Avoiding Malpractice Conflicts Of Interest In Bankruptcy ...

of 23

Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations
© 2001 Thompson, Coe, Cousins & Irons, LLP
Alison H. Moore
May 17, 2001

In grievance and legal malpractice proceedings, alleged conflicts of interest are among the most
common, and often the most troublesome, claims. This is particularly true in bankruptcy representations.
In fact, a recent survey of 80 percent of all bankruptcy judges concluded that conflicts of interest issues
are quot;prevalentquot; in bankruptcy practice. Marie Leary, FJC Survey on Attorney Ethics Finds Most Judges
Satisfied With Rules, 19-FEB Am. Bankr. Inst. J. 17 (2000).

In addition to the risk of denial or ordered forfeiture of fees under the Bankruptcy Code, the Texas
Supreme Court's recent opinion in Burrow v. Arce, 997 S.W.2d 229 (Tex. 1999), recognizes a fee
disgorgement claim against attorneys for breach of fiduciary duty, including conflicts of interest, even
when no actual damage can be shown. This recent development has lent fuel to the legal malpractice
fire, as it opens every aspect of a representation to an after-the-fact quot;conflicts check,quot; judging legal
representation against a requirement of quot;absolute and perfect candor, openness and honesty, and the
absence of any concealment or deception.quot; Perez v. Kirk & Carrigan, 822 S.W.2d 261, 265 (Tex. App. -
Corpus Christi 1991, writ denied).

Legal malpractice claims, breach of fiduciary duty claims, and grievance complaints arising from
conflicts of interest can be avoided by understanding of the identity of the client, the duties owed to the
client and to third parties, the issues that give rise to potential conflicts in the bankruptcy context, and
the required disclosures and permissible waivers.

II. THE STANDARDS

Beyond good conscience and high morals, there are several sources of guidance for a lawyer's
professional conduct. Conflict of interest issues are evaluated and resolved under the applicable
disciplinary rules and under the Bankruptcy Code itself. Because the crux of this article is the
identification and avoidance of conflicts of interest that might give rise to a legal malpractice or breach
of fiduciary duty, this article focuses on the conflict analysis in the cases cited, regardless of whether the
issue arose in a disqualification proceeding, a malpractice action, or in the approval of employment or
fees by a bankruptcy court.

A. The Disciplinary Rules

1. The Model Code and The Model Rules. The ABA Model Code of
Professional Responsibility (the quot;Model Codequot;) and the ABA Model Rules of
Professional Conduct (the quot;Model Rulesquot;) set forth the ABA's minimum
standards for a lawyer's conduct. Although a majority of states have replaced
the Model Code with the Model Rules as the applicable standard for attorney
conduct, courts continue to look to both standards in evaluating conflict issues.
City of El Paso v. Salas-Porras Soule , 6 F.Supp.2d 616, 620 (W.D. Tex. 1988).

The Model Rules address conflicts of interest in the context of preserving client
confidences, required disclosures, and competing interests. For example, Model
Rule 1.7(b) provides for the disqualification of an attorney where a
representation may be quot;materially limited by the lawyer's responsibilities to

Avoiding Malpractice: Conflicts of Interest in Bankruptcy Representations Page 2 of 23

another client or to a third person, or by the lawyer's own interests.quot; However,
the rule permits an attorney to take on or continue the representation if the
attorney quot;reasonably believesquot; that the client's interests will not be harmed, and
if the client consents. In bankruptcy representations, this last contingency
should be amended to read quot;if the client and the bankruptcy court consent.quot;

2. Appearance of Impropriety. With respect to conflict issues, one of the most
notable differences between the Model Code and the Model Rules is the
absence in the Rules of any prohibition against quot;even the appearance of
impropriety,quot; a subjective standard originally set forth in the Model Code. Even
so, result-oriented courts continue to rely on this analysis in evaluating
conflicts. See, e.g., City of El Paso v. Salas-Porras Soule, 6 F. Supp.2d 616,
625, n. 10 (W.D. Tex. 1998)(quot;Although the Model Code does not specifically
address conflict of interest concerns involving former clients, it does require an
attorney to preserve the confidences of his client and to avoid even the
appearance of impropriety.quot;)

3. The Texas Disciplinary Rules of Professional Conduct. Typically, federal
district courts adopt the standard of conduct adopted by the highest court in the
state; in turn, bankruptcy courts follow the standard of conduct adopted by the
referring district courts. 28 U.S.C. §151. In Texas, attorneys' conduct is
governed by the Texas Disciplinary Rules of Professional Conduct (quot;TDRPCquot;).
Generally, the TDRPC follow the Model Rules; however, there are significant
departures. Pertinent differences are mentioned herein.

4. Disciplinary Rules Create No Cause of Action. Both the TDRPC and the
Model Rules explicitly disclaim an intention to create a cause of action against
attorneys who fail to meet the ethical standards. quot;These rules do not undertake
to define standards of civil liability of lawyers for professional conduct.
Violations of a rule do not give rise to a private cause of action nor does it
create any presumption that a legal duty to a client has been breached.quot;
TDRPC, Preamble: Scope 15; see also, Model Rules, Preamble 6.

Texas courts have consistently agreed with these disclaimers. quot;While private
persons can file complaints based on violations of the rules, the only party who
has standing to enforce these rules is the State Bar. Accordingly, we overrule
[plaintiff's] second point of error to the extent that it asserts the existence of a
private right of action for a violation of State Bar Rules.quot; Home Advantage,
Inc. v. Shaw, Bailey & Shaw, P.C. , No. 07-97-0309-CV, 1998 WL 487042, at
*3 (Tex.App. -- Amarillo Aug. 19, 1998, no writ history)(not designated for
publication); see also, Martin v. Trevino, 578 S.W.2d 763, 770 (Civ.App. --
Corpus Christi 1978, writ ref'd n.r.e.)(violations of the Code of Professional
Responsibility do not give rise to a private cause of action).

5. Disciplinary Rules Are Used for Guidance. Even though ethics rules will not
be used to create a cause of action, expert witnesses in legal malpractice cases
regularly testify that the TDRPC represent the applicable standard of care for
an attorney practicing in Texas. In a procedural disqualification case, the Texas
Supreme Court approved the practice of referring to the rules for guidance,
even after noting that the rules were not intended to set a standard for
procedural decisions. In re Meador, 968 S.W.2d 346, 350 (Tex. 1998); see


also, Anderson Producing Inc., v. Koch Oil Co., 929 S.W.2d 416, 421 (Tex.
1996)(TDRPC establish standard of attorney conduct and can be used for
guidance in procedural disqualification determinations).

B. National Standards

The 5th Circuit has held that, at least in disqualification proceedings, quot;national standards,quot;
including the Model Rules, local court rules, and case law, as well as the TDRPC, should be
applied in a conflicts analysis. In re Dresser Indus., Inc., 972 F.2d 540, 543 (5th Cir. 1992);
accord, In re American Airlines, Inc., 972 F.2d 605, 610 (5th Cir. 1992); see also, FDIC v.
United States Fire Ins. Co., 50 F.3d 1304, 1312 (5th Cir. 1995)(holding that numerous
ethical rules are relevant to a federal inquiry regarding the disqualification of counsel).

C. Bankruptcy Rules

Conflicts of interest rules are examined more rigorously in the bankruptcy context, most
often with respect to professionals retained in business bankruptcy proceedings. Conflicting
interests are inevitable in such cases, in which multiple parties compete for the same limited
dollars. Often, the quot;guidelinesquot; set forth in the various disciplinary rules are so broad that
they are of little assistance in evaluating the propriety of a bankruptcy representation. Even
under the provisions of the Bankruptcy Code, however, the cases reflect the fact intensive
nature of a conflicts analysis.

1. 11 U.S.C. § 327. Section 327 of the Bankruptcy Code provides a heightened
standard in evaluating conflicts, and is written to protect debtors, and their
creditors, from attorneys whose interests conflict with the bankruptcy estate. §
327(a) includes dual requirements: an attorney employed by the Trustee quot;must
not hold or represent an interest adverse to the estate,quot; and further, must be
quot;disinterested.quot; 11 U.S.C. § 327(a). See 11 U.S.C. § 101(14)(E)(1994)(defining
quot;disinterested personquot;); see also, In re Red Lion, Inc., 166 B.R. 296, 298
(Bankr. S.D. Tex. 1994)(emphasizing that § 327 contains dual requirements).
The Bankruptcy Code requirements of disinterestedness and absence of adverse
interest are intended to avoid divided loyalties and to ensure the fulfillment of
fiduciary duties.

