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In the wake of the Enron debacle, we are once again reminded that when the patient has died, those in mourning look to others to place blame and to be recompensed. To date we have seen the guns leveled at Enron’s board of directors and officers, and its outside auditors. No word yet that the lawyers have been implicated, but, unfortunately, that is probably only a matter of time.

Which leads me to discuss a few of those nagging issues which we as debtors’ counsel face in our day to day practice.

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CASE ANALYSIS
Releasing Nondebtors from Liability through Chapter 11 Plans

Catherine E. Vance, Esq.
Columbus, Ohio
Email: vance76@earthlink.net

Summary: Despite being relatively simple and straightforward, the language of Bankruptcy Code § 524(e) has produced divergent judicial interpretations in the context of a Chapter 11 plan that proposes to release a nondebtor obligor from liability. Section § 524(e) provides that the “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” Judicial interpretations of this language have run the gamut, ranging from concluding that § 524(e) prohibits plan provisions that release nondebtors from liability to the permissive interpretation that the language does not, of itself, preclude such provisions. In In re Dow Corning, 2002 U.S. App. LEXIS 1204 (6th Cir. Jan. 29, 2002), the United States Court of Appeals for the Sixth Circuit weighed in on the issue, holding that non-consensual releases of nondebtor parties in a Chapter 11 plan are not violative of the Code, but that they may be approved only under “unusual circumstances.”

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Rule 9011 Sanctions. Bankruptcy Court sanctioned counsel, whose client was not a party to bankruptcy case, for sending letter to court indicating debtor’s counsel had been suspended from practice in state court. District Court reversed. Klein v. Wilson, Elser, Moskowitz, Edelman & Dicker (In re Highgate Equities, Ltd.,), 257 B.R. 391 (S.D.N.Y. 2001). On appeal, Second Circuit Court of Appeals affirmed, noting that letters to court may give rise to sanctions and holding that, before sanctions may be imposed, party must be given specific notice of conduct alleged to be sanctionable and standard by which that conduct would be assessed, and an opportunity to be heard. Klein v. Wilson, Elser, Moskowitz, Edelman & Dicker (In re Highgate Equities, Ltd.), 2002 U.S. App. LEXIS 1433 (2d Cir. Jan. 31, 2002).

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SUA SPONTE

In the wake of the Enron debacle, we are once again reminded that when the patient has died, those in mourning look to others to place blame and to be recompensed. To date we have seen the guns leveled at Enron’s board of directors and officers, and its outside auditors. No word yet that the lawyers have been implicated, but, unfortunately, that is probably only a matter of time.

Which leads me to discuss a few of those nagging issues which we as debtors’ counsel face in our day to day practice.

First, the attorney client privilege. We know by the teachings of the United States Supreme Court in CFTC vs. Weintraub, 471 U.S. 343 (1985), that the privilege may be waived in a corporate bankruptcy case by a subsequently appointed trustee. The rationale is that the “actor whose duties most closely resemble those of management should control the privilege in bankruptcy.” Id. at 351-352. That actor, the Court held, was the trustee. Which means that we, as debtors’ counsel, likely have the duty to advise our clients, before the first confidential communication is uttered, of their bankruptcy Miranda rights -- that what is about to be said can and will be used against them in a court of law, if a trustee in bankruptcy succeeds to their rights. How could we not be obligated to provide our clients with a bankruptcy Miranda warning, as a component of our duties of loyalty, confidentiality, and of zealous representation to our clients?

Now place yourself in the shoes of the lawyers for Enron. Do you think those lawyers had the foresight to provide the bankruptcy Miranda warning? If the lawyers knew of the alleged unlawful conduct, their duty to either disclose the information (if it related to the commission of a crime) or to withdraw should have been front and center in their minds. And if a trustee is appointed and the privilege is waived, wouldn’t it be interesting to watch a suit by the officers and directors against the attorneys for having failed to provide them with the bankruptcy Miranda warning? While we as debtors’ lawyers may not have clients as large as Enron, we certainly have clients who, for public reporting or bank covenant purposes, are looking at their financial statements and are routinely asking themselves (and sometimes us) how the statements can be manipulated to meet their desired or mandated goals. So the issues we face, while likely not as large, raise the same ethical dilemmas.

