Law Firm Faces Another Conflict Accusation Due to Non-Disclosure
Practitioners in the bankruptcy world are accustomed to dealing with representations that in other practice areas might be construed as a conflict of interest. For example, a law firm may represent a Chapter 7 trustee in a consumer bankruptcy case and at the same time represent a creditor in a case where that same Chapter 7 Trustee, an attorney in his own right, represents the debtor. Similarly, there may be times when a firm represents both the Trustee and a creditor in the same bankruptcy with an appropriately limited scope of representation of the Trustee. With such arrangements commonplace, it is important for bankruptcy practitioners to still remain vigilant regarding any potential conflicts hiding in the underbrush, especially when dealing with issues of non-disclosure.
SonicBlue, the creator of the Rio MP3 player, filed under Chapter 11 in the Northern District of California, and its attorneys, Pilsbury Winthrop, have created two separate issues for itself. "In March, U.S. Bankruptcy Judge Marilyn Morgan of San Jose, Calif., disqualified Pillsbury, citing a 'complete breakdown of creditor confidence' after the firm failed to disclose that it had been threatened with a lawsuit by some of the creditors." Now, Pilsbury has been accused of another damaging non-disclosure that created a conflict with its client:
On Tuesday, McGrane and other lawyers for a claims trader -- SonicBlue Claims, created to buy creditors' claims against the failed electronics maker -- accused Pillsbury in a court filing of not disclosing a tolling agreement between the firm and directors and officers of its client SonicBlue. The agreement, extending the statute of limitations on a potential malpractice claim, stems from a dispute over insurance. The board blamed Pillsbury for its insurance company's refusal to pay directors' and officers' coverage for a suit filed against SonicBlue by some note holders.
"Disputes have arisen as to whether Pillsbury is liable to the directors for damages that may have been incurred by the directors as a result of the coverage denial," reads the agreement, dated Aug. 18, 2006. Lawyers for the claims trader -- from Los Angeles' Stutman Treister & Glatt and San Francisco's McGrane Greenfield -- argue that the dispute and the subsequent tolling agreement gave Pillsbury conflicting motivations in handling claims against the board. The claims trader says the situation should've been disclosed to the court. (read the full law.com article here)
In the first instance, Pilsbury lost the business of representing SonicBlue in the case, and thus its presumable large revenue stream. Now, if the accusation comes to anything, Pilsbury stands to lose money in the form of damages for losses to the corporation due to the directors actions. Yikes.
It is important for bankruptcy counsel to always bear in mind the competing constituencies involved in every bankruptcy proceeding. What may be a good idea in garden variety civil litigation, may be a devastating decision in the bankruptcy arena. Deals with clients in business litigation such as that between Pilsbury and the SonicBlue board may be perfectly reasonable in most situations, but in bankruptcy, where the interests of creditors are paramount in a debtor-in-possession situation, such a deal undermines the entire process because Pilsbury could not be expected to fully pursue claims against the board if Pilsbury was potentially on the hook for any damages by agreement. Being able to recognize hidden conflicts as well as the obvious ones is essential to a successful bankruptcy practice, as the SonicBlue representation highlights.
The conflict of interest issue in the bankruptcy industry is well settled as to the law, but the reality is that many members of the community simple view the law as "not up with the times". The laws were passed for a reason, to keep attorneys for a Debtor from abusing the exceptional circumstances of court protection for the benefit of simultaneous clients other than the Debtor.
Significantly, members of the Judiciary and Department of Justice concur in the notion that Legislators attempt at placing restrictions on attorneys should be ignored. The "only" problem, aside from blatant violation of law, is that excuse conflict and fraudulent failures to disclose in any given case inevitably leads to the result where bankruptcy rings control the distribution of billions of dollars in the largest public company bankruptcies. Extreme cases include death threats against a creditor who sought to have conflicts exposed in the Worldcom bankruptcy case, and absurdities such as having lawyers Department Of Justice personnel decide upon investigations and prosecutions against their own former law partners. All the government would need do is start exercising the full force of the laws against fraud upon a court, as it has chosen to do against the likes of Martha Stewart, Little Kim, and Roger Clemens ; and there would be dozens of bankruptcy professionals heading to prison. Not to mention a dramatic decrease in losses in the bankruptcy courts by banking institutions and small business creditors.