2. Bankruptcy Code Enforcement. The Code enforces adherence to the
quot;disinterestedquot; and no adverse interest requirements with the threat of denial of
compensation for a professional who is not disinterested, or who holds or
represents an interest that is adverse to the estate. 11 U.S.C. § 328(c); 11 U.S.C.
§ 1103(b). The allowance or disallowance of fees is an issue that rests within
the discretion of the bankruptcy court. These determinations can be made at the
time employment is approved, or even after the fact, on a court's own motion or
when the attorney seeks court approval of compensation for services previously
rendered.

In terms of the reasonableness of fees charged, the Fifth Circuit has held,
however, that the bankruptcy court's prior approval of the terms of an
engagement pursuant to § 327 constitutes a finding that those terms are
reasonable. Matter of National Gypsum Co., 123 F.3d 861 (5th Cir. 1997).
Therefore, the bankruptcy court's review of an attorney's final fee application is


limited to whether any subsequent unanticipated, or previously unknown
circumstances or events affected the reasonableness of the agreement.

3. Actual Versus Potential Conflicts Under the Bankruptcy Code. Section 327
of the Bankruptcy Code clearly prohibits attorneys from representation where
an actual conflict of interest exists. Potential conflicts, however, are a different
question. While some courts have held that even a potential conflict will
disqualify an attorney from a bankruptcy representation, other courts have
applied a more liberal standard. Compare In re Kendavis Indus. Int'l., 91 B.R.
742, 754 (Bankr. N.D. Tex. 1988)(all conflicts are actual and potential conflicts
do not exist) with In re Global Marine, Inc., 108 B.R. 998, 1004 (Bankr. S.D.
Tex. 1987)(attorney may be disqualified only for actual conflicts) and In re S.I.
Acquisition, 58 B.R. 454, 462 (Bankr. W.D. Tex. 1986)(equity justified joint
representation of affiliated entities). Unfortunately, the plethora of cases that
discuss the distinction between actual and potential conflicts in evaluating an
attorney's bankruptcy representation provides little guidance beyond
demonstrating the fact intensive nature of a conflicts analysis in every
circumstance. Whether an identified conflict is actual or potential, full
disclosure is required under the Bankruptcy Code and Rules.

4. Best Interests of the Estate. There is some limited authority holding that 11
U.S.C. § 105, which provides bankruptcy courts with the discretionary power
to enter orders quot;necessary or appropriatequot; to carry out the purposes of the
Bankruptcy Code, permits courts to deviate from the requirements of § 327,
particularly in smaller bankruptcy cases. In re PHM Credit Corp., 110 B.R.
284, 288 (Bankr. E.D. Mich. 1990). In this regard, various factors have
impacted a conflicts analysis, including:

1.) the debtor's ability to reorganize;
2.) the economic effect of disqualifying counsel;
3.) the likelihood that a potential conflict will materialize or
develop to the point that disqualification would be required in the
future;
4.) fairness and equity. See, e.g., In re O'Conner, 52 B.R. 892, 897
(Bankr. W.D. Okla. 1985).

Despite these cases, the majority of courts addressing the issue have held that §
105 cannot be used to circumvent the clear prohibitions set forth in § 327. In re
Palm Coast, 101 F.3d 253 (2nd Cir. 1996); In re Middleton Arms, 119 B.R. 131
(Bankr. M.D. Tenn. 1990).

III. ANALYZING CONFLICTS

Case law addressing conflicts of interest reveals the factual nature of the analysis. The existence or
absence of a conflict may be determined as a matter of law, but only where the surrounding facts and
circumstances are undisputed. See, e.g., FDIC v. U.S. Fire Ins. Co., 50 F.3d 1304 (5th Cir. 1995).
Otherwise the question of whether a conflict of interest exists is a fact question for the court . . . or the
jury.

A conflict exists if an attorney must choose between advancing a client's interest and advancing other


interests to the detriment of his client's interest. See, e.g., In re Kuykendahl Place Associates, Ltd., 112
B.R. 847 (Bankr. S.D. Tex. 1989). In order to evaluate whether a conflict exists, a lawyer must know
who the client is, and what duties arise from that representation.

A. Who is the Client?

An attorney-client relationship arises from the agreement to render professional services for
a client. Yaklin v. Glusing, Sharpe & Krueger, 875 S.W.2d 380, 383 (Tex. App. - Corpus
Christi 1994, no writ). An attorney-client relationship is, by definition, a fiduciary
relationship. Moreover, an attorney's fiduciary responsibilities may arise even during
preliminary consultations regarding possible representation. Nolan v. Foreman, 665 F.2d
738, 739 n.3 (5th Cir. 1982).

1. Implied Attorney-Client Relationships. Even absent an express agreement,
Texas courts have held, as have courts in virtually every state, that attorney-
client relationships can be inferred based upon the conduct of the parties. Banc
One Capital Partners Corp. v. Kneipper, 67 F.3d 1187, 1198 (5th Cir. 1995).
No formal contract is required; in fact, the putative client can even be
represented by other counsel. See Vinson & Elkins v. Moran, 946 S.W.2d 381,
404-406 (Tex.App. -Houston [14th Dist.] 1997, writ dism'd by agr.)(finding
attorney-client relationship between attorneys for estate's executors and estate
beneficiaries based upon extensive communication and interaction with
beneficiaries); In re Legal Econometrics, Inc., No. 3-95-CV-0457-R, 1997 WL
560617, at *3 (N.D. Tex. 1997)(finding an attorney-client relationship existed
based on the expectations of the 'client' and extensive communications between
the firm and the 'client').

Factors that have been considered in determining whether an express or implied
attorney-client relationship exists include the communication of confidential
information, In re Evaristo Reyes-Requana, 926 F.2d 1423 (5th Cir. 1991), the
existence of a relationship of trust and confidence, Perillo v. Johnson, 205 F.3d
775 (5th Cir. 2000)(attorney previously represented client and served as her
surrogate father at her wedding); billing and payment for legal services, City of
El Paso v. Salas-Porras Soule, 6 F.Supp.2d (W.D. Tex. 1998); and
representation of one party by another attorney, The First National Bank of
Durant v. Lane & Douglass, 142 F.3d 802 (5th Cir. 1998).

2. Implied Fiduciary Relationships. In addition to formal fiduciary
relationships, courts have held that fiduciary relationships exist when the
parties are quot;under a duty to act upon matters within the scope of their relation,quot;
and the relationship is one of trust and confidence. ARA Automotive Group v.
Central Garage, Inc., 124 F.3d 720, 723 (5th Cir. 1997). Such informal
fiduciary relationships may arise from quot;a domestic or purely personal
relationship of trust and confidence, generally called a confidential
relationship.quot; Assoc. Indem. Corp. v. Contracting, Inc., 964 S.W.2d 276, 287
(Tex. 1998). Because of the quot;extraordinary dutiesquot; imposed upon a fiduciary,
however, a fiduciary duty quot;will not be lightly created,quot; and courts look
carefully at the surrounding facts and circumstances. Crim Truck & Tractor v.
Navistar Int'l, 823 S.W.2d 591, 594 (Tex. 1992).

3. Creditors and Creditor Committees as Clients. In most creditor


representations, a lawyer's ethical obligations run directly to the creditor.
Lawyers representing creditors' committees face a slightly more involved
inquiry arising from the differing interests of the committee constituents.
Courts generally find that the committee itself constitutes an entity that is
separate and distinct from its members. Lawyers employed by such committees
therefore represent the committee, and are obliged to serve the interests of the
committee and the class of creditors generally, not the interests of individual
creditors. See In re EBP, Inc., 171 B.R. 601, 602 (Bankr. N.D. Ohio 1994)
(committee lawyer represents entire class of creditors). It is for this reason that
attorneys hired by individual members of a creditors' committee may not
recover professional fees from the estate. In re Firstplus Financial, Inc., 254
B.R. 888 (Bankr. N.D. Tex. 2000).

