Opposition Brief — Southmark Corp. v. Coopers & Lybrand, L. L. P., 119 S. Ct. 2339 (1999) (No. 98-1643)

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Supreme Court, U.S

2. eek w

No. 98-1645

YEON. A ee : FA: CT oR NT ah AY, nd 1299

In the doa

CLERK gh

Supreme Court of the Wviteh ett

October Term. |S98

IN THE MATTER OF: SOUTHMARK CORPORATION

SOU THMARK CORPORATION,

P Lili at }

COOPERS & LYBRAND L.L.P..

‘ _ ~ j rr y «

On Petition for Writ of Certiorari to the United S

J r

Court of Apbeats for the Fifth Circuit

BRIEF IN OPPOSITION TO PETITION

FOR A WRIT OF CERTIORARI

Judith Elkin Michael S. Feldberg

HAYNES AND BOONE, L.L.P. Counsel of Record

3100 Bank of America Plaza Frank J. LaSalle

901 Main Street SCHULTE ROTH

Dallas, Texas 75202 & ZABEL L.L.P.

(214) 651-S000 900 Third Avenue

Attorneys for Respondent New York, NY 10022

Coopers & Lybrand L.L.P. (212) 756-2000

Alton eys for Respondent

( oope rs & Lybrand eR ag

Wright/Curry & Taylor Appellate Services

COUNTER-STATEMENT OI

QUESTION PRESENTED

Whether claims alleging official raisconduct by bank

ruptey court appointed professionals constitute core bank

ruptcy proceedings

DISCLOSURE STATEMENT

Pursuant to Supreme Court Rule of Procedure 29(6),

Respondent Coopers & Lybrand L.L.P. has no parent corpo-

rations and no wholly-owned subsidiaries. Effective July 1,

1998, Coopers and Lybrand L.L.P. and Price Waterhouse

LLP combined their practices to form Pricewaterhouse Coo-

pers LLP

TABLE OF CONTENTS

Counter-Statement of Question Presented

Disclosure Statement

lable of Contents .

lable of Authorities

Argument ......-.-eeeeeeereeee

| The Decision Of The Fifth Circuit Maintains

The Constitutional Limits Prescribed By

ei ny ewan es He hee oes

A. Southmark’s Claims Are In The Nature O!

A Challenge To Cooper's Disinterestedness

As A Bankruptcy Court-Appointed

Professional. .........--

B. Ensuring The Disinterestedness Of Court-

Appointed Professionals Is Essential To The

Proper Functioning Of The Bankruptcy Court

And Therefore Is Within The Core Bankruptcy

he BS, RES, Oe DE Or EF

C. Failure To Treat Southmark’s Claims As

Core Bankruptcy Proceedings Would | nder-

mine The Power Of The Bankruptcy Court lo

Restructure Debtor-Creditor Relations.

1. The Courts Of Appeals Are In Agreement

Phat Claims Of Misconduct By Court-

Appointed Officers In The Performance Of!

heir Official Duties Constitute Core Bank-

ruptcy Proceedings.

Conclusion ......-seceseeeeeee:

Appendix

Page

, ry , . , lay 4 7 *,*

Motion to Rec onsidel \ward O| f ees 10 LOO

pers & Lybrand and Brief in Support Thereof

In re Vebeliunas, 231 B.R. 181 (Bankr.

TABLE OF AUTHORITIES

Cases

(rnold Print Works, Inc. v. Apkin, (In re Ar-

nold Print Works, Inc.), 815 F.2d 165, 169 (Ist

Ci. F96F) ws vee sdedesccwcdaes

Billing v. Ravin, Greenberg & Zackin, P.A., 22

F.3d 1242 (3d Cir. 1994) .....

Commodity Futures Trading Comm'n vy. Schor,

ry, BERS oak Gy. | ° eRe pap oe Py

In re American Solar King, 142 B.R. 772

(Bankr. W.D. Tex. 1992)

In re Balboa Improvements, Inc.. 99 B.R. 966

(B.A.P. 9th Cir, 19G9) on ici c cc eccew tases cedees

In re Diamond Mortgage Corp., 135 B.R. 78

(Bankr, N.D. Ti. T9890) 2.6 vccceee:

In re Elegant Equine, Inc., 155 B.R. 189

(Bankr. N.D. Ill. 1993) .......

In re Enviordyne, 174 B.R. 955 (Bankr. N.D

ean eedeaces

In re Vebeliunas, No. 98 B 45466, 1999 WI

152577 (Bankr. S.D.N.Y. Mar. 10, 1999)

In the Matter of Linton, 136 F. 3d 544 (7th Cir.

a aa

Northern Pipeline Co. v. Marathon Pipe Line

Co.. 458 U.S. 50 (1982)

Pierson & Galen v. Creel & Atwood, (In the

Vatter of Consolidated Bancshares, Inc.), 785

F.3d 1249 (Sth Cir. 1986) ........

Page

Rome v. Braunstein, 19 F.3d 54 (1st Cir. 1994)

Sanders Confectionary Products, Inc. v. Heller

Financial, Inc., 973 F. 2d 474 (6th Cir. 1992) ...

laxel v. Electronic Sports Research, (1n re

Cinematronics, Inc.), 916 F.2d 1444 (9th Cir.

SPE ac Keh oka bie ehh ieenes shawrcineet PANE rere

Torkelson v. Maggio (In re Guild and Galler)

Plus, Inc.), 72 F.3d 1171 (3d Cir. 1996) .......

Walsh v. Northwestern National Insurance Co

(In re Ferrante), 51 F. 3d 1473 (9th Cir. 1995)

Statutes

28 U.S.C. §157(b)(3)

Supreme Court Rules

Supreme Court Rule 29.6 .....

ARGUMENT

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decision Ol tic UU

conflict with any decision of this ( ourt or oT an OU

Appeals. The Fifth Circuit’s holding that state-law cor

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and tort claims asserted Dy Southmark Corporation |

mark”) against Coopers & Lybrand L.L.P. (“Coopers”

a core bankruptcy proceeding Hecause they arose out

leged misconduct in C¢ Ope»>rs performance of its duties as

are A - . hh —_ ~ -

accounting firm appointed by the bankruptcy court In 5¢

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mark $ Chapter il Dankruptcy is in accordance witn '

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grant of jurisdiction to Dankruptcy courts, <5

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The Decision Of The Fifth Circuit Maintains |

Constitutional Limits Prescribed By Marathon.

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the state law character of a claim talismanic power in Article

II] inquiries.”). Instead, the court should inquire into the na-

ture of the proceeding——how the proceeding relates to the ba-

sic function of the bankruptcy court. See Arnold, 815 F.2d at

169. Under this analysis, the Fifth Circuit's fact-bound deci-

sion is consistent with the constitutional scope of the bank-

ruptcy power enunciated in Marathon.

A. Southmark’s Claims Are In The Nature Of

A Challenge To Cooper's Disinterestedness

\s A Bankruptcy Court-Appointed

Professional.

Southmark’s claims against Coopers for breach of

contract, fraud and deceit, breach of fiduciary duty, and negli-

gent misrepresentation arise out of Coopers’ alleged miscon-

duct as the bankruptcy court-appointed accountant for the

examiner in the Southmark bankruptcy case. Pet. at 57a-72a.

For example, in its fraud and deceit count, Southmark alleged

that

Coopers represented to Southmark that the

reason Coopers did not develop claims against

Drexel was because of lack of time, lack of

corroborative evidence, and the fact that

Drexel had filed for bankruptcy. In fact, how-

ever, Coopers never intended to investigate

claims against Drexel, its largest audit client,

and it deliberately suppressed evidence con-

cerning such claims developed by one of its

managers,

Pet. at 69a "36. Similarly, Southmark’s breach of fiduciary

duty count alleged that Coopers “subvert{ed] the

investigation of claims against Drexel in the interest of

Drexel and contrary to the interest of Southmark.” Pet. at 70a

q2g.

Southmark does not contest that its claims are based

on Coopers’ alleged bias in performing its duties as the court-

appointed accounting firm, but argues that the “substantive

nature” of the claims is that they are “state-created private

rights,” based in large part on the fact that the claims arise

under state law and are to be decided through application o!

standards supplied by state law. Pet. at | 1-12. The argument

that a proceeding is non-core because it will be resolved un-

der state law has been explicitly rejected in the Bankruptcy

Code. See 28 U.S.C §157(b)\ 3).

Southmark’s claims cannot be divorced from the

bankruptcy context within which they arose. Like an exam-

‘ner or a trustee, a court-appointed professional is a creature

of the bankruptcy process. As such, it owes a duty not only

to the estate on whose behalf it was retained, but also to the

examiner/trustee, the creditors and the court, and no claim

against it can be determined without consideration of these

varied obligations. The duties of Coopers and any claims

against Coopers for its alleged breach of those duties are de

pendent upon its role in the bankruptcy process and could not

exist but for that process.

B. Ensuring The Disinterestedness Of Court-

Appointed Professionals Is Essential To

The Proper Functioning Of The Bank

ruptcy Court And Therefore Is Within The

Core Bankruptcy Power.

Court-appointed professionals play a prominent role

in the bankruptcy process and, as was the case here, are often

entrusted with significant responsibility in connection with

the administration of the bankruptcy estate. In recognition of

the role played by such professionals, the Bankruptcy Code

requires that professionals “do not hold or represent an inter-

est adverse to the estate, and that [they] are disinterested per-

sons.” 11 U.S.C. §327(a). The disinterestedness requirement,

in particular, is strictly enforced in order to maintain the in-

tegrity of the bankruptcy process. See Jn re Diamond Mort-

gage Corp., 135 B.R. 78, 90 (Bankr. N.D. Ill. 1990); see also

Pierson & Galen v. Creel & Atwood (In the Matter of Con-

solidated Bancshares, Inc.), 785 F.2d 1249, 1256 n.6 (Sth

Cir. 1986). To that end, bankruptcy courts are charged with

an ongoing obligation to “root out impermissible conflicts of

interest” whenever they arise. Rome v. Braunstein, 19 F.3d

54, 58 (Ist Cir. 1994) (quotation omitted); see In re Vebeliu-

nas, No. 98 B 45466, 1999 WL 152577, at *3 (Bankr.

S.D.N.Y. Mar. 10, 1999) (the disinterestedness requirement

“is so crucial to the proper functioning of the bankruptcy sys-

tem,” the court may address any alleged lack of disinterested-

ness whenever the issue arises) (a copy is attached at

Appendix 34b).

The non-core claims in Marathon and Granfinanciera

S.A. v. Nordberg, 492 U.S. 33 (1989), upon which Southmark

relies, are of an entirely different nature than the claims raised

by Southmark. In Marathon, the debtor asserted a contract

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claim against Marathon in relation to a pre-petition agreement

to construct a pipeline. Granfinanciera involved an action in

which the bankruptcy trustee alleged that a non-creditor had

received a fraudulent conveyance from the debtor prior to

bankruptcy. In both cases, the claims related to pre-petition

conduct that possessed neither a temporal nor structural

nexus to the bankruptcy process. In contrast, Southmark’s

claims against Coopers arose during and in the conduct of the

bankruptcy proceeding; without the bankruptcy proceeding,

Coopers would have had no relationship with Southmark and

the claims would not exist.

Southmark’s own Motion to Reconsider Award of

Fees to Coopers & Lybrand and Brief in Support Thereof (a

copy is attached at Appendix 1b) demonstrates the core na-

ture of its claims:

Shielding one of its largest clients from claims

that could have substantially enhanced creditor

recoveries was plainly inimical to the interests

of Southmark’s creditors and a violation of

Coopers & Lybrand’s fiduciary and statutory

duties... . {This type of misconduct threatens

the very integrity of, and the public trust in,

the bankruptcy process.

{58 (emphasis added). Southmark argued further that Coo-

pers’ conduct constituted fraud on the court, which South-

mark described as “fraud committed by an officer of the court

which affects the judicial machinery in such a way that the

judicial machinery cannot perform in the usual manner its

impartial task of adjudging cases that are presented for adju-

dication.” /d. at $59 (internal quotation omitted and empha-

sis added).

Claims concerning conduct that “threatens the very in-

tegrity of . .. the bankruptcy process” and that prevents the

court from “perform[ing] in the usual manner” involve the

core bankruptcy power. That proposition is no less sellf-

evident because the claims are cast in terms of tort or contract

rather than a fee objection, or because the claims are asserted

in state court rather than bankruptcy court.

i Failure To Treat Southmark’s Claims As

Core Bankruptcy Proceedings Would

Undermine The Power Of The Bankruptcy

Court To Restructure Debtor-Creditor

Relations.

Southmark argues that, to the extent its claims of offi-

cial misconduct against Coopers do implicate “public rights,”

those rights were vindicated by the bankruptcy court’s order

disgorging a portion of Coopers’ fees. Therefore, in South-

mark's view, it is free to pursue its private rights in another

forum.

Such a procedure would seriously undermine the

power of the bankruptcy court to control the conduct of court-

appointed officers. In the analogous context of a bankruptcy

court’s denial of leave to sue a trustee in state court, the Sev-

enth Circuit, through Chief Judge Posner, stated:

At stake in the present case, however, is a con-

cern... with the integrity of the bankruptcy

jurisdiction. If debtors, creditors, defendants

in adversary proceedings, and other parties to

a bankruptcy proceeding could sue the trustee

in state court for damages arising out of the

conduct of the proceeding, that court would

— Si a ae aad ne ee ete "

have the practical power to turn bankruptcy

losers into bankruptcy winners, and vice versa.

In the Matter of Linton, 136 F.3d 544, 546 (7th Cir. 1998).

Similarly, if debtors are permitted to raise what are essen-

tially fee objections in state court following an adverse deci-

sion by the bankruptcy court, the state court in essence gains

the power to turn a fee loser into a fee winner.

This instant case is a perfect example of this concern.

Southmark became aware of Coopers’ alleged misconduct in

1993. It subsequently moved in bankruptcy court for dis-

gorgement of Coopers’ entire $4 million fee. In March of

1995, the bankruptcy court ordered Coopers to disgorge

$220,000 of its fee, plus pay Southmark’s legal fees and costs

for its motion. The bankruptcy court also held that Coopers’

conduct did not cause Southmark to fail to file timely a proof

of claim in the Drexel Burnham Lambert, Inc. bankruptcy

case. Neither Southmark nor Coopers appealed this decision

and the judgment was immediately paid in full. It was not

until after that decision that Southmark filed its state-law

claim, alleging virtually identical facts as it had before the

bankruptcy court and, in part, seeking the same relief. The

fact that Southmark waited until 1995 to bring its state-law

action shows that the state-law action is a collateral attack on

what Southmark believed to be an unsatisfactory bankruptcy

court decision on a core proceeding: the conduct of court-

appointed professionals.

Southmark argues that permitting bankruptcy courts

to adjudicate claims such as the ones it has asserted against

Coopers interferes with the sovereignty of the state courts.

To a large extent, this contention is subsumed by the question

of whether the claims are core—if the action is a core

proceeding, by definition it is federal in nature. Moreover, a

regard for state sovereignty does not mean that states should

have the power to interfere with the bankruptcy court’s indis-

putable power to control the award of protessionals’ fees, as

would be the case here.

Il. Che Courts Of Appeals Are In Agreement That

Claims Of Misconduct By Court-Appointed Offi-

cers In The Performance Of Their Official Duties

Constitute Core Bankruptcy Proceedings.

Southmark argues that the Court should resolve the

“{[cjonfusion over what claims fall within the core of the fed-

eral bankruptcy power.” Pet. at 22. Although the Courts of

Appeals may differ somewhat on the outer constitutional lim-

its of what constitutes “core proceedings,” there is no disa-

greement that actions of the sort initiated by Southmark

against Coopers fall squarely within the constitutional con-

fines of the core of the bankruptcy power.’