To complicate matters further, the law is less than clear regarding to whom a debtor’s counsel owes its duties of loyalty, confidentiality, and zealous representation. The issue is whether a debtor’s fiduciary duty to the estate and its creditors translates into a fiduciary duty of the debtor’s attorney to the same non-client parties. Certain courts have held that the fiduciary duties of counsel are equivalent to the fiduciary duties of the debtor or trustee. In re Imperial 400 International, Inc., 456 F. 2d 926 (3rd Cir. 1972). The Restatement (Third) of the Law Governing Lawyers §73 (A) (Tentative Draft No. 8), states that a duty of care is owed, inter alia, to non-clients “when the lawyer’s client is a trustee, guardian, executor or fiduciary acting primarily to perform similar functions for the non-client.”

Other courts have held that such an interpretation is unworkable, because (1) the interests of secured creditors, unsecured creditors, and equity holders are inherently different and cannot be represented by one lawyer simultaneously; (2) the Model Rules prohibit a lawyer from representing conflicting constituencies simultaneously; (3) the ABA Committee on Ethics states with respect to counseling a fiduciary, the duty runs to the client and not to the client’s beneficiaries; and (4) if a duty to creditors is owed, then counsel would be subject to suit by the creditors for breach of fiduciary duty, a result which is unworkable. Hansen, Jones & Leta v. Siegal, 220 B.R. 434 (D. Utah, 1998).

Section 330 of the Bankruptcy Code does not help clarify the issue, as it immediately limits the duty of zealous representation by imposing a standard of reasonableness regarding the services provided and a requirement of necessity for the services rendered. These assessments are not to be made by the client, but by the Bankruptcy Court, based on objections of non-client parties. Section 330 further requires the Bankruptcy Court to determine “whether the services were . . . beneficial at the time at which the service was rendered toward the completion of a case under this title” and prohibits payment for services which were “not reasonably likely to benefit the debtor’s estate” or “necessary to the administration of the case.” Clearly § 330 at least supports an argument that an attorney’s duties to a debtor are limited, and counsel’s judgment is compromised, as payment for services rendered is left to a standard of benefit to constituents other than the debtor client.

This means that in the Enron or any other debtor representation situation, we as debtors’ counsel may have duties to non-client third parties. Bankruptcy courts generally rely on fee disallowance as the punishment for ethical failures-failures not in representing the debtor, the client, but in taking action which did not benefit the creditors or was not necessary to the administration of the case. But if the basis for fee reduction is an ethical failure or breach of a duty, then why can’t the constituents harmed by such conduct (i.e., creditors) sue directly for such failures or breaches. Remarkably, there are few reported decisions where creditors have sued a debtor’s counsel for breach of fiduciary duty. Certainly the landscape is ripe for such suits, and Enron would be a prime candidate for such litigation. Bad facts make bad law, and in the case of Enron, the facts, at least as they currently present themselves, appear to be about as bad as they can be.

So as they said at the conclusion of each morning briefing session on the television show Hill Street BluesHiH, “Let’s be careful out there.”

Mr. Jay L. Welford
Jaffe, Raitt, Heuer & Weiss
One Woodward Avenue Suite 2400 Detroit, MI 48226
Phone: 313-961-8380 Fax: 313-961-8358
Email: jwelford@jafferaitt.com

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CASE ANALYSIS
Releasing Nondebtors from Liability through Chapter 11 Plans

Catherine E. Vance, Esq.
Columbus, Ohio
Email: vance76@earthlink.net

Summary: Despite being relatively simple and straightforward, the language of Bankruptcy Code § 524(e) has produced divergent judicial interpretations in the context of a Chapter 11 plan that proposes to release a nondebtor obligor from liability. Section § 524(e) provides that the “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” Judicial interpretations of this language have run the gamut, ranging from concluding that § 524(e) prohibits plan provisions that release nondebtors from liability to the permissive interpretation that the language does not, of itself, preclude such provisions. In In re Dow Corning, 2002 U.S. App. LEXIS 1204 (6th Cir. Jan. 29, 2002), the United States Court of Appeals for the Sixth Circuit weighed in on the issue, holding that non-consensual releases of nondebtor parties in a Chapter 11 plan are not violative of the Code, but that they may be approved only under “unusual circumstances.”