4. Trustees, Debtors, and Debtors-in-Possession as Clients.

a. Pre-petition vs. post-petition. In pre-petition debtor
representation, the client is typically the individual or entity
contemplating bankruptcy. The lawyer's legitimate quot;bankruptcy
planningquot; advice is intended to advance the interests of the client
over the future interests of the bankruptcy estate and creditors.
However, this analysis changes the moment the bankruptcy
petition is filed. At that point, the lawyer has a quot;newquot; client, the
debtor or the debtor-in-possession, who, like trustees, owes
fiduciary duties to the bankruptcy estate and the creditors.
Commodity Futures Trading Comm'n v. Weintraub, 471 U.S. 343,
355 (1985)(noting debtors-in-possession owe obligations similar to
those of trustee). As one commentator describes it, professionals
appointed under § 327 quot;work for the debtor-in-possession, but are
responsible for working in the best interest of the estate.quot; Nancy
Rapoport, The Need for New Bankruptcy Ethics Rules: How Can
quot;One Size Fits Allquot; Fit Anybody? 10 No. 1 Prof. Law. 20, 20 (Fall
1998). Post-petition, the debtor's lawyer must advance and protect
the interests of the estate and the creditors over those of the debtor,
a representation that conflicts, or at least potentially conflicts, with
the prior pre-petition representation. Diamond Lumber, Inc. v.
Unsecured Creditors' Comm. , 88 B.R. 773 (Bankr. N.D. Tex.
1988).

b. Attorney as Fiduciary for Estate. In addition to representing a
fiduciary, many courts hold that an attorney employed by a debtor-
in-possession or trustee actually becomes a fiduciary for the
bankruptcy estate as well. Hansen, Jones & Leta, P.C. v. Segal ,
220 B.R. B.R. 434 (Bankr. C.D. Utah 1998). This imposition of a
fiduciary duty is inconsistent with an attorney's representation of
fiduciaries in other contexts. See ABA Comm. on Ethics and
Professional Responsibility, Formal Op. 380 (1994)(noting that a
lawyer for a fiduciary does not incur duties to the client's
beneficiary). Nonetheless bankruptcy courts have justified this
conclusion by holding that the bankruptcy estate itself is actually
the client. See In re Delta Petroleum (P.R.), Ltd., 193 B.R. 99, 111
(D.P.R. 1996)(holding that the estate, not the trustee, is the


lawyer's client); In re El San Juan Hotel Corp., 149 B.R. 263, 272
(D.P.R. 1992) aff'd., 7 F.3d 218 (1st Cir. 1993)(finding trustee's
attorney to be estate's attorney with fiduciary duties as such). Other
courts have simply held that the attorney becomes a fiduciary to
the estate by virtue of the debtor-in-possession's or trustee's status
as fiduciary. See In re Whitney Place Partners, 147 B.R. 619, 620
(Bankr. N.D. Ga. 1992)(noting that both debtor-in-possession and
attorney for debtor-in-possession are estate fiduciaries); In re
Gregory, 214 B.R. 570, 576 (S.D. Tex. 1997)(discussing attorney's
obligations to ensure debtor-in-possession acts in best interest of
estate). Courts in a few jurisdictions have rejected the idea that an
attorney owes a direct fiduciary duty to the estate. See In re Sidco,
Inc., 173 B.R. 194, 196 (E.D. Cal. 1994)(explicitly rejecting idea
that debtor-in-possession's lawyer has a duty to estate).

5. Entities as Clients. In representing corporate entities or partnerships, the
potential for conflicts arises from the fact that a lawyer's client is the entity
itself, not any related companies and not individual officers, directors,
shareholders or partners. Marshall v. Quinn-L Equities, Inc., 704 F. Supp. 1384
(N.D. Tex. 1988)(attorney representing limited partnership did not represent
individual investors); FDIC v. Howse, 802 F. Supp. 1554 (S. D. Tex. 1992)
(attorney representing corporation owed no duty to corporate director). See
also, Model Rule 1.13; TDRPC 1.12(a).

Representation of related entities is an area for serious consideration of the
loyalties owed, particularly with respect to debtor's counsel. quot;The duty and
loyalty of the attorney is to the debtor and not to the partners or individuals that
control the partners of the Debtor.quot; In re Kuykendahl Place Associates, Ltd.,
112 B.R. 847, 850 (Bankr. S.D. Tex. 1989)(finding conflict arising from
representation of general partner in limited partnership).

B. The Duties Owed

1. As an Attorney. An attorney owes a duty to act as a reasonably prudent
attorney under the facts and circumstances. Cosgrove v. Grimes, 774 S.W.2d
662, 664-65 (Tex. 1989). quot;If an attorney makes a decision which a reasonably
prudent attorney could make under the same or similar circumstance, it is not
an act of negligence even if the result is undesirable.quot; Id.

2. As a Fiduciary. The attorney-client relationship is also recognized as a
formal fiduciary relationship. SMWNPF Holdings, Inc. v. Devore, 165 F.3d
360, 365 (5th Cir. 1999); Willis v. Maverick, 760 S.W.2d 642, 645 (Tex. 1988).

Once a plaintiff proves the existence of a fiduciary duty, the burden of proof
shifts to the defendant to prove that the underlying transaction was fair and
equitable, that the defendant acted in the utmost good faith and exercised the
most scrupulous honesty, and that the defendant did not place himself in a
position in which his personal interests conflicted with is obligations as a
fiduciary. Burrow v. Arce, 958 S.W.2d 239, 246 (Tex. App. - Houston [14th
Dist.] 1997, rev'd on other grounds, 997 S.W.2d 229.


3. Continuing Duties. A lawyer's fiduciary obligations, as well as the obligation
to be competent (of course), continue until the representation has ended.
Denkman Assoc. v. International Paper Co., 132 FRD 168, 175, n.21 (M.D. La.
1990)(attorney has continuing duty to disclose conflicts of interest as they
arisequot;). Further, certain obligations survive termination of the attorney-client
relationship. Pursuant to TDRPC 1.05 and 1.09, an attorney must keep client
confidences in perpetuity. Moreover, an attorney is prohibited from
representing anyone adverse to a former client on the same or a substantially
related matter. TDRPC 1.09. Though waiver of a conflict arising from such
continuing duties is allowed in either case, the obligations to the first client
control until a fully informed consent can be obtained.

4. The Duty Not to Make Misrepresentations to Non-Clients. In 1999, the
Texas Supreme Court joined other jurisdictions in recognizing negligent
misrepresentation, as defined in the RESTATEMENT (SECOND) OF TORTS
§ 552 (1997), as a cause of action that can be raised against an attorney by a
third party. McCamish, Martin, Brown & Loeffler v. F.E. Appling Interests, 991
S.W.2d 787, 791 (Tex. 1999). A negligent misrepresentation cause of action
requires that the attorney know that the third party is relying on the attorney's
representations and, in fact, intend such reliance. quot;Under the tort of negligent
misrepresentation, liability is not based on a breach of the duty a professional
owes his or her clients or others in privity, but on an independent duty to the
non-client based on the professional's manifest awareness of the non-client's
reliance on the misrepresentation and the professional's intention that the non-
client so rely.quot; Id. at 792. Although the third party's reliance must be justified,
most courts agree that reliance is never justified in an adversarial situation. Id.
at 794. Other courts have limited liability for negligent misrepresentation to
advice given in business transactions, as opposed to, for example, conduct
undertaken in litigation. See Robinson v. Omer , 952 S.W.2d 423, 428 (Tenn.
1997).

5. Intentional Torts. A lawyer can be liable for intentionally tortious conduct,
such as fraud and conspiracy, for wrongful activities undertaken independently
or in concert with a client. Likover v. Sunflower Tourists II, Ltd., 696 S.W.2d
468, 472 (Tex. App. - Houston [1st Dist.] 1985). In addition, a lawyer can be
liable for aiding and abetting another in the breach of fiduciary duties.
Resolution Trust Corp. v. Bonner, 848 F.Supp. 96 (S.D. Tex 1994); In re C-
Power Prods. v. Schiro, 230 B.R. 800 (Bankr. N.D. Tex 1998).

6. Duties to the Court.

a. Disciplinary Rules. Both the Model Rules and the TDRPC
address attorneys' obligations to the court. TDRPC 1.5(f) requires
an attorney to reveal confidential client information when doing so
is necessary to comply with TDRPC 3.03, requiring candor
towards the tribunal. Those rules prohibit a lawyer from making
false statements of material fact to the tribunal, assisting a criminal
or fraudulent act by failing to disclose a relevant fact to the
tribunal, offering false evidence, or failing to correct or withdraw
false evidence. TDRPC 3.03.


b. Bankruptcy Code and Rules. Attorneys appointed by the
bankruptcy court are officers of the court, and as such are
fiduciaries. In the matter of Consolidated Bancschares, Inc., 785
F.2d 1249, 1256, n.7 (5th Cir. 1986).

