Avoiding Malpractice Conflicts Of Interest In Bankruptcy ...

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  • 1. Page 1 of 23 Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations © 2001 Thompson, Coe, Cousins & Irons, LLP Alison H. Moore May 17, 2001 In grievance and legal malpractice proceedings, alleged conflicts of interest are among the most common, and often the most troublesome, claims. This is particularly true in bankruptcy representations. In fact, a recent survey of 80 percent of all bankruptcy judges concluded that conflicts of interest issues are quot;prevalentquot; in bankruptcy practice. Marie Leary, FJC Survey on Attorney Ethics Finds Most Judges Satisfied With Rules, 19-FEB Am. Bankr. Inst. J. 17 (2000). In addition to the risk of denial or ordered forfeiture of fees under the Bankruptcy Code, the Texas Supreme Court's recent opinion in Burrow v. Arce, 997 S.W.2d 229 (Tex. 1999), recognizes a fee disgorgement claim against attorneys for breach of fiduciary duty, including conflicts of interest, even when no actual damage can be shown. This recent development has lent fuel to the legal malpractice fire, as it opens every aspect of a representation to an after-the-fact quot;conflicts check,quot; judging legal representation against a requirement of quot;absolute and perfect candor, openness and honesty, and the absence of any concealment or deception.quot; Perez v. Kirk & Carrigan, 822 S.W.2d 261, 265 (Tex. App. - Corpus Christi 1991, writ denied). Legal malpractice claims, breach of fiduciary duty claims, and grievance complaints arising from conflicts of interest can be avoided by understanding of the identity of the client, the duties owed to the client and to third parties, the issues that give rise to potential conflicts in the bankruptcy context, and the required disclosures and permissible waivers. II. THE STANDARDS Beyond good conscience and high morals, there are several sources of guidance for a lawyer's professional conduct. Conflict of interest issues are evaluated and resolved under the applicable disciplinary rules and under the Bankruptcy Code itself. Because the crux of this article is the identification and avoidance of conflicts of interest that might give rise to a legal malpractice or breach of fiduciary duty, this article focuses on the conflict analysis in the cases cited, regardless of whether the issue arose in a disqualification proceeding, a malpractice action, or in the approval of employment or fees by a bankruptcy court. A. The Disciplinary Rules 1. The Model Code and The Model Rules. The ABA Model Code of Professional Responsibility (the quot;Model Codequot;) and the ABA Model Rules of Professional Conduct (the quot;Model Rulesquot;) set forth the ABA's minimum standards for a lawyer's conduct. Although a majority of states have replaced the Model Code with the Model Rules as the applicable standard for attorney conduct, courts continue to look to both standards in evaluating conflict issues. City of El Paso v. Salas-Porras Soule , 6 F.Supp.2d 616, 620 (W.D. Tex. 1988). The Model Rules address conflicts of interest in the context of preserving client confidences, required disclosures, and competing interests. For example, Model Rule 1.7(b) provides for the disqualification of an attorney where a representation may be quot;materially limited by the lawyer's responsibilities to
  • 2. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 2 of 23 another client or to a third person, or by the lawyer's own interests.quot; However, the rule permits an attorney to take on or continue the representation if the attorney quot;reasonably believesquot; that the client's interests will not be harmed, and if the client consents. In bankruptcy representations, this last contingency should be amended to read quot;if the client and the bankruptcy court consent.quot; 2. Appearance of Impropriety. With respect to conflict issues, one of the most notable differences between the Model Code and the Model Rules is the absence in the Rules of any prohibition against quot;even the appearance of impropriety,quot; a subjective standard originally set forth in the Model Code. Even so, result-oriented courts continue to rely on this analysis in evaluating conflicts. See, e.g., City of El Paso v. Salas-Porras Soule, 6 F. Supp.2d 616, 625, n. 10 (W.D. Tex. 1998)(quot;Although the Model Code does not specifically address conflict of interest concerns involving former clients, it does require an attorney to preserve the confidences of his client and to avoid even the appearance of impropriety.quot;) 3. The Texas Disciplinary Rules of Professional Conduct. Typically, federal district courts adopt the standard of conduct adopted by the highest court in the state; in turn, bankruptcy courts follow the standard of conduct adopted by the referring district courts. 28 U.S.C. §151. In Texas, attorneys' conduct is governed by the Texas Disciplinary Rules of Professional Conduct (quot;TDRPCquot;). Generally, the TDRPC follow the Model Rules; however, there are significant departures. Pertinent differences are mentioned herein. 4. Disciplinary Rules Create No Cause of Action. Both the TDRPC and the Model Rules explicitly disclaim an intention to create a cause of action against attorneys who fail to meet the ethical standards. quot;These rules do not undertake to define standards of civil liability of lawyers for professional conduct. Violations of a rule do not give rise to a private cause of action nor does it create any presumption that a legal duty to a client has been breached.quot; TDRPC, Preamble: Scope 15; see also, Model Rules, Preamble 6. Texas courts have consistently agreed with these disclaimers. quot;While private persons can file complaints based on violations of the rules, the only party who has standing to enforce these rules is the State Bar. Accordingly, we overrule [plaintiff's] second point of error to the extent that it asserts the existence of a private right of action for a violation of State Bar Rules.quot; Home Advantage, Inc. v. Shaw, Bailey & Shaw, P.C. , No. 07-97-0309-CV, 1998 WL 487042, at *3 (Tex.App. -- Amarillo Aug. 19, 1998, no writ history)(not designated for publication); see also, Martin v. Trevino, 578 S.W.2d 763, 770 (Civ.App. -- Corpus Christi 1978, writ ref'd n.r.e.)(violations of the Code of Professional Responsibility do not give rise to a private cause of action). 5. Disciplinary Rules Are Used for Guidance. Even though ethics rules will not be used to create a cause of action, expert witnesses in legal malpractice cases regularly testify that the TDRPC represent the applicable standard of care for an attorney practicing in Texas. In a procedural disqualification case, the Texas Supreme Court approved the practice of referring to the rules for guidance, even after noting that the rules were not intended to set a standard for procedural decisions. In re Meador, 968 S.W.2d 346, 350 (Tex. 1998); see
  • 3. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 3 of 23 also, Anderson Producing Inc., v. Koch Oil Co., 929 S.W.2d 416, 421 (Tex. 1996)(TDRPC establish standard of attorney conduct and can be used for guidance in procedural disqualification determinations). B. National Standards The 5th Circuit has held that, at least in disqualification proceedings, quot;national standards,quot; including the Model Rules, local court rules, and case law, as well as the TDRPC, should be applied in a conflicts analysis. In re Dresser Indus., Inc., 972 F.2d 540, 543 (5th Cir. 1992); accord, In re American Airlines, Inc., 972 F.2d 605, 610 (5th Cir. 1992); see also, FDIC v. United States Fire Ins. Co., 50 F.3d 1304, 1312 (5th Cir. 1995)(holding that numerous ethical rules are relevant to a federal inquiry regarding the disqualification of counsel). C. Bankruptcy Rules Conflicts of interest rules are examined more rigorously in the bankruptcy context, most often with respect to professionals retained in business bankruptcy proceedings. Conflicting interests are inevitable in such cases, in which multiple parties compete for the same limited dollars. Often, the quot;guidelinesquot; set forth in the various disciplinary rules are so broad that they are of little assistance in evaluating the propriety of a bankruptcy representation. Even under the provisions of the Bankruptcy Code, however, the cases reflect the fact intensive nature of a conflicts analysis. 1. 