Facts: The Dow Corning bankruptcy is unquestionably one of the larger and more complex Chapter 11 cases in bankruptcy history. As a producer of silicone gel breast implants, Dow Corning’s presence accounted for nearly one-half of that entire market. In the 1980s, however, medical research suggested a causal link between silicone gel implants and auto-immune diseases such as lupus, scleroderma and rheumatoid arthritis. Dow Corning ceased manufacturing the implants after the Food and Drug Administration ordered that silicone gel implants be taken off the market in 1992. Tens of thousands of lawsuits were filed against Dow Corning and, in 1995, the company filed a petition under Chapter 11 of the Bankruptcy Code.

After a long battle involving significant litigation and negotiation, Dow Corning obtained confirmation of a plan of reorganization that provided, inter alia, a $2.35 billion fund be established with money contributed by Dow Corning’s insurers, shareholders, and from its cash reserves. In exchange for providing these funds, the plan proposed to release the insurer’s and shareholders from liability on personal injury claims, and permanently enjoined parties holding claims released against Dow Corning from bringing actions related to those claims against the insurers and shareholders. The Bankruptcy Court confirmed the plan over the objection of certain claimants. In construing the plan’s release and injunction provisions with respect to nondebtor entities, the Bankruptcy Court determined that, although generally not prohibited, they were properly applied only against consenting creditors. The District Court affirmed confirmation, In re Dow Corning, 255 B.R. 445 (E.D. Mich. 2000), but reversed the Bankruptcy Court’s limited application of the release and injunction provisions. The District Court reasoned, instead, that the provisions could be applied to both consenting and non-consenting creditors.

Issue: The principal issue presented in this case concerns whether a bankruptcy court may enjoin a non-consenting creditor’s claims against a non-debtor to facilitate a Chapter 11 reorganization plan.

Holding: After determining that a plan provision releasing nondebtors from liability and enjoining action against those nondebtor entities is inconsistent with neither the Bankruptcy Code nor the relevant judicial authorities, the Court held that plans containing such release and injunction provisions may be confirmed over the objection of creditors so long as “unusual circumstances” are present. Specifically, a bankruptcy court may enjoin a non-consenting creditor’s claims against a nondebtor where: 1) there is an identity of interests between the debtor and the third party, usually and indemnity relationship, such that a suit against the nondebtor is, in essence, a suit against the debtor or will deplete the assets of the estate; 2) the nondebtor has contributed substantial assets to the reorganization; 3) the injunction is essential to reorganization, in other words, the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against the debtor; 4) the impacted class, or classes, has overwhelmingly voted to accept the plan; 5) the plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction; 6) the plan provides an opportunity for those claimants who choose not to settle to recover in full; and 7) the bankruptcy court made a record of specific factual findings that support its conclusions.

Analysis: The Court’s reasoning focused both on the Bankruptcy Court’s limited construction of the release and injunction provisions and the case law holding that such provisions are per se prohibited, a position with which the Court disagreed. According to the Court, § 524(e), which serves as the principal basis for the per se prohibition adopted in some jurisdictions, merely explains the effect of a discharge; the section does not, by its terms, prohibit the release of nondebtors. Moreover, § 105(a), which confers upon the bankruptcy courts broad equitable power to carry out the provisions of the Bankruptcy Code, and § 1123(b)(6), which permits a Chapter 11 plan to include any appropriate provision not inconsistent with the Bankruptcy Code, combine to confer upon the bankruptcy courts substantial power to reorder debtor/creditor relations as needed to achieve successful reorganization.

The Bankruptcy Court’s error, in limiting the effect of the release and discharge provisions to consenting creditors, was not its interpretation of the Bankruptcy Code, which it found to authorize nondebtor releases, but in its reliance on nonbankruptcy law that confines a court’s general equitable powers. The Bankruptcy Court had relied on judicial precedent holding that “a court’s use of it general equitable powers is confined within the broad boundaries of traditional equitable relief,” and, although authorized by the Bankruptcy Code, nondebtor releases were nevertheless impermissible because they were “unprecedented in traditional equity jurisprudence.”

Like the District Court, the Court of Appeals disagreed, finding there to be case law supporting a distinction from the authoritative principles upon which the Bankruptcy Court relied. The proper source of authority, according to the Court, is the Bankruptcy Code itself, which, through § 105(a), allows the exercise of broad equitable power. Because of this express grant of statutory authority, the bankruptcy courts are not confined in the manner contemplated by authority cited by the Bankruptcy Court in this case.
Although it affirmed the propriety of the release and injunction provisions generally, the Court was nevertheless constrained to limit the circumstances under which such provisions could be approved, finding that “an injunction is a dramatic measure to be used cautiously.” Therefore, the Court remanded the case to the Bankruptcy Court for a determination of whether the provisions in this plan comport with the “unusual circumstances” test articulated and adopted in the decision.