(1.) 11 U.S.C. § 327 and § 329. The Bankruptcy Code
and Rules require disclosure of the compensation
arrangement, as well as all facts that might affect the
quot;disinterestednessquot; of a professional, or a possible
adversity in the interests represented. The disclosure
requirement under Bankruptcy Code § 327 is a tool
intended to enable a court to determine if the attorney
is, in fact, disinterested and therefore employable. In
the matter of Triangle Chemicals, Inc., 697 F.2d 1280,
1286, n.8 (5th Cir. 1986). To that end, attorneys are
charged with disclosing all connections, no matter
how tenuous, even when the attorneys believe that
they truly are disinterested. quot;All the facts that may
have bearing on the disinterestedness of a professional
must be disclosed. Consistent with the duty placed on
the professional, it is the responsibility of the
professional, not the court, to make sure that all
relevant connections have been brought to light.quot; In re
Leslie Fay Companies, Inc., 175 B.R. 525, 533 (Bank.
S.D. N.Y. 1994).

§ 329 requires any attorney representing the debtor to
file a statement of the compensation paid or agreed to
be paid in contemplation of and in connection with the
bankruptcy case. This requirement includes the
disclosure of the source of any such compensation.

(2.) Fed. R. Bankr. P. 2014. Bankruptcy Rule 2014
requires that an attorney who seeks to represent a
debtor must fully disclose at the time the application
for employment is made all connections with the
debtor, creditors, and other parties in interest. Fed. R.
Bankr. P. 2014. All facts that may be relevant to a
determination of whether an attorney is disinterested
or holds or represents an interest adverse to the
debtor's estate must be disclosed to the court. See, e.g.,
In re Southmark Corp., 181 B.R. 291, 294 (Bankr.
N.D. Tex. 1995); Diamond Lumber, Inc. v. Unsecured
Creditors' Comm. of Diamond Lumber, Inc., 88 B.R.
773 (N.D. Tex. 1988)(holding that Rule 2014 requires
full and complete disclosure).

(3.) Fed. R. Bankr. P. 2019. Even though there is no
Bankruptcy Court approval required for the
representation of creditors in a bankruptcy proceeding,
however, Bankruptcy Rule 2019 requires that an


attorney representing quot;more than one creditor or
equity security holderquot; file a verified statement listing
the clients, and the general nature of the claim. This
rule was promulgated quot;to prevent improper
participation in a reorganization by attorneys
representing creditors and stockholders.quot; In re I.G.
Services, Ltd., 244 B.R. 377 (Bankr. W.D. Tex. 2000)
[citations omitted]. Although the failure to comply
with the requirements of Rule 2019 could result in the
loss of a client's opportunity to be heard (or, in some
cases, compensated) in the bankruptcy proceeding, In
re American Solar King Corp., 92 B.R. 207, 208
(Bankr. W.D. Tex. 1988), the language of the rule
gives the bankruptcy court discretionary latitude in
enforcement.

7. Negligent Misrepresentations to the Bankruptcy Court. In In re Ward, 894
F.2d 771 (5th Cir. 1990), the court appeared to recognize a cause of action for
negligent misrepresentation to the Bankruptcy Court (at least under Louisiana
law), but held that the claim was not actionable under facts and circumstances
of that case. The claim arose from the alleged failure by the debtors' prior
attorneys (who were not the debtors' bankruptcy counsel) to disclose the
omission of a certain judgment from the debtors' schedule of assets. The court
held that the law firm had no affirmative duty to disclose the omission to the
Bankruptcy Court, because, among other things, the firm did not represent the
debtors in the bankruptcy proceeding. The implication that can be drawn from
the 5th Circuit's language, however, is that such a cause of action does exist.

IV. AREAS WHERE CONFLICTS ARISE

There are a myriad of circumstances in which a lawyer's duties to others may conflict with duties owed
to a client. The following instances are illustrative of some of the circumstances that can give rise to
conflicts of interest in bankruptcy representations.

A. Multiple Representations.

Conflicts arising from ongoing concurrent representation raise issues relating to an
attorney's duty of undivided loyalty. Model Rule 1.7. Any number of multiple
representations can, at least potentially, give rise to conflicts of interest. In an interesting
opinion, the court in In re Roberts, 46 B.R. 815 (Bankr. D. Utah 1985), includes an
extensive listing of bankruptcy cases that analyze alleged conflicts of interest

1. The Model Rules. The Model Rules directly address adverse representation
situations in Rules 1.7-1.9. Model Rule 1.7(a) prohibits a representation that
will be directly adverse to another client unless both clients consent and the
lawyer believes that neither client relationship will be adversely affected.
Model Rule 1.7(b) addresses situations where the representation of one client
might be materially limited by a lawyer's duties to other clients or third parties.
The representation can be undertaken if the client consents after a full
disclosure and the attorney believes that the representation will not be
adversely affected. In either case, any belief that the representation will be


adversely affected creates an unwaivable conflict of interest. Id.

2. The TDRPC. Texas Rules 1.06-1.09 generally follow the Model Rules on
conflicts arising from multiple representations that are conflicting, with one
important difference: TDRPC 1.06 flatly prohibits the representation of adverse
parties in litigation.

3. The Bankruptcy Code. Even beyond a showing of quot;disinterestednessquot; and
lack of an adverse interest in a bankruptcy representation, the various
responsibilities of both the lawyer and the client should be carefully explained,
as should the fact that, if a conflict does arise, the estate's interest must prevail
over the interests of a debtor. In short, both the lawyer and the client,
particularly a debtor client, must be cognizant of the quot;complex web of
interdependent duties.quot; See In re Delta Petroleum (P.R.), Ltd., 193 B.R. 99,
110 (D. P.R. 1996); In re Rivers, 167 B.R. 288-301 (Bankr. N.D. Ga.1994).

4. Evolving Representations. Conflicts arising from multiple or adverse
representations frequently arise when legal representation quot;evolvesquot; as a
proceeding or transaction progresses. SMWNPF Holdings, Inc. v. Devore, 165
F. 3d 360 (5th Cir. 1999); Simpson v. James, 903 F.2d 372 (5th Cir. 1990).
Because the obligation to disclose facts that may affect the quot;disinterestedquot; or
adverse interest analysis is continuing, developments and events over the
course of a bankruptcy proceeding may require additional disclosure to the
Bankruptcy Court. It follows that a conflicts analysis must continue throughout
the entire representation. In re Diamond Lumber, Inc. 88 B.R. 773, 779 (Bankr.
N.D. Tex. 1988); In re Office Products of America, Inc., 136, B.R. 983 (Bankr.
W. D. Tex. 1992).

5. Factual Scenarios.

a. Representation of Trustee or DIP and Creditors. Although a
strict interpretation of section 327(c) appears to allow for the
concurrent representation of a creditor and the trustee or debtor-in-
possession in the absence of an actual conflict of interest, courts
look to the surrounding facts and circumstances to determine
whether the representation interferes with the obligation of
undivided loyalty and compliance with fiduciary responsibilities.
In re Quality Beverage Company, Inc., 216 B.R. 592 (Bankr. S.D.
Tex. 1995)(actual conflict created by accounting firm's services for
creditors' committee precluded work for Trustee, which had
potential preference actions against members of committee). In In
re Global Marine, Inc., 108 B.R. 1009 (Bankr. S.D. Tex. 1988),
the attorneys represented the debtor, as well as the debtor's parent
company and another wholly owned subsidiary of the parent
company. The court held that, although various inter-company
debts essentially resulted in the attorneys representing both the
debtor and at least one creditor, no actual conflict existed; the court
did note, however, that it would continue to monitor the potential
for conflicts throughout the case.

Even in cases in which the bankruptcy court determines that no


actual conflict exists, it is arguable that TDRPC 1.06(a) precludes
the joint representation of a debtor and a creditor, regardless of
disclosure or consent: quot;A lawyer shall not represent opposing
parties to the same litigation.quot; Although no case addressing
specific this point could be located, the question of whether a
debtor and creditor are quot;opposing partiesquot; is probably subject to
debate. Even if the joint representation of a debtor and a creditor is
allowed under the ethical rules and the Bankruptcy Code, the
attorney must provide full disclosure and obtain a client's consent,
and must have no belief that the interests of either client will be
adversely affected. Model Rule 1.7.

b. Representation of Two or More Creditors. If the concurrent
representation of two or more creditors is in accordance with the
ethical rules, there is no prohibition to the representation in a
bankruptcy proceeding.