11 U.S.C. § 327. Section 327 of the Bankruptcy Code provides a heightened standard in evaluating conflicts, and is written to protect debtors, and their creditors, from attorneys whose interests conflict with the bankruptcy estate. § 327(a) includes dual requirements: an attorney employed by the Trustee quot;must not hold or represent an interest adverse to the estate,quot; and further, must be quot;disinterested.quot; 11 U.S.C. § 327(a). See 11 U.S.C. § 101(14)(E)(1994)(defining quot;disinterested personquot;); see also, In re Red Lion, Inc., 166 B.R. 296, 298 (Bankr. S.D. Tex. 1994)(emphasizing that § 327 contains dual requirements). The Bankruptcy Code requirements of disinterestedness and absence of adverse interest are intended to avoid divided loyalties and to ensure the fulfillment of fiduciary duties. 2. Bankruptcy Code Enforcement. The Code enforces adherence to the quot;disinterestedquot; and no adverse interest requirements with the threat of denial of compensation for a professional who is not disinterested, or who holds or represents an interest that is adverse to the estate. 11 U.S.C. § 328(c); 11 U.S.C. § 1103(b). The allowance or disallowance of fees is an issue that rests within the discretion of the bankruptcy court. These determinations can be made at the time employment is approved, or even after the fact, on a court's own motion or when the attorney seeks court approval of compensation for services previously rendered. In terms of the reasonableness of fees charged, the Fifth Circuit has held, however, that the bankruptcy court's prior approval of the terms of an engagement pursuant to § 327 constitutes a finding that those terms are reasonable. Matter of National Gypsum Co., 123 F.3d 861 (5th Cir. 1997). Therefore, the bankruptcy court's review of an attorney's final fee application is
  • 4. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 4 of 23 limited to whether any subsequent unanticipated, or previously unknown circumstances or events affected the reasonableness of the agreement. 3. Actual Versus Potential Conflicts Under the Bankruptcy Code. Section 327 of the Bankruptcy Code clearly prohibits attorneys from representation where an actual conflict of interest exists. Potential conflicts, however, are a different question. While some courts have held that even a potential conflict will disqualify an attorney from a bankruptcy representation, other courts have applied a more liberal standard. Compare In re Kendavis Indus. Int'l., 91 B.R. 742, 754 (Bankr. N.D. Tex. 1988)(all conflicts are actual and potential conflicts do not exist) with In re Global Marine, Inc., 108 B.R. 998, 1004 (Bankr. S.D. Tex. 1987)(attorney may be disqualified only for actual conflicts) and In re S.I. Acquisition, 58 B.R. 454, 462 (Bankr. W.D. Tex. 1986)(equity justified joint representation of affiliated entities). Unfortunately, the plethora of cases that discuss the distinction between actual and potential conflicts in evaluating an attorney's bankruptcy representation provides little guidance beyond demonstrating the fact intensive nature of a conflicts analysis in every circumstance. Whether an identified conflict is actual or potential, full disclosure is required under the Bankruptcy Code and Rules. 4. Best Interests of the Estate. There is some limited authority holding that 11 U.S.C. § 105, which provides bankruptcy courts with the discretionary power to enter orders quot;necessary or appropriatequot; to carry out the purposes of the Bankruptcy Code, permits courts to deviate from the requirements of § 327, particularly in smaller bankruptcy cases. In re PHM Credit Corp., 110 B.R. 284, 288 (Bankr. E.D. Mich. 1990). In this regard, various factors have impacted a conflicts analysis, including: 1.) the debtor's ability to reorganize; 2.) the economic effect of disqualifying counsel; 3.) the likelihood that a potential conflict will materialize or develop to the point that disqualification would be required in the future; 4.) fairness and equity. See, e.g., In re O'Conner, 52 B.R. 892, 897 (Bankr. W.D. Okla. 1985). Despite these cases, the majority of courts addressing the issue have held that § 105 cannot be used to circumvent the clear prohibitions set forth in § 327. In re Palm Coast, 101 F.3d 253 (2nd Cir. 1996); In re Middleton Arms, 119 B.R. 131 (Bankr. M.D. Tenn. 1990). III. ANALYZING CONFLICTS Case law addressing conflicts of interest reveals the factual nature of the analysis. The existence or absence of a conflict may be determined as a matter of law, but only where the surrounding facts and circumstances are undisputed. See, e.g., FDIC v. U.S. Fire Ins. Co., 50 F.3d 1304 (5th Cir. 1995). Otherwise the question of whether a conflict of interest exists is a fact question for the court . . . or the jury. A conflict exists if an attorney must choose between advancing a client's interest and advancing other
  • 5. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 5 of 23 interests to the detriment of his client's interest. See, e.g., In re Kuykendahl Place Associates, Ltd., 112 B.R. 847 (Bankr. S.D. Tex. 1989). In order to evaluate whether a conflict exists, a lawyer must know who the client is, and what duties arise from that representation. A. Who is the Client? An attorney-client relationship arises from the agreement to render professional services for a client. Yaklin v. Glusing, Sharpe & Krueger, 875 S.W.2d 380, 383 (Tex. App. - Corpus Christi 1994, no writ). An attorney-client relationship is, by definition, a fiduciary relationship. Moreover, an attorney's fiduciary responsibilities may arise even during preliminary consultations regarding possible representation. Nolan v. Foreman, 665 F.2d 738, 739 n.3 (5th Cir. 1982). 1. Implied Attorney-Client Relationships. Even absent an express agreement, Texas courts have held, as have courts in virtually every state, that attorney- client relationships can be inferred based upon the conduct of the parties. Banc One Capital Partners Corp. v. Kneipper, 67 F.3d 1187, 1198 (5th Cir. 1995). No formal contract is required; in fact, the putative client can even be represented by other counsel. See Vinson & Elkins v. Moran, 946 S.W.2d 381, 404-406 (Tex.App. -Houston [14th Dist.] 1997, writ dism'd by agr.)(finding attorney-client relationship between attorneys for estate's executors and estate beneficiaries based upon extensive communication and interaction with beneficiaries); In re Legal Econometrics, Inc., No. 3-95-CV-0457-R, 1997 WL 560617, at *3 (N.D. Tex. 1997)(finding an attorney-client relationship existed based on the expectations of the 'client' and extensive communications between the firm and the 'client'). Factors that have been considered in determining whether an express or implied attorney-client relationship exists include the communication of confidential information, In re Evaristo Reyes-Requana, 926 F.2d 1423 (5th Cir. 1991), the existence of a relationship of trust and confidence, Perillo v. Johnson, 205 F.3d 775 (5th Cir. 2000)(attorney previously represented client and served as her surrogate father at her wedding); billing and payment for legal services, City of El Paso v. Salas-Porras Soule, 6 F.Supp.2d (W.D. Tex. 1998); and representation of one party by another attorney, The First National Bank of Durant v. Lane & Douglass, 142 F.3d 802 (5th Cir. 1998). 2. Implied Fiduciary Relationships. In addition to formal fiduciary relationships, courts have held that fiduciary relationships exist when the parties are quot;under a duty to act upon matters within the scope of their relation,quot; and the relationship is one of trust and confidence. ARA Automotive Group v. Central Garage, Inc., 124 F.3d 720, 723 (5th Cir. 1997). Such informal fiduciary relationships may arise from quot;a domestic or purely personal relationship of trust and confidence, generally called a confidential relationship.quot; Assoc. Indem. Corp. v. Contracting, Inc., 964 S.W.2d 276, 287 (Tex. 1998). Because of the quot;extraordinary dutiesquot; imposed upon a fiduciary, however, a fiduciary duty quot;will not be lightly created,quot; and courts look carefully at the surrounding facts and circumstances. Crim Truck & Tractor v. Navistar Int'l, 823 S.W.2d 591, 594 (Tex. 1992). 3. Creditors and Creditor Committees as Clients. In most creditor
