Opinion
Case No. 96-10346-AM, Case No. 96-10403-AM
March 15, 1996
Michael L. Bernstein, Esquire, Arnold Porte, Washington, DC, of counsel for debtor in possession
Jeanne Goldberg, Esquire, Victor M. Glasberg Associates, Alexandria, VA, of local counsel for debtor in possession
Richard E. Lear, Holland Knight, Washington, DC, of counsel for Equitable Life Assurance Society
MEMORANDUM OPINION
This matter is before the court on the applications of Arnold Porter to be employed as counsel to the debtors in possession, 1550 Wilson Boulevard L.P. ("1550 Wilson") and 1560 Wilson Boulevard L.P. ("1560 Wilson"). Timely objections were filed by Equitable Life Assurance Society, a secured creditor in both cases, and by the United States Trustee. A hearing was held February 27, 1996, after which the court took the matter under advisement to review the debtors' schedules which had not yet been filed and any supplemental memoranda that the parties desired to file. Upon a review of the schedules, the U.S. Trustee filed a supplemental objection to the employment applications. Arnold Porter also filed a supplemental memorandum in support of its applications. The court has reviewed the schedules, the statement of financial affairs, and the supplemental memoranda and is now prepared to rule. For the reasons stated herein, the court concludes that the proposed counsel to the debtor in possession, Arnold Porter, is not "disinterested" as required by 11 U.S.C. § 327, and that its employment as counsel to the debtors in possession should not be approved.
The schedules and statement of financial affairs in 1550 Wilson were due on February 26, 1996. Counsel, however, inaccurately believed that the schedules were due on February 27, 1996 " the date the schedules were due in the companion case, 1560 Wilson. The schedules in 1550 Wilson were ultimately filed on February 27, 1996.
Facts
The first debtor, 1550 Wilson, filed a voluntary chapter 11 petition in this court on January 26, 1996, and continues in operation of its business as debtor in possession. The debtor is a limited partnership whose sole asset is a seven-story office building located at 1550 Wilson Boulevard, Arlington, Virginia. The second debtor, 1560 Wilson, filed a voluntary chapter 11 petition three days later, January 29, 1996, and also continues in operation of its business as debtor in possession. The sole asset of this debtor is a 12-story office building located at 1560 Wilson Boulevard, Arlington, Virginia.
A. Equity Interests
The current general partners of 1550 Wilson are: Wilmil Corp. (1.00% interest) and 1550 Wilson, Inc. (1.00% interest). These entities replaced Stuart H. Miller (1.00%) and Geneva Enterprises, Inc. (1.00%), who withdrew from the partnership in November, 1995. Mr. Miller, however, retained his limited partnership interest. The entity's limited partners are: Robert M. Rosenthal (49.00%), Stuart Miller (16.35%), Robert E. Miller (16.30%), and Shauna M. Wertheim (16.35%).
The president of Wilmil Corp. is Stuart H. Miller.
It has been represented that the president and controlling shareholder of 1550 Wilson, Inc. is Stuart H. Miller.
It has been represented that Robert M. Rosenthal is the president of Geneva Enterprises, Inc.
1560 Wilson's current general partners are: Wilmil Corp. (2.16%) and 1550 Wilson, Inc. (2.16%). These entities replaced Stuart Miller, Robert Rosenthal, Brooke Peterson, Jane Cafritz and Nancy Rosenthal § all withdrew from the partnership as general partners in December, 1995, but retained their limited partnership interests. The limited partners are Robert Rosenthal (2.52%), Peterson (10.44%), Cafritz (10.44%), Nancy Rosenthal (10.44%), Columbia First Bank (28%), Stuart Miller (11.60%), Robert Miller (11.12%), and Shauna M. Wertheim (11.12%).
It has been represented that the other individual limited partners in this entity are the children of Robert Rosenthal. Arnold Porter Supplemental Memorandum, p. 18.
First Union National Bank of Virginia ["First Union"] is the successor-in-interest to Columbia First Bank.