6. DIP Representation. The representation of a DIP or a corporate debtor can be
particularly problematic in terms of competing interests in multiple
representations. Courts have denied compensation for an attorney's actions
taken on behalf of a debtor where a conflict of interest exists, regardless of
whether there is a showing of a benefit to the estate. In re Jones, 665 F.2d 60
(5th Cir. 1982).

a. Corporations. In bankruptcy, the directors of a corporate debtor-
in-possession bear quot;essentially the same fiduciary obligation to
creditors and shareholders as would the trustee.quot; Commodity
Futures Trading Comm'n. v. Weintraub, 471 U.S. 343, 355 (1985).
Conflicts of interest commonly arise in debtor representations,
when corporate officers and directors work closely with an
attorney in planning and implementing the corporation's
bankruptcy proceeding. During that process, informal legal advice
relating to the individual interests of an officer or director may
give rise to at least an implied attorney-client relationship between
the officer or director and the attorney. Under these circumstances,
a conflict of interest exists to the extent that the interests of the
officer or director conflict with the interests and duties of the
debtor. See, e.g., In re Kendavis Industries International, Inc., 91
B.R. 742, 757 (Bankr. N.D. Tex. 1988)(finding that attorneys for
DIP were representing interests of debtors' principals to the
detriment of estate and creditors); Wiebold Stores, Inc. v.
Schottenstein, 131 B.R. 655, 661 (N.D. Ill. 1991)(finding conflict
where attorney was assisting directors in connection with
representation of corporations). But see, In re Howell, 148 B.R.
269 (Bankr. S.D. Tex. 1992)(allowing attorneys' fees to attorney
representing both individual Chapter 11 debtors and their closely
held corporation, where unity of interest made dual representation
economically reasonable and legally appropriate); see also, In re
Huddleston, 120 B.R. 399 (Bankr. E.D. Tex. 1990).

b. Partnerships. Conflicts of interest almost always arise from


multiple representations of partnership entities and individual
partners, and such multiple representations are typically disallowed
in bankruptcy proceedings. In re W.F. Development Corp., 905
F.2d 883 (5th Cir. 1990), rehearing denied, cert. denied 111 S. Ct.
1311; In re Kendavis Industries Int'l, Inc., 91 B.R. 742 (Bankr.
N.D. Tex. 1988).

B. Prior Representations.

1. The Model Rules & TDRPC. Model Rule 1.9 and TDRPC 1.09 prohibit an
attorney from undertaking a new representation that is adverse to a former
client in a matter that is the same or substantially related to a prior matter
handled for the former client. These rules rely on the strict confidentiality
imposed on a client's information, and the prohibition against the use of this
information to a client's disadvantage. See, e.g., TDRPC 1.05(b)(3). The prior
representation inquiry includes a two-part showing: a prior attorney-client
relationship, either express or implied, and a quot;substantial relationshipquot; between
the prior and current representations. In re American Airlines, F.2d 605, 615
(5th Cir. 1992). The quot;substantially relatedquot; standard evolved from case law,
which requires quot;painstaking analysis of the facts and precise application of
precedent.quot; Id., at 614. In determining whether two matters are substantially
related, courts have looked to factors such as similarities between factual
circumstances, legal issues raised, nature and extent of the attorney's
involvement, the time period of the earlier representation, and the existence of
common parties. See, e.g., City of El Paso v. Salas-Porras Soule, 6 F.Supp.2d
616, 623-24 (W.D. Tex. 1998). In circumstances in which a prior representation
is found to be quot;substantially related,quot; courts apply a conclusive presumption of
shared confidences, regardless of whether the attorney actually obtained the
confidential information. This presumption is not rebuttable, even where the
firm attempts to screen the information with so-called quot;Chinese walls.quot; See,
e.g., Greene v. Administrators of Tulane Educ. Fund, 1998 LEXIS 769 (E.D.
La. 1998)(noting that 5th Circuit has never recognized possibility of a quot;Chinese
wallquot; to rebut the presumption of shared confidences).

2. Prior Representation of the Debtor. The Bankruptcy Code specifically
provides that prior representation of a debtor does not automatically disqualify
an attorney from acting as counsel for the debtor in a bankruptcy proceeding.
11 U.S.C. § 327(e). In order to meet the requirement of this provision, an
attorney must establish that:

1.) the attorney has previously represented the debtor;
2.) a special specific purpose for which approval is sought;
3.) the appointment of the attorney is in the best interests of the
estate; and
4.) the attorney has no conflict.

Even then, however, the cases addressing this issue reflect careful scrutiny of
the pre-petition representation. In re Kuyendahl Place Assoc., Ltd., 112 B.R.
847 (Bankr. S.D. Tex. 1989)(finding disqualifying conflict where attorney who
previously represented debtor's general partner, which personally guaranteed
debtor's indebtedness). Generally, subsequent bankruptcy representation has


not been allowed in the absence of a waiver of claims for pre-petition fees
owed. See, e.g., Diamond Lumber, Inc. v. Unsecured Creditors Committee, 88
B.R. 773 (Bankr. N.D. Tex. 1988). However, in In re Waterfall Village of
Atlanta, Ltd., 103 B.R. 340 (Bankr. N.D. Ga. 1989), the court deferred to the
debtor's right to retain counsel of choice, and held that an attorney who had
previously represented the debtor in unrelated matters was not automatically
disqualified, noting that the case was a one asset case with few creditors, and
the majority of debt was held by secured creditors who were represented by
counsel.

3. Prior Representation of a Creditor or Creditors' Committee. The prior
representation of a creditor on an unrelated matter does not necessarily
preclude an attorney from representing a bankruptcy Trustee or debtor. 28
U.S.C. §§ 327 (c). Again, however, the issue will come down to an analysis of
the facts and circumstances, as courts have been unable to formulate a hard and
fast rule. In the case of In re Humble Place Joint Venture, 936 F.2d 814 (5th
Cir. 1991), the court held that a firm's prior representation of a creditor (and
principal of the debtor) constituted a conflict and affirmed the ordered
disgorgement of attorneys' fees. The Humble Place court emphasized, however,
that the analysis was quot;fact-bound,quot; and limited the holding to the facts before it.

In the case of In re Quality Beverage Co., Inc., 216 B.R. 592 (Bankr. S.D.Tex.
1995), the Chapter 7 trustee sought to employ an accounting firm to assist in
the prosecution of preference claims against members of the unsecured
creditors' committee after the case had been converted from a Chapter 11. The
court refused to allow the employment, holding that, because the accounting
firm had previously performed professional services for the unsecured
creditors' committee, a conflict of interest existed.

C. Confidential Client Information.

1. Multiple Representations. Conflicts of interest arise when an attorney's duty
to maintain a client's confidential information conflicts with an independent
duty to disclose. In the simultaneous representation of two clients, the duty to
maintain one client's confidential information may conflict with the duty to
disclose the same information to another client.

TDRPC 1.05 provides that confidential information consists of privileged and
unprivileged client information, and can never be revealed or used without the
consent of the client or former client. TDRPC 1.09 reiterates this policy by
requiring prior consent of a former client in any situation where an attorney
seeks to represent a party adverse to the former client and there is a reasonable
probability that TDRPC 1.05 might be implicated. See generally, Phoenix
Founders, Inc. v. Marshall, 887 S.W.2d 831, 834 (Tex. 1994)(holding that even
unprivileged information is confidential client information under the Texas
disciplinary rules).

2. Client's Fraudulent or Wrongful Conduct.

a. The Ethical Rules. Model Rule 1.2(d) provides that an attorney


may not knowingly encourage or assist a client in fraudulent
conduct, and 18 U.S.C. §§ 152-157 broadly outlines criminal
bankruptcy fraud . . . and possible penalties, including fines and
imprisonment. It follows that knowledge of such conduct,
including concealment of assets or undisclosed transfers or
preferential payments, may invoke a lawyer's obligation to reveal
this information. At this point, it is the lawyer's interests that
conflict with the interests of the client. Fortunately, the ethical
rules and the bankruptcy code itself provide a good road map for a
lawyer seeking to disengage such a troublesome client.