  • 6. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 6 of 23 representations, a lawyer's ethical obligations run directly to the creditor. Lawyers representing creditors' committees face a slightly more involved inquiry arising from the differing interests of the committee constituents. Courts generally find that the committee itself constitutes an entity that is separate and distinct from its members. Lawyers employed by such committees therefore represent the committee, and are obliged to serve the interests of the committee and the class of creditors generally, not the interests of individual creditors. See In re EBP, Inc., 171 B.R. 601, 602 (Bankr. N.D. Ohio 1994) (committee lawyer represents entire class of creditors). It is for this reason that attorneys hired by individual members of a creditors' committee may not recover professional fees from the estate. In re Firstplus Financial, Inc., 254 B.R. 888 (Bankr. N.D. Tex. 2000). 4. Trustees, Debtors, and Debtors-in-Possession as Clients. a. Pre-petition vs. post-petition. In pre-petition debtor representation, the client is typically the individual or entity contemplating bankruptcy. The lawyer's legitimate quot;bankruptcy planningquot; advice is intended to advance the interests of the client over the future interests of the bankruptcy estate and creditors. However, this analysis changes the moment the bankruptcy petition is filed. At that point, the lawyer has a quot;newquot; client, the debtor or the debtor-in-possession, who, like trustees, owes fiduciary duties to the bankruptcy estate and the creditors. Commodity Futures Trading Comm'n v. Weintraub, 471 U.S. 343, 355 (1985)(noting debtors-in-possession owe obligations similar to those of trustee). As one commentator describes it, professionals appointed under § 327 quot;work for the debtor-in-possession, but are responsible for working in the best interest of the estate.quot; Nancy Rapoport, The Need for New Bankruptcy Ethics Rules: How Can quot;One Size Fits Allquot; Fit Anybody? 10 No. 1 Prof. Law. 20, 20 (Fall 1998). Post-petition, the debtor's lawyer must advance and protect the interests of the estate and the creditors over those of the debtor, a representation that conflicts, or at least potentially conflicts, with the prior pre-petition representation. Diamond Lumber, Inc. v. Unsecured Creditors' Comm. , 88 B.R. 773 (Bankr. N.D. Tex. 1988). b. Attorney as Fiduciary for Estate. In addition to representing a fiduciary, many courts hold that an attorney employed by a debtor- in-possession or trustee actually becomes a fiduciary for the bankruptcy estate as well. Hansen, Jones & Leta, P.C. v. Segal , 220 B.R. B.R. 434 (Bankr. C.D. Utah 1998). This imposition of a fiduciary duty is inconsistent with an attorney's representation of fiduciaries in other contexts. See ABA Comm. on Ethics and Professional Responsibility, Formal Op. 380 (1994)(noting that a lawyer for a fiduciary does not incur duties to the client's beneficiary). Nonetheless bankruptcy courts have justified this conclusion by holding that the bankruptcy estate itself is actually the client. See In re Delta Petroleum (P.R.), Ltd., 193 B.R. 99, 111 (D.P.R. 1996)(holding that the estate, not the trustee, is the
  • 7. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 7 of 23 lawyer's client); In re El San Juan Hotel Corp., 149 B.R. 263, 272 (D.P.R. 1992) aff'd., 7 F.3d 218 (1st Cir. 1993)(finding trustee's attorney to be estate's attorney with fiduciary duties as such). Other courts have simply held that the attorney becomes a fiduciary to the estate by virtue of the debtor-in-possession's or trustee's status as fiduciary. See In re Whitney Place Partners, 147 B.R. 619, 620 (Bankr. N.D. Ga. 1992)(noting that both debtor-in-possession and attorney for debtor-in-possession are estate fiduciaries); In re Gregory, 214 B.R. 570, 576 (S.D. Tex. 1997)(discussing attorney's obligations to ensure debtor-in-possession acts in best interest of estate). Courts in a few jurisdictions have rejected the idea that an attorney owes a direct fiduciary duty to the estate. See In re Sidco, Inc., 173 B.R. 194, 196 (E.D. Cal. 1994)(explicitly rejecting idea that debtor-in-possession's lawyer has a duty to estate). 5. Entities as Clients. In representing corporate entities or partnerships, the potential for conflicts arises from the fact that a lawyer's client is the entity itself, not any related companies and not individual officers, directors, shareholders or partners. Marshall v. Quinn-L Equities, Inc., 704 F. Supp. 1384 (N.D. Tex. 1988)(attorney representing limited partnership did not represent individual investors); FDIC v. Howse, 802 F. Supp. 1554 (S. D. Tex. 1992) (attorney representing corporation owed no duty to corporate director). See also, Model Rule 1.13; TDRPC 1.12(a). Representation of related entities is an area for serious consideration of the loyalties owed, particularly with respect to debtor's counsel. quot;The duty and loyalty of the attorney is to the debtor and not to the partners or individuals that control the partners of the Debtor.quot; In re Kuykendahl Place Associates, Ltd., 112 B.R. 847, 850 (Bankr. S.D. Tex. 1989)(finding conflict arising from representation of general partner in limited partnership). B. The Duties Owed 1. As an Attorney. An attorney owes a duty to act as a reasonably prudent attorney under the facts and circumstances. Cosgrove v. Grimes, 774 S.W.2d 662, 664-65 (Tex. 1989). quot;If an attorney makes a decision which a reasonably prudent attorney could make under the same or similar circumstance, it is not an act of negligence even if the result is undesirable.quot; Id. 2. As a Fiduciary. The attorney-client relationship is also recognized as a formal fiduciary relationship. SMWNPF Holdings, Inc. v. Devore, 165 F.3d 360, 365 (5th Cir. 1999); Willis v. Maverick, 760 S.W.2d 642, 645 (Tex. 1988). Once a plaintiff proves the existence of a fiduciary duty, the burden of proof shifts to the defendant to prove that the underlying transaction was fair and equitable, that the defendant acted in the utmost good faith and exercised the most scrupulous honesty, and that the defendant did not place himself in a position in which his personal interests conflicted with is obligations as a fiduciary. Burrow v. Arce, 958 S.W.2d 239, 246 (Tex. App. - Houston [14th Dist.] 1997, rev'd on other grounds, 997 S.W.2d 229.
  • 8. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 8 of 23 3. Continuing Duties. A lawyer's fiduciary obligations, as well as the obligation to be competent (of course), continue until the representation has ended. Denkman Assoc. v. International Paper Co., 132 FRD 168, 175, n.21 (M.D. La. 1990)(attorney has continuing duty to disclose conflicts of interest as they arisequot;). Further, certain obligations survive termination of the attorney-client relationship. Pursuant to TDRPC 1.05 and 1.09, an attorney must keep client confidences in perpetuity. Moreover, an attorney is prohibited from representing anyone adverse to a former client on the same or a substantially related matter. TDRPC 1.09. Though waiver of a conflict arising from such continuing duties is allowed in either case, the obligations to the first client control until a fully informed consent can be obtained. 4. The Duty Not to Make Misrepresentations to Non-Clients. In 1999, the Texas Supreme Court joined other jurisdictions in recognizing negligent misrepresentation, as defined in the RESTATEMENT (SECOND) OF TORTS § 552 (1997), as a cause of action that can be raised against an attorney by a third party. McCamish, Martin, Brown & Loeffler v. F.E. Appling Interests, 991 S.W.2d 787, 791 (Tex. 1999). A negligent misrepresentation cause of action requires that the attorney know that the third party is relying on the attorney's representations and, in fact, intend such reliance. quot;Under the tort of negligent misrepresentation, liability is not based on a breach of the duty a professional owes his or her clients or others in privity, but on an independent duty to the non-client based on the professional's manifest awareness of the non-client's reliance on the misrepresentation and the professional's intention that the non- client so rely.quot; Id. at 792. Although the third party's reliance must be justified, most courts agree that reliance is never justified in an adversarial situation. Id. at 794. Other courts have limited liability for negligent misrepresentation to advice given in business transactions, as opposed to, for example, conduct undertaken in litigation. See Robinson v. Omer , 952 S.W.2d 423, 428 (Tenn. 1997). 5. Intentional Torts. A lawyer can be liable for intentionally tortious conduct, such as fraud and conspiracy, for wrongful activities undertaken independently or in concert with a client. Likover v. Sunflower Tourists II, Ltd., 696 S.W.2d 468, 472 (Tex. App. - Houston [1st Dist.] 1985). In addition, a lawyer can be liable for aiding and abetting another in the breach of fiduciary duties. Resolution Trust Corp. v. Bonner, 848 F.Supp. 96 (S.D. Tex 1994); In re C- Power Prods. v. Schiro, 230 B.R. 800 (Bankr. N.D. Tex 1998). 6. Duties to the Court. a. Disciplinary Rules. Both the Model Rules and the TDRPC address attorneys' obligations to the court. TDRPC 1.5(f) requires an attorney to reveal confidential client information when doing so is necessary to comply with TDRPC 3.03, requiring candor towards the tribunal. Those rules prohibit a lawyer from making false statements of material fact to the tribunal, assisting a criminal or fraudulent act by failing to disclose a relevant fact to the tribunal, offering false evidence, or failing to correct or withdraw false evidence. TDRPC 3.03.
