7 ABR 381
UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF ALASKA
In re:
COMMUNITY ADVOCACY PROJECT OF ALASKA, INC.,
Debtors. |
Case No. F02-00420-DMD Chapter 7 |
MEMORANDUM APPROVING EMPLOYMENT OF SPECIAL COUNSEL
UNDER THE CONDITIONS IMPOSED BY THE COURT
A hearing on the trustee’s amended application to employ special counsel was held on November 20, 2002. James DeWitt appeared on behalf of Larry Compton, the chapter 7 trustee. Barbara Schuhmann and David Bundy appeared for Cook, Schuhmann & Groseclose. Daniel Winfree, special master in the state court proceeding, attended the hearing telephonically. Thomas Van Flein, the trustee’s proposed special counsel, also attended. After considering the application, oppositions and reply, and the comments of counsel made at the hearing, I have concluded the trustee’s amended application should be granted, but with conditions imposed by the court, as discussed below.
Case Background
The debtor, CAPA, served as guardian for certain incapacitated wards under appointments by the state. It has since been removed under allegations of misappropriation of funds, failure to account, breach of fiduciary duty and the like, and has filed a chapter 7 petition. Larry Compton was appointed chapter 7 trustee.
A number of wards are seeking recovery from CAPA and its various officers and employees. There are some insurance policies and/or bonds which cover certain claims against CAPA’s officers and directors.
7 ABR 382
The state court in Fairbanks appointed Dan Winfree to serve as special master to represent the interest of the wards who are located in the Second, Third and Fourth Judicial Districts of Alaska. 1.
Winfree is authorized to pursue litigation to recover from those liable for misuse of the wards’ assets. 2.
Recently, Compton discovered the existence of some insurance policies which may fund a substantial recovery. Also, Compton and Winfree want to recover any shortfall in full payment of creditors or wards from the personal assets of those they deem responsible for CAPA’s downfall. Included amongst the targets are Cook, Schuhmann & Groseclose, Inc., and its principals (collectively “CS&G”). Compton and Winfree have agreed to employ Thomas Van Flein of Clapp Peterson & Stowers (Clapp), to pursue these goals. The employment arrangement is subject to approval of both the state and bankruptcy courts. Clapp would represent the special master on behalf of the wards against the officers, directors, employees, attorneys and others affiliated with CAPA, but would not represent the wards against the estate per se. Clapp would also represent the bankruptcy estate for any injuries suffered directly by it. The contention is that since the operative facts and sources of recovery for both the wards and the bankruptcy estate may be the same, it did not make economic sense to have the parties fighting between themselves when the allocation of any recovery could be determined after liability was established. Mr. DeWitt, the trustee’s bank-
ruptcy case attorney, has indicated that the recovery by the wards directly (i.e., without passing through the bankruptcy estate) is anticipated to be the largest percentage of any recovery by far.CS&G, which is one of the largest individual creditors of the CAPA bankruptcy estate, objects to the trustee’s proposed employment of Clapp as special counsel on various grounds, including: (a) that there is an inherent conflict of interest in Clapp’s proposed dual representation; (b) that the appointment is unnecessary since an insurance company has agreed to cover the losses; and, (c) all interested parties have not received notice.
Discussion
The principal bankruptcy issue to be addressed in considering the trustee’s application is whether Clapp can undertake to represent the trustee and the special master at the same time without running afoul of the disinterestedness requirement under 11 U.S.C. § 327. There are lesser issues, including: (a) whether appointment of special counsel is advisable in light of the alleged cooperativeness of insurance companies to cover any loss and, (b) whether proper notice has been given.
The operative statute for determining the employment of Clapp by the trustee is 11 U.S.C. § 327. Section 327 provides, in part:
(a) Except as otherwise provided in this section, the trustee, with the court’s approval, may employ one or more attorneys, accountants, appraisers, auctioneers, or other professional persons, that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee’s duties under this title.
. . . .
(c) In a case under chapter 7, 12 or 11 of this title, a person is not disqualified for employment under this section solely because of such person’s employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.
An attorney generally cannot represent both the trustee and a creditor of the bankruptcy estate if this creates a conflict of interest. Such a conflict of interest cannot be waived. 3.
In Kittay, a law firm (Kornstein), represented a limited partner (Burstin) in a New York state court suit against a general partner (KNIL) and its principal (Kalka) for breach of fiduciary duty, alleging both direct actions against these parties and derivative actions on behalf of the limited partnership (Luckey Platt) against them. A large judgment was obtained by Burstin against KNIL and Kalka. The judgment named Burstin as receiver of Luckey Platt. This judgment was appealed by KNIL.