In addition to the decision of the Fifth Circuit below,

three Courts of Appeals have found that actions alleging mis-

conduct of court-appointed persons in the performance of

The vast majority of bankruptcy courts faced with this question

similarly have found that claims against court-appointed individuals for

alleged misconduct in the performance of their official duties are core

proceedings. See, e.g, In re Envirodyne, 174 B.R. 955, 964 (Bankr. N.D

Il. 1994) (claims against official committee members); /n re Elegant

Equine, Inc., 155 B.R. 189, 191 (Bankr. N.D. Ill. 1993) (action against

former trustee for breach of fiduciary duty); /n re American Solar King,

142 B.R. 772, 773 (Bankr. W.D. Tex. 1992) (breach of fiduciary duty by

trustee); /n re Balboa Improvements, Inc., 99 B.R. 966, 969 (B.A.P. 9th

Cir. 1989) (claims against debtor's attorney for interference with prospec-

tive economic advantage, fraud, interference with contract, negligence,

malpractice and detriment to the estate).

their official duty constitute core proceedings. In Sanders

Confectionery Products, Inc. v. Heller Financial, Inc., 973

F.2d 474 (6th Cir. 1992), debtor’s parent corporation sued

one of debtor’s lenders, the lender’s attorneys and the bank-

ruptcy trustee for, inter alia, common law fraud, securities

fraud and RICO violations arising from the making and ad-

ministering of a loan to debtor. In addressing the district

court’s conclusion that the action was a core proceeding, the

lhird Circuit pronounced that, although the action against the

lender and its attorneys was non-core, the action against the

trustee was a core proceeding. /d. at 483 n.4. According to

the court, “[w]hile the specific causes of action . . . exist inde-

pendently of bankruptcy cases, an action against a bankruptcy

trustee for the trustee’s administration of the bankruptcy es-

tate could not.” Jd. Accordingly, because “{a]ll claims

against [the trustee] related to his conducted during the . . .

bankruptcy,” they were core proceedings. Id

The Ninth Circuit reached a similar conclusion in

Walsh v. Northwestern National Insurance Co. (In re Fer

rante). 51 F.3d 1473 (9th Cir. 1995). In Ferrante, a succes-

sor Chapter il trustee brought an adversary action in the

bankruptcy court against the surety of the previous trustee, al-

leging embezzlement and breach of fiduciary duty by the

prior trustee in connection with his administration of the

bankruptcy estate. The court held that the successor trustee's

action was a core proceeding because It “concern{ed] the ad-

ministration of the estate.” /d. at 1476 (quotations omitted).

The court explained: “Because this case evokes the Bank-

ruptcy Act’s imposition of duties on trustees to administer es-

tate property... , it cannot be gainsaid that it involves a core

issue.” /d.

Finally, the Third Circuit, in Billing v. Ravin, Green

here & Zackin, P.A, 22 ¥.3d 1242, 1249-50 (3d Cir. 1994),

held that a separate malpractice action against debtor's attor-

neys, who were retained by court order, was part and parcel

with debtor's objections to the attorneys’ fee application, and

therefore was within the bankruptcy court’s core jurisdiction.

In that case, debtor retained the law firm of Ravin, Greenberg

& Zackin, P.A. (“RG&Z”). Following approval of the reor-

ganization plan, RG&Z applied to the court for attorneys’

fees, which the debtor opposed on grounds of legal malprac-

tice. The debtor also concurrently brought suit against

RG&Z tor malpractice in the district court.

On appeal, neither party contested the district court's

finding that the malpractice suit constituted a core proceed-

ing, and therefore the issue was not addressed directly by the

court. However, in finding that RG&Z did not have a right to

a jury trial on the malpractice claims,’ the court held that, by

raising legal malpractice as a defense to RG&Z’s application

for fees, the claims were converted “into an equitable dispute

over a share of the estate.” /d at 1253. The court explained.

“[t]he close connection between the malpractice action and

the objections to fees leads us to conclude that the debtors’

allegations of malpractice are part of the process of allowance

and disallowance of claims.” /d. at 1252. Therefore, like the

decisions in Sanders Confectionery and Ferrante, this deci-

sion is entirely consistent with the decision of the Fifth Cir-

cuit below.

As noted by Southmark, this Court has explained that a determi-

nation that a party is not entitled to a jury trial on an issue before a bank-

ruptcy court is tantamount to a finding that the bankruptcy court has

jurisdiction over the claim. See Granfinanciera, 492 U.S. at 53 (quoted

in Pet. at 14.4)

Southmark ignores Sanders Confectionery, Ferrante

and Billing and cites the Ninth Circuit’s decision in 7axe/ \

Electronic Sports Research (In re Cinematronics, Inc.), 916

F.2d 1444 (9th Cir. 1990), and the Third Circuit’s decision in

lTorkelson v. Maggio (In re Guild and Gallery Plus, Inc.), 72

F.3d 117i (3d Cir. 1996), to try to show a conflict between

the Courts of Appeals. This purported conflict is wholly)

illusory

In Cinematronics, the Ninth Circuit did not address

the issue of whether an action alleging misconduct against a

court-appointed person in the performance of his official du-

ties constituted a core proceeding. In that case, debtor was

sued in state court by a company unrelated to the bankruptcy

[he Chapter 11 trustee brought an action in bankruptcy court

against the third-party, alleging a violation of the automatic

stay provisions of the Bankruptcy Code (the “stay proceed-

ing”). The third-party responded in the stay proceeding by

asserting a counterclaim against the trustee, and a third-party

complaint against debtor’s president, alleging, inter alia,

breach of contract and breach of fiduciary duty. Upon motion

to determine the court’s jurisdiction, the bankruptcy court

held that the counterclaims and third-party complaint were

core proceedings. Debtor's president thereafter moved in the

district court to withdraw the reference to the bankruptcy

court so that a jury trial could be conducted on the core tis-

sues. The district court denied the motion.

On appeal, the Ninth Circuit held that the third-party

complaint against debtor’s president did not raise core issues.

However, because the court found that the trustee lacked

standing to bring an appeal, id. at 1148, it never addressed

whether the counterclaims against the trustee were core. In

fact, the issue was not even before the court because the

| 7

trustee neither challenged the bankruptcy court's finding that

the counterclaims were core proceedings, nor moved in the

district court to withdraw the reference based on his night to a

jury trial. See id

Presumably, Southmark is arguing that the court's

holding with respect to debtor’s president, in essence, 1s a

holding that the claims against the trustee likewise are not

core. However, that proposition is wholly untenable. The

Ninth Circuit’s decision rested squarely on the fact that debt-

or’s president was a non-debtor being sued in his individual

capacity. See id. at 1450 (“Here, the claims at issue are

against Pierce, a nondebtor, in his individual capacity. The

claims do not directly affect the estate or the confirmation of

the estate’s plan.”). In contrast, the trustee, as an officer of

the court charged with administering the estate, was inti-

mately tied to the bankruptcy proceeding. Moreover, the

trustee was not being sued in his individual capacity—the

conduct at issue was the trustee’s effort to enforce the auto-

matic stay provision on behalf of the estate. Finally, even if

there were ambiguity in the court’s holding, that ambiguity

has evaporated with the Ninth Circuit’s holding in Ferrante,

which indicates clearly that claims against trustees for official

misconduct are core proceedings. The decision below does

not conflict with Cinematronics.

Guild and Gallery also does not address the jurisdic-

tion of the bankruptcy court to hear and decide claims of offi-

cial misconduct by court-appointed persons. In that case, the

debtor, prior to filing for bankruptcy, took possession of sev-

eral paintings under a bailment contract. After the bank-

ruptcy petition was filed, the owner of the paintings sought

their return. One of the paintings was lost, leading to a

lawsuit against the bankruptcy trustee alleging negligence and

conversion

[he Third Circuit held that the action was not a core

proceeding based on the fact that the trustee’s alleged impro-

priety involved property that never was part of the bankruptcy

estate. 72 F.3d at 1173. As such, the alleged misconduct “a

fortiori . . . cannot fall within §157(b)(2)(A), which can only

be applied to matters concerning the administration of the

bankruptcy estate.” /d. The court in Guild and Gallery sim-

ply was not faced with the issue presented in this case and

therefore the case does not conflict with the decision below.

While Southmark argues that “[m]Jany other conflicts

flow from the uncertainty generated by Marathon,” Pet. at 23,

none of those alleged conflicts are implicated by the Fifth

Circuit’s fact-bound decision. On the issue raised in the in-

stant case. there is no controversy. Each Court of Appeal ad-

dressing, either directly or indirectly, whether claims against

court-appointed persons for alleged official misconduct con-

stitute core proceedings has, like the Fifth Circuit, answered

in the affirmative.

CONCLUSION

A bankruptcy proceeding is a unique process, and

court-appointed professionals play an integral part in that

process. In order to ensure that the process functions prop-

erly, bankruptcy courts must retain the authority to monitor

and control the professionals they appoint. In recognition of

this reality, the Fifth Circuit held that Southmark’s allega-

tions of misfeasance by Coopers in performing the official

duties with which it was charged constituted a core proceed-

ing within the meaning of the Bankruptcy Code and

Viarathon. That holding comports with the decisions of this

Court, as well as with the decisions of the other Courts of Ap-

peals, and therefore Southmark’s petition for a writ of certio-

rari should be denied.

Respectfully submitted,

Michael S. Feldberg

('‘ounsel of Record

Frank J. LaSalle

SCHULTE ROTH & ZABEL LLP

900 Third Avenue

New York. New York 10022

(212) 756-2000

Judith Elkin

HAYNES AND BOONE, L.L.P.

3100 Bank of America Plaza

901 Main Street

Dallas, Texas 75202

(214) 651-5000

Counsel for Respondent

Coopers & Lybrand L.L.P

IN THE I NITED STATES BANKRUPICY ¢ OURT FOR

DISTRICT OF TEXAS

DALLAS DIVISION

in re

SOUTHMARK CORPORATION,

Debtor

Case No 389036324-SAF-1 1

MOTION TO RECONSIDER AWARD OF FEES [TO COO-

PERS & LYBRAND AND BRIEF IN SUPPORT THEREOI

Robert B. Krakow, Esq.

State Bar No. 11702000

1717 Main Street, Suite 5400

Dallas. Texas 75201-4605

lelephone: (214) 698-3 100

Facsimile: (214) 698-3400

Attorneys for Southmark

Corporation

TABLE OF CONTENTS

ELA REE E Ge PAE coke hGw bss Gove oo oes |

PSE Sree éeawesSiastaa te A SRT 9

A. Jurisdictional Statement ...... RPS SN A 9)

B. Intorduction: Requirements For Employment Of

PPORCRGSOOMED TUh SIOTUNIOY oc dine sewwcviadsees sis. )

C. Coopers & Lybrand Was Not Disinterested As

Required By The Bankruptcy Code ................. 10

D. Coopers & Lybrand Held An Interest Adverse

$O EWee OWNER, TE Gc ha macseccurswonceseacsss 22

E. Coopers & Lybarnd's Failure To Disclose Man-

dates Disgorement Of Its Fees ..................000- 14

F. This Motion To Reconsider Is Timely Under

UGE SMAEE bic vingohvueareccecchbueiubes taekaterx: 16

CAFVRAMIEUEOES ho ope ncSkaebineae danse ceveienian irene 19

TABLE OF AUTHORITIES

(Cases

Bros. Inc. v. W.E. Grace Mfg. Co., 320 F.2d 594

(SthCir. 19635) ...0cceee. 17

Browning v. Navarro, 826 F. 2d 335 (Sth Cir.

ROT) sc cvccuckkocbhch ps ceddnayanenuexavetiones lace bain ae

Budge v. Post, 544 F. Supp. 370 (N.D. Tex 1982) ...... 18

In re Allegheny International, Inc., 134 B.R. 814

(Bankr. W.D. Pa 1991) ...... eee cece cece eee e er eees . 9,10

In re Amdura, 121 B.R. 862 (Bankr. D. Colo.

SSP) cose coe eaccccvenneae EPP PTS Y EI ER ee yee Y

In re Arlin's Dept. Stores, Inc., 615 F. 2d 925 (2d

CS SN nc hive enna be ennhes CFLS VNERS CAE

In re Baldwin United Corp., 46 B.R. 314 (Bankr

BID Chris FGBS) vnc ccccccctcscccscsccsesedestocvodesres 18

In re Coastal Equities, Inc., 39 B.R. 304 (Bankr.

OTD Cal, FOGG) vice ave vecndscascccveeqesenesss hh, 22

In re Cody, 122 B.R. 520 (Bankr. N.D. Ohio 1990) ..... 13

In re Consolidated Bancshares, Inc., 785 F. 2d 53,

1249 (Sth Cir. 1986) ........c cece reer ereeerees a hetenct ies

In re Cropper Co., 35 B.R. 625 (Bankr. M.D. Ga.

RE es is ke ckbe be cere becnsenure tees Py oer rae

In re Diamond Lumber, Inc., 88 B.R. 773 (N.D.

Fae SORRY ks cov cowagss vie cheese Cadeestseerenees eR

In re Diamond Mort. Corp. of Illinois, 135 B.R. 78

(Bankr. N.D. Ill. 1990) ........ 0 eee eee cece eee ees 13, 15

In re EWC. Inc., 138 B.R. 276 (Bankr. W.D. Okl.

es ETA MEER OE POT ELE TE ayia? |.

In re Food Town, Inc., 208 F. Supp. 139 (D. Md.

SEE a 256i vn Fk is ges ee OAR ed ae awe 18

In re H.B. Michelson, 141 B.R. 715 (Bankr. E.D.

CMR, ROPERS bcs Fic ae Sia os CPSs Ke ead a Le a 17

In re Kendavis Industries Intern., Inc., 91 B.R. 742

i UME 20 Ray DOK: ROD ci kak Geeks ban sedeegs besa on 13

In re Kuykendahl Place Associates, Ltd., 112 B.R.

B57 CRONE, Bild. BOK Te lank ire cs ukies cankbeatacks 13

In re Marine Outlet, Inc., 135 B.R. 154 (Bankr.

MLD; FUG O99T) so aes ieee re as 15

In re Micro-Time Managment Systems, Inc., 102 14,45,

BR. O02 (aot ED): Nich foe 6 a icin 16

In re Philadelphia Athletic Club, 20 B.R. 328

CREP PR See ass ck ese a eae hens 1]

In re Roberts, 46 B.R. 815 (Bankr. D. Utah 1985)

aff'd in relevant part and rev'd in part, 75 B.R.402 ‘13, 14,

HNO Ty 72 Seep reaper ar an aebsrienry n an RN aperg Van 15

In re Sky Valley, Inc., 135 B.R. 925 (Bankr. N.D.

AMM Se niece tateae suk s tee aay rials eit eevee kees ews 15

In re Southmark Corporation, 113 B.R. 280

(Haske, ND: Te, FI a sek eee a ie. 3

In re Thompson, 54 B.R. 311 (Bankr. N.D. Ohio

SRE 5 ecco cea os ee ee 15

In re Tinley Plaza Associates, L.P., 142 B.R. 272

(Hane, TEL UR. 2992S ok bo i ene ee eee ieee 15

In re Woods v. City Nat. Bank & Trust Co., 312

JD. 20Kj OF Tes Re WRT T AOD ike oe rie een rnes 13,14

Lucas v. City of Juneau, 20 F.R.D. 407 (D. Alaska

SPST) ik bach eis Ieper cal 17

en)

Batis:

Roger J. Au & Son, Inc. v. Aetna Ins. Co., 64 B.R.

GOO (0e2), CHD TSO 255 FG AREA I Te 13

United States v. McDonald, 86 F.R.D. 204 (N.D.

