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ILC Case Update: DIP's counsel who suspected officers were engaged
FYI From State Bar Insolvency Law Committee:
Henry M. Toles, J.D., M.B.A.
Henry M. Toles, A Law Corporation
11746 Goshen Avenue, No. 1
Los Angeles, California 90049-6113
Telephone: (310) 479-1400
Facsimile: (310) 575-0343
E-Mail: hmt@toles.org
Sent: Friday, February 08, 2008 14:27
To: Sections: Bus Law Insolvency Constituency List
Subject: ILC Case Update: DIP's counsel who suspected officers were engaged
in self-dealing but did not advance the court may be held liable for breach
of fiduciary duty.
Insolvency Law Committee - Business Law Section of the
State Bar of California
Bankruptcy e-Bulletin
Donna T. Parkinson
Chair
Parkinson Phinney
400 Capitol Mall, 11th Floor
Sacramento CA 95814
916-449-1444
FAX 916-449-1440
donna@parkinsonphinney.com
Christopher Celentino
Co Vice Chair
Duane Morris LLP
101 W. Broadway Suite 900
San Diego CA 92101
619-744-2200
FAX 619-744-2201
ccelentino@duanemorris.com
Ellen Friedman
Co Vice Chair
Friedman Dumas & Springwater LLP
150 Spear Street, Suite 1600
San Francisco, CA 94105
415-834-3800
FAX 415-834-1044
efriedman@friedumspring.com
February 8, 2008
Dear Insolvency Law Committee Constituency List Members:
The following is a recent case update by Professor Dan Schechter,
Loyola School of Law, regarding the fiduciary duty of counsel to a Chapter
11 estate.
Attorneys for Chapter 11 Debtor Who Suspect That Insiders May Be
Self-Dealing but Who Do Not Advise the Court May Be Held Liable for Breach
of Fiduciary Duty to the Estate. [In re Food Management Group, LLC, 2008
Westlaw 183410 (Bankr. S.D.N.Y.).]
A bankruptcy court in New York has held that when an attorney for a
Chapter 11 debtor in possession suspects that the DIP's insiders are engaged
in self-dealing, the attorney must advise the court of that fact or else
risk liability for breach of fiduciary duty to the estate. [In re Food
Management Group, LLC, 2008 Westlaw 183410 (Bankr. S.D.N.Y.).]
Facts: In the context of a Chapter 11 proceeding, the debtor in
possession sought to sell substantially all of its property. The attorneys
representing the DIP prepared the papers for that sale; among other things,
the DIP's procedures required that each bidder submit a registration form
certifying that the bidder was not an insider of the DIP.
During the DIP's negotiations with a potential bidder, the attorneys
for the DIP became suspicious that one of the insiders might be involved
with the bidder, behind the scenes. The attorneys warned the parties not to
involve any of the insiders. The same attorneys later submitted the
transaction to the court for its approval, but the court was not advised
that the new bidders had failed to provide the required certification
regarding the absence of involvement by the insiders.
Eventually, the truth came out. Following the appointment of a
Chapter 11 trustee, the trustee brought suit against the insiders and the
attorneys for breach of fiduciary duty. The attorneys moved to dismiss for
lack of standing, claiming that the DIP was in pari delicto ("in equal
fault"), thus barring the estate from bringing suit. The attorneys also
claimed that they owed no fiduciary duty to the estate at large.
Reasoning: The court first held that although the doctrine of in pari
delicto might apply if the prepetition debtor had brought suit against a
faithless insider, the rule did not apply where the alleged misconduct took
place post-petition. Noting a split of authority, the court then held that
the attorneys owed a fiduciary duty to the estate, in addition to their
duties to the DIP.
The attorneys argued that they were not responsible for ensuring that
the DIP would comply with the disclosure requirements. The court disagreed:
[The attorneys] are correct to a point in arguing that they had no
obligation to "ensure" [their] clients' compliance with agreements. While
counsel's duty to the estate may not rise to the level of a policeman for
the debtor's post-petition conduct, an attorney for the debtor in possession
has fiduciary obligations to the estate stemming from his fiduciary
obligations to the debtor in possession and his responsibilities as an
officer of the court . . . . [T]he attorney cannot simply close his or her
eyes to matters having an adverse legal and practical consequence for the
estate and creditors . . . . [Bracketed material added; citations and
internal punctuation omitted.]
COMMENT: What should these attorneys have done? Blow the whistle?
Withdraw suddenly and awkwardly? These attorneys did not know that the
insiders were preparing to engage in self-dealing. They suspected it, and
they warned the insiders not to do so. The insiders disregarded the
warning, and the attorneys now face liability for failing to act. If the
attorneys for the DIP merely suspect wrongdoing, do they have an obligation
to betray their client's confidences and advise the court? It seems that
this is the implication of the court's opinion.
This case is another in a series involving Chapter 11 counsel caught
between conflicting duties. I think that the moral of all of these cases is
clear: although the attorneys for the DIP owe all of the usual duties to
their immediate client, they owe a higher duty to the estate and to the
court.
These materials were written by Professor Dan Schechter of Loyola Law
School for his Commercial Finance Newsletter, published weekly on Westlaw.
Westlaw holds the copyright on these materials and has permitted the
Insolvency Law Committee to reprint them.
Best regards,
Ellen Friedman
Friedman Dumas & Springwater LLP
efriedman@friedumspring.com
Insolvency Law Committee, Co Vice Chair
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