TDRPC 1.05(c)(7) and (8) allow, but do not require, an attorney to
reveal confidential information when the attorney believes that
doing so is

1) necessary to stop the client from committing any
criminal or fraudulent act, or
2) to rectify the consequences of such acts when the
client used the attorney's services to effectuate the
crime or fraud.

Model Rule 1.06(b)(1) allows, but does not require, such
disclosure.

In cases where the attorney reasonably believes that the client will
commit a criminal or fraudulent act that will result in death or
substantial bodily harm to another, disclosure is required, not
discretionary. TDRPC 1.05(e). TDRPC 1.05(f) further protects
third parties by requiring disclosure of material facts to third
parties when such quot;disclosure is necessary to avoid making the
lawyer a party to a criminal act or knowingly assisting a fraudulent
act perpetrated by a client.quot; TDRPC 1.05(f). Under Model Rule
1.6, an attorney has the discretion to disclose confidential
information in these situations, although there is no requirement to
do so.

In cases where confidential information is disclosed, the disclosure
should be no greater than necessary, and must be limited to those
who quot;have a need to know.quot; Because Model Rule 1.6 and TDRPC
1.05 allow the disclosure of a client's confidential information in
connection with the collection of legal fees, whether by a fee
application or in the prosecution of a collection action, the
disclosure should be carefully reviewed, and if necessary, steps
should be taken to limit the dissemination of the information.
Judwin Properties, Inc. v. Griggs & Harrison, P.C., 981 S.W.2d
868 (Tex. App. - Houston 1998, pet. den'd per curiam 11 S.W.2d
188)(disclosure must be quot;as protective of client's interest as
possiblequot;). The Comment to Model Rule 1.6 specifically
references the need to seek appropriate protective actions,
presumably protective orders or limited disclosure agreements.


3. Candor to the Tribunal. The ethical rules require candor before the courts,
giving rise to conflicting obligations on the part of attorneys. When the tribunal
is involved, the Texas Rules closely track Model Rule 3.3. Both require that an
attorney reveal client information to a tribunal when the attorney knows that
not doing so would require him or her to make a false statement to the tribunal,
offer false evidence, or aid the client in committing a crime or fraud. Further, if
an attorney learns after the fact that material evidence is false, he must attempt
to persuade the client to allow the evidence to be withdrawn or corrected. If the
client does not cooperate, the attorney must take steps to remedy the error,
including revealing the confidential information. TDRPC 3.03(c); Plunkett v.
State, 883 S.W.2d 349, 355 (Tex.App. - Waco 1994, pet. ref'd) (holding a
lawyer has an affirmative obligation to disclose the fact that his client had paid
jurors to obtain a hung jury).

D. Lawyer as a Witness.

Another issue that gives rise to conflicts of interest issues arises in cases where a lawyer
may be required to testify as a witness. Though this issue is not frequently addressed in the
case law, 37% of bankruptcy judges polled identified 'lawyer as witness' to be an ethics
issue that they had dealt with at least once in the prior two years. Marie Leary, FJC Survey
on Attorney Ethics Finds Most Judges Satisfied With Rules, 19-FEB Am. Bankr. Inst. J. 17,
18 (2000). As a practical matter, the question of a lawyer as a witness comes up most often
in disqualification proceedings; in the bankruptcy context, however, the possibility that an
attorney would be required to testify at some point should be considered in order to avoid
subsequent disqualification proceeding or worse, the possible denial of fees.

1. The Ethical Rules. Model Rule 3.7 prohibits an attorney from being both an
advocate and a witness at a trial. The rule provides exceptions when the
testimony is about an uncontested issue, when the issue is the nature and value
of the attorneys' legal services, or when disqualification would be a substantial
hardship on the client.

The TDRPC Rules are similar, but include some important distinctions.
TDRPC 3.08(a) provides that an advocate may not be a witness quot;before a
tribunal in a contemplated or pending adjudicatory proceeding.quot; Anderson
Producing v. Koch Oil Co., 929 S.W.2d 416, 422 (Tex. 1995)(Rule 3.08 does
not prevent attorney from quot;engaging in pre-trial, out -of-court matters such as
preparing and signing pleadings, planning trial strategy, and pursing settlement
negotiations,quot; nor does it prohibit attorney from sitting at counsel table during
trial). TDRPC 3.08(a)(2) allows testimony by the attorney when the matter is a
mere formality and there is little likelihood that substantial opposition evidence
will be offered.

TDRPC 3.08(a)(5) allows the attorney to act as witness when disqualification
would be a hardship on the client, but requires that opposing counsel be
notified promptly. More importantly, TDRPC 3.08(b) allows a fully informed
client to consent to representation even when the lawyer believes that he or she
will be compelled to testify in a way that will be substantially adverse to the
client.

2. Other Considerations. Despite the disciplinary rules, courts have noted that


the prohibition against a lawyer testifying as a witness arises from the concern
that a jury would give undue weight to an attorney's testimony, or would be
unable to distinguish an attorney's sworn testimony from arguments made on a
client's behalf. Crowe v. Smith, 151 F.3d 217, 223-24 (5th Cir. 1998). At least
in the context of a disqualification proceeding, courts have held that the
prohibition against an attorney acting as a witness does not apply to bench
trials. Id. Moreover, even in cases where the prohibition applies to one lawyer,
courts have refused to disqualify other lawyers from the same firm. FDIC v.
U.S. Fire, Ins. Co., 50 F.3d 1304 (5th Cir. 1995).

Finally, in the few reported bankruptcy cases discussing the lawyer as a
witness, courts have construed their own local rules. In re Galaxy Associates,
114 B.R. 11, 13 (Bankr.D.Conn. 1990)(holding that the local rule regarding
lawyer as witness does not have the same meaning as similar state ethics rules);
see also, In re Captran Creditors Trust, 104 B.R. 442, 444 (Bankr. M.D. Fla.
1989)(construing the Rules of the Middle District of Florida regarding lawyer
as witness).

E. Fees.

Attorneys' fees give rise to as many claims of conflict of interest as any other issue.

1. Denial or Forfeiture Fees Under the Bankruptcy Code. Under the Bankruptcy
Code, an attorney who is not quot;disinterestedquot; may face a forfeiture of fees. 11
U.S.C. § 328(c). However, the Fifth Circuit has refused to hold that § 328(c)
requires the denial of all fees to an attorney found not to be disinterested,
noting that the bankruptcy court has discretion in ruling on fee applications. In
re Humble Place Joint Venture, 936 F. 2d 814, 819 (5th Cir. 1991). In the case
of In re Southmark Corp., 181 B.R. 291 (Bankr. N.D. Tex. 1995), the court
held that compensation should be denied when a professional holds conflicting
interests, even if no fraud or unfairness resulted from the conflict. quot;The
bankruptcy court cannot speculate on what might have been in the absence of a
conflict. Where an actual conflict arises, compensation should be denied.quot; Id. at
295. The court went on to hold, however, that the question of whether all or just
a portion of a professional's compensation should be denied required a factual
inquiry, including the benefit and/or harm to the estate, time and labor
employed, and egregiousness of the failure to disclose. Id. at 296-97.

In re Hudson Shipbuilders, Inc. case, 1985 U.S. Dist. LEXIS 17654 (Bankr.
S.D. Miss. 1985) is a good example of how conflict of interest issues can
unexpectedly arise from the murk of a bankruptcy representation. In that case,
the attorney represented a secured creditor in the collection of a promissory
note, which included a provision allowing for recovery of attorneys fees in the
event of default. The court awarded attorneys' fees, which was appealed. The
debtor and a junior lienholder claimed that the attorney should be precluded
from recovering the attorneys' fee award because a conflict of interest existed
in the representation of a secured creditor (the client) and an unsecured creditor
(the attorney). The court concluded that the attorney fee award was a property
right that actually vested in the client, not the attorney, and thus held that no
conflict existed. The result may have been different, however, had the
attorney's client been the party to raise the potential conflict of interest in an


effort to avoid the payment of the attorney's fees.

2. Payment of Fees by Third Parties. The payment of an attorney's fees by a
third party is allowed under the ethical rules, however, only when the client
consents, and only when it will not interfere with the attorney's judgment or the
attorney-client relationship. Model Rule 1.8(f). Some bankruptcy courts,
however, have held that the conflict of interest that arises from a third party's
payment of a debtor's attorney's fees precludes representation under § 327. In re
Hathaway Ranch Partnership, 116 B.R. 208, 219 (Bankr. C.D. Cal. 1990); In
re WPMK, Inc., 42 B.R. 157, 163 (Bankr. D. Haw. 1984). In Woods v. City
Nat'l Bank & Trust Co., 312 U.S. 262, 268 (1941), the Supreme Court held that
an attorney should not allow another to pay a client's fees, because the practice
unfairly forces the attorney to choose between conflicting duties.