Beh POY co eo hig dhe ck ed a Rs a gk 17

Statutes

EB ORS ly BL | Sarr Tah eennes Meer coe rter Pe, 10

SAT te EN Kin cud chase cence can peascadoe pe anaes 10

PTA Oe BLAG Gos kc sk dna bask ba hs 09s Chonan ts ERGs 10

TRB S Ge S59 CMe spay meer Deane reer eee 10, 14

PE Ree SE ine ha Nein sendeks Canwest Se aenes 30,55

PR AO Sack se sk ve kakentce vans css reatawalynoees 9

PUTS TUE 2088 sinc gsc 'vnp as nen ebesdeenees 10, 14, 15

Bankruptcy Rule 9024 onic vec ccc eeteks cweewane 1, 16

PITY FE FOS acc i cdicncs cased cnesacsinenes Eo

Ee ae, | OP Ae Serene prey tee 1, 16,17, 18

Other Authorities

2 Collier on Bankruptcy § 327.03 at 327-19, 20

CES, TIS ois es i wees a REE 10, 11

SOUTHMARK CORPORATION (“Southmark” or

the “Debtor’), hereby submits its Motion to Reconsider

Award of Fees to Coopers & Lybrand pursuant to Bankruptcy

Rule 9024, incorporating Fed. R Civ. P. 60(b), and in support

thereof shows the Court as follows:

STATEMENT OF FACTS

1. Southmark was organized in 1970 as a

Maryland real estate investment trust. later known as South-

mark Properties. In 1981, Gene E. Phillips and William S.

Friedman acquired control of Southmark Properties and ap-

pointed themselves chairman and vice-chairman, respec-

tively. Southmark Properties’ headquarters was moved to

Dallas, Texas, and on May 1, 1982, Southmark Properties

was convened to a Georgia corporation and its name was

changed to Southmark Corporation.

2. The principal business of Southmark was

sponsoring private and publicly syndicated real estate partner-

ships. Through private and public borrowings, Southmark ac-

quired other real estate companies, as well as a savings and

loan association and insurance companies.

3. In April, 1989, fouowing two years of in-

creasing financial distress, Southmark announced a $1 billion

write-down of its asset values. This write-down wiped out

Southmark’s shareholders’ equity, reducing equity from $604

million to negative $428 million. On July 14, 1989, South-

mark filed a Chapter 11 bankruptcy proceeding in Atlanta.

The case was subsequently transferred to Dallas. Under the

plan of reorganization adopted by the Bankruptcy Court,

holders of Southmark’s more than one billion dollars in pub-

lic debt received approximately five cents on each dollar of

sss. Nt" SSS,

inniitiionidevendniniscinuaanaiiaalll

RESIS 5 RS

their investment in cash, as well as securities in reorganized

Southmark which could be worth as much as another 13 cents

on the dollar.

4. From 1982 until shortly before South-

mark’s bankruptcy in 1989, Drexel Burnham Lambert

(“Drexel”) served as underwriter, broker and financial advi-

sor to Southmark and several of its subsidiaries. Much of

Southmark’s dealings with Drexel were directly with the

High Yield Department, run by Michael Milken. Through the

High Yield Department Drexel was able to foster and sustain

the illusion of a liquid market for issues of high yield corpo-

rate debt and preferred stock, which eventually and more ac-

curatcly came to be known as “junk bonds.” Underwriting

junk bond issues and manipulating the junk bond markets

earned Drexel exorbitant profits through underwriting fees,

markups and trading profits.

5. Issuers of Drexel-underwritten bonds. such

as Southmark, were forced through a variety of means to in-

vest a portion of the issue proceeds in junk bonds underwrit-

ten by Drexel for other clients. Drexel clients who refused to

invest in junk bonds found Drexel unwilling to underwrite

further debt or preferred stock issues, which were frequently

necessary just to retire maturing debt or redeem earlier pre-

ferred stock issues.: Drexel clients who did not continue to

purchase Drexel-underwritten bonds for their own portfolios

also found Drexel unwilling to sell bonds the companies al-

ready owned.

6. Through the efforts of Drexel, Southmark

raised well over a billion dollars through high-interest public

debt issues, which quickly imposed a huge interest expense

and principal repayment obligations on Southmark. The debt

incurred by Southmark was well in excess of the legitimate

operational needs of the company. Southmark was induced by

Drexel to invest the excess funds, over $400 million, in high-

yield bonds of other Drexel clients. Southmark ultimately lost

substantially in excess of $150 million on these junk bonds in

1988 and 1989. The crushing burden of debt service on junk

bond issues, combined with devastating losses in its junk

bond portfolio, contributed directly and substantially to

Southmark’s demise.

7. On July 28, 1989, shortly after it filed for

bankruptcy, Scuthmark moved the Bankruptcy Court for the

appointment of an Examiner, stating, “the Debtor believes

that it is in the best interests of the estate and this Chapter | |

case to have a disinterested, independent individual review

and investigate the pre-Chapter 11 activities of the debtor as

they relate to third party transactions and relationships, and

potential causes of action against such third parties on behalf

of Southmark and the estate.” Motion, § 6. Southmark sought

“an unbiased, independent assessment as to whether legal ac-

tion by Southmark against various third parties, including any

of its former officers and directors, is appropriate and should

be pursued.” Id. 4 9.

8. On September 8, 1989, the Bankruptcy

Court issued an order approving the appointment of Neal Bat-

son, a partner in the firm of Alston & Bird, as Examiner. The

order charged the Examiner with the “investigation and re-

view of any allegations of fraud, dishonesty, incompetence,

misconduct, mismanagement or irregularity in the manage-

ment of the pre-Chapter 11 affairs of the Debtor, and ...

making recommendations as to causes of action discovered in

such investigation and review.” The Court specifically

authorized the Examiner to retain attorneys and accountants

sews ae

ose

Suan Saeaae

to assist the Examiner in his investigation and review, with

“the fees and expenses of such professionals to be paid from

the estate upon proper application” On September 14, 1989,

the Court approved the appointment of Alston & Bird as at-

torneys to assist the Examiner.

9. On September 26, 1989, the Examiner ap-

plied to the Court for an order authorizing the employment of

Coopers & Lybrand as accountants to the Examiner, to inves-

tigate allegations of fraud, dishonesty, incompetence, miscon-

duct, mismanagement or irregularity in the management of

the pre-Chapter 11 affairs of the Debtor. The application is

attached hereto as Exhibit A.

10. Attached to the application of the Exam-

iner was an affidavit from David A. Carpenter, the engage-

ment partner from Coopers & Lybrand. In paragraph 3 of that

affidavit. Carpenter listed all “known connections” between

Coopers & Lybrand and other parties in interest. Mr. Carpen-

ter noted that “Coopers & Lybrand provides accounting and

consulting services for Drexel in matters unrelated to this

case.” Mr. Carpenter did not indicate that Coopers & Ly-

brand’s relations with Drexel would in any way impede or in-

terfere with its duties as accountants to the Examiner

11. The appointment of Coopers & Lybrand

was subsequently approved by the Court, pursuant to section

10S5(a) of the Bankruptcy Code, effective September 26,

1989. This Court noted that, “[w]hile the court could direct

that the appointed examiner use the services of the commit-

tee’s court-appointed accountant, that might defeat the objec-

tive of a disinterested examiner not associated with or serving

creditors or equity security holders,” In re Southmark Corpo-

ration, 113 BR. 280, 282 (Bankr N.D. Tex. 1990).

10b

12. Most of the investigative work between

September 26, 1989 and July 9, 1990, the date of the Examin-

er’s final report, was performed by Coopers & Lybrand. In-

deed, Coopers & Lybrand itself wrote substantial portions of

the various interim and final reports filed by the Examiner.

13. On or about October 1, 1989, there was an

initial meeting of the Coopers & Lybrand engagement team,

which consisted of David Carpenter, Knute Kurtz (a new

partner working under Carpenter), and a number of managers,

including Selene Yu, David Kennedy, Steve Schocket and

William Galbally. At that meeting, Carpenter assigned vari-

ous members of the team to work on and investigate specific

issues concerning the Southmark bankruptcy. Mr. Galbally

was assigned to investigate issues including but not limited to

possible avoidance claims that Southmark might have against

Drexel arising, inter alia, out of Drexel’s relationship as un-

derwriter of bonds sold by Southmark and as broker of “high

yield” bonds (i.e., payments by Southmark during the ninety

days preceding the filing for bankruptcy that might be recov-

erable by Southmark).

14. Between October 2, 1989 and approxi-

mately December 4, 1989, Mr. Galbally worked on various

litigation issues including possible claims against Drexel. As

his work progressed, Mr. Galbally came to believe that

Southmark’s claims against Drexel were potentially the most

significant and valuable of all the claims Southmark might

pursue. In particular, Mr. Gaibally believed that Southmark

had substantial claims against Drexel in connection with

Drexel’s activities as underwriter of bonds issued by South-

mark and as broker for bonds purchased by Southmark. Prior

to December 4, 1989, Mr. Galbally told Mr. Kurtz among

llb

others, about the potential significance of the claims against

Drexel.

15. On or about the night of December 4,

1989, Mr. Carpenter and Mr. Kurtz visited Mr. Galbally at

the apartment in Dallas that Mr. Galbally shared with David

Kennedy. According to Mr. Galbally, Mr. Carpenter asked

Mr. Galbally what he (Galbally) had on Drexel. Mr. Galbally

told Mr. Carpenter that Southmark’s claims against Drexel

were the most important in the engagement, that there ap-

peared to be substantial misconduct by Drexel, and that

Drexel had very deep pockets. According to Mr. Galbally,

Mr. Carpenter became extremely angry and screamed repeat-

edly at Mr. Galbally. Mr. Carpenter told Mr. Galbally not to

pursue the Drexel issues any further. Mr. Carpenter shouted

at Mr. Galbally, among other things: “Don’t [mess] with

Drexel. Drexel is our largest audit client.” When Mr. Galbally

insisted that the Drexel issues had to be investigated, Mr.

Carpenter told Mr. Galbally that he (Galbally) was being

taken off the issues related to Drexel. Mr. Galbally was sub-

sequently Sent to Atlanta to work on Southmark preference

actions under the supervision of David Kennedy, even though

Mr. Kennedy was Mr. Galbally’s junior at Coopers & Ly-

brand. See Affidavit of William Galbally, attached hereto as

Exhibit B.

16. On or about January 3, 1990, the potential

claims against Drexel were reassigned to Jeffrey Kessler. De-

spite billing time to the Drexel matter, Mr. Kessler never de-

veloped a basis for claims against Drexel as identified by Mr.

Galbally. On information and belief, Mr. Kessler, among oth-

ers, knew why Mr. Galbally had been reassigned, and this

knowledge effectively chilled any further Coopers & Lybrand

investigation of the Drexel claims identified by Mr. Galbally.

12b

17. On February 13, 1990, Drexel’s parent,

[he Drexel Burnham Lambert Group, Inc. (“Drexel Group”),

filed a petition for relief under chapter | | of the Bankruptcy

Code. The court in the Drexel Group bankruptcy set October

|, 1990 as the bar date for the assertion of pre-petition claims

against Drexel Group,

18. On March 1, 1990. John C. Weitnauer of

Alston & Bird, wrote to R. Paul Wickes, Thompson &

Knight, to explain that Southmark might wish to pursue cer-

tain claims against Drexel in connection with the Examiner's

review of potential preferential transfers, of which Drexel

may have received $985,000 or more. Mr. Weitnauer’s letter

did not however, mention any potential claims Southmark

might have against Drexel arising out of Drexel’s activities

identified by Mr. Galbally, including those as underwriter of

bonds issued by Southmark and as broker for bonds pur-

chased by Southmark.

19. On April 17, 1990, Neal Batson sent a let-

ter to R. Paul Wickes, Thompson & Knight (with copies to

David Carpenter and Knute Kurtz) advising Thompson &

Knight to pursue a “potential voidable preference paid to

Drexel Burnham Lambert Incorporated ... within the ninety-

day period prior to Southmark’s Chapter 11 filing on July 14,

1989.” In this letter, the Examiner specifically states that he

and his experts “have not attempted to invesrigate” any “se-

curities claims which Southmark may have as the purchaser

of bonds underwritten or sold by Drexel.” The Examiner also

stated that “[i]n light of the plan requirement that the Exam-

iner file his final report by the conclusion of the hearings on

confirmation and the recent bankruptcy of the parent, we are

not inclined to devote additional resources to a further inves-

tigation of any potential Southmark claims against Drexel.” A

true and correct copy of the April 17, 1990 letter is attached

hereto as Exhibit C.

20. On May 1, 1990, the Examiner filed his

Fourth Interim Report (the “Report’). Despite the disclaimer

in the Examiner’s April 17 letter stating that he and his ex-

perts had not investigated claims which Southmark may have

as the purchaser of bonds underwritten or sold by Drexel, this

Report purported to deal with precisely those claims. The Re-

port, which was written by Coopers & Lybrand. notes that

“Southmark’s access to the high-yield bond market was

largely due to the efforts of Drexel” and that Souchmark lost

large amounts of money by buying on margin from Drexel a

large portfolio of high-yield bonds. The Report then states

that Drexel’s role in these activities “was investigated more

extensively [than other aspects of the Drexel relationship] be-

cause of the general, oft-repeated, potential charge that

Drexel clients had to support the high-yield bond network.”

21. The Report notes that “[pJublic ailegations

involving Drexel and the support of the high-yield bond net-

work revolve round allegations of Drexel’s underwriting of

high-yield bond issuances for companies with the understand-

ing that the company would use part of the proceeds to pur-

chase the high-yield bonds of other Drexel clients, thus

helping to create what effectively would be a false market for

these high-yield instruments.” The Report, however, states at

page 41 that proving these allegations was “made difficult by

the facts.” The Report states that any “ultimate proof” of

Drexel’s wrongdoing “must await examination of the in-

volved parties.” The Report goes on to note that “[s]uch ex-

aminations have not, and will not be a priority for the

Examiner as any claims against Drexel Burnham Lambert

and/or Michael Milken could be of limited value due to the

14b

[Drexel bankruptcy] and [Milken’s indictment on criminal

charge].” The Report then states that the Examiner had spe-

cifically referenced these issues to Southmark’s legal counsel.

In fact, no such reference was ever made. True and correct

copies of excerpted portions of the Fourth Interim Report are

attached hereto as Exhibit D.

22. William Galbally read the portions of the

Report dealing with Drexel before it was sent to the Exam-

iner for his approval. According to Mr. Galbally, he told Mr.

Kessler that the Report on Drexel was completely inadequate

and that Coopers & Lybrand had an obligation either to in-

vestigate the Drexel issues fully and fairly or else to explain

to the Examiner that, because of Drexel’s status as a major

audit client of Coopers & Lybrand. the firm had decided not

to investigate Drexel. Mr. Galbally further told Mr. Kessler

that the sort of self-serving disclaimer put in the Report, shift-

ing the responsibility for investigation to counsel for South-

mark, was improper. According to Mr. Galbally, Mr. Kessler

responded that Mr. Carpenter wanted the Drexel issues han-

dled this way and that he (Mr. Kessler) was not going to

delve into the substance of those issues in the Report.

23. On July 9, 1990, the Examiner filed his Fi-

nal Report. In the Final Report, which was also written by

Coopers & Lybrand, Coopers & Lybrand provides yet another

excuse for its failure fully to investigate potential claims

against Drexel. Appendix I to the Final Report states that

“[tlime has not permitted a complete investigation into the

awareness of... Drexel Burnham about the true financial con-

dition of Southmark or the soundness of its business methods

and operations. The Examiner has requested Southmark’s

counsel, Thompson & Knight to undertake the necessary

15b

investigation into/and pursuit of any claims against Drexel

Burnham While these outside professionals must have been

aware of the specific actions they took, the Examiner has not

evaluated their levels of knowledge and whether they fully

appreciated how their actions may have produced and main-

tained the Southmark mirage.” The Final Report acknowl-

edges, however, that “*the Southmark mirage could not have

been projected without the assistance, inadvertent or inten-

tional, of these outside professionals.” The Final Report then

state that since Drexel filed for bankruptcy during the pen-

dency of Southmark’s bankruptcy, “the Examiner left to

counsel for Southmark the necessary investigation into and

pursuit of any claims against Drexel Burnham The Examiner

does not know whether Southmark’s counsel has taken any

action in this regard.” In fact, there was never any specific

reference of claims against Drexel to Southmark’s counsel,

and Coopers & Lybrand never provided outside counsel for

Southmark with any investigative material with respect to po-

tential claims against Drexel. True and correct copies of ex-

cerpted portions of the Final Report are attached hereto as

Exhibit E.

