With a slide into recession, and the continuing aftershocks of the collapse of the high tech and dot-com stock market boom, the bankruptcy system has been asked to deal with some spectacular failures involving hundreds of billions of dollars in assets and liabilities, and thousands of creditors. Recent examples include Enron, Global Crossing, Pacific Gas & Electric and FINOVA Group. The proliferation of megacases means, inevitably, that many bankruptcy lawyers or firms will have more than one client in a case.

This article considers the need (and timing) for client consent where the conflicts search you perform for your non-debtor bankruptcy client (NBC) discloses that one or more non-debtor pre-existing clients of your firm (PEC) are parties in interest in the case, but are represented by other firms.² The article also considers distinctions in practice and procedure to be followed where one or more PECs are being represented in the bankruptcy case by others in your firm, or more than one client (whether new or pre-existing) seek to have the same lawyer represent them.

Most lawyers have a strong revulsion to seeking consent from firm clients who are represented by other firms in a case, because they see nothing but a downside in the effort. Obtaining and documenting consent is often uncomfortable and burdensome. But it is the direct threat to employment that is most troubling. Consent connotes the power to refuse, and refusals can be irrational or unreasonable (not that any of my firm's clients would act that way). So what lawyers want to hear is that where your PECs are represented by other firms in a bankruptcy case, there is no need for their informed consent to representation of NBC unless and until there is actual, as distinct from hypothetical, adversity between them and your NBC.

The deferral (or avoidance) of informed consent from the PECs until an actual adverse situation—a manifest conflict of interest—has arisen is probably the evolving norm in complex bankruptcy cases, though it is apparently not supported by a strict reading of the Model Rules of Professional Responsibility that govern conflicts and consents in most jurisdictions.³

There was an episode from the original Star Trek series in which Captain Kirk had to come up with a way to defeat a malevolent computer. He did so by asking the computer to solve a problem. He told the computer to assume as a premise that everything he said was the truth. He then followed that with the statement that he was lying. The computer's logic circuits burned to a crisp as it sought to evaluate whether Kirk's statement that he was lying, which under the premise had to be assumed to be true, thereby negated the original premise of truth. Then it considered that if the opening premise was a lie (inasmuch as the second statement indicated he lied about the premise to assume the truth) then Kirk's second statement that he was lying might now be disbelieved, in which case the original premise of truth would be restored, leading back to the second statement and then back to the first ad infinitum. This loop could not be resolved, and the machine destroyed itself.

Lawyers' logic circuits can also be burned attempting to interpret how the law of professional responsibility should apply in bankruptcy contexts, at least where one wishes to link the need for client consent to actual, as distinct from potential, adversity. The reason is that the professional conduct rules seem to treat a potential conflict as an actual, present conflict, and an actual, present conflict is governed by Model Rule of Professional Responsibility 1.7, which requires informed consent of each client. As Kirk might say, assume there is no conflict today, and only a potential conflict in the future. But then I tell you that a potential conflict in the future is the same as an actual conflict today. Can you solve that without burning your logic circuits?⁴

It is fair to question whether the professional responsibility rules were even intended to apply in the "strict" way in the bankruptcy context. In a large bankruptcy case, isn't every party potentially adverse to every other party? The bulk of the professional conduct rules appear to have been written with traditional litigation in mind, or other matters in which there are essentially two sides, such that potential adversity would almost inevitably ripen into actual adversity. Large bankruptcy cases do not lend themselves to such neat, two-party analyses. Moreover, despite the possibility of positing hypothetical adversity between and among every possible combination of parties in interest, practitioners know that at the outset of a case, few, if any, potential clashes could be considered inevitable.

Even conflicts that may seem inevitable will not pit creditor against creditor in a direct manner. An unsecured creditor may compete with another unsecured creditor for the same pool of assets, but will not inevitably challenge the other creditor's right to recovery. An unsecured creditor is subordinate to a secured creditor, but will not inevitably challenge the secured creditor's lien. They may have adverse positions, but not direct adversity in the sense of a contest. Even where such challenges have to be brought, contests over liens or claims are usually brought by the debtor or a creditors' committee, not by one unsecured creditor against another, or by an unsecured creditor against a secured creditor. Thus, even where there is direct positional adversity, there is no inevitable adversity in fact, in the sense of one client facing off against another, each being represented by the same firm.

