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Come to Houston for Your Chapter 11s?

posted by Bob Lawless

In a recent court opinion, Judge Marvin Isgur ruled that one partner's lack of disinterest would not be imputed to his entire law firm. Hence, the law firm of Bracewell & Giuliani--yes, it's that Giuliani--could represent Cygnus Oil & Gas in its bankruptcy even though one of the partners served as a corporate director for Cygnus shortly before its bankruptcy filing.

How do I know this? You make all kinds of friends, apparently, running a blog. An employee of the public relations firm of Hellerman Baretz sent me an unsolicited e-mail suggesting the case would make a good blog story. Those sorts of e-mails now find themselves in my inbox, but this one caught my eye. The e-mail suggested the case was a great reason for corporations filing bankruptcy to do so in Houston, a fact that not coincidentally redounds to the benefit of the Houston legal community.

Judge Isgur's ruling revolved around the question of whether the Bankruptcy Code required one attorney's disqualification to extend automatically to the attorney's entire law firm. To be an attorney for the debtor, the attorney must be a "disinterested person." The relevant code section, § 101(14), defines a "disinterested person" as someone who (1) is not a creditor or shareholder of the debtor, (2) is not a director or officer of the debtor now or within the two years before the case, OR (3) does not have an interest materially adverse to the interest of the bankruptcy estate or to creditors. The U.S. Trustee argued that because one partner of the law firm was disqualified under (1) and (2), the entire law firm automatically was disqualified. (For our nonlawyer readers, imputation of disqualification is fairly common under state law rules of professional conduct.) Judge Isgur reasoned that the relevant statutory language was very clear -- the partner and not the law firm was a shareholder and a director. Rather than being automatically disqualified, the entire law firm was disqualified only if it held a material adverse interest to the estate under part (3). Because the law firm had taken steps to wall off the affected partner from any knowledge or participation in the case, the law firm was disinterested.

I have not thought deeply about this issue, and those of you who know me will not be surprised by that. But, on balance, Judge Isgur's ruling strikes me as the better reading of the statute. It allows for a more nuanced and contextualized determination of disinterestedness in individual cases. Judge Isgur's ruling was in line with the decisions of most every other court that has considered the issue. Importantly, Judge Isgur's ruling directly contradicts the ruling of another bankruptcy court -- the U.S. Bankruptcy Court for the District of Delaware, which is the forum of choice for many corporations filing bankruptcy. In the case of In re Essential Therapeutics, 295 B.R. 203 (Bankr. D. Del. 2003), that court ruled that the disqualification of one attorney extended to the entire firm.

Here is what the public relations firm wrote to me about the decisions:

When large companies file Chapter 11 bankruptcy petitions, they often look to Delaware or New York for venue. However, venue in Delaware and New York may be harsher on professionals than a Texas venue. In April, Cygnus Oil and Gas Corporation filed its petition in the Houston Division of the United States Bankruptcy Court for the Southern District of Texas. While the case is ongoing, a significant ruling should have bankruptcy lawyers taking note.

On May 29, US Bankruptcy Judge Marvin Isgur signed a memorandum opinion in which he found Bracewell to be a disinterested person as outlined in section 101(14) of the Bankruptcy Code. Consequently, Bracewell was able to represent Cygnus as counsel in its Bankruptcy proceeding, despite the fact that a Bracewell lawyer had earlier been on the Cygnus Board of Directors. The Court held that the disinterestedness of a former Board Member was not imputed to the entire firm. This decision is directly opposite the decision rendered in the Delaware Bankruptcy Court in In re Essential Therapeutics, Inc., 295 B.R. 203 (Bankr. D. Del. 2003), where the bankruptcy court expressed concerns that under the "current climate of distrust of officers and directors," the officers of debtors may be subjected to interrogation based on their role in debtors thereby rendering it “impossible” for a firm in which an officer was a member to "adequately represent the Debtors’ interests. . ." The Cygnus decision also runs contrary to In re Vebeliunas, 231 B.R. 181 (Bankr. S.D.N.Y. 1999), which adopts the "general rule" that "when one member of a firm is disqualified, all members of that firm must be disqualified." 

Click here for a copy of the ruling http://react.bracewellgiuliani.com/reaction/announcements/bracewellopinion.pdf.