24. At no time during the course of Coopers &

Lybrand’s engagement on the Southmark bankruptcy did

Coopers & Lybrand inform the Examiner, counsel for South-

mark, or Southmark itself that Coopers & Lybrand was hold-

ing back from a full investigation of potential claims that

Southmark might have against Drexel in order to protect

Coopers & Lybrands lucrative audit engagement with Drexel.

25. At no time during the course of Coopers &

Lybrand’s engagement on the Southmark bankruptcy did

Coopers & Lybrand inform the Examiner, counsel for South-

mark, or Southmark itself that the Coopers & Lybrand

l6b

employee originally charged with investigating the Drexel

claims believed, contrary to the Reports prepared for the Ex-

aminer, that Southmark had substantial claims against Drexel

arising out of Drexel’s activities as underwriter of bonds is-

sued by Southmark and as broker for bonds purchased by

Southmark.

26. Coopers & Lybrand failed to investigate

claims against Drexel that one of its managers considered to

be perhaps the most significant claims held by Southmark.

According to that manager, who is still today a Coopers &

Lybrand emplovee, the investigation was blocked due to a

conflict of interest never disclosed to Southmark to the Ex-

aminer or to this Court. Indeed, upon information and belief,

Mr. Carpenter went out of his way to convince the Examiner

and his counsel that the Drexel audit relationship would not

impair the thoroughness of the investigation of Drexel claims.

27. Beyond the failure to investigate (or to dis-

close why it could not investigate) Drexel claims, Coopers &

Lybrand drafted the Examiner’s Fourth Interim Report to sug-

gest that it had dome some investigation of such claims and

that such claims would be difficult to prove.

28. Southmark emerged’ from bankruptcy in

August 1990. One of the first major decisions for reorganized

Southmark was whether to engage outside professionals to in-

vestigate further claims against Drexel in order to be in a po-

sition to file a claim in the Drexel Group bankruptcy on or

before the October 1, 1990 bar date imposed in that case. Due

to a combination of factors including Southmark’s limited li-

quidity at the time and the express and implicit lack of enthu-

siasm for such claims in the Examiner’s report, Southmark

17b

did not pursue a further investigation at that time and did not

file a claim in the Drexel Group bankruptcy.

29. In early 1991, its coffers somewhat in-

creased, Southmark engaged an outside law firm to investi-

gate the Drexel claims for purposes of the possible filing of a

claim against a fund set up by Mr. Milken to compensate de-

frauded Drexel investors. That investigation revealed the ex-

istence of claims virtually identical to the claims Mr. Galbally

wanted to further investigate.

30. Southmark proceeded to file a claim

against the Milken settlement fund for more than $600

million. Although negotiations are still ongoing, Southmark

believes that the magnitude of its claim entitles it to a signifi-

cant part of the $250 million in the Milken settlement fund.

Had Southmark filed a claim in the Drexel Group bankruptcy

- which it surely would have done had Mr. Galbally’s theories

been further investigated and disclosed - Southmark likely

would have recovered many millions of dollars on that claim

as well.

31. On or about March 5, 1991, this Court is-

sued its Memorandum Opinion and Order on Final Applica-

tions for Compensation for Professional Persons and

approved Coopers & Lybrand fees and expenses in this case

in the approximate amount of $3.7 million.

32. In the early part of 1993, Southmark

learned from a former Coopers & Lybrand employee that Mr.

Galbally wanted to speak with Southmark about what had

happened. Notwithstanding the obvious peril to his own ca-

reer, Mr. Galbally told Southmark about the events that give

rise to this motion. Since that disclosure, Southmark has had

18b

a number of discussions with Coopers & Lybrand in an at-

tempt to resolve this matter. Those discussions have not led

to a resolution, and Southmark therefore brings this motion

for determination by the Court of whether Coopers & Ly-

brand should be required to disgorge some or all of the fees

previously awarded by the Court.

ARGUMENT

A. Jurisdictional Statement

33. This Court has jurisdiction over this Mo-

tion pursuant to 28 U.S.C. § 1334 and the plan of reorganiza-

tion confirmed by this Court.

B. Introduction: Requirements For Employment

Of Professionals In Bankruptcy

34. Professionals in the bankruptcy process

owe a fiduciary duty, not only to the parties they represent,

but also to the court. /n re Allegheny International Inc., 134

BR. 814, 820 (Bankr. W.D. Pa. 1991). “The professionals

must be capable of proving that all actions taken are ethical

and accomplished in good faith." Jd.

35. In order to ensure that bankruptcy profes-

sionals live up to their fiduciary duty of good faith, the Bank-

ruptcy Code sets forth certain employment and disclosure

requirements. Section 327(a) of the Bankruptcy Code sets

forth a two part test for the appointment of a professional per-

son: (1) the professional may not hold or represent an interest

adverse to the estate and (2) the professional must be a disin-

terested person. 11 U.S.C. § 327(a).

19b

36. Additionally, Bankruptcy Rule 2014 sets

forth the disclosure requirements for employment pursuant to

Bankruptcy Code sections 327, 1103 or 1114. An application

for the employment of a professional person requires disclo-

sure “at any time during such person’s employment” of,

among other things, “all the professional’s connections with

the debtor, Creditor, any other party in interest, their respec-

tive attorneys and accountants.” The statutory basis for denial

of compensation is found in Bankruptcy Code section 328(c)

which states that if, during the employment of a professional

under sections 327 or 1103, a court determines that the pro-

fessional is no longer disinterested or holds or represents an

adverse interest the court may deny compensation for services

and reimbursement of expenses. 11 U.S.C. § 328(c).

es Coopers & Lybrand Was Not Disinterested

As Required By The Bankruptcy Code

37. Section 101(14) of the Bankruptcy Code

defines a disinterested person as one who:

(A) is not a creditor, an equity secu-

rity holder, or an insider,. . .

(E) does not have an interest mate-

rially adverse to the interest of the estate

or of any class of creditors or equity se-

curity holders, by reason of any direct or

indirect relationship to, connecton with,

or interest in, the debtor or an invest-

ment banker . . . . or for any other

reason

11 U.S.C. § 101(14)

20b

38. In quoting Collier, the Fifth Circuit stated

that the requirement of disinterestedness:

Appears broad enough to include anyone

who in the slightest decree might have

some interest or relationship that would

color the independent and impartial atti-

tude required by the Code. ... Indirect

or remote association or affiliations, as

well as direct, may engender conflicting

loyalties.

In re Consolidated Bancshares, Inc., 785 F.2d 1249, 1256

(Sth Cir. 1986) quoting 2 Collier on Bankruptcy § 327.03 at

327-19, 20(15th ed. 1985) (emphasis added).

39. The Fifth Circuit went on to say that Con-

gress has determined that, due to the unique nature of the

bankruptcy process, the employment of professionals in a

bankruptcy case must be subject to strict standards. /d fn. 6,

citing /n re Cropper Co., 35 B.R. 625, 629 (Bankr. M.D. Ga.

1983). Finally, on the subject of disinterestedness, the Fifth

Circuit quotes language from /n re Philadelphia Athletic

Club, Inc., which states as foilows:

Professionals engaged in the conduct of

a bankruptcy case should be free of the

slightest_personal interest which might

be reflected in their decisions concern-

ing matters of the debtor’s estate or

which might impair the high degree of

impartiality and detached judgment

eee 2 i

Te ie OE EN Get EN Sma REMUS TET St aR ACT TaN SearE TELE Ene aren MAE TE iS Ce aU RS RCE Cac

A EE RETNS

21b

expected of them during the course of

administration.

Consolidated Bancshares, 785 F.2d at 1256, n.6. quoting /n

re Philadelphia Athletic Club, 20 B.R. 328, 334 (E.D. Pa.

1982) (emphasis added).

40. It is clear that applying the language of

Consolidated Bancshares Coopers & Lybrand could not have

been held to be disinterested if it had fully disclosed the na-

ture of its relationships with Drexel. Coopers & Lybrand was

not free of personal interest and its relationship with Drexel

did in fact color the independent and impartial attitude re-

quired by the Bankruptcy Code.

41. Coopers & Lybrand will surely point to the

fact that it did disclose the existence of the Drexel audit rela-

tionship. The nature of that disclosure, however, did not indi-

cate that the Drexel relationship would impede or impair the

investigation of claims against Drexel. And once Coopers &

Lybrand had made the determination that it would not inves-

tigate these claims valued in the hundreds of millions of dol-

lars, surely it had a duty to disclose this conflict to the

Examiner, Southmark and the Court, particularly in light of

the extensive role Coopers & Lybrand played in the investi-

gation of third party claims,

42. Rather than disclose the conflict, Mr. Car-

penter told the Examiner that there was no conflict. To add

insult to injury, Coopers & Lybrand then expressly (by noting

how difficult it would be to prove such claims) and implicitly

(by running up millions of dollars in fees investigating far

22b

less significant claims) downplayed the significance of such

claims in conscious disregard to its duties in this case.

43. A similar issue was raised in In re Amdura

where the court stated that the past representation of a former

client does not create a conflict, unless the professional be-

lieves, that for any reason, it would not be able to “diligently

and zealously” represent the debtor on the issue involving the

former client. /n re Amdura, 121 B.R. 862, 870 (Bankr. D.

Colo. 1990). The court stated that if the former client is “not

the band that feeds,” and if the firm is not otherwise inhib-

ited, the professional is not prohibited from acting as counsel.

On the other hand, where the professional had openly de-

clared an inability or unwillingness to “joust” with an ongo-

ing client, the issues surrounding that client were pervasive,

and the ongoing client was a multi-million-dollar-a-year cli-

ent of the professional, the court stated that it found it diffi-

cult if not impossible, to find the professional disinterested.

Id.

44. Drexel was indeed “the hand that feeds”

Coopers & Lybrand and Coopers & Lybrand failed to openly

declare to this Court its unwillingness to “joust” with Drexel.

Coopers & Lybrand clearly displayed its inability to “dili-

gently and zealously” represent Southmark on issues involv-

ing Drexel. In fact, the relationship between Coopers &

Lybrand and Drexel perfectly mirrors the relationship in /n re

Amdura that the court found impossible to label disinterested.

Coopers & Lybrand declared, albeit not openly, an unwilling-

ness to “joust” with Drexel, the Drexel issues were pervasive

and Drexel was a multi-million dollar client. Had this been

disclosed to the Court, Coopers & Lybrand could not possibly

have been deemed disinterested. Indeed, had the conflict been

disclosed to the Examiner, he almost certainly would not

have sought to retain Coopers & Lybrand in the first instance.

D. Coopers & Lybrand Held An Interest

Adverse To The Southmark Estate

45. Although the term “adverse interest” is not

defined in the Bankruptcy Code itself, the following judicial

definition has developed:

(a) to possess or assert any eco-

nomic interest that would tend to lessen

the value of the bankruptcy estate or that

would create either an actual or potential

dispute in which the estate is

a rival claimant; or

(b) to possess a predisposition un-

der circumstances that render such a bias

against the estate.

In re Diamond Mortg. Corp. of Illinois, 135 BR 78 94 (Bankr

N.D. Ill. 1990): In re Kuykendahl Place Associates, Ltd., \\2

B.R. 847, 850 (Bankr. S.D. Tex. 1989); In re Roberts, 46

B.R. 815, 827 (Bankr. D. Utah 1985) aff'd in relevant part

and rev'd in part, 75 B.R. 402 (D. Utah 1987); Roger J. Au &

Son, Inc. v. Aetna Ins. Co., 64 B.R. 600, 604 (N.D. Ohio

1986).

46. Under the judicial definition of adverse in-

terest, Coopers & Lybrand clearly should have been disquali-

fied fromm employment by the examiner. Coopers & Lybrand

had a predisposition which rendered a bias against the estate

in favor of its multi-million dollar client. Not only did it have

24b

a predisposition it actually did “render such bias against the

estate” in failing to vigorously pursue the Drexel claims.

47. The Supreme Court has held, in the con-

text of a bankruptcy proceeding, that: “[w]here an actual con-

flict of interest exists, no more need be shown in this type of

case to support a denial of compensation.” /n re Woods v

City Nat. Bank & Trust Co., 312 U.S. 262, 268, 61 S.Ct. 493,

497 (1940). See also Consolidated Bancshares, 785 F.2d at

1256; In re EWC, Inc., 138 B.R. 276, 280 (Bankr W.D. OkI.

1992); In re Diamond Mortg. Corp. of Illinois, 135 B.R. at

92; In re Coay, 122 B.R. 520, 526 (Bankr. N.D. Ohio 1990):

In re Micro-Time Management Systems, Inc., 102 B.R. 602.

606 (Bankr. E.D. Mich. 1989); In re Kendavis Inc., 91 B.R.

742, 752 (Bankr. N.D. Tex. 1988). In other words. no show-

ing of fraud or unfairness need be shown, in fact, nothing

more than the conflict itself is required to be shown. Woods,

61 S.Ct. at 497.

48. The Supreme Court gives the following

reason for not requiring any showing beyond the actual

conflict:

The incidence of a particular conflict of

interest can seldom be measured with

any degree of certainty. The bankruptcy

court need not speculate as to whether

the result of the conflict was to delay ac-

tion where speed was essential, to close

the record of past transactions where

publicity and investigation were needed,

to compromise claims by inattention

where vigilant assertion was necessary

or otherwise to dilute the undivided

aa a a aici

25b

loyalty owed to those whom the claim-

ant purported to represent.

Id.

49. As with the discussion of disinterestedness

above, based upon Mr. Gallbally’s sworn statements, there

can be no genuine dispute as to whether Coopers & Lybrand

had an actual conflict here. Plainly, it did. Accordingly, under

either prong of section 327(a), Coopers & Lybrand was not

qualified to work on behalf of Southmark and the Examiner.

E. Coopers & Lybrand’s Failure To

Disclose Mandates Disgorgement Of Its Fees

50. Pursuant to Bankruptcy Rule 2014 and its

predecessor, the professional who seeks to represent the

debtor must fully disclose at the time of the application for

employment all connections with the debtor, creditors and

other parties in interest. See /n re Arlin’s Dept Stores, Inc.,

615 F.2d 925, 931 (2d Cir. 1979); In re Roberts, 73 B.R. at

411: In re Coastal Equities Inc., 39 B.R. 304, 308 (Bankr.

S.D. Cal. 1984); Jn re Diamond Lumber, Inc., 88 B.R. 7753,

776 (N.D. Tex. 1988). All facts that may be relevant to a de-

termination of whether a professional is disinterested or holds

or represents an interest adverse to the debtor estate must be

disclosed to the court. See, e.g., Jn re Arlin, 615 F.2d at

931-933: In re Diamond Lumber, 88 B.R. at 777, In re Rob-

erts. 75 B.R. at 411; In re Coastal Equities, Inc..39 B.R. at

308. The duty to disclose is broad because the court, rather

than the professional, must decide whether the facts consti-

tute an impermissable conflict of interest. See /n re Roberts,

75 B.R. at 410-411; In re Coastal Equities, Inc., 39 B.R. at

ee heee |

308: In re Diamond Lumber, 88 B.R. at 777

26b

51. The duty to disclose is not only predicated

on the statutory requirements of Rule 2014, but also the obli-

gation to disclose in the capacity as an officer of the court and

fiduciaries. /n re Coastal Equities, 39 B.R. at 308.

52. Professionals, when making disclosure, are

on notice that if the disclosure is inadequate, if the facts are

incorrect or if the changing facts and circumstances reveal an

actual conflict, and the professional is later proved to be in-

terested, the court is empowered to deny or reduce fees. /n re

Sky Valley, Inc., 135 B.R. 925, 935 (Bankr. N.D. Ga. 1992).

See also In re EWC, Inc., 138 B.R. at 282 (“[p]rofessionals

employed for the estate are under a continuing duty to dis-

close their connections.”): Jn re Diamond Mortg. Corp., 133

B.R. at 90. Furthermore, if the duty to properly disclose is ne-

glected, however innocently, the professional performs the

duties to the estate at its peril. Jn re Coastal Equities, 39 B.R.

at 308.