  • 9. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 9 of 23 b. Bankruptcy Code and Rules. Attorneys appointed by the bankruptcy court are officers of the court, and as such are fiduciaries. In the matter of Consolidated Bancschares, Inc., 785 F.2d 1249, 1256, n.7 (5th Cir. 1986). (1.) 11 U.S.C. § 327 and § 329. The Bankruptcy Code and Rules require disclosure of the compensation arrangement, as well as all facts that might affect the quot;disinterestednessquot; of a professional, or a possible adversity in the interests represented. The disclosure requirement under Bankruptcy Code § 327 is a tool intended to enable a court to determine if the attorney is, in fact, disinterested and therefore employable. In the matter of Triangle Chemicals, Inc., 697 F.2d 1280, 1286, n.8 (5th Cir. 1986). To that end, attorneys are charged with disclosing all connections, no matter how tenuous, even when the attorneys believe that they truly are disinterested. quot;All the facts that may have bearing on the disinterestedness of a professional must be disclosed. Consistent with the duty placed on the professional, it is the responsibility of the professional, not the court, to make sure that all relevant connections have been brought to light.quot; In re Leslie Fay Companies, Inc., 175 B.R. 525, 533 (Bank. S.D. N.Y. 1994). § 329 requires any attorney representing the debtor to file a statement of the compensation paid or agreed to be paid in contemplation of and in connection with the bankruptcy case. This requirement includes the disclosure of the source of any such compensation. (2.) Fed. R. Bankr. P. 2014. Bankruptcy Rule 2014 requires that an attorney who seeks to represent a debtor must fully disclose at the time the application for employment is made all connections with the debtor, creditors, and other parties in interest. Fed. R. Bankr. P. 2014. All facts that may be relevant to a determination of whether an attorney is disinterested or holds or represents an interest adverse to the debtor's estate must be disclosed to the court. See, e.g., In re Southmark Corp., 181 B.R. 291, 294 (Bankr. N.D. Tex. 1995); Diamond Lumber, Inc. v. Unsecured Creditors' Comm. of Diamond Lumber, Inc., 88 B.R. 773 (N.D. Tex. 1988)(holding that Rule 2014 requires full and complete disclosure). (3.) Fed. R. Bankr. P. 2019. Even though there is no Bankruptcy Court approval required for the representation of creditors in a bankruptcy proceeding, however, Bankruptcy Rule 2019 requires that an
  • 10. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 10 of 23 attorney representing quot;more than one creditor or equity security holderquot; file a verified statement listing the clients, and the general nature of the claim. This rule was promulgated quot;to prevent improper participation in a reorganization by attorneys representing creditors and stockholders.quot; In re I.G. Services, Ltd., 244 B.R. 377 (Bankr. W.D. Tex. 2000) [citations omitted]. Although the failure to comply with the requirements of Rule 2019 could result in the loss of a client's opportunity to be heard (or, in some cases, compensated) in the bankruptcy proceeding, In re American Solar King Corp., 92 B.R. 207, 208 (Bankr. W.D. Tex. 1988), the language of the rule gives the bankruptcy court discretionary latitude in enforcement. 7. Negligent Misrepresentations to the Bankruptcy Court. In In re Ward, 894 F.2d 771 (5th Cir. 1990), the court appeared to recognize a cause of action for negligent misrepresentation to the Bankruptcy Court (at least under Louisiana law), but held that the claim was not actionable under facts and circumstances of that case. The claim arose from the alleged failure by the debtors' prior attorneys (who were not the debtors' bankruptcy counsel) to disclose the omission of a certain judgment from the debtors' schedule of assets. The court held that the law firm had no affirmative duty to disclose the omission to the Bankruptcy Court, because, among other things, the firm did not represent the debtors in the bankruptcy proceeding. The implication that can be drawn from the 5th Circuit's language, however, is that such a cause of action does exist. IV. AREAS WHERE CONFLICTS ARISE There are a myriad of circumstances in which a lawyer's duties to others may conflict with duties owed to a client. The following instances are illustrative of some of the circumstances that can give rise to conflicts of interest in bankruptcy representations. A. Multiple Representations. Conflicts arising from ongoing concurrent representation raise issues relating to an attorney's duty of undivided loyalty. Model Rule 1.7. Any number of multiple representations can, at least potentially, give rise to conflicts of interest. In an interesting opinion, the court in In re Roberts, 46 B.R. 815 (Bankr. D. Utah 1985), includes an extensive listing of bankruptcy cases that analyze alleged conflicts of interest 1. The Model Rules. The Model Rules directly address adverse representation situations in Rules 1.7-1.9. Model Rule 1.7(a) prohibits a representation that will be directly adverse to another client unless both clients consent and the lawyer believes that neither client relationship will be adversely affected. Model Rule 1.7(b) addresses situations where the representation of one client might be materially limited by a lawyer's duties to other clients or third parties. The representation can be undertaken if the client consents after a full disclosure and the attorney believes that the representation will not be adversely affected. In either case, any belief that the representation will be
  • 11. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 11 of 23 adversely affected creates an unwaivable conflict of interest. Id. 2. The TDRPC. Texas Rules 1.06-1.09 generally follow the Model Rules on conflicts arising from multiple representations that are conflicting, with one important difference: TDRPC 1.06 flatly prohibits the representation of adverse parties in litigation. 3. The Bankruptcy Code. Even beyond a showing of quot;disinterestednessquot; and lack of an adverse interest in a bankruptcy representation, the various responsibilities of both the lawyer and the client should be carefully explained, as should the fact that, if a conflict does arise, the estate's interest must prevail over the interests of a debtor. In short, both the lawyer and the client, particularly a debtor client, must be cognizant of the quot;complex web of interdependent duties.quot; See In re Delta Petroleum (P.R.), Ltd., 193 B.R. 99, 110 (D. P.R. 1996); In re Rivers, 167 B.R. 288-301 (Bankr. N.D. Ga.1994). 4. Evolving Representations. Conflicts arising from multiple or adverse representations frequently arise when legal representation quot;evolvesquot; as a proceeding or transaction progresses. SMWNPF Holdings, Inc. v. Devore, 165 F. 3d 360 (5th Cir. 1999); Simpson v. James, 903 F.2d 372 (5th Cir. 1990). Because the obligation to disclose facts that may affect the quot;disinterestedquot; or adverse interest analysis is continuing, developments and events over the course of a bankruptcy proceeding may require additional disclosure to the Bankruptcy Court. It follows that a conflicts analysis must continue throughout the entire representation. In re Diamond Lumber, Inc. 88 B.R. 773, 779 (Bankr. N.D. Tex. 1988); In re Office Products of America, Inc., 136, B.R. 983 (Bankr. W. D. Tex. 1992). 5. Factual Scenarios. a. Representation of Trustee or DIP and Creditors. Although a strict interpretation of section 327(c) appears to allow for the concurrent representation of a creditor and the trustee or debtor-in- possession in the absence of an actual conflict of interest, courts look to the surrounding facts and circumstances to determine whether the representation interferes with the obligation of undivided loyalty and compliance with fiduciary responsibilities. In re Quality Beverage Company, Inc., 216 B.R. 592 (Bankr. S.D. Tex. 1995)(actual conflict created by accounting firm's services for creditors' committee precluded work for Trustee, which had potential preference actions against members of committee). In In re Global Marine, Inc., 108 B.R. 1009 (Bankr. S.D. Tex. 1988), the attorneys represented the debtor, as well as the debtor's parent company and another wholly owned subsidiary of the parent company. The court held that, although various inter-company debts essentially resulted in the attorneys representing both the debtor and at least one creditor, no actual conflict existed; the court did note, however, that it would continue to monitor the potential for conflicts throughout the case. Even in cases in which the bankruptcy court determines that no
  • 12. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 12 of 23 actual conflict exists, it is arguable that TDRPC 1.06(a) precludes the joint representation of a debtor and a creditor, regardless of disclosure or consent: quot;A lawyer shall not represent opposing parties to the same litigation.quot; Although no case addressing specific this point could be located, the question of whether a debtor and creditor are quot;opposing partiesquot; is probably subject to debate. Even if the joint representation of a debtor and a creditor is allowed under the ethical rules and the Bankruptcy Code, the attorney must provide full disclosure and obtain a client's consent, and must have no belief that the interests of either client will be adversely affected. Model Rule 1.7. b. Representation of Two or More Creditors. If the concurrent representation of two or more creditors is in accordance with the ethical rules, there is no prohibition to the representation in a bankruptcy proceeding. 6. DIP Representation. The representation of a DIP or a corporate debtor can be particularly problematic in terms of competing interests in multiple representations. Courts have denied compensation for an attorney's actions taken on behalf of a debtor where a conflict of interest exists, regardless of whether there is a showing of a benefit to the estate. In re Jones, 665 F.2d 60 (5th Cir. 1982). a. Corporations. In bankruptcy, the directors of a corporate debtor- in-possession bear quot;essentially the same fiduciary obligation to creditors and shareholders as would the trustee.quot; Commodity Futures Trading Comm'n. v. Weintraub, 471 U.S. 343, 355 (1985). Conflicts of interest commonly arise in debtor representations, when corporate officers and directors work closely with an attorney in planning and implementing the corporation's bankruptcy proceeding. During that process, informal legal advice relating to the individual interests of an officer or director may give rise to at least an implied attorney-client relationship between the officer or director and the attorney. Under these circumstances, a conflict of interest exists to the extent that the interests of the officer or director conflict with the interests and duties of the debtor. See, e.g., In re Kendavis Industries International, Inc., 91 B.R. 742, 757 (Bankr. N.D. Tex. 1988)(finding that attorneys for DIP were representing interests of debtors' principals to the detriment of estate and creditors); Wiebold Stores, Inc. v. Schottenstein, 131 B.R. 655, 661 (N.D. Ill. 1991)(finding conflict where attorney was assisting directors in connection with representation of corporations). But see, In re Howell, 148 B.R. 269 (Bankr. S.D. Tex. 1992)(allowing attorneys' fees to attorney representing both individual Chapter 11 debtors and their closely held corporation, where unity of interest made dual representation economically reasonable and legally appropriate); see also, In re Huddleston, 120 B.R. 399 (Bankr. E.D. Tex. 1990). b. Partnerships. Conflicts of interest almost always arise from