Additionally, the case illustrates the potential to overcome the unintended hurdles presented as law firms get bigger and the likelihood increases that one or more partner might have previously been on the board of a company that the firm represents.

As Stephen Lubben discussed here and here in his guest-blogging stint for us, there is a big controversy about whether and how different bankruptcy courts compete for large corporate bankruptcies. Lynn LoPucki has claimed that courts have been "corrupted" and compete for cases by rulings favorable to those who decide where these cases are filed. Lubben was less certain but questions whether there is evidence that the competition has led to poor outcomes for cases filed in Delware and Manhattan.

In light of this discussion, the e-mail was quite intriguing. The e-mail's none-too-subtle message is that the Houston bankruptcy court has done bankruptcy law firms a big favor. "Come to Houston," seems to be the message, "and we'll treat you right." Because of the controversy over this topic, I want to be clear that I do not think Judge Isgur is responsible for the public relation's firm use of his ruling. But the public relations e-mail would seem to be pretty clear evidence of jurisdictional marketing. I do not know for whom the public relations firm was working, but it appears to be someone with an interest in having large corporate bankruptcy cases come to Houston.

On the other hand, there is nothing misleading in the public relations e-mail. What is wrong with publicizing a court decision? Attorneys make decisions on whether and where to file all kinds of cases based on a court's past decisions. That is part of the expertise for which clients pay. What bothers me here is that the public relations pitch is to file because the decision is good for attorneys who are supposed to act in their clients' best interest, not their own. The message is not just that "We'll treat you right" but that "We'll treat you attorneys right." One part of the jurisdictional competition controversy was that courts were competing by pandering to professionals with loose rulings on disinterestedness and professional fees. The e-mail from the public relations firm feeds that perception.



I'd bet the PR firm is doing work for a law firm. What a fascinating find!

1. I don’t think the idea that courts have been competing for big bankruptcy cases is controversial. Nearly every big city bankruptcy court revised its rules in response to Delaware’s surge of the mid-1990s. Some courts stated publicly that they were making changes to stop the outflow of cases to Delaware.

2. Delaware is clearly winning the competition for big cases. Yet, as Bob correctly points out, on this issue the Houston Court’s decision is more favorable to the case placers than the Delaware Court’s decision. Such an inversion is interesting, but hardly unusual in regulatory competitions. For example, Delaware remains the leader in the corporate charter competition even though it's court decisions are less favorable to management on a number of legal points. All Delaware has to do in both competitions is to remain sufficiently more favorable on the entire array of issues that it doesn’t lose significant numbers of cases to other courts. So far, it is doing that. You can watch the flow of cases to particular courts on the WebBRD at http://law.ucla.edu.

3. Whether malicious or in good faith, court competition is sapping the regulatory power of the bankruptcy courts, just as it sapped the regulatory power of corporate law. If you don't think parties should be free to contract around the bankruptcy system, you should be worried.

This kind of issue is more likely to arise in a small case, rather than a mega-case. Mega-companies' ethics policies generally bar, or heavily burden any chance of, hiring directors' outside businesses, and top law firms will shy away from the risk of being accused of a potential conflict in a litigious environment like a chapter 11.

For those with an ax to grind, it is an inconvenient truth that venue decisions reflect a number of factors unrelated to the decisional law on professionals or the bankruptcy court's predilections on any issue. For instance, the number of airline and auto cases filed in New York is directly related to Second Circuit authority on labor issues, including 1113 & 1114, contrasted with the other Circuits' approaches on the same points. The 5th Circuit's Braniff and Continental decisions limiting 363 sales have been a factor in avoiding courts there. A Circuit's approach to the hypothetical vs. actual debate over 365(c) is a major factor in determining venue for some cases where IP value is a critical factor. A management's desire to avoid confronting employees, local media or public interest litigants in court is another factor that influences venue choice. Venue selections are normally supported by the largest creditors as well.

In any system involving complexity and judgment, whether it be legal, financial, medical, insurance, political, advertising or whatever, market share seems to become lumpy over time and is not homogenized. Experience and reliability are critical factors that clients seek in professionals when facing a major crisis. In turn, the professionals look at the same factors when advising on venue choices. While experience and reliability are factors tends to lead to concentration, rather than dispersion, of the caseload, they are hardly illicit, suspicious or something to be "worried" about.

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