Catherine E. Vance, Esq.
Columbus, Ohio
(614) 890-0709
Email: vance76@earthlink.net


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CASE LAW UPDATE

Rule 9011 Sanctions. Bankruptcy Court sanctioned counsel, whose client was not a party to bankruptcy case, for sending letter to court indicating debtor’s counsel had been suspended from practice in state court. District Court reversed. Klein v. Wilson, Elser, Moskowitz, Edelman & Dicker (In re Highgate Equities, Ltd.,), 257 B.R. 391 (S.D.N.Y. 2001). On appeal, Second Circuit Court of Appeals affirmed, noting that letters to court may give rise to sanctions and holding that, before sanctions may be imposed, party must be given specific notice of conduct alleged to be sanctionable and standard by which that conduct would be assessed, and an opportunity to be heard. Klein v. Wilson, Elser, Moskowitz, Edelman & Dicker (In re Highgate Equities, Ltd.), 2002 U.S. App. LEXIS 1433 (2d Cir. Jan. 31, 2002).

Subject Matter Jurisdiction Over Claims. Bankruptcy Court was without jurisdiction to determine late-filed claim as it concerned reasonableness of collection costs, and to enjoin collection thereof, where no objection to claim was filed until after debtor completed chapter 13 plan payments and discharge had been issued. Educational Credit Management Corp. v. McAlpin (In re McAlpin), 263 B.R. 881 (8th Cir. B.A.P. 2001), aff’d per curiam, 2002 U.S. App. LEXIS 1108 (8th Cir. Jan. 28, 2002).

Disgorgement of Fees. Four months prior to filing chapter 7 bankruptcy, debtor transferred real property, which was not disclosed to bankruptcy court. Proceeds were transferred to debtor’s attorney, who retained $40,000 as attorney fees, half of which was transferred postpetition. Court affirmed B.A.P. decision, Brown v. Luker (In re Zepecki), 258 B.R. 719 (8th Cir. B.A.P. 2001), upholding bankruptcy court’s order that attorney disgorge all but $7,160 in fees received. Court found representation in land transfer was in contemplation of bankruptcy in that debtor knew bankruptcy would be filed when property was transferred and attorney performed no postpetition services. Brown v. Luker (In re Zepecki), 2002 U.S. App. LEXIS 972 (8th Cir. Jan. 25, 2002).

Trustee’s Surcharge Against Collateral. Where trustee challenges secured claim against property, and claim is disallowed, and trustee later seeks to surcharge collateral pursuant to 11 U.S.C. § 506(c) for actions taken prior to disallowance of claim, trustee cannot recover as a matter of law because there is no “allowed secured claim,” as required by that section. Poonja v. Alleghany Properties (In re Los Gatos Lodge, Inc.), 2002 U.S. App. 712 (9th Cir. Jan. 17, 2002).

Confirmation of Chapter 13 Plan. Chapter 13 trustee objected to debtors’ plan, requesting, as a condition of confirmation, debtors be required to periodically serve affidavit of income and expenses pursuant to local bankruptcy rule, which bankruptcy court granted and district court affirmed. Acknowledging concerns that debtors might deflate income for plan confirmation purposes and later seek more lucrative employment, Court of Appeals reversed, stating express provisions of 11 U.S.C. § 1325(a), if met, compel confirmation and courts may not, absent exceptional circumstances, exercise undefined equitable powers to alter specific statutory requirements. Petro v. Mishler, 2002 U.S. App. LEXIS 370 (7th Cir. Jan. 10, 2002).

Exceptions to the Automatic Stay. Plaintiff in nonbankruptcy proceeding filed motion to compel discovery responses against debtor, who commenced his chapter 7 bankruptcy case six days later. Magistrate judge nevertheless granted motion to compel. Court of Appeals affirmed; even though no contempt or violation of court order had been found, matter could go forward to determine whether such misconduct had occurred, in which case application of automatic stay would be improperly used to immunize contumacious behavior. America Online, Inc. v. CN Productions, Inc., 2002 U.S. Dist. LEXIS 1607 (E.D. Va. Jan. 31, 2002).