  • 13. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 13 of 23 multiple representations of partnership entities and individual partners, and such multiple representations are typically disallowed in bankruptcy proceedings. In re W.F. Development Corp., 905 F.2d 883 (5th Cir. 1990), rehearing denied, cert. denied 111 S. Ct. 1311; In re Kendavis Industries Int'l, Inc., 91 B.R. 742 (Bankr. N.D. Tex. 1988). B. Prior Representations. 1. The Model Rules & TDRPC. Model Rule 1.9 and TDRPC 1.09 prohibit an attorney from undertaking a new representation that is adverse to a former client in a matter that is the same or substantially related to a prior matter handled for the former client. These rules rely on the strict confidentiality imposed on a client's information, and the prohibition against the use of this information to a client's disadvantage. See, e.g., TDRPC 1.05(b)(3). The prior representation inquiry includes a two-part showing: a prior attorney-client relationship, either express or implied, and a quot;substantial relationshipquot; between the prior and current representations. In re American Airlines, F.2d 605, 615 (5th Cir. 1992). The quot;substantially relatedquot; standard evolved from case law, which requires quot;painstaking analysis of the facts and precise application of precedent.quot; Id., at 614. In determining whether two matters are substantially related, courts have looked to factors such as similarities between factual circumstances, legal issues raised, nature and extent of the attorney's involvement, the time period of the earlier representation, and the existence of common parties. See, e.g., City of El Paso v. Salas-Porras Soule, 6 F.Supp.2d 616, 623-24 (W.D. Tex. 1998). In circumstances in which a prior representation is found to be quot;substantially related,quot; courts apply a conclusive presumption of shared confidences, regardless of whether the attorney actually obtained the confidential information. This presumption is not rebuttable, even where the firm attempts to screen the information with so-called quot;Chinese walls.quot; See, e.g., Greene v. Administrators of Tulane Educ. Fund, 1998 LEXIS 769 (E.D. La. 1998)(noting that 5th Circuit has never recognized possibility of a quot;Chinese wallquot; to rebut the presumption of shared confidences). 2. Prior Representation of the Debtor. The Bankruptcy Code specifically provides that prior representation of a debtor does not automatically disqualify an attorney from acting as counsel for the debtor in a bankruptcy proceeding. 11 U.S.C. § 327(e). In order to meet the requirement of this provision, an attorney must establish that: 1.) the attorney has previously represented the debtor; 2.) a special specific purpose for which approval is sought; 3.) the appointment of the attorney is in the best interests of the estate; and 4.) the attorney has no conflict. Even then, however, the cases addressing this issue reflect careful scrutiny of the pre-petition representation. In re Kuyendahl Place Assoc., Ltd., 112 B.R. 847 (Bankr. S.D. Tex. 1989)(finding disqualifying conflict where attorney who previously represented debtor's general partner, which personally guaranteed debtor's indebtedness). Generally, subsequent bankruptcy representation has
  • 14. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 14 of 23 not been allowed in the absence of a waiver of claims for pre-petition fees owed. See, e.g., Diamond Lumber, Inc. v. Unsecured Creditors Committee, 88 B.R. 773 (Bankr. N.D. Tex. 1988). However, in In re Waterfall Village of Atlanta, Ltd., 103 B.R. 340 (Bankr. N.D. Ga. 1989), the court deferred to the debtor's right to retain counsel of choice, and held that an attorney who had previously represented the debtor in unrelated matters was not automatically disqualified, noting that the case was a one asset case with few creditors, and the majority of debt was held by secured creditors who were represented by counsel. 3. Prior Representation of a Creditor or Creditors' Committee. The prior representation of a creditor on an unrelated matter does not necessarily preclude an attorney from representing a bankruptcy Trustee or debtor. 28 U.S.C. §§ 327 (c). Again, however, the issue will come down to an analysis of the facts and circumstances, as courts have been unable to formulate a hard and fast rule. In the case of In re Humble Place Joint Venture, 936 F.2d 814 (5th Cir. 1991), the court held that a firm's prior representation of a creditor (and principal of the debtor) constituted a conflict and affirmed the ordered disgorgement of attorneys' fees. The Humble Place court emphasized, however, that the analysis was quot;fact-bound,quot; and limited the holding to the facts before it. In the case of In re Quality Beverage Co., Inc., 216 B.R. 592 (Bankr. S.D.Tex. 1995), the Chapter 7 trustee sought to employ an accounting firm to assist in the prosecution of preference claims against members of the unsecured creditors' committee after the case had been converted from a Chapter 11. The court refused to allow the employment, holding that, because the accounting firm had previously performed professional services for the unsecured creditors' committee, a conflict of interest existed. C. Confidential Client Information. 1. Multiple Representations. Conflicts of interest arise when an attorney's duty to maintain a client's confidential information conflicts with an independent duty to disclose. In the simultaneous representation of two clients, the duty to maintain one client's confidential information may conflict with the duty to disclose the same information to another client. TDRPC 1.05 provides that confidential information consists of privileged and unprivileged client information, and can never be revealed or used without the consent of the client or former client. TDRPC 1.09 reiterates this policy by requiring prior consent of a former client in any situation where an attorney seeks to represent a party adverse to the former client and there is a reasonable probability that TDRPC 1.05 might be implicated. See generally, Phoenix Founders, Inc. v. Marshall, 887 S.W.2d 831, 834 (Tex. 1994)(holding that even unprivileged information is confidential client information under the Texas disciplinary rules). 2. Client's Fraudulent or Wrongful Conduct. a. The Ethical Rules. Model Rule 1.2(d) provides that an attorney
  • 15. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 15 of 23 may not knowingly encourage or assist a client in fraudulent conduct, and 18 U.S.C. §§ 152-157 broadly outlines criminal bankruptcy fraud . . . and possible penalties, including fines and imprisonment. It follows that knowledge of such conduct, including concealment of assets or undisclosed transfers or preferential payments, may invoke a lawyer's obligation to reveal this information. At this point, it is the lawyer's interests that conflict with the interests of the client. Fortunately, the ethical rules and the bankruptcy code itself provide a good road map for a lawyer seeking to disengage such a troublesome client. TDRPC 1.05(c)(7) and (8) allow, but do not require, an attorney to reveal confidential information when the attorney believes that doing so is 1) necessary to stop the client from committing any criminal or fraudulent act, or 2) to rectify the consequences of such acts when the client used the attorney's services to effectuate the crime or fraud. Model Rule 1.06(b)(1) allows, but does not require, such disclosure. In cases where the attorney reasonably believes that the client will commit a criminal or fraudulent act that will result in death or substantial bodily harm to another, disclosure is required, not discretionary. TDRPC 1.05(e). TDRPC 1.05(f) further protects third parties by requiring disclosure of material facts to third parties when such quot;disclosure is necessary to avoid making the lawyer a party to a criminal act or knowingly assisting a fraudulent act perpetrated by a client.quot; TDRPC 1.05(f). Under Model Rule 1.6, an attorney has the discretion to disclose confidential information in these situations, although there is no requirement to do so. In cases where confidential information is disclosed, the disclosure should be no greater than necessary, and must be limited to those who quot;have a need to know.quot; Because Model Rule 1.6 and TDRPC 1.05 allow the disclosure of a client's confidential information in connection with the collection of legal fees, whether by a fee application or in the prosecution of a collection action, the disclosure should be carefully reviewed, and if necessary, steps should be taken to limit the dissemination of the information. Judwin Properties, Inc. v. Griggs & Harrison, P.C., 981 S.W.2d 868 (Tex. App. - Houston 1998, pet. den'd per curiam 11 S.W.2d 188)(disclosure must be quot;as protective of client's interest as possiblequot;). The Comment to Model Rule 1.6 specifically references the need to seek appropriate protective actions, presumably protective orders or limited disclosure agreements.