During the pendency of the appeal, Luckey Platt filed a chapter 11 bankruptcy petition. Luckey Platt moved to retain Kornstein as special counsel to defend it in the state court proceedings. In addition to his involvement in the KNIL appeal, Kornstein
had been defending Luckey Platt in a foreclosure action filed prepetition by a bank. Luckey Platt wanted to retain Kornstein as special counsel because of his prior involvement in the state court matters and his extensive familiarity with them. 6.KNIL and Kalka objected to the employment of Kornstein, arguing that his representation of both the bankruptcy estate and Burstin in the state court appeal created a conflict of interest. The court noted that both Burstin and the bankruptcy estate had a common goal of pursuing assets to satisfy the KNIL judgment and that, without Kornstein, Luckey Platt wouldn’t be able to effectively pursue its claims against KNIL and Kalka. However, to avoid any potential conflict of interest that could arise from Kornstein’s representation of both Luckey Platt and Burstin against KNIL and Kalka, the bankruptcy court’s retention order required that all recoveries against KNIL or Kalka be placed in escrow, subject to the bankruptcy court later determining which entity was entitled to which portion of the recovery.
Kalka agreed to settle with Burstin for over $9 million, the full amount of the state court judgment. After this settlement was reached, Luckey Platt’s bankruptcy case converted to chapter 7, and Kittay was appointed trustee. Although Kittay obtained a bankruptcy court order confirming that the $9 million was to be placed in escrow pursuant to Kornstein’s earlier retention order, the settlement funds were never placed in escrow. Ultimately, Kittay settled with Burstin, with bankruptcy court approval, and $687,500.00 of the $9 million was paid to the Luckey Platt bankruptcy
estate. Kittay represented to the bankruptcy court that he considered this to be an excellent settlement for the estate.After reaching the settlement, Kittay sued Kornstein on several grounds, but the only issue pertinent to the CAPA case concerns Kittay’s allegation that Kornstein’s representation of Luckey Platt and Burstin created a conflict of interest. Kittay contended Kornstein impermissibly represented multiple clients and favored Burstin’s interests over those of Luckey Platt in handling the state court appeal. The Second Circuit affirmed the district court’s dismissal of this count of Kittay’s complaint.
After discussing the New York state ethics rules for attorneys, the Second Circuit held that the bankruptcy court’s retention order, which required that any recovery from KNIL and Kalka be escrowed for later allocation between Luckey Platt and Burstin, had eliminated any potential conflict of interest. The court also noted that Luckey Platt and Burstin had had a common purpose, to maximize recovery against KNIL and Kalka, and it deferred to the bankruptcy judge’s analysis of the situation when he authorized Kornstein’s retention:
Nonetheless, we believe that the Bankruptcy Court's retention and escrow order effectively resolved this conflict by, essentially, eliminating any incentive to compete. By acting in a manner that it believed would increase the chance of recovery, and by assuming the task of allocating that recovery, the Bankruptcy Court aligned the interests of Luckey Platt and Burstin for purposes of the state court appeal. See In re AroChem Corp., 181 B.R. 693, 703 (Bankr. D. Conn.1995) (finding that agreement to pool proceeds from judgment for later allocation cured a conflict resulting from rivalry over the judgment), aff'd, 176 F.3d 610 (2d Cir.1999). Luckey Platt and Burstin shared the common goal of obtaining a judgment against Kalka, and the Bankruptcy Court found--at the urging of Luckey Platt--that Kornstein was best able to procure that judgment. “Bankruptcy judges’ findings on conflict of interest questions are entitled to deference because a bankruptcy
judge is on the front line, in the best position to gauge the ongoing interplay of factors and to make the delicate judgment calls which such a decision entails.” In re AroChem Corp., 176 F.3d 610, 628 (2d Cir.1999) (internal quotation marks omitted). 7.
Adoption of the Kittay procedure in the CAPA case will alleviate the chief objection of CS&G about an alleged conflict of interest. If Clapp, the trustee and the special master consent, with the state court’s approval, to any recovery being held by the trustee subject to a determination of its allocation by the bankruptcy court, the goal of special counsel will be simply to maximize recovery for all. The interests of the bankruptcy estate and the wards will be aligned. 8.
Nor is the argument of excessive cost raised by CS&G persuasive. The costs of the suit are being funded in part by a $10,000.00 advance by a state agency, and any recovery would be subject to the same contingent fee amount, whether the
recovery belongs to the bankruptcy estate or the wards. Further, CS&G has filed a claim in this bankruptcy case for $108,000.00, 9.The sincerity of CS&G’s other arguments, about proper notice and the necessity for appointing Clapp in the first place, are also viewed with skepticism. Regarding the necessity issue, the court will defer to the trustee’s business judgment about the need for retaining Clapp. The estate has the potential for receiving a sizeable recovery from several sources, but the issues are far from resolved and, on the present record, the court cannot say that the trustee has a definite commitment from any insurance company to fund the trustee’s claims.
