The Insider’s Scoop: “Unwise” to Approve Retention of Dechert LLP As Debtors’ Counsel Due to Actual and Potential Conflicts of Interest

In re Newbury Common Assocs., LLC, Case No. 15-12507 (LSS) (Bankr. D. Del. Feb. 12, 2016) [Transcript Ruling]

In a bench ruling, Judge Silverstein denied Newbury Common Associates, LLC’s (and its affiliated debtors, the “Debtors”) application to retain and employ Dechert LLP (“Dechert”) as its bankruptcy counsel.  The Court held that Dechert’s prior representation of certain individuals—William Merritt and Thomas Kelly (the “Individuals”)—in a matter related to the Debtors’ bankruptcy, no matter how short in duration or extent, created an actual conflict of interest.  To the extent there was not an actual conflict, the Court held that it was within its discretion to find that numerous potential conflicts warranted disqualification.

Collectively, the Debtors are a corporate enterprise that own certain commercial and residential real estate in Stamford, Connecticut and the surrounding area.  The Debtors’ structure is atypical in that each of the Debtors have unique sets of owners.  The Individuals (or various entities owned by them) hold equity ownership interests in the various Debtors.  A third individual, John DiMenna, also holds equity in the Debtors and oversaw the day-to-day management of the Debtors.  Allegedly, DiMenna improperly entered into various agreements on behalf of the Debtors and is also alleged to have forged the signatures of the Individuals on personal guarantees granted to various lending parties.  Prior to the Petition Date, Dechert was hired by the Individuals to investigate the assets and liabilities of the Debtors.  Dechert ceased its representation of the Individuals, and was then retained by debtor Seaboard Realty, LLC to represent the Debtors in the bankruptcy proceeding.  A retainer was paid to Dechert partially by debtor Tag Forest, LLC and partially by Merritt on behalf of Tag Forest.  Seaboard Realty did not own any equity in Tag Forest, and Tag Forest’s assets were sold prepetition.  It is these circumstances that led the Court to conclude that Dechert was not disinterested, and thus, refused to approve its retention as Debtors’ counsel.

Under Third Circuit precedent and section 327 of the Bankruptcy Code, the Court: (i) must disqualify an attorney who has an actual conflict of interest; (ii) has discretion to disqualify an attorney who has a potential conflict; and (iii) cannot disqualify an attorney based on the appearance of a conflict alone.  Courts consider the nature of the disclosures made, whether the interests of the parties are parallel or conflicting, and the nature and extent of inter-debtor claims.

The Court found and held that Dechert represented the Individuals in a prepetition related matter, thus giving rise to an actual conflict.  Although “actual conflict of interest” is not defined in the Bankruptcy Code, courts consider the nature of the disclosures made, whether the interests of the parties are aligned and the nature of the claims between them.  As important here, the Court focused on whether the interests of the Debtors and the Individuals were parallel and the claims against each other.  While the Individuals’ interests were aligned with the Debtors from their shareholder perspective, the Court explained that they diverge (at least potentially) when considering the Individuals’ roles as managers of the Debtors, the Individuals’ potential indemnification claims against the Debtors, the Debtors’ potential claims against the Individuals, the purported guarantees made by the Individuals, and the issues surrounding the retainer paid to Dechert.  To further complicate matters, if Dechert’s retainer is considered property of the estate, or the payment is otherwise avoided, Dechert would be a creditor of the Debtors, creating another actual conflict under In re Pillowtex, Inc., 304 F.3d 246 (3d Cir. 2002).

The Court observed that this case is in its infancy, and although the Court’s ruling will cause some disruption to these cases, the Debtors have very competent co-counsel that can take the helm.  The Court also noted that conflicts counsel can work in appropriate situations, but the typical situation—a representation of a creditor in a former unrelated matter—is not present in these cases.  Simply put, the Court stated that allowing Dechert to continue as counsel to the Debtors will be worse for the Debtors as well as Dechert.