53. Many courts have held that failure to com-

ply with the disclosure requirement is an independent basis

for denial of all fees under 11 U.S.C. Section 328, The court

in Jn re EWC, Inc., stated as follows:

Therefore, if, a person has at any time

during employment by the estate, any

connections with the debtor, creditors,

any other party in interest, their attor-

neys and accountants, . . .. pursuant to

Fed. R.Bankr.Pro. 20 14(a), and fails to

disclose those ‘connections’ to the best

of his or her knowledge, it is necessary

and appropriate that employment of that

‘3

hit ate

27b

person must be set aside to carry out the

provisions of the Bankruptcy Code. Any

request for compensation must be de-

nied, and any compensation received

must be disgorged.

138 B.R. 276, 280-281 (Bankr. W.D. Okl. 1992). See also

Consolidated Banchsares, 755 F.2d at 1256 n. 7; In re Rob-

erts, 75 B.R. at 412; Jn re Coastal Equities, 39 B.R. at 308;

In re Thompson, 54 B.R. 311, 316 (Bankr. N.D. Ohio 1983);

In re Marine Outlet, Inc., 135 B.R. 154, 156 (Bankr. M.D.

Fla. 1991) (“failure to comply with the mandate of Bank-

ruptcy Rule 20 14(a) merits a total forfieture of all fees”); /n

re Tinley Plaza Associates. L.P., 142 B.R. 272, 278 (Bankr.

N.D. Ill. 1992) (“if an attorney does not disclose a conflict

arising after employment has been allowed, the court must. .

. disgorge any compensation granted during the period the

conflict existed”); Jn re Micro-Time, 102 B.R. at 608 (all

compensation was denied the trustee and accountant because,

had they fully disclosed they would not have been appointed

and thus they have nothing on which to base their claim for

compensation, despite substantial contribution). Contra /n re

Roberts, 75 B.R. at 412 (“where equities outweigh the need

for attorney discipline for failure to disclose potential con-

flicts, the law does not require the denia! of fees and costs”).

The court in /n re Micro-Time, in referring to the complete

denial of fees, stated:

The argument that possible harm .

could be counter-balanced by greater

benefit [to the estate] does not cover the

policy considerations which look to the

harm to representation, the loss of confi-

dence, etc. Moreover, [i]t is almost

28b

impossible for a court to determine what

benefit has accrued to the estate as op-

posed to what detriment might have

accrued...absent a conflict of interest....

In re Micro-Time, \02 B.R. at 608.

54. Although Coopers & Lybrand disclosed

the existence of its relationship with Drexel, it failed to dis-

close the significance of that relationship and the potential

impact on its duties as the accountant to the Court appointed

examiner. While this Court endeavored to employ a disinter-

ested examiner to diligently review the potential claims of the

estate, Coopers & Lybrand failed to disclose its predisposi-

tion to protect its relationship with Drexel and thus tainted

the disinterestedness of the Examiner. As noted in /n re

Micro-Time, in hindsight it is impossible for this Court to de-

termine what benefit might have accrued to the estate absent

this conflict of interest and what detriment did in fact accrue.

¥. This Motion To Reconsider Is Timely

Under Rule 60(B)

55. Rule 60(b) of the Federal Rules of Civil

Procedure, through the operation of Bankruptcy Rule 9024,

governs both the rounds and the time limitations for a motion

to reconsider a bankruptcy court order.

56. Rule 60(b) provides that:

[o]n motion and upon such terms as are

just, the court may relieve a party or a

party’s legal representative from a final

Maths Stes Stain earl

29b

judgment, order, or proceeding for the

following reasons: (1) mistake, inadver-

tence, surprise, or excusable neglect; (2)

newly discovered evidence which by

due diligence could not have been dis-

covered in time to move for a new trial

under Rule 59(b); (3) fraud (whether

heretofore denominated intrinsic or ex-

trinsic), misrepresentation, or other mis-

conduct of an adverse party; (4) the

judgment is void; (5) the judgment has

been satisfied, released, or discharged,

or a prior judgment upon which it is

based has been reversed or otherwise

vacated, or it is no longer equitable that

the judgment should have prospective

application; or (6) any other reason

justifying relief from the operation of

the judgment. The motion shall be made

within a reasonable time, and for rea-

sons (1), (2), and (3) not more than one

year after the judgment, order, or

proceeding was entered or taken. A

motion under this subdivision (b) does

not affect the finality of a judgment or

suspend its operation. This rule does not

limit the power of a court to set aside a

judgment for fraud upon the court...

Fed. R. Civ. P. 60(b) (emphasis added). As is evident from

the language of the Rule itself, Rule 60(b)’s one year time

limitation for bringing a motion to reconsider does not apply

to (a) Rule 60(b)(6) (“any other rcason justifying relief from

the operation of a judgment”) or (b) fraud upon the court.'

30b

57. Rule 60(b)(6): The purpose of Rule

60(b)(6), which provides relief from a judgment for “any

other reason justifying relief”, is to prevent extreme hardship

or injustice. See United States v. McDonald, 86 F.R.D. 204,

208 (N.D. Ill. 1980). Once hardship or injustice is found,

“Rule 60(b)(6) is to be liberally applied to ‘accomplish jus-

tice.”” Id. In the Fifth Circuit, Rule 60(b)(6) applies where

“something more” than mistake, fraud or newly discovered

evidence is shown. See, e.g., Bros. Inc. v. W.E. Grace Mfg.

Co., 320 F.2d 594, 608-09 (Sth Cir. 1963) (Rule 60(b)(6) in-

voked upon showing of “something more” than mere plea to

reopen based upon newly discovered evidence or fraud).

58. Here, Coopers & Lybrand committed fraud

by failing to disclose that its substantial relationship with

Drexel would preclude its vigorous investigation of claims

against Drexel. However, Coopers & Lybrand’s activities (as

developed more fully herein) go far beyond mere fraud. Here,

the “something more” arises from the context of Coopers &

Lybrand’s misconduct, i.e. Coopers & Lybrand's fiduciary

Status with respect to the Court, its affirmative duty to

: Both of these exceptions to Rule 60(b)’s one year time limitation

appear, based upon the language of the Rule, to apply only to judgments

as opposed to orders: however, case law interpreting Rule 60(b) does not

support such a rigid interpretation. See Lucas v. City of Juneau, 20 F.R.D.

407, 410 (D. Alaska 1957) (Rule 60(b)(6) applies to order as well as judg-

ment); /n re H.B. Michelson, 141 B.R. 715, 725-26 (Bankr. E.D. Cal.

1992) (fraud on the court is basis for revoking order confirming reorgani-

zation plan). Moreover, even if the Rule 60(b)(6) and the fraud upon the

court exceptions apply only to judgments, these exceptions still apply un-

der the presented facts since Bankruptcy Rule 9002 defines “judgment”,

as it is used in the Federal Rules of Civil Procedure including Rule 60(b),

to include “any order appealable to an appellate court. “ Because the order

of this Court approving Coopers & Lybrand’s fee is an appealable order,

it is also a “judgment” pursuant to Bankruptcy Rule 9002.

31b

disclose any potential conflicts of interest to the Court, the

requirement of disinterestedness and, most important, the

public interest in seeing that the creditors of Southmark are

treated fairly and equitably. Shielding one of its largest clients

from claims that could have substantially enhanced creditor

recoveries was plainly inimical to the interests of South-

mark’s creditors and a violation of Coopers & Lybrand’s fi-

duciary and statutory duties. Moreover, this type of

misconduct threatens the very integrity of, and the public trust

in, the bankruptcy process. Consequently, the Court must re-

consider its order award of fees to Coopers & Lybrand pursu-

ant to Rule 60(b)(6).

59. Fraud upon the Court: Like a motion

brought pursuant to Rule 60(b)(6), a motion to reconsider

based on fraud upon the court is not subject to the one year

time limitation of Rule 60(b). Fed. R. Civ. P. 60(b). “Fraud

upon the court” is fraud committed by an officer of the court

which affects the judicial machinery in such away “that the

judicial machinery cannot perform in the usual manner its im-

partial task of adjudging cases that are presented for adjudica-

tion.” Browning v. Navarro, 826 F.2d 335, 344-45 n. 12 (Sth

Cir. 1987); Budge v. Post, 544 F. Supp. 370, 377 (N.D. Tex.

1982). The Examiner is an officer and fiduciary of this Court.

See In re Baldwin United Corp., 46 B.R. 314, 318-17 (Bankr.

S.D. Ohio 1985) (examiner, as non-adversarial officer o the

court, operates as a civil grand jury “to ascertain legitimate

areas of recovery” for the estate). By concealing the extent of

its relationship with Drexel and by failing to develop claims

against Drexel. Coopers & Lybrand tainted the Examiner’s

Interim Reports, and committed a fraud upon this Court.

Moreover, Coopers & Lybrand, as court-appointed account-

ants, were quasi-officers and fiduciaries of this Court. See /n

re Food Town, Inc., 208 F. Supp. 139, 148-49 & n.6 (D. Md.

32b

1962). By concealing the effect of its relationship with Drexel .

on the work it was charged to perform and by failing to inves-

tigate and/or covering up Southmark’s claims against Drexel,

Coopers & Lybrand perpetrated a fraud upon both the Court-

appointed Examiner and this Court.

60. Consequently, this Motion is not time

barred by the one year limitations period set out in Rule

60(b).

CONCLUSION

61. Coopers & Lybrand’s failure to disclose its

disinterestedness and adverse interest resulted in the very type

of injury to the estate that the strict requirements of the Bank-

ruptcy Code seek to avoid. Coopers & Lybrand failed to vig-

orously pursue certain actions against Drexel creditors.

Complete disgorgement here is necessary and appropriate (a)

in light of the harm caused Southmark by the Coopers & Ly-

brand misconduct and (b) to serve as a warning to other pro-

fessionals that the requirements under the Bankruptcy Code

are to be taken seriously and that misleading partial disclo-

sures of conflicts of interest will not be tolerated. Accord-

ingly, Southmark respectfully requests that the Court

reconsider the previous award of over $3.7 million in frees

and expenses to Coopers & Lybrand and order Coopers &

Lybrand to fully disgorge all such fees and expenses to

Southmark.

DATED: January 4, 1994.

Respectfully Submitted,

GIBSON, DUNN & CRUTCHER

By:

Robert B. Krakow, Esq.

State Bar No. 11702000

1717 Main Street, Suite 5400

Dallas, Texas 75201-4605

Telephone: (214) 698-3100

Facsimile: (214) 698-3400

Attorneys for Southmark

Corporation

34b

‘Any footnotes trail end of document)

UNITED STATES BANKRUPTCY COURT FOR THE

SOUTHERN DISTRICT OF NEW YORK

IN RE: VYTAUTAS VEBELIUNAS, Debtor

Chapter 7, Case No. 98 B 45466 (TLB)

March 10, 1999, Decided

COUNSEL: Edgar H. Booth, Esq., Donald L. Kuba, Esq.,

Warren R. Graham, Esq., WARSHAW BURSTEIN COHEN,

SCHLESINGER & KUH, L.L.P., New York, New. York, for

Chapter 7 Trustee.

ROY BABITT, ESQ., Chapter 7 Trustee, New York, New

York.

VYTAUTAS VEBELIUNAS, Debtor, Pro se, Richmond

Hill, New York.

Alan E. Gamza, Esq.,. MOSES & SINGER, L.L.P., New

York, New York, for Citibank, N.A.

TRACY HOPE DAVIS, ESQ., Office of the United States

Trustee, New York, New York.

JUDGES: HONORABLE TINA L. BROZMAN, CHIEF

UNITED STATES BANKRUPTCY JUDGE.

OPINION BY: TINA L. BROZMAN

OPINION: OPINION DISQUALIFYING COUNSEL TO

CHAPTER 7 TRUSTEE

HONORABLE TINA L. BROZMAN

WN Dm tay

SPE SEL PRIEST PS IORI AA RI HS

ve)

CHIEF UNITED STATES BANKRUPTCY JUDGE:

Concerns and fears of partisan bias in the House of Represen-

tatives and in the voting by Senators rocked the impeachment

process of President William Jefferson Clinton. As it turned

out, once the Senators viewed the evidence and gave it the

weight they deemed appropriate, they did not vote along uni-

fied party lines but acquitted the President. I mention this

only to illustrate what a destructive force bias can be if it is

allowed to go unchecked and how important in the judicial

and quasi-judicial arenas it is first to amass reliable evidence

and only then to formulate an opinion.' In fact. the point in

time when an opinion is formed is essential to the distinction

between bias on the one hand and reasoned judgment on the

other. Today, I address that very issue as it relates to the dis-

interestedness of counsel to the chapter 7 trustee on account

of his clear expression of prejudice against the debtor before

any § 341 or other examination of him by the trustee.

A. Procedural History

Vytautas Vebeliunas, the debtor pro se in this converted

chapter 7 case, moved to disqualify Roy Babitt, the chapter 7

trustee assigned to his case, by reason of an alleged conflict

of interest arising out of a prior representation of the debtor's

affiliate by the firm where Mr. Babitt is of counsel but which

does not represent him in this matter. In a decision issued

36b

from the bench, | held that there was absolutely no basis in

law or fact warranting the trustee's disqualification for a con-

flict of interest or for any other reason, however, I instructed

the trustee to engage substitute counsel because it had be-

come apparent from the pleadings that his counsel, specifi-

cally Warren Graham of Warshaw Burstein Schlesinger &

Kuh ("Warshaw Burstein"), was not disinterested as required

by § 327(a) of title 11 of the United States Code (the "Bank-

ruptcy Code"). Warshaw Burstein expressed shock at my rul-

ing, not only because the firm clearly did not appreciate it,’

but because it claims it was not put on notice that | was going

to raise and address what was in the papers but what the

debtor did not address during his oral argument. Being a firm

believer in due process and not wishing to deprive anyone of

his or her right to be heard, I allowed Warshaw Burstein to

respond in writing and then orally at a subsequent hearing.” |

did this despite the fact that I regarded the issue of counsel's

disinterestedness to be sufficiently glaring from the papers

submitted that adequate and sufficient notice of its existence

was provided. However, that is only my opinion and reason-

able minds do differ.

B. Background

1. The Lattingtown Question

Vebeliunas may or may not own a piece of property located

in Lattingtown, New York, which was last valued at $ 4.5

million. When he filed his chapter 11 petition, Vebeliunas did

not schedule the property, taking the position instead that it is

owned by a trust in which he has a 20% interest. Several

37b

banks with liens against the property totaling less than $ 2

million moved to dismiss the chapter 11 case, asserting that

Vebeliunas did indeed own the property but that they could

pursue foreclosure in state court. Instead, because Vebeliunas

may have significant unsecured debt which, if the Latting-

town property is his, possibly could be satisfied in whole by

his equity in that property, I converted the case to a chapter 7

liquidation, noting that the trustee was to examine into the

ownership question. Roy Babitt was appointed chapter 7 trus-

tee, with Warshaw Burstein being retained as his counsel.

2. The Telephone Call With Monica Setikas

Prior to the debtor's scheduled § 341 examination,’ Vebeliu-

nas' assistant, Ms. Monica Setikas, telephoned Graham re-

questing information about the upcoming meeting. Her

reason for calling, she claimed, was that Vebeliunas had not

received timely notice of it and that the notice he finally did

receive contained inaccurate information. In response to her

request, Graham allegedly told Ms. Setikas that he did not be-

lieve "anything the debtor said in this case," that he was get-

ting a court reporter and that Vebeliunas had better be at the

meeting. This conversation was first brought to the court's at-

tention in Vebeliunas' papers moving for the trustee's dis-

qualification. See Vebeliunas Moving Affidavit, P15. In his

papers opposing the debtor's motion, Graham recounts the

same exchange as follows:

The Debtor's suggestion in paragraph 15 of the

Vebeliunas Affidavit that "Mr. Babitt, without

ever speaking to [him], has instructed his

38b

attorneys not to believe [him]," is also without

any factual basis. The Debtor's motion papers

then go on to detail a conversation between

Monica Setikas, an associate of tne Debtor,

and Warren R. Graham, a member of the War-

shaw Burstein firm, and the author of these pa-

pers, quoting Mr. Graham as stating that he

"did not believe anything Mr. Vebeliunas said

in this case." While that quote is substantially

accurate, the skepticism contained therein is

entirely predicated on the record and the gross

inconsistency of the Debtor's position concern-

ing ownership of the property, with among

other things, his previous sworn statements."”