B. Creditors
Equitable Life Assurance Society of the United States ("Equitable") is the principal secured creditor in both of these cases. In 1550 Wilson, Equitable holds a $22,353,967 claim arising from an October 6, 1987 loan to the debtor, secured by a first deed of trust against the property, in the original principal amount of $20,160,000.00. The payment of a portion of the loan was guaranteed by Stuart Miller and Rosenthal Nissan, Inc., the predecessor in interest to Geneva Enterprises. Miller and Geneva Enterprises are listed as co-debtors on Schedule H. The only other secured creditor in 1550 Wilson is Cowles Nissan, which is listed as having a $14,632.16 claim. Equitable Life is the only secured creditor in 1560 Wilson. It holds a $19,255,395 claim " which is listed as disputed " arising from a December 9, 1987 loan to the debtor, secured by a first deed of trust against the property, in the original principal amount of $20,640,000.00. Equitable asserts that the payment of a portion of the loan was guaranteed by Stuart Miller and Robert Rosenthal. Neither person is listed as a co-debtor in 1560 Wilson.
The debtor has qualified the amount of Equitable's claim, stating that it does not "reflect the $237,898.63 that Equitable took into its possession pre-petition from the tenant improvements/commissions escrow."
In its supplemental memorandum, Arnold Porter contradicted Equitable's assertions regarding a payment guarantee in 1560 Wilson. Arnold Porter contends that this payment guarantee was canceled in December, 1990, and attached to its supplemental memorandum a copy of Equitable's letter acknowledging cancellation of the guaranty.
The Arlington County Treasurer is listed as having an unsecured priority claim for pro-rated real estate taxes in 1550 and 1560 Wilson in the amount of $16,097.17 and $18,571.74, respectively. Arlington County is also listed as having a $200.00 and $125.00 claim in 1550 and 1560 Wilson, respectively, for pro-rated personal property taxes.
1550 Wilson has listed $63,446.95 in unsecured non priority claims on its schedules. Of this amount, $11,964.50 arises from unpaid fees owed to its management company, the Stuart H. Miller Company, pursuant to a management agreement. The remainder is primarily owed to Virginia Power and assorted trade creditors. For the most part, the unsecured creditors in 1560 Wilson are similar, with one important exception. Of the $2,436,435.73 scheduled in unsecured claims in 1560 Wilson, $2,359,454.00 is listed as being owed to 7550 Wilson. The claim is listed as disputed. Accordingly, 1550 Wilson is the single largest creditor of 1560 Wilson, except of course for Equitable.
Stuart H. Miller Company is the management company for both 1550 Wilson and 1560 Wilson. Pursuant to cash collateral orders entered in each of the cases, Equitable has consented to the continued retention of Stuart H. Miller Company and has consented to a 3 percent management fee.
While the debtors list the value of the real estate on their schedules as unknown, counsel for the debtors represented at a cash collateral hearing that the value could very well be less than the amount of the debt owed Equitable.
The schedules in 1550 and 1560 Wilson disclose that substantial distributions were made to the partners in the limited partnerships at a time in which the entities were not making their required mortgage payments to Equitable and were apparently insolvent.
In the two months prior to 1550 Wilson's January 26 filing, the partnership made four pro-rata distributions, totaling $1,021,555.00, to its partners. On December 1, 1995 it paid $194,000.00. On December 5, 1995 it paid $497,555.00. On December 19, 1995 it paid $140,000.00. Finally, on January 16, 1996, just 10 days prior to filing its bankruptcy petition, it distributed $190,000 to its partners. Furthermore, Equitable has asserted that the last payment received by it was in November 1995. out of October rents. Prior to that, the debtor had been making monthly payments in the approximate amount of $173,000.00 each.
Similarly, in the two months prior to 1560 Wilson's January 29 filing, the partnership made three pro-rata distributions, totaling $1,145,000.00, to its partners. On December 1, 1995, it paid $720,000.00. On December 19, 1995, it paid $175,000.00. Finally, on January 16, just 13 days prior to its filing, it distributed $250,000.00 to its partners. It has been asserted by Equitable that 1560 Wilson's loan with Equitable matured on January 1, 1996. Equitable further asserts that the debtor's failure to pay the loan upon maturity constituted a default under the loan documents.
D. Arnold Porter
Arnold Porter " in its application to be employed as counsel, in the schedules it filed on behalf of the debtors, and in the hearings that have been held " has made numerous disclosures regarding (1) its prior representation of the debtors; (2) its prior associations with debtors' principals; (3) compensation it has received from the debtors pre-petition; and (4) agreements made with some of the debtors' limited partners regarding payment of post-petition compensation. These disclosures include:
1. In December, 1995, the debtors paid retainers to Arnold Porter totaling $216,000.00 " $108,000.00 each. Shortly before the bankruptcies were filed, the law firm credited $31,489.00 from 1550 Wilson and $26,614.00 from 1560 Wilson for services rendered since October 24, 1995 for pre-bankruptcy related work.
