Opinion
Case No. 98-20732, Chapter 11
September 2, 1998
ORDER ON OBJECTION TO CONTINUED EMPLOYMENT OF COUNSEL
On August 25, 1998, the court held a hearing on the Objection to Continued Employment of Counsel filed by the United States Trustee. Georg Jensen, court appointed counsel for the debtor in possession, appeared on his own behalf.
Mr. Jensen is general bankruptcy counsel for the debtor in possession. He and the debtor entered into a Bankruptcy and Reorganization Retainer Fee Agreement, also called a Retention Agreement, which was attached to the debtor's application. On May 29, 1998, the court approved Mr. Jensen's employment by the debtor in possession.
The debtor is a corporation. Michael Puhr, Lorinda Liang, and Wen Jen Allen Lan each signed a personal guaranty of fees owed to Mr. Jensen by the debtor in possession, including fees which are not authorized as an administrative claim by the Bankruptcy Court. Mr. Purh, Ms. Liang, and Mr. Lan are creditors, insiders, and shareholders or officers of the debtor. These relationships to the debtor in possession were not disclosed by Mr. Jensen in any of the employment documents.
Prior to filing, the debtor paid Mr. Jensen a retainer. In his Rule 2014 statement, Mr. Jensen stated the source of the funds for the retainer was from a potential investor in the debtor corporation, Allen J. Hwang. As usual, after an objection by the U.S. Trustee, further information concerning the insiders and Mr. Hwang was forthcoming.
Mr. Hwang is the president of a company called Acadia Investments which is proposing the investment arrangement. Mr. Hwang is directly involved in the proposed deal to invest in or purchase assets from the debtor.
The U.S. Trustee raises two concerns. First, she argues that the source of the retainer from a potential investor's funds creates an actual, disqualifying conflict of interest. Under 11 U.S.C. § 327(a), the debtor in possession may employ an attorney that does not hold or represent an interest adverse to the estate, and that is disinterested.
The Code does not define an adverse interest. The definition found in In re Roberts, 46 B.R. 815, 827 (Bankr.D.Utah 1985), aff'd in part and rev'd in part, 75 B.R. 402 (D.Utah 1987) (en banc) is generally accepted:
Under § 101(14), the Code defines a disinterested person as a person that "(A) is not a creditor, an equity security holder, or an insider," and "(E) does not have an interest materially adverse to the interest of the estate . . . by reason of any direct or indirect relationship to, connection with, or interest in, the An actual conflict of interest is always disqualifying under § 327. Most courts hold that even a potential conflict of interest is sufficient to render a party non-disinterested. See In re Glenn Electric Sales Corp., 99 B.R. 596 (D.N.J. 1988). Recognizing the changes in circumstance that can develop as a bankruptcy case progresses, this court has looked to the remoteness of any potential conflict as a pertinent consideration when authorizing employment.
Mr. Jensen contends there is no conflict of interest, that he is neutral on the investment proposal (comments in his response aside), and that the debtor supports his continued representation. While relevant to matters concerning the quality of counsel, the court does not believe the opinion of the debtor in possession is particularly persuasive on this issue. Mr. Jensen is the party responsible for advising the debtor concerning the ethical and fiduciary responsibilities of the debtor in possession and the professionals employed, and for evaluating all potential conflicts of interest.
As to the facts which might indicate a conflict of interest, Mr. Jensen stated that he avoided contact with the persons providing the funds for his retainer, even though he questions the "propriety" of allowing a client to "enter into a transaction without the benefit of legal counsel; or advise (sic)," because of future ramifications from the U.S. Trustee. The failure to
Nevertheless, based on the facts as now presented to the court, i.e., that the retainer funds were provided to the debtor without any quid pro quo but solely because of the potential investment opportunity; that the funds were paid to counsel by the debtor rather than Mr. Hwang; that Mr. Hwang has no creditor, fiduciary or other relationship to the estate; and that Mr. Jensen has no relationship with Mr. Hwang, the court does not find a disqualifying conflict of interest at this time. If the facts are otherwise, the circumstances change, or Mr. Jensen becomes entangled in a dispute, Mr. Jensen has a responsibility to evaluate the facts, represent them to the court, and to resign as counsel if necessary.
The second matter to be addressed is the issue raised by the fee guaranty. While the law is undisputed that counsel cannot represent both a shareholder and the debtor corporation, In re Dasom, Inc., 180 B.R. 430, 431 (Bankr.W.D.Pa. 1995), there is more disagreement when the relationship with the shareholder is limited to a fee guaranty. Some courts hold that when an insider funds counsel's fees, the relationship creates an actual conflict of interest for counsel. In re Hathaway Ranch Partnership, 116 B.R. 208 (Bankr.C.D.Cal. 1990). Others evaluate the underlying relationship between the insider and the debtor, as well as other factors, to determine whether an adverse interest is evident. In re Lotus Ranch Properties LP, 200 B.R. 388 (Bankr.C.D.Cal. 1996) In general terms, a guaranty of counsel's fees implicitly creates an appearance of competing loyalties. An insider's interests may diverge from those of the estate, and hence the creditors. Counsel, who owes undivided loyalty to the estate, cannot be compromised by a fee arrangement which may divide that loyalty. Clearly, there is the appearance of a predisposition toward the interests of the guarantors, whether real or perceived.
More specific to this case, the guarantors are creditors of the estate. Although Mr. Jensen is not directly representing the guarantors, he is ultimately dependent on them to receive full payment of fees. Yet, in his role as counsel to the estate, Mr. Jensen has the responsibility to review the claims of all creditors, investigate potential avoidance claims, and give advice which may not be in the best interests of the equity holders. In this court's view, the guaranty ensures Mr. Jensen is not a disinterested person.
Mr. Jensen argues that in a corporation, the shareholders' and officers' interests are aligned with that of the debtor and the decisions of the debtor in possession are ultimately made by these very persons. In short, the debtor can only act through the insiders.
Be that as it may, a bankruptcy estate is more than just a separate entity driven by shareholders. The shareholders and counsel have the interests of the creditors to consider. The court is cognizant of the tension and the dilemma created by the corporate structure, particularly in small or close corporations (which this debtor is not). However, the circumstance of the relationship is also the very factor that creates the potential for conflict, ultimately the reason counsel must be especially attentive to the appearance and existence of conflicting loyalties.
In this case, the guaranty raises another troubling issue. Under its terms, the guarantors are responsible for the payment of all fees incurred, whether or not disallowed by the court as an administrative expense. In the case of an individual debtor, some services may be performed for the debtor which, although compensable, are not compensable from the estate. However, this debtor is a corporation and disallowed fees cannot be collected from third parties because the right to payment does not exist. In re Gantz, 209 B.R. 999, 1003 (Bankr. 10th Cir. 1997). Either the fees are allowed under § 330, or they are not.
Rather than disqualify counsel, the court will permit counsel to void the guaranty and continue to represent the debtor in possession, or to withdraw on that basis.
It is, therefore, ORDERED that the United States Trustee's objection to the continuing employment of Georg Jensen as counsel for the estate is overruled in part; and further
ORDERED that Mr. Jensen shall void the guaranties from the debtor's insiders and notify the court within ten days of the date of this order, failing which the court will enter an order disqualifying him from further representation of the debtor in possession.