See Trustee's Opposition, P19 (emphasis added). However, at

the hearing, Graham testified that he did not remember the

conversation with any specificity; with respect to his com-

ment expressing his disbelief of Vebeliunas, Graham said he-

thought that he made that remark in connection with Vebeliu-

nas claims of deficient notice. In their papers moving for re-

consideration, neither the firm nor Graham makes any

statement reflecting this position. In fact and significantly, the

firm's and Graham's affidavits in opposition to disqualifica-

tion continue to recount Graham's remark to Monica Setikas

as one expressing disbelief of anything the debtor had to say

in the case generally. See Warshaw Burstein Affidavit in Op-

position to Disqualification, P12; Graham Affidavit Annexed

to Warshaw Burstein Affidavit in Opposition to Disqualifica-

tion, P7. In paragraph 7 of Graham's affidavit, he goes

through a detailed list of reasons, only one of which was the

repeated claim of deficient notice, why "in frustration and ex-

asperation, [he] spontaneously remarked that [Graham] did

not believe anything [Vebeliunas] said." Graham Affidavit

Pere Sond

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39b

Annexed to Warshaw Burstein Affidavit in Opposition to

Disqualification, P7. If Graham had wished to clarify the con-

text in which he remarked on the debtor's credibility, he had

several opportunities to do so before the de novo hearing. But

he did not. Had Graham not changed his story when he testi-

fied, it would have been unnecessary to make a credibility de-

termination. But I believe I have no other choice now other

than to render such a determination. | find Graham's testi-

mony at the hearing to have been evasive and not credible.

In the most recent brief submitted by Warshaw Burstein in

opposition to its disqualification, Warshaw Burstein attempts

to justify Graham's conclusions about the debtor by stating:

it is respectfully urged upon this court that

when a debtor swears to directly contrary facts

on numerous occasions and transfers the same

piece of property numerous times outside the

chain of title, it is not essential for the Trustee,

or his counsel, to "get his side of the story"

prior to concluding that he has no credibility.

See Warshaw Burstein Affidavit in Opposition to Disqualifi-

cation, P27. Graham also suggested that his frustration and

exasperation with the debtor® "together with the Debtor's

status as a convicted felon [which] gave [Graham] ample jus-

tification to doubt [Vebeliunas'] credibility, and did not im-

pose upon [Graham] an additional duty 'to get his side of the

story." See Graham Affidavit annexed to Warshaw Burstein

Affidavit in Opposition to Disqualification, P8. Notwith-

standing Graham's statements, Vebeliunas has contended in

court papers that the other parties in interest misapprehend

40b

the facts relating to the chain of title of the property and Ve-

beliunas further says that he has an explanation to support his

own view of the documents to which Graham has referred.

II.

Counsel's compliance with the disinterestedness requirement

under § 327(a) not only applies at the time of retention but

also throughout the case, see In re Granite Partners, L.P., 219

B.R. 22, 32 (Bankr. S.D.N.Y. 1998); Rome v. Braunstein, 19

F.3d 54, 62 (1st Cir. 1994), and is so crucial to the proper

functioning of the bankruptcy system that a court may raise it

and dispose of it whenever its sanctity is questioned. See In re

Martin, 817 F.2d 175, 180 (1st Cir. 1987) (discussing the

bankruptcy court's fundamental responsibility to monitor the

integrity of the proceedings before it); In re Plaza Hotel Cor-

poration, 111 B.R. 882, 891 (Bankr. E.D. Cal. 1990) (the

court has a continuing supervisory role during the case which

includes the ability to revisit issues such as disinterestedness

whenever appropriate); Booth v. Continental Insurance Com-

pany, 167 Misc. 2d 429, 634 N.Y.S.2d 650, 653-654 (Sup.

Ct. West. Co. 1995) (citing Wagenheim v. Pomerantz,

N.Y.L.J. 7/7/70, p.13, col.7 at p. 14, col.1 (Sup. Ct. West.

Co.) (citing cases) ("the judiciary will not close its eyes when

the suggestion of impropriety appears on the record and the

issue may be raised sua sponte"); In re Kelton Motors, Inc..

109 B.R. 641, 650 (Bankr. D.Vt. 1989); see generally Flush-

ing Savings Bank v. FSB Properties, Inc., 105 A.D.2d 829.

482 N.Y.S.2d 29, 31 (App. Div. 1984). If there was any infir-

mity in my issuing my prior ruling without advising the firm

that | was considering its removal, that infirmity has been

cured by the leave I subsequently granted Warshaw Burstein

to appear and be heard on this issue. See Kelton Motors, 109

B.R. at 650.

ge kane ae ae eee nD

41b

The crux of Warshaw Burstein's argument is that neither the

trustee nor trustee's counsel need be disinterested vis-a-vis

the debtor and that counsel had no duty to question the debtor

before concluding that he is completely untrustworthy. Fur-

ther, Warshaw Burstein argues, Graham was entitled to disbe-

lieve the debtor pre-examination without compromising

counsel's disinterestedness should I find that that standard ap-

plies to the firm.

IT.

I feel compelled to first put to bed any doubt as to Graham's

bias and how I reached the conclusion that he possessed one.

The pertinent facts are simple. Prior to any examination of

the debtor by the trustee or his counsel in connection with the

chapter 7 case, Graham made an unequivocal statement to the

effect that he believed Vebeliunas to be a liar. In his affida-

vits, Graham manifested a further belief that the debtor did

not deserve the opportunity to explain himself because he is a

convicted felon. See Graham Affidavit annexed to Warshaw

Burstein Affidavit in Opposition to Disqualification, P8.

WEBSTER'S THIRD NEW INTERNATIONAL DICTION.

ARY defines prejudice as "a preconceived judgment or opin-

ion" and "an opinion or leaning adverse to anything without

just grounds or before sufficient knowledge." WEBSTER'S

THIRD NEW INTERNATIONAL DICTIONARY ( Merriam-

Webster, Springfield Mass. 1981). The same source defines

bias as "such prepossession with some object or point of view

that the mind does not respond impartially to anything related

to this object or point of view."’ Id. While Vebeliunas may

turn out to be guilty, as alleged, of supplying misinformation

to the parties in interest, Graham simply cannot have

42b

concluded that Vebeliunas is lying absent a bias or prejudice

on Graham's part because there has not been an examination

of Vebeliunas, and, therefore, the totality of evidence needed

for Graham to have formed a reasoned judgment is not yet

available. Quite obviously Graham is biased against the

debtor, for when Ms. Setikas merely requested information

for Vebeliunas, Graham responded by attacking the debtor's

credibility, thereby demonstrating a complete lack of imparti-

ality with respect to anything having to do with him.

Warshaw Burstein and Graham contend that the comments to

Ms. Setikas about the debtor were perhaps "impolitic" but not

serious enough to raise a question as to counsel's disinterest-

edness. An impolitic remark is an unwise remark. See id.

During his conversation with Ms. Setikas, had Graham

quipped "Vebeliunas probably threw out the notice I sent

him," that would have been an unwise and inappropriate re-

mark, but not one indicating bias or prejudice. However, tell-

ing a debtor's representative that you don't believe a word the

debtor says before you have spoken with the debtor is signifi-

cantly more troubling. It indicates a predisposition not to

trust, listen to, believe in or have confidence in that person.

| recognize that, factually at least, this case is unique, unlike

any other reported decision. Whereas most of the decisions

regarding the propriety of the retention of counsel involve a

conflict of interest, this case admittedly does not address an

actual, potential or apparent conflict; the debate that sur-

rounds disqualifying conflicts of interest is not implicated

here. Jurisprudential precedent on this topic therefore may

only serve to guide me as | make inroads into what amounts

to be pristine territory. See Board of Education of the City of

New York v. Nyquist, 590 F.2d 1241, 1246 (2d Cir. 1979)

(quoting Fund of Funds, Ltd. v. Arthur Andersen & Co., 567

F.2d 225, 227 (2d Cir. 1977)).

43b

IV.

The Bankruptcy Code sets forth a two-pronged test for the re-

tention of estate professionals. See 11 U.S.C. § 327(a); 11

U.S.C. § 101(14). In order for the trustee to retain profession-

als to represent or assist him or her in carrying out the duties

spelled out under § 704 of the Bankruptcy Code, those pro-

fessionals must meet both requirements. See Martin, 817 F.2d

at 180; Granite, 219 B.R. at 32; In re Envirodyne Industries,

Inc., 150 B.R. 1008, 1016 (Bankr. N.D.IIl. 1993). First, §

327(a) authorizes the trustee, with the court's approval, to em-

ploy "one or more attorneys ... that do not hold or represent

an interest adverse to the estate;" and second, "that are disin-

terested persons.” 11 U.S.C. § 327(a). The "adverse interest"

element in § 327(a) is undefined by the Bankruptcy Code but

has been judicially fashioned to mean either (1) the posses-

sion or assertion of any economic interest that would tend to

lessen the value of the bankruptcy estate or create an actual or

potential dispute with the estate as a rival claimant, or (2) a

predisposition of bias against the estate. Kravit, Gass & We-

ber, S.C. v. Michel (In re Crivello), 134 F.3d 831, 835-36

(7th Cir.1998); Smith v. Marshall (In re Hot Tin Roof), 205

B.R. 1000, 1003 (B.A.P. Ist Cir. 1997); Granite, 219 B.R. at

33; Envirodyne, 150 B.R. at 1016-17; In re Roberts, 46 B.R.

815, 827 (Bankr. D. Utah 1985) aff'd in part, modified in part

and rev'd in irrelevant part, 75 B.R. 402 (D. Utah 1987). We

are unconcerned here with § 327(a)'s first prong, no adverse

interest, but are more concerned with disinterestedness, the

second prong, because the bias exhibited is against the

debtor, rather than the estate.

44b

Unlike the "adverse interest" prong of the test, disinterested-

ness is delineated in the Bankruptcy Code. So far as relevant

here, § 101(14)(E) of the Bankruptcy Code, more commonly

known as the catch-all clause, see Granite, 219 B.R. at 32; 3

L. King, COLLIER ON BANKRUPTCY, P327.04[4}[e] at

327-43 (15th ed. rev. 1996), defines a disinterested person as

one that “does not have an interest materially adverse to the

interest of the estate or of any class of creditors or equity se-

curity holders, by reason of any direct or indirect relationship

to, connection with, or interest in, the debtor or an investment

banker specified in subparagraph (B) or (C) of this paragraph,

or for any othe’ reason.” 1] U.S.C. § 101(14)(E) (emphasis

added); see In re Marvel Entertainment Group, Inc., 140 F.3d

463, 476 (3d Cir. 1998) ("One is a ‘disinterested person’ only

if he [or she] has no interest that is materially adverse to a

party in interest in the bankruptcy."). It is well-recognized

that the meaning of the phrase "interest materially adverse” in

the definition of a disinterested person overlaps with that of

"interest adverse" in the first prong of § 327(a) and together,

they form one hallmark with which to evaluate whether pro-

fessionals seeking court-approved retention (or to remain re-

tained by the estate) meet the absence of adversity

requirements embodied in the Bankruptcy Code. See Martin,

817 F.2d at 180: Hot Tin Roof, 205 B.R. at 1003; Granite,

219 BR. at 33: In re Leslie Fay Cos., 175 B.R. 525, 532

(Bankr. S.D.N.Y.1994); Envirodyne, 150 B.R. at 1017.

Warshaw Burstein does not deny that it must be disinterested

but takes issue with whether it must be so vis-a-vis the

debtor, since the latter is not named in the statute. See 1]

U.S.C. § 101(14)(E). Only if I determine that the debtor is

owed such a duty need I address the second question, which

45b

is whether Graham's bias constitutes a lack of disinterested-

ness under the second prong of § 327(a).

A. Must Warshaw Burstein Be Disinterested As To The

Debtor?

1. The Debtor As A Potential Equity Security Holder

Counsel's obligation to be disinterested runs to the parties in

interest. See Marvel, 140 F.3d at 476. In the typical case, the

debtor has no standing to be heard on many matters not in-

volving the discharge of debt because the outcome is irrele-

vant to the debtor when the estate will not generate a surplus.

However, cases discussing a chapter 7 debtor's right to be

heard when he or she retains an equity interest in the estate

hold that the debtor has standing to lodge an objection to a

claim against the estate or to participate in litigation sur-

rounding the asset that stands to produce the surplus. See 4 L.

King, COLLIER ON BANKRUPTCY, P502.02[2][c] at

502-14 (15th ed. rev. 1996) (debtor is a party in interest and

has standing to object to a claim where there could be a sur-

plus after all claims are paid); In re Manshul Construction

Corp., 223 B.R. 428, 430 (Bankr. S.D.N.Y. 1998); In re

McCorhill Publishing, Inc., 89 B.R. 393, 396 (Bankr.

S.D.N.Y. 1988) (in a liquidation under chapter 7, a debtor has

standing to object to claims where disallowance of the claims

would produce a surplus); In re Sobiech, 125 B.R. 110, 113

(Bankr. $.D.N.Y. 1991); In re Silverman, 10 B.R. 734, 735

(Bankr. S.D.N.Y. 1981), affd 37 B.R. 200 (S.D.N.Y. 1982).

In In re Gulph Woods Corporation, 116 B.R. 423 (Bankr.

E.D. Pa. 1990), the receiver for the plaintiff in an adversary

46b

proceeding commenced against the debtor sought to prevent

the debtor from participating in litigation regarding the sale

of property of the estate. The receiver argued that the only in-

terest the debtor could have would be a residuary one under §

726(a)(6), which is not an independent interest and therefore

unable to confer standing on the debtor to assert a claim

against the receiver. The court held that standing in bank-

ruptcy cases is unlike standing in other cases and that "a

debtor may participate in litigation if that litigation will gen-

erate or protect a surplus in the estate." Id. at 428. In inter-

preting Silverman, a case from this district which ultimately

denied the debtor's request for standing to object to a claim

against the estate because the court determined that no sur-

plus would be generated from the claim's disallowance, the

Gulph Woods court explained that "the [Silverman] court's

language clearly implied that, if the debtor could have shown

that there may have been a surplus for his estate, he would

have had standing, independent of trustee [sic], to object to

the claim in question." Id. at 428-29 (emphasis added).

Pursuant to § 726(a)(6), if all of Vebeliunas’ obligations are

satisfied, he will be entitled to any surplus proceeds generated

by the liquidation of the Lattingtown property.’ Thus, this

debtor should be considered a party in interest, see COL-

LIER, P502.02[2][c] at 502-14; McCorhill, 89 B.R. at 395

(debtor is a party in interest where he or she will retain a pe-

cuniary interest in the equity of the estate if all the creditors

can be paid in full); In re Hutchinson, 5 F.3d 750, 756 (4th

Cir. 1993) (party in interest is generally understood to include

all persons whose pecuniary interests are affected by the

bankruptcy proceedings); In re James Wilson Assoc., 965

F.2d 160, 169 (7th Cir. 1992) (everyone with a claim to the

res has a right to be heard before the res is disposed of since

that disposition will extinguish all such claims), the legal

consequence of which is that Graham ought be disinterested

Oe ee ae eee

47b

vis-a-vis Vebeliunas because he is, for all intents and pur-

poses, the potential class of equity security holders under | |

U.S.C. § 101(14)(E). There is no method of protecting Ve-

beliunas later while a non-disinterested professional is pres-

ently in charge of the investigation, should Vebeliunas prove

to be the class of equity holders. The only protection can be

given now. But the broader point, despite the statute's refer-

ence to equity security holders rather than debtors,’ is that the

trustee's professionals cannot be allowed under any circum-

stances to lack disinterestedness through bias against a debtor

given the responsibilities of the trustee in regard to a natural

debtor, specifically, to examine into and object to inappropri-

ate proofs of claim (which can inure to a debtor's benefit if

the claim is not dischargeable or if there may be a surplus); to

investigate into the debtor's financial affairs; if advisable, to

oppose the debtor's discharge; and, if there be a surplus, to

deliver it to the debtor. See 11 U.S.C. §§ 704(4), (5) and (6)

and 726(a)(6).