I also find that notice of the trustee’s amended application to employ special counsel was proper in this case. The notice was served on the matrix. 10.
which have been raised in opposition to the trustee’s retention of special counsel are likewise overruled.
One final condition to approval of Clapp’s appointment will be imposed, however. If the court is to determine the allocation of the recovery between the bankruptcy estate and the wards, the court must also retain the right to rule on Clapp’s fee application. Since this will only be a mathematical calculation on the funds which are the estate’s property and not on the funds which are the wards’ property, the task will not be as onerous as in most bankruptcy cases. Therefore, the paragraph involving fee disputes and reference to arbitration in the proposed employment and fee agreement 12.
Should the employment contract not be entered into because of the inability of all parties to agree on these conditions, the trustee and special master should review the possible use of 11 USC § 503(b)(3)(B), which some 9th Circuit courts feel is a “free pass” from the disinterestedness requirement. 13.
Conclusion
The court will approve the appointment of Clapp Peterson & Stowers, LLC, as special counsel for the trustee, subject to the following conditions:
1) All recovery in the state court proceedings will be escrowed by the trustee until further order of this court.
2) The allocation of all funds so escrowed, as between the bankruptcy estate and the wards represented by the special master, will be determined by the bankruptcy court.
3) Special counsel, the trustee and the special master must agree that the bankruptcy court retains the primary right to determine the special counsel’s compensation, as otherwise governed by the contingency fee agreement, with respect to property recovered for the bankruptcy estate.
A separate order will be entered consistent with this memorandum. 14.
DATED: December 20, 2002
BY THE COURT
DONALD MacDONALD IV
United States Bankruptcy Judge
N O T E S:
1.
Mr. Winfree has been appointed special master in In the Matter of Community Advocacy Program\ of Alaska, Inc. (CAPA), Case No. 4FA-02-1037-Civ, in the Superior Court for the State of Alaska, Fourth\ Judicial District at Fairbanks (consolidated with the Superior Court case in the Third Judicial District at\ Anchorage, Case No. 3AN-02-7890 Civ).2.
See, Order for Appointment of Special Master, dated May 2, 2002, filed in Fairbanks Superior Court Case No. 4FA-02-1037-Civ (a copy of this order is attached as Exhibit C to CS&G’s Response to Amended Application to Employ Special Counsel, filed Nov. 6, 2002 [Docket No. 110]).3.
11 U.S.C. § 327(c); 3 Collier on Bankruptcy ¶ 327.04[a][7][i] (15th ed. revised 2002).4.
See, e.g., In re Alaska Towboat Corp., 2 A.B.R. 166 (Bankr. D. Alaska 1991).5.
230 F.3d 531(2nd Cir 2000).6.
It should be noted that Kornstein’s employment was sought under the provisions of 11 U.S.C. § 327(e), relating to the trustee’s employment, for a special purpose, of an attorney who has previously represented the debtor. The conflict of interest issues resolved in Kittay are, nonetheless, similar to those present here, even though the pending application for employment of special counsel is brought under § 327(a) and (c).7.
Kittay, 230 F.3d at 538.8.
The ward’s interests are not so disparate from those of the bankruptcy estate’s in any event. The wards are the largest group of creditors in the CAPA bankruptcy estate and thus have a stake in maximizing the estate’s recovery as well as their own.9.
Proof of Claim No. 2, filed May 16, 2002.10.
See Cert. of Service by Mail, filed Oct. 15, 2002 [Docket No. 110].11.
See Cert. of Service of Notice of Hearing on Trustee’s Amended Application to Employ Special Counsel, filed Nov. 11, 2002 [Docket No. 116].12.
Paragraph 10 of the proposed Employment and Fee Agreement, attached to the Trustee’s Amended Application of Chapter 7 Trustee to Employ Special Counsel, filed Oct. 15, 2002 [Docket No. 108].13.
See COM-1 v. Wolkowitz (In re Maximus Computers, Inc.), 278 BR 189, 197 (B.A.P. 9th Cir. 2002); In re Gondon, Inc., 275 BR 555, 567 (Bankr. E.D. Cal. 2002).14.
This memorandum was drafted with the able assistance of the Hon. Herbert A. Ross and my law clerk, Amy A. McFarlane, Esq.