2. Arnold Porter has also disclosed that it represents/will represent Stuart Miller and Geneva Enterprises "in a possible suit on a guarantee provided to Equitable with respect to its loan to the partnership." Arnold Porter Application in 1550 and 1560 Wilson, p. 6.
The application to employ Arnold Porter as counsel in 1560 Wilson Boulevard contains an error. Both Arnold Porter applications assert that Stuart Miller and Geneva Enterprises provided payment guarantees on the Equitable loans. While this is true for 1550 Wilson, in 1560 Wilson the payment guarantee was made by Stuart Miller and Robert Rosenthal. Furthermore, Arnold Porter now contends that this payment guarantee was canceled in December, 1990. Arnold Porter Supplemental Memorandum, Exhibit A.
3. Arnold Porter has disclosed that "Robert M. Rosenthal, President of one of the corporate general partners of the Debtor and Stuart H. Miller, President of the other corporate general partner of the debtor, in their individual capacities, have agreed jointly and severally to pay Arnold Porter the difference, if any, between the amounts Arnold Porter is paid by the Partnership as approved by the Bankruptcy Court and the total fees and expenses incurred in connection with its representation of the partnership." Arnold Porter Application in 1550 and 1560 Wilson, p. 7-8.
4. Arnold Porter has disclosed that it represents another partnership which shares common partners with the debtors " a non-debtor entity known as 1555 Wilson Boulevard L.P.
Arnold Porter has also disclosed that the schedule of hourly billing rates for the attorneys in its firm that would be working on these cases ranges from $165.00 to $367.00.
Kari M. Desgalier bills at $165.00 per hour. Michael L. Bernstein bills at $232.00 per hour. Both Daniel M. Lewis and S. Lee Narrow bill at $367.00 per hour. Some of these rates are substantially in excess of the maximum rate of $175.00 per hour historically allowed by this court. Higher rates have of course been allowed where justified by the complexity of the case and other relevant factors, but the rates the counsel intend to charge increase the likelihood that counsel's billed fees may exceed the amount ultimately approved by this court. As noted, payment of the excess of the billed fees over the approved fees is being guaranteed by two of debtors' principals who are themselves potential targets of fraudulent conveyance actions that the debtors in possession (advised by their counsel) must determine whether to pursue.
Discussion and Conclusions of Law
In a chapter 11 case in which a trustee has not been appointed, the debtor remains in control of its business affairs as "debtor in possession" and has the powers and generally performs the functions of a trustee. 11 U.S.C. § 1101(1) and 1107. Thus, a debtor in possession is a statutory fiduciary of its own estate. Section 327 of the Bankruptcy Code permits a trustee or debtor in possession, with court approval, to employ professionals that (i) do not hold an interest or represent an interest adverse to the estate and (ii) are disinterested persons. A disinterested person is defined by the Bankruptcy Code as one who is not a creditor or an insider and who
"[I]t is the duty of counsel for the debtor in possession to survey the landscape in search of property of the estate, defenses to claims, preferential transfers, fraudulent conveyances and other causes of action that may yield a recovery to the estate. The jaundiced eye and scowling mien that counsel for the debtor is required to cast upon everyone in sight will likely not fall upon the party with whom he has a potential conflict." Interwest Business Equipment, Inc. v. United States Trustee (In re Interwest Business Equipment, Inc.), 23 F.3d 311, 316 (10th Cir. 1994) quoting In re McKinney Ranch Assoc., 62 B.R. 249, 254, (Bankr. C.D. Calif. 1986).
11 U.S.C. § 101(10)(A) defines creditor to mean an "entity that has a claim against the debtor that arose at the time of or before the order for relief concerning the debtor."
does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor . . .
The Fourth Circuit, like many other courts, has eschewed the creation of "bright line" rules regarding the disqualification of professionals. Harold Williams Dev't Co. v. United States Trustee (In re Harold Williams Dev't. Co.), 977 F.2d 906 (4th Cir. 1992). Instead, the Fourth Circuit instructs the bankruptcy court to "take into account facts of a particular case and the overall objectives of the bankruptcy system." Id. at 909. In rejecting the application of an attorney " who was also an accountant " to be employed both as counsel and as accountant to the debtor in possession, the bankruptcy court and the district court adopted a per se rule against dual employment applications. In reversing, the Fourth Circuit noted that while attorney-client privilege and disclosure problems "do tend inherently to weigh against dual appointments," a specific inquiry must be made at the outset into the facts of each particular case. Id. at 910, citing In re Martin, 817 F.2d 175, 183 (1st Cir. 1987) ("[T]he potential for conflict and the appearance of conflict, without more, can justify [judicial action based on an absence of `disinterest']. Yet, horrible imaginings alone cannot be allowed to carry the day."). Consequently, this court has recognized that a "fact-intensive inquiry into the situation presented" is required. In re Palumbo Family Limited Partnership, 182 B.R. 447, 466 (Bankr. E.D. Va. 1995) (Bostetter, C.J.).