2. "Or For Any Other Reason"

Separate and apart from whether or not Vebeliunas can be

considered tantamount to an equity security holder under §

101(14)(E), there is a strong argument to be made that the "or

for any other reason" language at the end of that subsection is

intended, as noted by Collier, '° to permit "the court to find a

particular person lacking in disinterestedness for reasons

other than the non-exclusive statutory guidelines." Roberts,

46 B.R. at 828 n.26 (citing In re Philadelphia Athletic Club,

Inc., 20 B.R. 328, 333 (E.D. Pa. 1982) (quoting | COLLIER

BANKRUPTCY MANUAL § 101.13 (1981))). The oft-

quoted language '' that "professionals engaged in the conduct

48b

of a bankruptcy case should be free of the slightest personal

interest which might be reflected in their decisions concern-

ing matters of the debtor's estate or which might impair the

high degree of impartiality and detached judgment expected

of them during the course of administration," '’ lifted from

the COLLIER BANKRUPTCY MANUAL excerpt quoted in

Philadelphia Athletic Club and Roberts is the manual's con-

clusion of the function and effect of the "or for any other rea-

son" clause as it affects the meaning of disinterestedness.

COLLIER BANKRUPTCY MANUAL § 101.13. Under this

view, the definition of disinterestedness pursuant 11 U.S.C. §

101(14) is not exclusive and is an attempt, albeit not a very

clear one from the drafting perspective, to allow a court to re-

ject an attorney if it "deems a particular person's associations

to be prejudicial to disinterestedness ... even though those as-

sociations do not come within the purview of section

101(13)." Id. Although the Second Circuit has not passed on

this issue, other Circuits have implicitly endorsed this view

by quoting Roberts (and hence the COLLIER BANK-

RUPTCY MANUAL) when defining disinterestedness. See

Crivello, 134 F.3d at 835 (citing In re BH&P, Inc, 949 F.2d

1300, 1308 (3d Cir. 1991) (citing In re BH & P, Inc. 119 B.R.

35, 42 (D.N.J. 1990) (citing In re Glenn Electric Sales Corp.,

99 B.R. 596, 601 (D.N.J. 1988) (quoting Roberts, 46 B.R. at

828 n.26)))) (the catch-all clause is sufficiently broad to in-

clude any professional with an "interest or relationship that

would even faintly color the independence and impartial atti-

tude required by the Bankruptcy Code); Winship v. Cook (In

re Cook), 223 B.R. 782, 789 (B.A.P. 10th Cir. 1998) (quoting

BH&P, 949 F.2d at 1309 (quoting Roberts, 46 B.R. at 828

n.26))(same). Under this broad view, Graham is required to

be disinterested with respect to the debtor regardless of

whether or not Vebeliunas is a potential equity security

holder.

49b

B. Standards of Disinterestedness

Courts examine the goals and purposes of the disinterested-

ness requirement in order to understand the full contours of

that concept. To be disinterested is "to prevent even the ap-

pearance of a conflict irrespective of the integrity of the per-

son or firm under consideration." In re Codesco, 18 B.R. 997,

999 (Bankr. S.D.N.Y. 1982) (quoted in Martin, 817 F.2d at

181; Hot Tin Roof, 205 B.R. at 1003; In re Kendavis Indus-

tries International, Inc., 91 B.R. 742, 754 (Bankr. N.D. Tex.

1988)). Further, a disinterested person "should be divested of

any scintilla of personal interest which might be reflected in

his decision concerning estate matters." Codesco, 18 B.R. at

999 (quoted in Martin, 817 F.2d at 181; Hot Tin Roof, 205

B.R. at 1003; Kendavis, 91 B.R. at 754). The most modest in-

terest or relationship will undo a person's disinterestedness if

it "would even faintly color the independence and impartial

attitude required by the Code and Bankruptcy Rules.” Rob-

erts, 46 B.R. at 828 n. 26 (quoting Philadelphia Athletic

Club, 20 B.R. at 334 (quoting COLLIER BANKRUPTCY

MANUAL, § 101.13)); Granite, 219 B.R. at 33; COLLIER,

P327.04[3][a] at 327-30 (citing and cited in Envirodyne, 150

B.R. at 1017) ("Professional persons employed by the trustee

should be free of any conflicting interest which might in the

view of the trustee or the bankruptcy court affect the perform-

ance of their services or which might impair the high degree

of impartiality and detached judgment expected of them dur-

ing the administration of a case."). From this we see that what

is behind prohibiting the existence of a conflict of interest or

relationship is the desire to ensure the independence and im-

partiality of the professional to be retained.

50b

Any determination regarding Graham's disinterestedness

would not be complete without a!so taking into account the

fiduciary duties he has as counsel to the chapter 7 trustee. A

trustee in bankruptcy, see King v. United States, 379 US.

329, 337, 13 L. Ed. 2d 315, 85 S. Ct. 427 (1964); In re Lehal

Realty Associates, 101 F.3d 272, 276 (2d Cir. 1996) (a bank-

ruptcy trustee is an officer of the court that appoints him or

her); Marvel, 140 F.3d at 474, as well as his or her counsel,

are officers of the court. nl13 See Securities and Investor Pro-

tection Corporation vy. Charisma Securities Corporation, 506

F.2d 1191, 1193-1194 (2d Cir. 1974); Grant v. George Schu-

mann Battery and Tire Company, 908 F.2d 874, 884 (11th

Cir. 1990); Continental Illinois National Bank & Trust v.

Charles N. Wooten, Ltd. (In re Evangeline Refining Com-

pany), 890 F.2d 1312, 1323 (Sth Cir. 1989). "Where persons

perform duties in the administration of the bankruptcy estate,

they act ‘as officers of the court’ and not private persons.”

Evangeline Refining, 890 F.2d at 1323. "As such, trustees

and attorneys for trustees are held to high fiduciary standards

of conduct.” Id.; Marvel, 140 F.3d at 474; Philadelphia Ath-

letic Club, 20 B.R. at 333 ("the attorney for the trustee had to

exercise the same degree of disinterestedness as the trustee

himself"); Codesco, 18 B.R. at 999 ("trustee's selection of

counsel, however, must be consistent with high standards re-

quired of the officers of the federal courts"). These fiduciary

duties are owed not only to the entire creditor body but to the

debtor as well. See Germain v. The Connecticut National

Bank, 988 F.2d 1323, 1330 n.8 (2d Cir. 1993). So the trus-

tee's disinterested counsel must treat with the debtor in accor-

dance with the high standards of conduct expected from

fiduciaries in bankruptcy.

Moreover, as an attorney admitted to practice in the State of

New York, Graham is subject to the American Bar Associa-

tion's Code of Professional Responsibility, specifically

Sib

Canons 5 and 9, which require that a lawyer exercise inde-

pendent judgment on behalf of his client and that "a lawyer

should avoid even the appearance of impropriety." MODEL

CODE OF PROFESSIONAL RESPONSIBILITY, Canons 5

and 9 (1997). Without a dcubt, this case differs from the ar-

chetypical conflicts case which gives rise to consideration of

the Canons. Canon 5 applies by analogy, a situation which is

not so unfamiliar in the bankruptcy context because the Can-

ons of Professional Responsibility are not an exact fit in cases

involving potentially hundreds of parties and shifting alli-

ances. See Gerald K. Smith, "Standards for the Employment

of Professionals in Bankruptcy Cases: A Response to Profes-

sor Zywicki's 'Case for Retaining the Disinterestedness Re-

quirement for Debtor in Possession's Professionals," 18

MISS. C. L. REV. 327, 357-58 (Spring 1998). If we consider

Warshaw Burstein's client to be the trustee and the estate,

Canon 5 calls for the firm and, by extension, Graham to exer-

cise independent judgment when making decisions on their

behalf, a directive which sounds strikingly familiar to the

goals of disinterestedness just discussed. See Martin, 817

F.2d at 181; Hot Tin. Roof, 205 B.R. at 1003; Kendavis, 91

B.R. at 754; Codesco, 18 B.R. at 999 (a disinterested person

must be devoid of "any scintilla of personal interest which

might be reflected in his decision concerning estate matters");

COLLIER, P327.04[3][a] at 327-30.

Most courts acknowledge that to be disinterested also re-

quires an attorney to heed the admonition contained in Canon

9. See Martin, 817 F.2d at 180-81 ("Section 327 is intended

... to address the appearance of impropriety as much as its

substance, to remove the temptation and opportunity to do

less than duty demands."); Hot Tin Roof, 205 B.R. at 1003;

Granite, 219 B.R. at 34 (despite the fact that the Model Rules

of Professional Conduct have dropped the appearance of im-

propriety standard, § 327(a) nevertheless retains it) n14;

52b

Glenn Electric, 99 B.R. at 601 ("the bankruptcy rules in and

of themselves incorporate considerations which are the

equivalent of Canon 9's ‘appearance of impropriety’ stan-

dard"); Codesco, 18 B.R. at 999; but see Marvel, 140 F.3d at

477 ("We do not believe that BH&P’s discussion of §

101(14)(E)'s disinterest requirement, as applied to the dis-

qualification of a trustee, mandates a conclusion that apparent

conflicts alone allow a finding of disinterestedness."'’).

C. Cv unsel Is Not Disinterested

Just because there is no conflict of interest does not mean that

the disinterestedness standard has not been violated and that

there has not been a breach of the Canons of the Code of Pro-

fessional Responsibility. Where there is a conflict, the fear is

that counsel's attention and loyalty are divided by the dual

representation or that counsel is swayed by an economic or

personal interest so that one party is favored over another.

See generally Leslie Fay, 175 B.R. 525 (counsel investigating

financial irregularities of debtor in possession failed to dis-

close relationships with directors who were targets of investi-

gation, thereby calling into question validity of investigation

as a result of which counsel was sanctioned and removed

from all new matters in case). The bottom line concern is that

counsel's independent judgment should not be compromised

in any way. If the goal is disinterestedness, whether an attor-

ney holds a bias or instead suffers from the likelihood of

tainted judgment as a result of a conflict of interest, the

wrong is the same, for his or her ability to maintain independ-

ence of judgment will be negatively affected.

a ee ee

Ad nati ai ail Ry

a a alam er

Tench Sie AED ah! tm

53b

Another reason why this case is different from the more typi-

cal one is, for lack of a better term, the direction of the bias.

While the ratio decidendi of most cases dealing with conflicts

of interest centers on the actuality or eventuality that counsel

will favor or is favoring cne party over another, there is a flip

side to this coin. Where one party is actively or purposely fa-

vored, another party becomes disfavored. Thus, whether

counsel is disfavoring one party over another is equally sig-

nificant to a court's reasoning in determining whether or not

counsel is disinterested. The reason the latter construct is

probably less often discussed is because the natural course of

events assumes the former: that counsel develops a bent in fa-

vor of one party which disturbs the balance of impartiality

and causes another party necessarily to become slighted, al-

beit unintentionally. In other words, counsel may not have

started off with any bias against this second party.

Graham's attitude is impossible to reconcile with counsel's fi-

duciary duties to the debtor as well as his duty to avoid even

the appearance of impropriety and to exercise independent

judgment. Graham is not disinterested as to Vebeliunas as

Graham is required to be, either because Vebeliunas is poten-

tially akin to the class of equity security holders under §

101(14)(E) or because Graham fails the disinterest test pursu-

ant to a more expansive reading of the subsection's last

clause. His bias impairs "the high degree of impartiality and

detached judgment expected from [counsel to the trustee]"

during a case. COLLIER, P327.04[3][a] at 327-30; see supra

n.11. Without a doubt Graham has leapfrogged right over the

mere appearance of impropriety to land four-square on im-

propriety itself. This is not a situation where ethical concerns

are raised by circumstantial evidence. There is direct evi-

dence of actual bias and prejudice against the debtor. War-

shaw Burstein was retained to assist the trustee in performing

his duties, such as spearheading the investigation of the

54b

financial affairs of the debtor and advising the trustee to op-

pose the debtor's discharge, if advisable. See 11 U.S.C. § 704.

Graham has a fiduciary duty on behalf of the trustee, the es-

tate and the debtor to carry out these tasks impartially. This is

why he must be disinterested. In explaining why counsel for a

chapter 11 trustee needed to be disinterested, the court in

Philadelphia Athletic Club explained:

This, of course, ... (was) quite sensible, for it would be

anomalous indeed to require a trustee to be aloof from all

connection with the debtor or its management, yet permit the

trustee's attorney, who would necessarily be active in further-

ing the trustee's duties of investigation, management, prose-

cution, development of plans and the like, to have a close

relationship with the debtor, its management or associates.

Philadelphia Athletic Club, 20 B.R. at 333 (citing 6 L. King,

COLLIER ON BANKRUPTCY, P7.06 at 1203 (14th ed.

1978)). Obviously, in that case, the court was concerned that

the trustee's counsel's bias would cause him to favor the

debtor over the rest of the creditor body. The converse con-

cern is present in this case, but the same reasoning governs.

Given Graham's prejudice, it would be naive on my part to

expect Graham to be able now to conduct an impartial, un-

tainted and independent investigation of the debtor, particu-

larly since, in Graham's newest papers and aware of my

concerns, he nevertheless asserts that he has no duty to be im-

partial regarding the debtor and has enough information

without ever talking to the debtor to disbelieve him. See Gra-

ham Affidavit annexed to Warshaw Burstein Affidavit in Op-

position to Disqualification, P8.

D. Disinterestedness Aside, Counsel Should Be Removed

eT TT |

~ Say AP ald cae

At least one court has found: that disinterestedness need not

be the exclusive test when evaluating the propriety of an at-

lorney’s retention. nl6 In In re Kurtzman, 220 B.R. 538

(S.D.N.Y. 1998), the district court affirmed the bankruptcy

court's refusal to approve the retention of the chapter 7 trus-

tee's chosen counsel. The bankruptcy court had denied the re-

tention because it believed the Jaw firm to be irresponsible

with its billing practices and determined that it would not be

in the best interest of the estate for the trustee to retain this

particular firm. The district court affirmed, reasoning:

Indeed, section 327(a) vests the authority for

“approval” within the sound discretion of the

Court. That authority would be eviscerated

were the Court required to approve counsel

who met the technical test for disinterest but

was ill-suited for other reasons such as, for ex-

ample, inexperience.

Id. at 542. Recognizing that the Third Circuit's decision in

Marvel limited disqualification of an attorney on the basis of

conflicts of interest to situations involving actual or potential

conflicts, the district court remarked:

Marvel, however, did not bar considerations other than con-

flict of interest in a court's determination of whether to ap-

point an attorney as trustee's counsel under § 327(a). Thus.

while disinterestedness and the absence of conflicts may be

central to the inquiry, they are by no means exclusive.

56b

Id. Applying that rationale to this case, | believe Graham is

ill-suited to serve as the trustee's counsel because of his ex-

pressed prejudice against the debtor. Cf. Plaza Hotel, 111

B.R. at 891.92 (where debtor's counsel exhibited clear gender

bias against the chapter 11 trustee and the United States Trus-

tee and an unwillingness to work with them for that same rea-

son, debtor's counsel was disqualified for his unwillingness to

assist the debtor in performing its duty to cooperate with

them). In addition, if, indeed, the likely litigation surrounding

the Lattingtown property results in a judgment that it is prop-

erty of Vebeliunas’ estate, then there is a possibility that Ve-

beliunas will receive a distribution in his case. With this in

mind, Graham's bias takes on new proportions. His fiduciary

obligations to Vebeliunas not only with respect to the latter's

bankruptcy discharge but also with respect to his potential eq-

uity in the Lattingtown property may be compromised by

Graham's partiality and impaired judgment.