  • 16. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 16 of 23 3. Candor to the Tribunal. The ethical rules require candor before the courts, giving rise to conflicting obligations on the part of attorneys. When the tribunal is involved, the Texas Rules closely track Model Rule 3.3. Both require that an attorney reveal client information to a tribunal when the attorney knows that not doing so would require him or her to make a false statement to the tribunal, offer false evidence, or aid the client in committing a crime or fraud. Further, if an attorney learns after the fact that material evidence is false, he must attempt to persuade the client to allow the evidence to be withdrawn or corrected. If the client does not cooperate, the attorney must take steps to remedy the error, including revealing the confidential information. TDRPC 3.03(c); Plunkett v. State, 883 S.W.2d 349, 355 (Tex.App. - Waco 1994, pet. ref'd) (holding a lawyer has an affirmative obligation to disclose the fact that his client had paid jurors to obtain a hung jury). D. Lawyer as a Witness. Another issue that gives rise to conflicts of interest issues arises in cases where a lawyer may be required to testify as a witness. Though this issue is not frequently addressed in the case law, 37% of bankruptcy judges polled identified 'lawyer as witness' to be an ethics issue that they had dealt with at least once in the prior two years. Marie Leary, FJC Survey on Attorney Ethics Finds Most Judges Satisfied With Rules, 19-FEB Am. Bankr. Inst. J. 17, 18 (2000). As a practical matter, the question of a lawyer as a witness comes up most often in disqualification proceedings; in the bankruptcy context, however, the possibility that an attorney would be required to testify at some point should be considered in order to avoid subsequent disqualification proceeding or worse, the possible denial of fees. 1. The Ethical Rules. Model Rule 3.7 prohibits an attorney from being both an advocate and a witness at a trial. The rule provides exceptions when the testimony is about an uncontested issue, when the issue is the nature and value of the attorneys' legal services, or when disqualification would be a substantial hardship on the client. The TDRPC Rules are similar, but include some important distinctions. TDRPC 3.08(a) provides that an advocate may not be a witness quot;before a tribunal in a contemplated or pending adjudicatory proceeding.quot; Anderson Producing v. Koch Oil Co., 929 S.W.2d 416, 422 (Tex. 1995)(Rule 3.08 does not prevent attorney from quot;engaging in pre-trial, out -of-court matters such as preparing and signing pleadings, planning trial strategy, and pursing settlement negotiations,quot; nor does it prohibit attorney from sitting at counsel table during trial). TDRPC 3.08(a)(2) allows testimony by the attorney when the matter is a mere formality and there is little likelihood that substantial opposition evidence will be offered. TDRPC 3.08(a)(5) allows the attorney to act as witness when disqualification would be a hardship on the client, but requires that opposing counsel be notified promptly. More importantly, TDRPC 3.08(b) allows a fully informed client to consent to representation even when the lawyer believes that he or she will be compelled to testify in a way that will be substantially adverse to the client. 2. Other Considerations. Despite the disciplinary rules, courts have noted that
  • 17. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 17 of 23 the prohibition against a lawyer testifying as a witness arises from the concern that a jury would give undue weight to an attorney's testimony, or would be unable to distinguish an attorney's sworn testimony from arguments made on a client's behalf. Crowe v. Smith, 151 F.3d 217, 223-24 (5th Cir. 1998). At least in the context of a disqualification proceeding, courts have held that the prohibition against an attorney acting as a witness does not apply to bench trials. Id. Moreover, even in cases where the prohibition applies to one lawyer, courts have refused to disqualify other lawyers from the same firm. FDIC v. U.S. Fire, Ins. Co., 50 F.3d 1304 (5th Cir. 1995). Finally, in the few reported bankruptcy cases discussing the lawyer as a witness, courts have construed their own local rules. In re Galaxy Associates, 114 B.R. 11, 13 (Bankr.D.Conn. 1990)(holding that the local rule regarding lawyer as witness does not have the same meaning as similar state ethics rules); see also, In re Captran Creditors Trust, 104 B.R. 442, 444 (Bankr. M.D. Fla. 1989)(construing the Rules of the Middle District of Florida regarding lawyer as witness). E. Fees. Attorneys' fees give rise to as many claims of conflict of interest as any other issue. 1. Denial or Forfeiture Fees Under the Bankruptcy Code. Under the Bankruptcy Code, an attorney who is not quot;disinterestedquot; may face a forfeiture of fees. 11 U.S.C. § 328(c). However, the Fifth Circuit has refused to hold that § 328(c) requires the denial of all fees to an attorney found not to be disinterested, noting that the bankruptcy court has discretion in ruling on fee applications. In re Humble Place Joint Venture, 936 F. 2d 814, 819 (5th Cir. 1991). In the case of In re Southmark Corp., 181 B.R. 291 (Bankr. N.D. Tex. 1995), the court held that compensation should be denied when a professional holds conflicting interests, even if no fraud or unfairness resulted from the conflict. quot;The bankruptcy court cannot speculate on what might have been in the absence of a conflict. Where an actual conflict arises, compensation should be denied.quot; Id. at 295. The court went on to hold, however, that the question of whether all or just a portion of a professional's compensation should be denied required a factual inquiry, including the benefit and/or harm to the estate, time and labor employed, and egregiousness of the failure to disclose. Id. at 296-97. In re Hudson Shipbuilders, Inc. case, 1985 U.S. Dist. LEXIS 17654 (Bankr. S.D. Miss. 1985) is a good example of how conflict of interest issues can unexpectedly arise from the murk of a bankruptcy representation. In that case, the attorney represented a secured creditor in the collection of a promissory note, which included a provision allowing for recovery of attorneys fees in the event of default. The court awarded attorneys' fees, which was appealed. The debtor and a junior lienholder claimed that the attorney should be precluded from recovering the attorneys' fee award because a conflict of interest existed in the representation of a secured creditor (the client) and an unsecured creditor (the attorney). The court concluded that the attorney fee award was a property right that actually vested in the client, not the attorney, and thus held that no conflict existed. The result may have been different, however, had the attorney's client been the party to raise the potential conflict of interest in an