Upon a review of the employment application and schedules, this court has a number of serious concerns with the proposed employment of Arnold Porter. First, 1550 Wilson, aside from Equitable, is the largest creditor of 1560 Wilson. Second, two of the limited partners — who are also the principals of the corporate general partners-of 1550 Wilson and 1560 Wilson have guaranteed that Arnold Porter will be paid its total fees and expenses, regardless of what compensation is ultimately approved by this court. Of great concern to the court is that these two limited partners received pro-rata distributions of more than $2 million from the debtors within two months of the bankruptcy filing and while the partnerships were in default on their obligations to Equitable. Third, within one month of the two filings, the debtors paid retainers to Arnold Porter totaling $216,000.00 — $108,000.00 each. Shortly before the bankruptcies were filed, the law firm credited $31,489.00 from 1550 Wilson's retainer and $26,614.00 from 1560 Wilson's retainer for services rendered since October 24, 1995 for pre-bankruptcy related work. Fourth, Arnold Porter represents certain limited and general partners of the debtors with respect to potential litigation with Equitable.
Arnold Porter's lengthy explanation in its defense, resounding the "extreme unlikelihood" that Mr. Miller and Mr. Rosenthal will become creditors in the cases, and the aboveboard nature of the fee guarantee, simply misses the point. It may well be, as Arnold Porter argue at exhaustive length, that no single circumstance connected with their proposed representation of the two debtors is, in and of itself, disqualifying. A number of them, however, clearly constitute red flags, justifying closer inquiry. While no single factor may compel disqualification, the combination of circumstances, viewed as whole, may inexorably lead — as it does here — to the conclusion that the competing demands on Arnold Porter's loyalties arising from their connection with parties other than the debtor in possession in each case, are too extensive to permit them to serve as counsel. Each of these circumstances will be examined in turn.
A. 1550 Wilson is one of the largest creditors of 1560 Wilson
Of the $2,436,435.73 of unsecured claims scheduled in 1560 Wilson, $2,359,454.00 is listed as being owed to 1550 Wilson. The claim is listed as "disputed." As noted above, this is the largest single claim in 1560 Wilson, aside from what is owed to Equitable. Arnold Porter argues that what appears to be problematic at "first blush," poses no actual conflict. Arnold Porter asserts that because there appears to be little or no cash in 1560 Wilson's estate, the creditors of 1550 Wilson would have no economic incentive to pursue a claim against 1560 Wilson. Arnold Porter also contends that, because of the virtual identity of interests, the creditors and equity holders of both estates are "indifferent" as to whether this $2 million is in one estate or the other. Arnold Porter further represents that the listing of the claim as "disputed" was not because of any actual known dispute, "but only to preserve 1560's ability to further examine the 1986 transaction that gave rise to the claim." Arnold Porter Supplemental Memorandum, p. 17, fn. 14.
In its defense, Arnold Porter principally relies on In re Global Marine, Inc. for the general proposition that
[T]he mere existence of an intercompany claim does not in and of itself constitute an impermissible conflict of interest that would justify disqualification *** [T]here is a fundamental distinction between `potentially conflicting interests that may arise in every instance of joint representation and an `actual conflict of interest' as envisioned by § 327(c).
In re Global Marine, Inc., 108 B.R. 998, 1004 (Bankr. S.D. Tex. 1987). In Global Marine, a parent holding company and its 13 subsidiaries filed voluntary petitions under chapter 11. These 14 cases were subsequently joined for administrative purposes via an order of joint administration. The evidence before the court was that all of the debtors, whose estates had a unity of ownership and guaranteed obligations, "functioned as one enterprise *** with a unity of interest and singleness of purpose." Id.