Disinterestedness. Law firm is not per se disqualified from employment by chapter 11 debtor solely because one partner of firm had served as officer of debtor until just before the bankruptcy filing; rather, proper determination of disinterestedness requires individualized inquiry into specific circumstances of professional’s involvement with debtor. Stanley v. Keravision, Inc. (In re Keravision, Inc.), 2002 U.S. Dist. LEXIS 1586 (N.D. Cal. Jan. 18, 2002).

Dischargeability of Student Loans. Although in agreement with those courts holding that 11 U.S.C. § 523(a)(8), which governs dischargeability of student loans, does not preclude partial discharge, amount debtor may discharge remains controlled by statute’s “undue hardship” standard. Bankruptcy court erred in granting partial discharge after finding no undue hardship and no good faith effort toward repayment. Tennessee Student Assistance Corp. v. Mort (In re Mort), 2002 U.S. Dist. LEXIS (W.D. Va. Jan. 18, 2002).

Catherine E. Vance, Esq.
Columbus, Ohio
(614) 890-0709
Email: vance76@earthlink.net

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Networking Spotlight
Joint Legislative Conference March 10 - 12, 2002

The Commercial Law League of America and the National Association of Credit Management will hold a Joint Legislative Conference March 10 - 12, 2002 at the Crystal Gateway Marriott in Arlington, Virginia. The Conference will offer attendees more than 25 hours of educational programming to choose from and will feature visits to Capitol Hill. In addition, members of the CLLA and NACM will attend one breakfast, two luncheons and two networking receptions.

On Sunday, March 10, attendees will hear an update on political and economic issues in a daylong program that will feature a distinguished group of individuals with responsibility for policy making. Included will be representatives from the Treasury Department, the Federal Reserve, the State Department and the Department of Commerce.

Monday, March 11 will feature three different sets of concurrent educational programs presented throughout the day. In the morning slot, attendees can choose from the following:

• "Employment Law - You Should Know Better!"
• "Measures to Evaluate the Health of Accounts Receivable Portfolios"
• "Bankruptcy Overview"

During the mid-morning slot, three more programs will be available to attendees. These include:

• "Identity Theft-Learn to Fight Back"
• "Advanced Issues in Bankruptcy"
• "Reclamation"

Following a networking lunch, featuring a presentation by Neil Abercrombie, (D-HI), a member of the House Armed Services Committee, attendees will be able to attend one of three additional concurrent educational programs as follows:

• "The Anatomy of a Composition Agreement"
• "The Enron Bankruptcy - Lessons that Need to be Learned"
• "Improving Your Collection Performance"

On Tuesday, following a breakfast which features a presentation by a Congressional Representative, conference participants will make courtesy calls on their Congressmen and Senators to discuss the differences between consumer and commercial credit as well as other timely topics that impact business commerce. The Conference will conclude on Tuesday with a closing reception at La Colline, providing the opportunity to share experiences gained throughout the day.
Conference details

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CLLA/FCIB International Conference
April 28-30, 2002
Dublin, Ireland

The CLLA and FCIB are offering an exciting opportunity for CLLA members. The FCIB (Finance, Credit and International Business) is one of the world's leading International Credit and Export Finance Management Associations, and it is affiliated with NACM. FCIB represents over 800 member companies worldwide.

Members of the Law Society of Ireland have also been invited to participate in this conference, as well as all of the attendees from our previous three International conferences. This will be an outstanding opportunity to network with counterparts from throughout Europe and North America, while demonstrating the availability of expert legal and collections services among the CLLA membership.

David Franklin of Montreal and Edmund Fry of Dublin have organized an outstanding Educational Program, and the International Workshop will afford a unique opportunity to interface with the FCIB members in attendance. Spouses and guests are welcome to join us for the Cocktail Reception on Sunday evening and the Gala Dinner Event on Monday night. The conference concludes with a Luncheon on Tuesday afternoon.

Because it is currently regarded as a hotspot for both business and travel, Dublin is the perfect venue for this joint CLLA/FCIB conference, which will be hosted at a five-star facility located in the heart of Dublin.

To be assured of hotel accommodations, it is advised to make reservations by the February 27th deadline.

Registration Form
Program Schedule
Hotel Reservation Form


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©2002, Commercial Law League of America