Without question, | am vested with the authority to disqualify

counsel where there is evidence of lack of disinterestedness

or an ethical violation justifying such a sanction. See Cheng

v. GAF Corp., 631 F.2d 1052, 1055 (2d Cir. 1980) (disquali-

fication is within the court's discretion); W.T. Grant Co. v.

Haines, 531 F.2d 671, 678 (2d Cir. 1976); Martin, 817 F.2d at

182 ("it is for the court to decide whether the attorney's pro-

posed interest carries with it a sufficient threat of material ad-

versity to warrant prophylactic action (say, disqualification or

disgorgement or invalidation of a lien)."); Leslie Fay, 175

B.R. at 538 (court has wide discretion in its selection of the

appropriate remedy). The Second Circuit, however, generally

57b

disfavors disqualification because it can have an immediate

adverse effect on the client by separating him or her from his

or her counsel of choice. n17 See Nyquist, 590 F.2d at 1246:

In re Wingspread Corp., 152 B.R. 861. 863 (Bankr. S.D.N-Y,

1993), On the other hand, an exception to that general rule

has been created where the attorney's conduct tends to taint

the underlying trial, see Nyquist, 590 F.2d at 1246: Wing-

spread, 152 B.R. at 863, with any doubts to be resolved in fa-

vor of disqualification, See Hull v. Celanese Corp., 513 F.2d

568, 571 (2d Cir, 1975); Wingspread, 152 B.R. at 863.

In this regard, "disqualification has been ordered only in es-

sentially two kinds of cases: (1) where an attorney's conflict

of interests in violation of Canons § and 9 of the Code of Pro-

fessional Responsibility undermines the Court's confidence in

the vigor of counsel's representation, or. more commonly, (2)

when the attorney is at least potentially in a situation to use

privileged information concerning the other side through

prior representation... " Nyquist, 590 F.2d at 1246 (citing

Fund of Funds, 567 F.2d at 232-33: Cinema 5, Ltd. v. Cin-

erama, Inc., 528 F.2d 1384 (2d Cir.1976): Emle Industries,

Inc. v. Patentex, Inc., 478 F.2d 562. 565 (2d Cir. 1973)). It

goes without saying that the inquiry is case-specific. See

Nyquist, 590 F.2d at 1246; Martin, 817 F.2d at 182 (the bank-

ruptcy judge is on the front line and in the best position to

view the situation and make the delicate judgment calls

which a disqualification decision entails).

However, while separating a client from his or her chosen

counsel will undoubtedly cause disruption, "where the choice

of counsel must be approved by the court as appropriate, such

that the integrity of the judicial process is implicated, the cost

and delay of replacing counsel with a conflict of interest may

be outweighed." Leslie Fay, 175 B.R. at 538 (citing Bohack

Corp. v. Gulf & Western Industries, Inc. (In re Bohack

Corp.), 607 F.2d 258, 263-64 (2d Cir. 1979)). This is

S8b

especially true in the bankruptcy context because "the disin-

terestedness requirement must be strictly enforced." Hot Tin

Roof, 205 B.R. at 1003; Consolidated Bancshares, 785 F.2d

at 1256 n.6 ("standards for the employment of professional

persons are strict, for Congress has determined that strict

standards are necessary in light of the unique nature of the

bankruptcy process"); Plaza Hotel, 111 BR. at 890; Philadel-

phia Athletic Club, 20 B.R, at 333 (tests of disinterestedness

to be rigidly applied); Codesco, 18 B.R. at 1000 (citing

Woods v. City National Bank & Trust Co,, 312 U.S. 262,

269, 85 L. Ed. 820, 61 S. Ct. 493 (1940) (citing Meinhard vy,

Salmon, 249 N.Y, 458, 464, 164 N.E. 545 (1928) (Cardozo,

J.))) (only strict adherence to these equitable principles can

keep the standard of conduct for fiduciaries ‘at a level higher

than that trodden by the crowd"); Michael P. Schuster, "Deci-

phering Conflicts of Interest in Bankruptcy Representation",

98 COM. L.J. 127, 139 (Summer 1993) (Professional ethical

standards are more strictly applied in the bankruptcy context,

at least insofar as the retention of professionals by the estate

is concerned, in order to maintain the integrity of and sespect

for the bankruptcy process.).

| have found Graham to be lacking in disinterestedness. To

reach this conciusion, | have considered the standards of dis-

interestedness, the fiduciary duty imposed on counsel as an

officer of the court, and the Code of Professional Responsi-

bility. Adopting the analogy between the estate and a client

that | suggested before, Graham's prejudice clearly clouds and

will continue to cloud his independent judgment when mak-

ing decisions regarding estate matters in violation of Canon 5,

particularly with respect to decisions involving the investiga-

tion which he is conducting, the likely Lattingtown property

litigation and whether to oppose the debtor's discharge. Inas-

much as Graham is biased, he has also, by definition, com-

mitted the "lesser included offense" of not avoiding even the

59b

appearance of impropriety. The breach of Canon 9 is prem-

ised on Graham's very real manifestation of impropriety and

is not based on any “horrible imaginings alone." Martin, 817

F.2d at 183, Graham is therefore equally subject to disqualifi-

cation on these grounds since there is a strong threat of taint

which would pervade the administration of this case were

Graham to remain as counsel to the trustee, See Nyquist, 590

F.2d at 1246. To allow a biased attorney to conduct what is

supposed to be an impartial investigation of the debtor, to ad-

minister the debtor's estate when the debtor may have an eq-

uity therein and to advise the trustee whether to object to the

debtor's discharge will undoubtedly engender public suspi-

cion of the integrity of the judicial process. As observed by

Judge Friendly in the well-known case In re Ira Haupt & Co.,

361 F.2d 164, 168 (2d Cir. 1966), "the conduct of bankruptcy

proceedings not only should be right but must seem right."

Practically speaking, to consider an economic sanction does

not solve the problem because it will leave Grahain's bias to

reign over the administration of the case. The only way to in-

sure that the investigation of the debtor and the administra-

tion of his case are conducted with impartiality and

independent judgment is to remove and disqualify counsel

from representing the trustee.

VI.

The only remaining issue is whether the whole firm must be

disqualified or whether, as the firm requests, only Graham

need be removed. The general rule is that when one member

of a firm is disqualified, a!! members of that firm must be

similarly disqualified. See United States v. Reynoso, 6 F.

Supp. 2d 269, 271 (S.D.N.Y. 1998); Solow v. W.R. Grace &

60b

Company, 83 N.Y.2d 303, 306, 610 N.Y.S.2d 128, 632

N.E.2d 437 (1994); Philadelphia Athletic Club, 20 B.R. at

338 n.11. The reason for this rule is that any interest held by

one attorney is imputed to the rest of the lawyers in a firm. If

this were not the case, the court would be required to evaluate

every other attorney in the firm in order to determine whether

they were in fact affected by that interest. See Reynoso, 6 F.

Supp. 2d at 271. In correspondence to the court, Edgar Booth,

a senior member of Warshaw Burstein who represented that

he was speaking on behalf of the whole firm, stated that he

has adopted the position espoused by Graham, that neither the

trustee nor kis counsel is under any duty to give Vebeliunas

an opportunity to explain his allegedly questionable behavior

because of prior statements by the debtor and the fact that he

is a convicted felon. As such, the rationale cited above finds a

home in this case as well. If Graham's outlook is to be im-

puted to Warshaw Burstein, as the firm itself suggests, then

the disinterestedness not only of Graham but of the whole

firm is defective. The trustee may to some extent be discom-

fited by having to engage new counsel. However, no § 341

examination has been conducted and the case, while not new-

born, is still in its youth. Questions regarding who will ad-

minister the Lattingtown property have not even been

resolved. Disqualifying counsel may be a set-back in the pro-

gress of the case, but it is an unavoidabie one, in my opinion.

| reiterate my instruction to the trustee to engage new

counsel.

SETTLE ORDER on the debtor and the trustee consistent

with this decision.

Dated: New York, New York

March 10, 1999

/s/ Tina L. Brozman

61b

CHIEF UNITED STATES BANKRUPTCY JUDGE

‘| wish only to use this event in history to describe the poten-

tial evils of bias. I express no position whatsoever on the im-

peachment of President Clinton.

* After the hearing, I received a scathing letter from Edgar

Booth of Warshaw Burstein, asserting that my ruling had im-

pugned the integrity of not only Graham, but himself and, ul-

timately, the whole firm. That leap of logic, or illogic,

continues to mystify me. Moreover, | am not impugning Gra-

ham's integrity as an attorney appearing in this court. What |

am saying is that he has exhibited in this case an unfortunate

bias which demands his removal.

’ | have treated this matter de novo, rather than as a motion

for reconsideration, inasmuch as Warshaw Burstein ques-

tioned whether it received due process the first time round.

4 -¥ ,* . .

lo date, no § 341 examination has taken place.

* The banks seeking dismissal of the case had asked, when

the case was retained, that the state court receiver for the

property also be retained. They ultimately withdrew that re-

quest in favor of having the trustee administer the property,

which, by the way, is income producing. Vebeliunas coun-

tered with an assertion that the trustee could not administer

the property because it did not belong to the debtor's estate.

Graham probably extrapolated from Vebeliunas' petition and

his opposition to the request for the trustee to administer the

property as well as from documents which the banks showed

Graham from the time when their mortgages were granted

that Vebeliunas was not credible, despite the fact that Graham

62b

had not yet asked Vebeliunas if there was any explanation for

what Graham saw as inconsistencies.

* | do not mean to suggest that the debtor is the cooperative,

easy-going sort. Graham's frustration and exasperation may

be quite legitimate. The issue, however, is not whether Gra-

ham has good reason for disliking Vebeliunas.

’ Quoting Walter Moberly, the dictionary gives a particularly

apt illustration of the word's meaning: "The most pernicious

kind of bias consists in falsely supposing yourself to have

none.”

* Since standing is limited to parties in interest, see Licensing

by Paolo, Inc. v. Sinatra (In re Gucci), 126 F.3d 380, 388 (2d

Cir. 1997), if Vebeliunas has standing to object, then he

should most obviously also be considered a party in interest.

* The lack of precision in the statute may well be due to Con-

gress’ desire to have one standard of disinterestedness apply

to professionals for all sorts of debtors’ estates be they corpo-

rate, partnership or natural persons.

” In its discussion of the term "disinterested person" as de-

fined in § 101(!3) - now renumbered § 101(14) - the Bank-

ruptcy Reform Act of 1978, Collier states:

The enunciated elements provide a minimum

standard for the guidance of the court in its ap-

pointments, and insure that the persons em-

ployed shall have the essential character of

independence and disinterestedness which is

required. These elements do not, however, es-

tablish an exclusive standard. As was the case

under pre-Code bankruptcy practice, (contin-

ued by virtue of the "catchall" provision of

clause (E)), if a court deems a_ particular

63b

person's associations to be prejudicial to disin-

terestedness, it may reject him even though

those associations do not come strictly within

the purview of section 101(13). Thus, the

phrase "or for any other reason" permits the

court to find a particular person lacking in dis-

interestedness for reasons other than the non-

exclusive statutory guidelines.

As noted above, clause (E) may be termed a

"catch-all clause," and it seems broad enough

to include anyone who in the slightest degree

might have some interest or relationship that

would even faintly color the independent and

impartial attitude required by the Code and

Bankruptcy Rules. The reasons supporting this

extensive inclusion are the same, of course, as

those previously recounted. Indirect or remote,

as well as direct, associations or affiliations

may engender conflicting loyalties.

“_* *

It is clear, therefore, that the definition of dis-

interested person in paragraph (13) promotes

the policy that as a general principle profes-

sionals engaged in the conduct of a bankruptcy

case should be free of the slightest personal in-

terest which might be reflected in their deci-

sions concerning matters of the debtor's estate

or which might impair the high degree of im-

partiality and detached judgment expected of

them during the course of administration.

| COLLIER BANKRUPTCY MANUAL, § 101.13 (1981).

64b

'' The following case are examples of courts using the "high

degree of impartiality and detached judgment" language

quoted above or its slight variation “faintly color the inde-

pendent and impartial attitude required by the Code," also

from the same COLLIER BANKRUPTCY MANUAL ex-

cerpt, to elucidate disinterestedness: Crivello, 134 F.3d at

835; In re BH & P, Inc. 949 F.2d 1300, 1308 (3d Cir. 1991);

Martin, 817 F.2d at 181; Piersen & Gayler, Ray & Terrell &

Grubbs v. Creel & Atwood and Jack Bryant (In re Consoli-

dated Bancshares, Inc.) 785 F.2d 1249, 1256 (Sth Cir. 1986);

Winship v. Cook (In re Cook), 223 B.R. 782, 789 (B.A.P.

10th Cir. 1998): Hot Tin Roof, 205 B.R. at 1003; In re Glenn

Electric Sales Corp., 99 B.R. 596, 601(D.N.J. 1988); Roger J.

Au & Son, Inc. v. Aetna Insurance Company (In re Roger J.

AU & Son, Inc.), 64 B.R. 600, 604 (N.D. OH. 1986); In re

Quality Beverage & Company, 216 B.R. 592, 595 (Bankr.

S.D. Tex. 1995); Granite, 219 B.R. at 33; In re Prudent Hold-

ing Corp., 153 B.R. 629, 631 (Bankr. E.D.N.Y. 1993); Envi-

rodyne, 150 B.R. at 1017; In re Ochoa, 74 B.R. 191, 193

(Bankr. N.D.N.Y. 1987); In re Kendavis Industries Interna-

tional, 91 B.R. 742, 754 (Bankr. N.D. Tex. 1988): Roberts,

46 B.R. at 829; Philadelphia Athletic Club, 20 B.R. at 334

(citing COLLIER BANKRUPTCY MANUAL, § 101.13); In

re Codesco, 18 B.R. 997, 999 (Bankr. S.D.N.Y. 1982). [*27]

° This language is only slightly modified in the current edi-

tion of COLLIER ON BANKRUPTCY. See 4 L. King, COL-

LIER ON BANKRUPTCY, P327.04[3][a] at 327-30 (15th

ed. rev. 1996).

'’ Obviously, both chapter 7 and chapter 11 trustees are offi-

cers of the court. Many of the cases discussing the fiduciary

duties of a trustee and his or her counsel are those involving

chapter 11 trustees, which, independently under the

65b

Bankruptcy Code, must be disinterested. See § 1104(b). Al-

though that may not be a requirement for a chapter 7 trustee

elected by creditors, it is a requirement for an interim trustee

that becomes a permanent trustee under § 702(d) because in-

terim trustees are required to be disinterested under §

701(a)(1). Such is the case here. Accordingly, those cases de-

scribing the fiduciary duties of counsel to a disinterested trus-

tee also apply here.

'* New York has not adopted the newer American Bar Asso-

ciation's Model Rules of Professional Conduct but adheres to

the Model Code of Professional Responsibility.

'S Although the word "disinterestedness" is employed in this

sentence, it is clear from the context that the Third Circuit in-

tended interestedness or lack of disinterestedness. In this

vein, because I find Graham has demonstrated bias, my hold-

ing that he is not disinterested on that basis does not run afoul

of the teachings of Marvel. The Third Circuit in Marvel ac-

knowledged a per se rule for disqualification of counsel hold-

ing an actual conflict of interest, a rule for discretionary

disqualification of counsel with a potential conflict of interest

and a prohibition against disqualification of counsel based on

an appearance of conflict alone. See Marvel, 140 F.3d at 476.

other reason,” broadly, as I believe is its proper construction,

then Kurtzman could come within the failure of

disinterestedness.

'" Another reason motions for disqualification are frowned

upon is that they are often interposed for tactical reasons. See

Nyquist, 590 F.2d at 1246. However, this concern is not a

factor here considering that I have raised the issue on my own

motion.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.