Aside from the obvious differences § 1550 and 1560 Wilson are each distinct single-asset debtors in possession whose cases are not being jointly administered " the picture presented in Global Marine is quite different from the one that has come to light in the present cases. First, 1550 Wilson and 1560 Wilson do not possess that same identity of ownership. In addition to a number of other individual limited partners in 1560 Wilson, First Union holds a 28 percent interest in the entity. Arnold Porter maintains that First Union's equity position is a "passive economic interest" and that it has had "no involvement in the affairs of 1560 and has never formally been admitted to the partnership." Arnold Porter Supplemental Memorandum, p. 19. Despite Arnold Porter's argument " which the court may have to address at some later date " the schedules of 1560 Wilson list First Union as a 28 percent limited partner. Furthermore, Arnold Porter maintains that First Union's treatment " regardless of whether 1550 Wilson asserts a claim against 1560 Wilson " would be no different because there is nothing to recover. Consequently, the firm asserts that any conflict that may arise due to its interest in 1560 Wilson is "more theoretical than real." At this early stage in the cases, the court can see that the presence of First Union creates something more than theoretical conflict.
A second difference between Global Marine and the instant cases is that the intercompany debt here is listed as disputed. Arnold Porter contends that the claim was listed as disputed solely to "preserve 1560's ability to further examine the 1986 transaction that gave rise to the claim." As a practical matter, there is no possibility that the nature and history of this transaction can be examined aggressively without forcing Arnold Porter to divide its allegiance between two separate clients § 1550 Wilson and 1560 Wilson. In re U.S. Jet, Inc., 127 B.R. 11, 13 (Bankr. E.D.Va. 1991), citing In re Roger J. Au Son, Inc., 101 B.R. 502, 505 (Bankr. N.D. Ohio 1989) ("Having to divide one's allegiance between two clients is what Section 327 attempts to prevent").
B. Fee Guarantee
Another troubling aspect " perhaps, the most troubling aspect " of Arnold Porter's applications is that two of the limited partners of 1550 Wilson and 1560 Wilson " Stuart Miller and Robert Rosenthal " have guaranteed that Arnold Porter will be paid its total fees and expenses, regardless of what compensation is ultimately approved by this court. The court has several distinct concerns with this proposition. First, Mr. Miller and Mr. Rosenthal, within two months of the bankruptcy filing and at a time in which the partnerships were in default on their obligations to Equitable, received pro-rata distributions of more than $2 million from 1550 and 1560 Wilson. Furthermore, during this same period, the debtors also paid retainers to Arnold Porter totaling $216,000.00 " $108,000.00 each, a substantial amount of which was applied on the eve of the bankruptcy filings on account of existing fees owed the firm. It has been represented that both debtors are insolvent.
1. Disclosure
Arnold Porter suggests that their full disclosure regarding the pre-petition retainer payments and the fee guarantee somehow purifies these transactions so as to render Arnold Porter disinterested. This is not the case. While § 327 requires that any attorney who seeks to be employed by a debtor in possession be approved by the court as "disinterested," § 329 obligates any attorney representing the debtor to file a statement disclosing
the compensation paid or agreed to be paid, if such payment or agreement was made after one year before the date of the filing of the petition, for services rendered or to be rendered in contemplation of or in connection with the case by such attorney, and the source of such compensation.
11 U.S.C. § 329. These disclosure requirements are mandatory, not voluntary. Failure to comply with these disclosure requirements can result in a forfeiture of any right to receive compensation for services rendered on the debtor's behalf and can even result in the disgorgement of funds already received. In re Investment Bankers, Inc. 4 F.3d 1556 (10th Cir. 1993), cert. denied, "U.S.", 114S.Q. 1061, 127 L.Ed.2d 381 (1994). But the converse is not true: full disclosure by itself does not negate or cure a conflict of interest.
2. Fee guarantees — generally
Ordinarily, counsel representing a debtor in possession in a chapter 11 reorganization should be paid by the debtor out of its own assets. The practical problem, of course, is that often a debtor in possession, while having assets of significant value, may be cash poor. In the case of a partnership, such cash shortage might be remedied a number of ways, the most obvious being by an infusion of cash, either in the form of a loan or capital contribution, from the existing partners. The funds would then be the debtor's, and there would be no question as to whom counsel would look both for direction and for payment of professional fees.
The question is whether one or more partners, instead of putting into the debtor sufficient cash to enable it to pay counsel, may directly pay, or guarantee payment of, counsel's legal fees. The obvious difficulty with such an arrangement is that if the interests of the debtor and the guarantor are not aligned, the guarantor, by virtue of holding the checkbook, has the power to influence or direct counsel's representation of the debtor to the guarantor's own advantage, rather than to the debtor's advantage. See, D.R. 5-106, Va. Code of Professional Responsibility.
