of directions by the creditors.
• Disclose all potential conflicts, no matter how unlikely they seem to come to fruition. While disclosure is not a panacea, it will help get conflict issues resolved early and greatly reduce counsel's risk of incurring the wrath of creditors and the court.
• Monitor potential conflicts as the case progresses. Identifying and deal-ing with conflicts as soon as they become apparent, by disclosure and by proposing means of dealing with them, such as the use of special counsel, can minimize the otherwise unpleasant consequences of being caught in a conflict.
• Be Realistic about the nature and significance of conflicts. Counsel should never underestimate the seriousness of conflicts but, at the same time, should remain realistic and practical, to avoid overreacting. In this way the proper balance of interests in the system can be maintained.

Jack L. Smith is a partner at Holland & Hart LLP in Denver. A member of this newsletter's Board of Editors, he may be reached at [email protected].