Third Circuit Rejects Side-Switching Disqualification Claim

The Third Circuit recently affirmed the bankruptcy court's approved retention of the debtor's counsel ("S") when that "law firm dropped an existing client to avoid conflicts that would prevent it from taking on a more lucrative client [i.e., the debtor]." In re Boy Scouts of America, 2022 WL 1634643, *7 (3d Cir. May 24, 2022) (BSA). According to the court, there were "not enough facts to put [the so-called "hot potato" doctrine] into play" and disqualify S under the Rules of Professional Conduct. Id. Moreover, because S's representation of the debtor "did not prejudice [the objecting former client], but disqualifying [S] would have been a significant detriment to [the debtor], it was well within the [bankruptcy] court's discretion to determine that the drastic remedy of disqualification was unnecessary." Id. Particular facts of the case, highlighted by the court, supported its finding that there was "nowhere close to an abuse of discretion" by the bankruptcy court's applying Bankruptcy Code (Code) §327(a) to approve S's retention.

Relevance

Conflicts of interest among clients are a chronic problem for law firms with many clients. How law firms address the problem — and they must — is what the BSA decision shows. The decision also shows the problems law firms have in balancing their ethical obligations against the desire for more business. In BSA, S was held to have acted properly, but one client still felt "jilted," if not betrayed. Id. at *1.

Facts

S had represented an insurer ("C") "in obtaining backup coverage from reinsurers of [C's] policies." Id. at *1. S "also represented the [debtor] in its restructuring efforts under the… Code…." Id. The debtor "made coverage claims under [C's] policies, [but] did so while represented by another firm ["H"]," excluding S from that work. S's "reinsurance services for [C] were limited to claims made against the reinsurers (and not [the debtor])." "That representation did not extend to the underlying direct insurance issued by [C] to [the debtor]." Id. Still, C "claimed a conflict concerning [S's] representation of it [and the debtor]," objecting to the debtor's motion to retain S in the bankruptcy court. C's objection "only concerned the ability of [S] to represent [the debtor]," but the bankruptcy court found that S "could do so effectively" after approving S's retention.