"(A) Except with the consent of his client after full and adequate disclosure under the circumstances, a lawyer shall not:
(1) Accept compensation for his legal services from one other than his client.
(2) Accept from one other than his client anything of value related to his representation of or his employment by his client.
(B) A lawyer shall not permit a person who recommends, employs, or pays him to render legal services for another to direct or regulate his professional judgment in rendering such legal services."
The ethical standards embodied in the Virginia Code of Professional Responsibility are binding on all attorneys practicing before this court. Local Rule 105(1).
In general, Arnold Porter argues that it is "wholly appropriate" for a non-debtor affiliate to guarantee the payment of the debtor's legal fees. Arnold Porter Supplemental Memorandum, p. 12. For this proposition, Arnold Porter relies on David Hagner, P.C, v. DHP Inc. and Dover Admin. Services, Inc., 171 B.R. 428 (D.D.C. 1994), aff'd, 70 F.3d 637 (D.C. Cir. 1995), and In re Palumbo Family Limited Partnership, 182 B.R. 447 (Bankr. E.D.Va. 1995). Both cases are distinguishable from 1550 Wilson and 1560 Wilson, and Arnold Porter's reliance upon them is misplaced.
In David Hagner, unlike the present cases, the district court was called upon to enforce " more than five years afterward " a fee guarantee by DHP, the parent corporation of the debtors, contained within the firm's application to be employed as counsel to two related debtors in possession. No objection having been filed, the bankruptcy court authorized the firm's retention, and " without referring specifically to it in the orders authorizing employment " implicitly approved the fee guarantee. Throughout the ensuing five years, and several hearings on interim fee applications, no party objected to either David Hagner's continued retention or to the fee guarantee. In enforcing the fee guarantee, the district court gave great deference to the bankruptcy court's past experience with these cases " the district court explicitly did not question David Hagner's initial retention. Interestingly, the district court, in examining the authority of the bankruptcy court to examine fees paid from a third-party to a debtor's counsel under 11 U.S.C. § 329, noted:
These two bankruptcy cases were transferred from the Eastern District of Pennsylvania to the District of Columbia in June 1988, about six months after they had been filed. David Hagner filed its applications to be employed as counsel to the debtors in possession on June 24 and July 7, 1988. These applications were approved shortly thereafter. While the fee guarantee itself was not signed until February 1989, it expressly applied the agreement retroactively, referencing "fee guarantee" language that was contained within the two employment applications. 171 B.R. at 431.
It cannot be said that the bankruptcy court in this case did not serve the goals of Section 329 to protect creditors and prevent overreaching by debtors' counsel. The creditors in this matter were protected because the fees paid by DHP would not come out of the estate. Furthermore, with respect to all fees paid during the pendency of the bankruptcy cases, the bankruptcy court was able to review any fees that were paid by the guarantor, as such fees were ultimately reviewed in connection with fee applications to the debtor's estates. For these reasons, this Court does not believe that [David Hagner's] arrangement with the guarantor evaded the scheme outlined under the Bankruptcy Code.
Id. at 437 [emphasis added]. In light of the fact that, shortly before the bankruptcy filings, considerable sums were distributed to the debtors' partners " the very same ones who are guaranteeing Arnold Porter's fees " the creditors in 1550 Wilson and 1560 Wilson do not enjoy the same protection that the creditors in David Hagner case did. The facts and procedural posture of the David Hagner case are significantly different from the present case. Accordingly, Arnold Porter's reliance on it to support a general proposition of law is misplaced.
In Palumbo, the court addressed a very different set of facts than presented in this case. The debtor, the Palumbo Family Limited Partnership, after a falling out with its counsel, sought to attack counsel's fee request on, among other grounds, the asserted impropriety of a guarantee of those fees by P.M. Palumbo, Jr., the general partner and limited partner owning a 97% interest in the partnership. The partnership maintained that when Palumbo provided a retainer to the law firm and guaranteed the firm's legal bills, he became a "contingent creditor," and his and the partnership's interests diverged. In rejecting that contention, and allowing the fee guarantee to stand, Chief Judge Bostetter of this court concluded that Palumbo and the partnership did not have separate legal interests. The court noted:
Unlike other limited partnerships, the [Palumbo] Partnership was not formed as an investment vehicle to benefit its limited partners. Rather, Palumbo created the Partnership to thwart a foreclosure sale of land he owned. It was Palumbo who contributed the land. It was Palumbo who personally owed money to the Bank. Additionally, the Partnership has no employees when it filed for bankruptcy. Taking into account all these circumstances, we conclude that Palumbo and the Partnership are one and the same. Thus we do no believe that Palumbo's interests were adverse to those of the Partnership.