More pragmatic courts, have allowed payment of an attorney's fees by a non-
client, but only after concluding that, under the specific facts and
circumstances, there was no adversity to the estate or the creditors, no apparent
conflict existed, and there was a specific benefit to the paying third party. See,
e.g. David & Hagner, P.C. v. DHP, Inc., 171 B.R. 429, 437 (Bankr. D. D.C.
1994), aff'd, 70 F. 3d 637 (D.C. Cir. 1995); In re Kelton Motors, Inc., 109 B.R.
641, 658 (Bankr. D. Vt. 1989); In re Missouri Mining, Inc., 186 B.R. 946, 949
(Bankr. W.D. Mo. 1995).

3. Fee Applications. Fee disputes between a lawyer and a client can raise sticky
conflicts of interest issues. Legal malpractice claims are compulsory
counterclaims that are required to be raised in response to a claim for fees in
any case. Goggin v. Grimes, 969 S.W.2d 135, 138 (Tex. App. - Houston [14th
Dist.] 1998, no writ)(claim of attorney malpractice is compulsory counterclaim
to claim for attorneys' fees); CLS Assoc., Ltd. v. A__B__, 762 S.W.2d 221, 223
(Tex. App. - Dallas, 1988, no writ). As such, any final determination of a
lawyer's fee claim acts as a res judicata bar to a subsequent legal malpractice
action.

The doctrine of res judicata precludes all claims that quot;were or could have been
advanced in support of the cause of action on the occasion of its former
adjudication, . . . not merely those that were adjudicated.quot; See Howe v.
Vaughan, 913 F.2d 1138, 1144 (5th Cir. 1990)(quoting Nilsen v. City of Moss
Point, 701 F.2d 556, 560 (5th Cir. 1983)); see also Eubanks v. FDIC, 977 F.2d
166, 173 (5th Cir. 1992). In a recent case that is closely on point, Matter of
Interlogic Trace, Inc. v. Ernst & Young, LLP, 200 F.3d 382, 388 (5th Cir.
2000), the Fifth Circuit held that accounting malpractice claims arising from
accounting work done for the bankruptcy debtor were barred by the bankruptcy
court's award of professional fees because the malpractice were compulsory
counterclaims to the claim for fees.

Despite the Interlogic Trace decision, the question becomes whether an
attorney should advise a client of the need to raise any objections about the
attorney's representation at the hearing on a fee application. If the lawyer has
reason to know of a potential legal malpractice claim, the duty of full and
complete disclosure arguably requires that the client be advised that the final
determination of a fee application, the confirmation of a plan or the discharge


of the debtor could preclude any subsequent claim. Although little case law
exists for guidance, it make sense to inform debtor clients, possibly in the
original fee agreement, of the import and ramifications of an application for
fees.

F. Waivers and Disclosures.

1. Ethical Rules. In any case involving conflicts or potential conflicts, full
disclosure to and consent by the client is critical; and in a legal malpractice
case, proof of the disclosure and consent is even more important. Although
possible curative measures are dependent on the facts and circumstances giving
rise to the conflict or potential conflict, disclosure is always required. This
means disclosure of both the facts and any potential adverse impact on the
client or the representation. One court invalidated a waiver obtained by an
attorney who knew he was likely to be called as a witness against his client,
because the letter describing the potential conflict did not discuss possible
adverse consequences and thus could not be considered a full disclosure. In re
Captran Creditors Trust, 104 B.R. 442, 445 (Bankr. M.D. Fla. 1989); see also,
Conoco Inc. v. Baskin, 803 S.W.2d 416, 419-420 (Tex.App. - El Paso 1991,
orig. proceeding)(holding that general disclosure that did not discuss details of
possible conflicts of interest was insufficient to validate waiver).

2. Waivers in Bankruptcy. The duties to disclose under the Bankruptcy Code
and Rules are strictly construed in order to ensure that the court, not the
attorney, decides whether the facts present an impermissible conflict of interest,
preferably before legal services are rendered. In re Office Products of America,
Inc., 136 B.R. 675, 382 (Bankr. W.D. Tex. 1992). An attorney's duty to
disclose all relevant facts is a continuing duty throughout the representation. In
re Southmark Corp., 181 B.R. 291 (Bankr. N.D. Tex. 1995).

Courts have consistently held that failure to comply with the Bankruptcy
Code's disclosure requirements is an independent basis for denial of fees under
11 U.S.C. § 328. See, e.g., In re Consolidated Bancshares, Inc., 785 F.2d 1249,
1256 n.7 (5th Cir. 1995); In re Southmark Corp., 181 B.R. 291 (Bankr. N.D.
Tex. 1995). In fact, the failure to disclose is of particular concern, and often a
deciding factor, in the consideration of attorneys' fees by bankruptcy courts. In
re GHR Energy Corp, 60 B.R. 52 (Bankr. S.D. Tex. 1985); Diamond Lumber,
Inc. v. Unsecured Creditors' Comm., 88 B.R. 773 (Bankr. N.D. Tex. 1988)(law
firm failed to disclose payment from debtor prior to filing bankruptcy petition);
In re MFlex Corp., 172 B.R. 854, 854 (Bankr. W.D. Tex. 1994).

3. Waivers Under the Bankruptcy Code. Although the ethical rules permit
informed waivers in many cases, a conflict may not be waived under
Bankruptcy Code §327. In re 50-Off Stores, Inc., 213 B.R. 646, 653 (Bankr.
S.D. Tex. 1997)(noting that the difference between conflicts of interest in the
bankruptcy context and in the non-bankruptcy context, but recognizing the
court's power to quot;fashion an alternative remedyquot;); In re Quality Beverage Co.,
Inc., 216 B.R. 592 (Bankr. S.D. Tex. 1995)(quot;The 'adverse interest' and
'disinterested person' limitations set forth in the statute governing the
employment of professionals cannot be excused by waiverquot;).


V. OTHER CONSIDERATIONS IN THE DEFENSE OF LEGAL MALPRACTICE AND
BREACH OF FIDUCIARY DUTY CLAIMS

A. Core v. Non-Core: Who will Judge?

The characterization of a legal malpractice or breach of fiduciary duty claim as core or non-
core can impact the forum in which the case will ultimately be decided. 28 U.S.C. § 157(b)
(1) allows bankruptcy courts to enter final judgments only in core proceedings. In non-core
proceedings, § 157(b)(3) provides that the bankruptcy court may only make findings of fact
and conclusions of law, at which point the referring district court must enter a final order.

In a recent case involving misconduct of an accounting firm employed by an estate, the
Fifth Circuit held that state law malpractice claims against court appointed professionals
constitute core proceedings. In re Southmark Corp., 163 F.3d 925, 932 (5th Cir. 1999); see
also, In re Park Place Associates, 118 B.R. 613, 616 (E.D. Ill. 1990)(motion to award
sanctions against an attorney for Chapter 11 debtor constitutes core proceeding); In re
Stockert Flying Services, Inc., 74 B.R. 704, 708 (D. N.D. Ind. 1987)(claim by creditors
against debtor's attorney for mishandling the estate is core proceeding); But see Diamond
Mortgage Corp. of Ill. v. Sugar, 913 F.2d 1233, 1239-40 (malpractice claim against pre-
petition attorneys not core proceeding).

The issue is complicated slightly when the parties claim a right to a jury trial. The Fifth
Circuit has held that a bankruptcy court lacks constitutional authority to hear a jury trial,
even in core proceedings, absent the consent of the parties. In re Clay, 35 F.3d 190, 197-198
(5th Cir. 1994).

B. Fractured Causes of Action

Texas courts have uniformly limited claims that arise from negligence in providing legal
services to legal malpractice tort claims, and have disallowed efforts to recast such claims
as breach of contract, breach of fiduciary duty or claims for DTPA violations or fraud,
noting that nothing is to be gained by quot;fracturingquot; a cause of action into numerous claims.
See Sledge v. Alsup, 759 S.W.2d 1, 2 (Tex. App.-El Paso 1988, no writ); see also, Klein v.
Reynold, Cunningham, Peterson & Cordell, 923 S.W.2d 45, 49 (Tex. App.-Houston [1st
Dist.]1995, writ denied)(noting that plaintiff's alternative causes of action were merely
different quot;means to an endquot; in asserting a legal malpractice claim). See also, Britton v.
Scale, 81 F.3d 602, 605 (5th Cir. 1996); Streber v. Hunter, 221 F.3d 701, 722 (5th Cir.
2000).