The possibility of some flexible interpretation for bankruptcy scenarios is suggested by comment 3 to Rule 1.7, which states that "simultaneous representation in unrelated matters of clients whose interests are only generally adverse, such as competing economic enterprises, does not require consent of the respective clients. Paragraph (a) [of Rule 1.7] applies only when the representation of one client would be directly adverse to the other." (emphasis supplied). Direct adversity, in the sense of one creditor suing another or seeking relief against another, in a bankruptcy context is actually pretty rare. Challenges to claims and positions more often come from debtors and committees against creditors and vice versa, not from creditor to creditor. Furthermore, creditors are generally adverse to one another, in that they may be seen as competing for common assets. Even though the comment expressly refers to representation in unrelated matters, the spirit of the comment would appear to support an argument that the NBC undertaking can be accepted without obtaining consents from PECs, except where it is clear that there "would" be direct adversity.

Perhaps future commentary to the professional responsibility rules will more fully address bankruptcy scenarios and expressly provide the interpretive flexibility that is now merely implied at best. Few bankruptcy lawyers are likely to either agree with or follow a strict construction that would require informed consent at the outset in any case where there is potential adversity somewhere along the line, or otherwise to equate potential conflict to an actual conflict requiring present consent. It is so easy to find hypothetical conflicts in a complex bankruptcy case that such a rule would seriously burden the bankruptcy practices of many firms by requiring consents (perhaps multiple consents) before beginning work in almost every case. In virtually every large case, consents would have to be obtained from every firm client who is a party in interest, as the condition of representing any one of them. The notion of having to obtain consent (and possibly losing an engagement) due to a hypothetical direct adversity that in most cases might never ripen into actual adversity is enough to burn the logic circuits of the most seasoned bankruptcy professionals.

Another way of justifying a more flexible approach to the conflict and consent rules is to ask, in the bankruptcy context, what purpose would be served by strict application. Absent an actual or inevitable conflict, it is difficult to see benefit to either the NBC or the PEC. The NBC seeking to engage you in the bankruptcy case would not seem to be served by a policy that accorded to other firm clients (who are not in this scenario even being represented by the firm) the power to refuse consent to the engagement. The PECs whose consent would be needed would not seem to be doing anything to advance or protect their position by refusing to consent at the point at which the conflict or adversity is hypothetical, especially where the rules are clear that their consent would be needed once the adversity were actual.

It can be argued that the PECs should have the right to prevent "their" lawyers from using their brains and skill to develop positions that some other party might eventually use against them. However, this argument is rather weak in the scenario where the PECs have already taken their bankruptcy representation in the particular case to other firms. It is much stronger where the PECs have already engaged your firm and do not wish at that point to have your firm take on any other parties in the same case. In that situation, however, as discussed below, the PECs very definitely have the right of consent, and they should.

None of these approaches should be followed without careful analysis of the facts each time the consent issue becomes relevant. There may be situations in which the potential adversity is so clearly bound to ripen into actual adversity that the actual adversity standard for consent under Rule 1.7 would apply, and it would be appropriate to equate potential with actual. In those situations, clients whose consents are needed might legitimately feel that their law firm should not be lending assistance to the potential adverse party, even if their consent would later be required in the event of actual adversity. Where adversity is inevitable, a lawyer or firm should also consider whether the rules of client loyalty are implicated in developing of strategies by which one client, to be armed with special counsel, goes against another client.

The Attorneys' Liability Assurance Society Inc. (ALAS) takes note of this ethics "practice" in the bankruptcy context as follows:

Bankruptcy counsel frequently contend that there is no "actual" conflict in a given situation. They do so in light of the anticipated positions each party is likely to advance and frequently argue that if a "real" conflict arises, special counsel may be retained to deal with that matter. From a strict legal ethics point of view, the situation presents a current conflict, which may be consentable with full disclosure, but which presents a slight possibility of developing into a non-consentable conflict in the future.

2001 ALAS Loss Prenvention Manual, p. 93. ALAS adds that the use of special counsel might obviate the conflict at the non-consentable stage, so long as the matter does not become embroiled in a disqualification contest before a court that follows the strict construction rule: potential = actual.⁵

Firms that follow a policy of deferring consent from pre-existing clients until there is an actual conflict should still take care to get the informed consent of the NBC before undertaking the engagement. The NBC should be informed about the potential limits of the engagement vis-a-vis the other firm clients, when and in what manner the consent of other clients will be sought, and what are the implications if consent is refused. That client must understand (and agree) that if direct adversity arises, it will have to resort to special or new counsel. "To be valid, client consent to a conflict of interest must...be given...after 'communication of information reasonably sufficient to permit the client to appreciate the significance of the matter in question.'" ALAS 2001 Loss Prevention Manual, p. 75 (quoting from Model Rules of Professional Conduct, Terminology (1999)).