Id. at 467. None of the singleness of purpose that was apparent in Palumbo is present in 1550 Wilson and 1560 Wilson. These partnerships, which were obviously formed as investment vehicles, function as separate on-going businesses, and do not have the same unity of ownership (for example, First Union is a 28% limited partner in 1560 Wilson) and purpose.
3. Partnership distributions
In the two months prior to 1550 Wilson's January 26 filing, the partnership made four pro-rata distributions, totaling $1,021,555.00, to its partners " including Miller and Rosenthal. Similarly, in the two months prior to 1560 Wilson's January 29 filing, the partnership made three pro-rata distributions, totaling $1,145,000.00, to its partners " including Miller and Rosenthal. These distributions, Equitable and the U.S. Trustee contend, were made at a time in which 1550 Wilson and 1560 Wilson were in default under their loans with Equitable. Furthermore, it has been represented that the liabilities of these debtors exceed the value of their assets.
At the outset, the Virginia Uniform Limited Partnership Act sets forth certain limitations on distributions. Specifically, "[a] partner may not receive a distribution from a limited partnership to the extent that, after giving effect to the distribution, all liabilities of the limited partnership, other than liabilities to partners on account of their partnership interests, exceed the fair value of the partnership assets." Va. Code Ann. § 50-73.42. Under 11 U.S.C. § 544(b), a trustee or debtor in possession may avoid any transfer by the debtor that could be avoided under state law by the holder of an allowed claim against the debtor. Additionally, the partnership distributions are also presumptively avoidable as fraudulent conveyances. 11 U.S.C. § 548 provides
(a) The trustee may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within one year before the date of the filing of the petition, if the debtor voluntarily or involuntarily —
(2)(A) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
(B)(i) was insolvent on the date that such transfer was made or such obligation, or became insolvent as a result of such transfer or obligation . . .
In light of the foregoing, and recognizing that there may well be defenses to any avoidance actions that the debtor in possession might bring against the partners, nevertheless, Arnold Porter's representation of the debtors — while simultaneously looking to the targets of any such avoidance actions for payment of their fees — places it in a situation of real, and not merely potential, conflict of interest when advising the debtor in possession whether to bring such an action.
It is also — to say the least — inferable, that some portion of these potentially recoverable partnership distributions are, in essence, the same funds that would ultimately be used to pay Arnold Porter's fees and expenses. Section 327 mandates that a professional must not "hold or represent an interest adverse to the estate." To hold an adverse interest is to
[1] possess or assert any economic 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 [2] possess a predisposition under circumstances that render such a bias against the estate.
In re Kuykendahl Place Associates, Ltd., 112 B.R. 847 (Bankr. S.D. Tex. 1989), citing In re Glenn Electronic Sales Corp., 89 B.R. 410, 413 (Bankr. D. N.J. 1998), aff'd 99 B.R. 596 (D.N.J. 1988). To represent an adverse interest means to serve any individual or entity holding such adverse interest. Miller and Rosenthal, the limited partners of the debtor and the presidents of the debtors' general partners, conceivably face litigation brought by the estate. By its very nature, this establishes that they hold an interest which may be adverse to the debtor in possession. As a result, their individual guarantee of Arnold Porter's fees certainly raises the specter that Arnold Porter would have a predisposition or bias against the estate — particularly where the funds that those guarantors might need to draw upon to honor their guarantees are the very funds the debtors in possession may be seeking to recover.