  • 18. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 18 of 23 effort to avoid the payment of the attorney's fees. 2. Payment of Fees by Third Parties. The payment of an attorney's fees by a third party is allowed under the ethical rules, however, only when the client consents, and only when it will not interfere with the attorney's judgment or the attorney-client relationship. Model Rule 1.8(f). Some bankruptcy courts, however, have held that the conflict of interest that arises from a third party's payment of a debtor's attorney's fees precludes representation under § 327. In re Hathaway Ranch Partnership, 116 B.R. 208, 219 (Bankr. C.D. Cal. 1990); In re WPMK, Inc., 42 B.R. 157, 163 (Bankr. D. Haw. 1984). In Woods v. City Nat'l Bank & Trust Co., 312 U.S. 262, 268 (1941), the Supreme Court held that an attorney should not allow another to pay a client's fees, because the practice unfairly forces the attorney to choose between conflicting duties. More pragmatic courts, have allowed payment of an attorney's fees by a non- client, but only after concluding that, under the specific facts and circumstances, there was no adversity to the estate or the creditors, no apparent conflict existed, and there was a specific benefit to the paying third party. See, e.g. David & Hagner, P.C. v. DHP, Inc., 171 B.R. 429, 437 (Bankr. D. D.C. 1994), aff'd, 70 F. 3d 637 (D.C. Cir. 1995); In re Kelton Motors, Inc., 109 B.R. 641, 658 (Bankr. D. Vt. 1989); In re Missouri Mining, Inc., 186 B.R. 946, 949 (Bankr. W.D. Mo. 1995). 3. Fee Applications. Fee disputes between a lawyer and a client can raise sticky conflicts of interest issues. Legal malpractice claims are compulsory counterclaims that are required to be raised in response to a claim for fees in any case. Goggin v. Grimes, 969 S.W.2d 135, 138 (Tex. App. - Houston [14th Dist.] 1998, no writ)(claim of attorney malpractice is compulsory counterclaim to claim for attorneys' fees); CLS Assoc., Ltd. v. A__B__, 762 S.W.2d 221, 223 (Tex. App. - Dallas, 1988, no writ). As such, any final determination of a lawyer's fee claim acts as a res judicata bar to a subsequent legal malpractice action. The doctrine of res judicata precludes all claims that quot;were or could have been advanced in support of the cause of action on the occasion of its former adjudication, . . . not merely those that were adjudicated.quot; See Howe v. Vaughan, 913 F.2d 1138, 1144 (5th Cir. 1990)(quoting Nilsen v. City of Moss Point, 701 F.2d 556, 560 (5th Cir. 1983)); see also Eubanks v. FDIC, 977 F.2d 166, 173 (5th Cir. 1992). In a recent case that is closely on point, Matter of Interlogic Trace, Inc. v. Ernst & Young, LLP, 200 F.3d 382, 388 (5th Cir. 2000), the Fifth Circuit held that accounting malpractice claims arising from accounting work done for the bankruptcy debtor were barred by the bankruptcy court's award of professional fees because the malpractice were compulsory counterclaims to the claim for fees. Despite the Interlogic Trace decision, the question becomes whether an attorney should advise a client of the need to raise any objections about the attorney's representation at the hearing on a fee application. If the lawyer has reason to know of a potential legal malpractice claim, the duty of full and complete disclosure arguably requires that the client be advised that the final determination of a fee application, the confirmation of a plan or the discharge
  • 19. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 19 of 23 of the debtor could preclude any subsequent claim. Although little case law exists for guidance, it make sense to inform debtor clients, possibly in the original fee agreement, of the import and ramifications of an application for fees. F. Waivers and Disclosures. 1. Ethical Rules. In any case involving conflicts or potential conflicts, full disclosure to and consent by the client is critical; and in a legal malpractice case, proof of the disclosure and consent is even more important. Although possible curative measures are dependent on the facts and circumstances giving rise to the conflict or potential conflict, disclosure is always required. This means disclosure of both the facts and any potential adverse impact on the client or the representation. One court invalidated a waiver obtained by an attorney who knew he was likely to be called as a witness against his client, because the letter describing the potential conflict did not discuss possible adverse consequences and thus could not be considered a full disclosure. In re Captran Creditors Trust, 104 B.R. 442, 445 (Bankr. M.D. Fla. 1989); see also, Conoco Inc. v. Baskin, 803 S.W.2d 416, 419-420 (Tex.App. - El Paso 1991, orig. proceeding)(holding that general disclosure that did not discuss details of possible conflicts of interest was insufficient to validate waiver). 2. Waivers in Bankruptcy. The duties to disclose under the Bankruptcy Code and Rules are strictly construed in order to ensure that the court, not the attorney, decides whether the facts present an impermissible conflict of interest, preferably before legal services are rendered. In re Office Products of America, Inc., 136 B.R. 675, 382 (Bankr. W.D. Tex. 1992). An attorney's duty to disclose all relevant facts is a continuing duty throughout the representation. In re Southmark Corp., 181 B.R. 291 (Bankr. N.D. Tex. 1995). Courts have consistently held that failure to comply with the Bankruptcy Code's disclosure requirements is an independent basis for denial of fees under 11 U.S.C. § 328. See, e.g., In re Consolidated Bancshares, Inc., 785 F.2d 1249, 1256 n.7 (5th Cir. 1995); In re Southmark Corp., 181 B.R. 291 (Bankr. N.D. Tex. 1995). In fact, the failure to disclose is of particular concern, and often a deciding factor, in the consideration of attorneys' fees by bankruptcy courts. In re GHR Energy Corp, 60 B.R. 52 (Bankr. S.D. Tex. 1985); Diamond Lumber, Inc. v. Unsecured Creditors' Comm., 88 B.R. 773 (Bankr. N.D. Tex. 1988)(law firm failed to disclose payment from debtor prior to filing bankruptcy petition); In re MFlex Corp., 172 B.R. 854, 854 (Bankr. W.D. Tex. 1994). 3. Waivers Under the Bankruptcy Code. Although the ethical rules permit informed waivers in many cases, a conflict may not be waived under Bankruptcy Code §327. In re 50-Off Stores, Inc., 213 B.R. 646, 653 (Bankr. S.D. Tex. 1997)(noting that the difference between conflicts of interest in the bankruptcy context and in the non-bankruptcy context, but recognizing the court's power to quot;fashion an alternative remedyquot;); In re Quality Beverage Co., Inc., 216 B.R. 592 (Bankr. S.D. Tex. 1995)(quot;The 'adverse interest' and 'disinterested person' limitations set forth in the statute governing the employment of professionals cannot be excused by waiverquot;).