[T]he key requirement for effective client consent is adequate disclosure. Ideally, the disclosure should be as thorough as possible, conveying all relevant facts, possible adverse effects from the conflicts, the reason those effects should not occur and alternative courses of action. Both the disclosure and the consent should be set forth in a written document. As to concurrent conflicts, the additional test of whether the lawyer's representation, or the lawyer-client relationship, will be adversely affected, must be satisfied.

Id. at 77.

Some distinctions in practice and procedure should also be noted where the conflict search for the NBC discloses that PECs are currently being represented by your firm, or where multiple potential NBCs want to engage you personally. In these situations, even if potential adversity might otherwise support a deferral of any effort to obtain consents (as discussed above), the fact that the emergence of an actual adversity will necessarily impact one or more of the clients' choice of lawyer makes initial written consent essential all the way around. According to Rule 1.7 (b)(2), "[w]hen representation of multiple clients in a single matter is undertaken, the consultation shall include explanation of the implications of the common representation and the advantages and risks involved." For example, an engagement letter might provide that in the event of such adversity, one of the parties agrees to obtain separate counsel and consents to the lawyer continuing as counsel to the other party. Alternatively, the parties might agree that in the event of direct adversity, they must each obtain new counsel and neither may use the lawyer first engaged.⁶ Where different lawyers within a firm are representing different clients, it is typical and appropriate to establish ethical walls to protect the privacy and confidentiality of each lawyer's advice to the respective client. Where the same lawyer is involved in multiple representations, it is typical and advisable to establish confidentiality understandings. Lawyers who are representing more than one creditor in a bankruptcy case (or whose firms are doing so), should also be aware of the disclosure rules (Bankruptcy Rule 2019 requires certain disclosures with respect to the representation of multiple creditors and equity-holders) and the various "positional" conflict rules of the Model Code of Professional Responsibility and related ethics rules, which address, and in some cases restrict, the extent to which a lawyer or firm can simultaneously advocate positions that are in conflict with one another.

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Footnotes

¹ This article is intended to be an opinion piece, and not by any means an exhaustive or definitive analysis of the relevant professional responsibility rules. Nevertheless, it does have a grounding in the ABA's Model Rules of Professional Responsibility and the 2001 Loss Prevention Manual of the Attorneys' Liability Assurance Society Inc. (ALAS). Special thanks are due to Andrew Shaffer, a bankruptcy associate in the New York office of Mayer, Brown, Rowe & Maw, who assisted with the research, and to ALAS. Return to article

² The Bankruptcy Code's disinterestedness and conflicts requirements make it extremely difficult, if not virtually impossible, for a lawyer or firm to represent, simultaneously, a debtor and any other party in interest (especially creditors) in a bankruptcy case. Those rules and requirements are fairly well-known and are not discussed here. For similar reasons, this article does not address simultaneous representation of an official committee and any other party in interest. Return to article

³ The Model Rules of Professional Responsibility have not been adopted uniformly. Some states have their own codes, or variations of the Model Rules. It is important to consult your own state's rules before making any definitive decisions about the consent requirements. Return to article

⁴ Another way of looking at it is to conclude that there is no such thing as a potential conflict in the law of professional responsibility. See, e.g., In re Kendavis, 91 B.R. 742 (Bankr. N.D. Tex. 1988) (concept of "potential" conflict incompatible with disinterestedness requirements of 11 U.S.C. §327). Return to article

⁵ ALAS cites In re Michigan General Corp., 78 B.R. 479 (N.D. Tex. 1987), as an example of disqualification in this kind of situation. Return to article

⁶ Lawyers should be wary of resolving such direct adversity issues through arrangements that would be detrimental to their continued employment, because such arrangements may compromise the independence of advice that must be provided. For example, the lawyer may try to "guide" the clients away from the adversity (even though addressing the adversity might be to the benefit of one or the other of them) for fear that he or she will lose the engagement at that point. Return to article