By Marshall S. Huebner, Adam L. Shpeen, and Hailey W. Klabo (Davis Polk & Wardwell LLP)
The Bankruptcy Code applies demanding ethical standards for the retention of a debtor’s professionals to ensure that such professionals’ interests are directly aligned with those of the debtor’s bankruptcy estate. Issues potentially arise when one or more individuals associated with a large firm that would otherwise meet these rigorous standards do not themselves. Do one or more individuals irrevocably taint and disqualify the entire firm? Can walls and proper disclosures to the Bankruptcy Court solve the issue? Do courts apply these standards equally to law firms and other estate professionals, such as financial advisors and investment banks? This article examines the current legal landscape relating to these issues.
Under section 327 of the Bankruptcy Code, a debtor may employ only “professional persons” who are “disinterested persons,” that is, those who are not or were not, within two years of the date of the bankruptcy filing, directors, officers or employees of the debtor, and who do not hold or represent an interest adverse to the debtor’s estate. Where a debtor seeks to retain a professional advisor, the “person” being retained is generally the professional firm itself, not any particular individual professional.
Nevertheless, the fact pattern gets complicated where an affiliated individual is himself or herself not “disinterested,” often by virtue of being or having recently been an officer or director of the debtor. This is because of the view, or risk, that the non-disinterestedness of a member of a professional firm is imputed to the firm as a whole. In the law firm context, court rulings have diverged on whether the failure of a particular professional to be disinterested should be imputed to the entire firm. While a few courts have applied a “per se” rule disqualifying law firms due to the non-disinterestedness of a single professional, the majority of courts have declined to adopt such a per se rule, including in the financial advisor context.
This article further examines the potential solutions firms may use to cure disinterestedness issues and prevent their firm from being disqualified. Courts, other than the few applying a per se rule of imputation, have generally approved the retention of professional firms employing non-disinterested individuals when those firms both made fulsome disclosures of such relationships and potential conflicts, and also implemented rigorous ethical walls and information barriers between the implicated professional and the members of the firm working for the debtor. Such walls should bar the conflicted person from access to files or documents related to the debtor’s case and prohibit discussions of the debtor’s case with or in the presence of that person. More extreme circumstances may demand resignation of the non-disinterested professional from the conflicted position, disgorgement of fees, and, in the case of financial advisory firms, deployment of the “Alix Protocol” pursuant to which a firm seeks retention under section 363(b) in order to provide a debtor with a chief restructuring officer prior to a bankruptcy filing and also enable the firm to be retained by the debtor in the bankruptcy.
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