  • 20. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 20 of 23 V. OTHER CONSIDERATIONS IN THE DEFENSE OF LEGAL MALPRACTICE AND BREACH OF FIDUCIARY DUTY CLAIMS A. Core v. Non-Core: Who will Judge? The characterization of a legal malpractice or breach of fiduciary duty claim as core or non- core can impact the forum in which the case will ultimately be decided. 28 U.S.C. § 157(b) (1) allows bankruptcy courts to enter final judgments only in core proceedings. In non-core proceedings, § 157(b)(3) provides that the bankruptcy court may only make findings of fact and conclusions of law, at which point the referring district court must enter a final order. In a recent case involving misconduct of an accounting firm employed by an estate, the Fifth Circuit held that state law malpractice claims against court appointed professionals constitute core proceedings. In re Southmark Corp., 163 F.3d 925, 932 (5th Cir. 1999); see also, In re Park Place Associates, 118 B.R. 613, 616 (E.D. Ill. 1990)(motion to award sanctions against an attorney for Chapter 11 debtor constitutes core proceeding); In re Stockert Flying Services, Inc., 74 B.R. 704, 708 (D. N.D. Ind. 1987)(claim by creditors against debtor's attorney for mishandling the estate is core proceeding); But see Diamond Mortgage Corp. of Ill. v. Sugar, 913 F.2d 1233, 1239-40 (malpractice claim against pre- petition attorneys not core proceeding). The issue is complicated slightly when the parties claim a right to a jury trial. The Fifth Circuit has held that a bankruptcy court lacks constitutional authority to hear a jury trial, even in core proceedings, absent the consent of the parties. In re Clay, 35 F.3d 190, 197-198 (5th Cir. 1994). B. Fractured Causes of Action Texas courts have uniformly limited claims that arise from negligence in providing legal services to legal malpractice tort claims, and have disallowed efforts to recast such claims as breach of contract, breach of fiduciary duty or claims for DTPA violations or fraud, noting that nothing is to be gained by quot;fracturingquot; a cause of action into numerous claims. See Sledge v. Alsup, 759 S.W.2d 1, 2 (Tex. App.-El Paso 1988, no writ); see also, Klein v. Reynold, Cunningham, Peterson & Cordell, 923 S.W.2d 45, 49 (Tex. App.-Houston [1st Dist.]1995, writ denied)(noting that plaintiff's alternative causes of action were merely different quot;means to an endquot; in asserting a legal malpractice claim). See also, Britton v. Scale, 81 F.3d 602, 605 (5th Cir. 1996); Streber v. Hunter, 221 F.3d 701, 722 (5th Cir. 2000). This common law limitation is potentially important for several reasons. First, fee disgorgement is not a measure of damage in a legal malpractice cause of action, nor are treble or additional damages. Disgorgement of fees is, however, a remedy available under a breach of fiduciary duty or DTPA claim, and treble damages (and attorneys' fees) are recoverable under the DTPA. Burrow v. Arce, 997 S.W.2d 229 (Tex. 1999); Tex. Bus. & Com. Code, § 17.50 (Vernon 1995). Attorneys' fees are also recoverable in a breach of contract case. Second, the statute of limitations on a breach of fiduciary duty claim is four years, as opposed to the two year statute that applies to legal malpractice claims. Tex. Civ. Prac. & Rem. Code § 16.004 (1999). For these tactical reasons, legal malpractice plaintiffs attempt to circumvent the prohibition
  • 21. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 21 of 23 against quot;fracturedquot; causes of action by alleging wrongful conduct outside of the attorney's professional services. For example, in Latham v. Castillo, 972 S.W.2d 66 (Tex. 1998), the Texas Supreme Court held that a lawyer's representation that he had filed suit on behalf of his clients when he had not was actionable under the DTPA. The court reasoned that because the representation was about the lawyer's professional services, the claim was not one for legal malpractice. Under this reasoning, then, a claim arising from a lawyer's exercise of professional judgment, advice or opinion would be limited to a legal malpractice cause of action, but any other allegedly wrongful conduct would not. Whether a breach of fiduciary claim arising from a conflict of interest would fall into this category is an interesting question, since, presumably, any conflict of interest is a breach of fiduciary duty. However, it is possible to envision claims arising from alleged conflicts of interest that would be, in essence, a complaint about the professional services rendered. For example, it is arguable that the reasonably prudent attorney standard should apply in cases in which the existence of a conflict, and thus the duty to disclose, is disputed. C. Elements of a Legal Malpractice Cause of Action Texas courts have provided clear guidance on the elements of legal malpractice, embracing the traditional tort negligence model in which a quot;plaintiff must prove that there is a duty owed to him by the defendant, a breach of that duty, that the breach proximately caused the plaintiff injury and that damages occurred.quot; Cosgrove v. Grimes, 774 S.W.2d 662, 665 (Tex. 1989) (citations omitted). 1. Breach of Duty. As discussed previously, the actions of an attorney are judged by an objective standard of reasonableness: whether a reasonably prudent attorney could make the same decisions under the same or similar circumstances. Id. In cases in which a lawyer is Board Certified in a particular specialized area, for example bankruptcy law, the standard is that of a reasonably prudent Board Certified bankruptcy attorney. Rhodes v. Batilla, 848 S.W.2d 833 (Tex. App. - Houston [14th Dist.] 1993, writ den'd). 2. Proximate Cause. Even if an attorney's conduct is negligent, it will not always lead to legal malpractice liability. A plaintiff may not recover without proof that the breach of duty proximately caused the damage claimed. Cosgrove v. Grimes, 774 S.W.2d 662, 665 (Tex. 1989). Proximate cause has been defined as including quot;foreseeability and cause in fact.quot; FDIC v. Shrader & York, 991 F.2d 216, 221 (5th Cir. 1993). Essentially, a legal malpractice plaintiff must prove that he or she would have prevailed on the underlying claim, but for the lawyer's conduct. Schlager v. Clements, 939 S.W.2d 183, 186-187 (Tex. App.-Houston [14th Dist.] 1996, writ denied). 3. Damages. a. Economic Damages. In Texas, economic damages are recoverable in a successful legal malpractice action. Millhouse v. Wisenthal, 775 S.W.2d 626, 627, n.2 (Tex. 1989). b. Mental Anguish. The Texas Supreme Court has held that mental anguish or emotional distress damages cannot be awarded in legal malpractice actions when the underlying injury is purely economic.
  • 22. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 22 of 23 Douglas v. Delp, 987 S.W.2d 879, 885 (Tex. 1999). The court refused to express an opinion on the appropriate standard when the underlying injury is not purely economic. Id. Two months after the Delp opinion was handed down, the same court refused, over the strenuous objection of Justice Hecht, to hear a case in which an appeals court upheld a $350,000 emotional distress award. In that case, the lawyer/defendant was found to have breached a fiduciary duty to her client in a divorce representation by colluding with the client's spouse, a friend from law school. See Vickery v. Vickery, 999 S.W.2d 342 (Tex. 1999); Vickery v. Vickery, No. 01-94-01004-CV, 1997 WL 751995 (Tex.App. -Houston [1st Dist.] Dec. 4, 1997, pet. denied). c. Punitive Damages. Texas Civil Practice and Remedies Code § 41.003 authorizes exemplary damages where a plaintiff can prove fraud or malice by clear and convincing evidence. In judging whether and to what degree exemplary, or punitive, damages are warranted, a court must look to quot;the nature of the wrong, the character of the conduct involved, the degree of the culpability of the wrongdoer, the situation and sensibilities of the parties concerned, and the extent to which such conduct offends a public sense of justice and propriety.quot; Alamo Nat'l Bank v. Kraus, 616 S.W.2d 908, 910 (Tex. 1981)(citations omitted). Further, a court may take into account what amount may be necessary to serve as a deterrent to others. Transportation Ins. Co. v. Moriel, 879 S.W.2d 10, 27 n.22 (Tex. 1994). Judge Buchmeyer of the Northern District of Texas recently affirmed a bankruptcy court's order of $3,504,000 in exemplary damages against a firm and its lawyers individually based on impermissible conflicts of interest and breach of fiduciary duty. In re Legal Econometrics, No. CA 3:98- CV-2297-R, 1999 W.L. 304564 (N.D. Tex. May 11, 1999). D. Fee Forfeiture. In cases involving a breach of fiduciary duty (in other words, where an attorney puts the interests of another client or him or herself ahead of the interests of a client), Texas common law allows a court order the forfeiture of all or part of the fee. As discussed previously, fee forfeiture is also a remedy under the Bankruptcy Code. 1. Burrow v. Arce. Last year the Texas Supreme Court eliminated the causation requirement for a breach of fiduciary duty, and held that in cases of a quot;clear and serious violation of a duty to a client,quot; fee disgorgement could be required, even in the absence of economic injury. Burrow v. Arce, 997 S.W.2d 229, 237- 238 (Tex. 1999). The Arce court did, however provide some protections for lawyers. The question of whether fee forfeiture is appropriate, and if so, whether all or only part of the fees should be forfeited, is to be determined by the trial court, not a jury. The trial court's inquiry requires review of the particular facts and circumstances, including the quot;gravity and timing of the violation, its willfulness, its effect on the value of the lawyer's work for the client, any other threatened or actual harm to the client, and the adequacy of
  • 23. Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 23 of 23 other remedies.quot; Id. 2. Bankruptcy Courts. Texas bankruptcy courts have ordered the forfeiture and disgorgement of fees long before the Burrow v. Arce opinion was handed down. As the cases discussed earlier in this paper reflect, the court's analysis is fact intensive, and the most punitive results generally occur in cases where the court believes the attorney was less than forthright in disclosures to the court or to the client. VI. IN CONCLUSION From the standpoint of defending a lawyer, or a lawyer's fees, the riskiest conflict of interest analysis is one that is undertaken after the fact, with hindsight. This risk can be minimized, if not eliminated, however by ongoing attention to the identity and interests of the client, as well as by making the required disclosures.