Furthermore, Arnold Porter received $216,000 in retainers from these debtors within two months of the bankruptcy petition. Shortly before the bankruptcies were filed, the law firm credited $31,489.00 from 1550 Wilson and $26,614.00 from 1560 Wilson for services rendered since October 24, 1995 for pre-bankruptcy related work. While the elimination of an attorney's "creditor" status by the waiving of pre-petition attorney fees has been approved by a number of courts, that is not what Arnold Porter did here. In re Adam Furniture Industries, Inc. 158 B.R. 291 (Bankr. S.D. Ga. 1993). Here, Arnold Porter did not waive their fees " rather the firm credited the pre-petition fees against the retainers it received for post-petition work. This court has previously noted that "any large or unusual payments by a debtor to counsel within the preference period are relevant to a conflicts analysis and warrant scrutiny by the court when pre-petition counsel is sought for employment post-petition." In re Fernando Morales Garza, 1994 WL 282570 (Bankr. E.D.Va. 1994), citing Diamond Lumber, Inc. v. Unsecured Creditors' Comm. (In re Diamond Lumber, Inc.), 88 B.R. 773, 779 (N.D. Tex. 1988). These types of payments pose a possible conflict in which the counsel and the estate may be rivals.
Retainers in bankruptcy cases are generally considered advance payments of fees that are to be held in trust until the court awards a fee and authorizes the fee to be paid from the fund. The bankruptcy retainer is, then, a deposit for work to be performed in the future. In re Plaza Hotel Corporation, 111 B.R. 882
In light of the foregoing, any assertion by Arnold Porter that its allegiance would not be divided belies common sense. Furthermore, any assertion that Arnold Porter could objectively investigate, and potentially litigate, fraudulent conveyance or preference actions against itself and those paying its fees similarly belies common sense.
C. Dual Representation of Equity
Finally, as has been noted previously, the payment of a portion of the Equitable loan to 1550 Wilson was guaranteed by Stuart Miller and Geneva Enterprises. Accordingly, both are listed as a co-debtors on Schedule H. Furthermore, Arnold Porter has disclosed that it represents, or will represent, Miller and Geneva Enterprises "in a possible suit on a guarantee provided to Equitable with respect to its loan to the partnership." "Simultaneous representation of a debtor corporation and the controlling shareholders, although not a disqualifying conflict per se, becomes a basis to disqualify when adverse interests either exist or are likely to develop *** [A]t best, counsel is in a delicate posture." Plaza Hotel Corp., 11 B.R. at 890 (internal citations omitted.) Given the scenario that has emerged in this case, it is simply not possible for Arnold Porter to represent these potentially diverse clients. No matter how vociferously Arnold Porter stresses that its loyalty is to the debtor, it simply cannot exercise impartial and undivided loyalty under these circumstances.
Ruling
This court, after carefully considering all the facts surrounding the proposed representation, concludes that Arnold Porter is not "disinterested" within the meaning of Section 327(a), Bankruptcy Code, and that its employment as counsel to the two debtors in possession should not be approved. No single factor bars employment, but the combination of the large disputed claim by one of the partnerships against the other, the guarantees of the firm's fees by persons who were recipients of presumptively avoidable transfers from the debtors, and the firm's own status as the recipient of possibly-preferential payments for pre-petition legal services, creates the very type of conflict that Section 327(a), Bankruptcy Code, seeks to avoid and weights most heavily in the court's calculus. The debtor in possession in a chapter 11 case is a fiduciary and it may not employ counsel whose loyalties are, or are reasonably likely to be, divided. Here, Arnold Porter simply cannot satisfy the test of disinterestedness, and the application to employ them must be denied.
The court does not lightly reach a conclusion that denies the debtor in possession the right to employ its first choice of counsel. There is no question that Arnold Porter's application is a model of full disclosure, and that the firm has capably and professionally represented the debtor in possession with respect to the various "first-day" motions that have already been heard. Nevertheless, as Chief Judge Bostetter of this court pointed out in a slightly different context, the court is not free to "ignore the conflict of interest standards set forth in the Bankruptcy Code and in relevant case law in favor of achieving an expedient solution to the debtors' purported shortage of financial resources." In re Huntmar Beaumeade I Ltd. Partnership. 127 B.R. 363, 366 (Bankr. E.D. Va. 1991).
In Huntmar Beaumeade, an application to employ counsel was denied where counsel's retainer was paid by an affiliate of the debtor controlled by an individual who was an unsecured creditor in the amount of $38,400, had guaranteed one of the debtor's loans, and, through a partnership he controlled, owned a 45% limited partnership interest in the debtor. While it is true, as Arnold Porter point out, that neither Mr. Miller nor Mr. Rosenthal is listed as a creditor in the two cases before the court, Mr. Miller's management company, Stuart H. Miller Company, is (Bankr. E.D. Calif. 1990).
A separate order will be entered in each case denying the employment application. The effect of the order will be stayed for 10 days to allow the debtors in possession an opportunity to obtain other counsel.