This common law limitation is potentially important for several reasons. First, fee
disgorgement is not a measure of damage in a legal malpractice cause of action, nor are
treble or additional damages. Disgorgement of fees is, however, a remedy available under a
breach of fiduciary duty or DTPA claim, and treble damages (and attorneys' fees) are
recoverable under the DTPA. Burrow v. Arce, 997 S.W.2d 229 (Tex. 1999); Tex. Bus. &
Com. Code, § 17.50 (Vernon 1995). Attorneys' fees are also recoverable in a breach of
contract case. Second, the statute of limitations on a breach of fiduciary duty claim is four
years, as opposed to the two year statute that applies to legal malpractice claims. Tex. Civ.
Prac. & Rem. Code § 16.004 (1999).

For these tactical reasons, legal malpractice plaintiffs attempt to circumvent the prohibition


against quot;fracturedquot; causes of action by alleging wrongful conduct outside of the attorney's
professional services. For example, in Latham v. Castillo, 972 S.W.2d 66 (Tex. 1998), the
Texas Supreme Court held that a lawyer's representation that he had filed suit on behalf of
his clients when he had not was actionable under the DTPA. The court reasoned that
because the representation was about the lawyer's professional services, the claim was not
one for legal malpractice. Under this reasoning, then, a claim arising from a lawyer's
exercise of professional judgment, advice or opinion would be limited to a legal malpractice
cause of action, but any other allegedly wrongful conduct would not. Whether a breach of
fiduciary claim arising from a conflict of interest would fall into this category is an
interesting question, since, presumably, any conflict of interest is a breach of fiduciary duty.
However, it is possible to envision claims arising from alleged conflicts of interest that
would be, in essence, a complaint about the professional services rendered. For example, it
is arguable that the reasonably prudent attorney standard should apply in cases in which the
existence of a conflict, and thus the duty to disclose, is disputed.

C. Elements of a Legal Malpractice Cause of Action

Texas courts have provided clear guidance on the elements of legal malpractice, embracing
the traditional tort negligence model in which a quot;plaintiff must prove that there is a duty
owed to him by the defendant, a breach of that duty, that the breach proximately caused the
plaintiff injury and that damages occurred.quot; Cosgrove v. Grimes, 774 S.W.2d 662, 665
(Tex. 1989) (citations omitted).

1. Breach of Duty. As discussed previously, the actions of an attorney are
judged by an objective standard of reasonableness: whether a reasonably
prudent attorney could make the same decisions under the same or similar
circumstances. Id. In cases in which a lawyer is Board Certified in a particular
specialized area, for example bankruptcy law, the standard is that of a
reasonably prudent Board Certified bankruptcy attorney. Rhodes v. Batilla, 848
S.W.2d 833 (Tex. App. - Houston [14th Dist.] 1993, writ den'd).

2. Proximate Cause. Even if an attorney's conduct is negligent, it will not
always lead to legal malpractice liability. A plaintiff may not recover without
proof that the breach of duty proximately caused the damage claimed.
Cosgrove v. Grimes, 774 S.W.2d 662, 665 (Tex. 1989). Proximate cause has
been defined as including quot;foreseeability and cause in fact.quot; FDIC v. Shrader &
York, 991 F.2d 216, 221 (5th Cir. 1993). Essentially, a legal malpractice
plaintiff must prove that he or she would have prevailed on the underlying
claim, but for the lawyer's conduct. Schlager v. Clements, 939 S.W.2d 183,
186-187 (Tex. App.-Houston [14th Dist.] 1996, writ denied).

3. Damages.

a. Economic Damages. In Texas, economic damages are
recoverable in a successful legal malpractice action. Millhouse v.
Wisenthal, 775 S.W.2d 626, 627, n.2 (Tex. 1989).

b. Mental Anguish. The Texas Supreme Court has held that mental
anguish or emotional distress damages cannot be awarded in legal
malpractice actions when the underlying injury is purely economic.


Douglas v. Delp, 987 S.W.2d 879, 885 (Tex. 1999). The court
refused to express an opinion on the appropriate standard when the
underlying injury is not purely economic. Id.

Two months after the Delp opinion was handed down, the same
court refused, over the strenuous objection of Justice Hecht, to hear
a case in which an appeals court upheld a $350,000 emotional
distress award. In that case, the lawyer/defendant was found to
have breached a fiduciary duty to her client in a divorce
representation by colluding with the client's spouse, a friend from
law school. See Vickery v. Vickery, 999 S.W.2d 342 (Tex. 1999);
Vickery v. Vickery, No. 01-94-01004-CV, 1997 WL 751995
(Tex.App. -Houston [1st Dist.] Dec. 4, 1997, pet. denied).

c. Punitive Damages. Texas Civil Practice and Remedies Code §
41.003 authorizes exemplary damages where a plaintiff can prove
fraud or malice by clear and convincing evidence. In judging
whether and to what degree exemplary, or punitive, damages are
warranted, a court must look to quot;the nature of the wrong, the
character of the conduct involved, the degree of the culpability of
the wrongdoer, the situation and sensibilities of the parties
concerned, and the extent to which such conduct offends a public
sense of justice and propriety.quot; Alamo Nat'l Bank v. Kraus, 616
S.W.2d 908, 910 (Tex. 1981)(citations omitted). Further, a court
may take into account what amount may be necessary to serve as a
deterrent to others. Transportation Ins. Co. v. Moriel, 879 S.W.2d
10, 27 n.22 (Tex. 1994). Judge Buchmeyer of the Northern District
of Texas recently affirmed a bankruptcy court's order of
$3,504,000 in exemplary damages against a firm and its lawyers
individually based on impermissible conflicts of interest and
breach of fiduciary duty. In re Legal Econometrics, No. CA 3:98-
CV-2297-R, 1999 W.L. 304564 (N.D. Tex. May 11, 1999).

D. Fee Forfeiture.

In cases involving a breach of fiduciary duty (in other words, where an attorney puts the
interests of another client or him or herself ahead of the interests of a client), Texas
common law allows a court order the forfeiture of all or part of the fee. As discussed
previously, fee forfeiture is also a remedy under the Bankruptcy Code.

1. Burrow v. Arce. Last year the Texas Supreme Court eliminated the causation
requirement for a breach of fiduciary duty, and held that in cases of a quot;clear and
serious violation of a duty to a client,quot; fee disgorgement could be required,
even in the absence of economic injury. Burrow v. Arce, 997 S.W.2d 229, 237-
238 (Tex. 1999). The Arce court did, however provide some protections for
lawyers. The question of whether fee forfeiture is appropriate, and if so,
whether all or only part of the fees should be forfeited, is to be determined by
the trial court, not a jury. The trial court's inquiry requires review of the
particular facts and circumstances, including the quot;gravity and timing of the
violation, its willfulness, its effect on the value of the lawyer's work for the
client, any other threatened or actual harm to the client, and the adequacy of


other remedies.quot; Id.

2. Bankruptcy Courts. Texas bankruptcy courts have ordered the forfeiture and
disgorgement of fees long before the Burrow v. Arce opinion was handed
down. As the cases discussed earlier in this paper reflect, the court's analysis is
fact intensive, and the most punitive results generally occur in cases where the
court believes the attorney was less than forthright in disclosures to the court or
to the client.

VI. IN CONCLUSION

From the standpoint of defending a lawyer, or a lawyer's fees, the riskiest conflict of interest analysis is
one that is undertaken after the fact, with hindsight. This risk can be minimized, if not eliminated,
however by ongoing attention to the identity and interests of the client, as well as by making the
required disclosures.

Avoiding Malpractice Conflicts Of Interest In Bankruptcy ...

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Viewers also liked

Viewers also liked (20)

Similar to Avoiding Malpractice Conflicts Of Interest In Bankruptcy ...

Similar to Avoiding Malpractice Conflicts Of Interest In Bankruptcy ... (20)

More from legal5

More from legal5 (20)

Avoiding Malpractice Conflicts Of Interest In Bankruptcy ...