Opinion
Bankruptcy Nos. 74-413, 74-414, 74-1079, 74-1246, 74-2271
December 29, 1978
Attorneys — Conflict of Interest — SEC Investigations — Fees
A law firm did not breach the appropriate standard of care by its multiple representation of two corporate officers as individuals and the corporation before an SEC staff investigative hearing. The firm did, however, subsequently breach its duty of care by representing a national banking organization and a corporate conglomerate at the same time.
Background . . . A complaint was brought by the Trustees of Westgate-California Corporation and its subsidiaries objecting to claims filed by the law firm and affirmatively claiming damages. The bankruptcy trustees' contended that the firm violated its contractual professional, fiduciary and ethical duties, and was guilty of malpractice because at one and the same time it represented Westgate on the one hand in connection with a Securities and Exchange Commission formal investigation and lawsuit, and United States National Bank on the other in connection with an investigation of the FBI and the Comptroller of Currency as well as in the SEC matter involving Westgate. Further the trustees complained that the firm simultaneously represented the de facto chief of both Westgate and USNB and the nominal head of Westgate as individuals in connection both with the SEC proceedings and the FBI and Comptroller of the Currency matters.
Both USNB and Westgate had been controlled by C. Arnholt Smith and the financial affairs of the two companies had been intertwined to the point of total mutual inter-dependence. As a result of the investigations, the Comptroller issued a Cease and Desist Order which ousted Smith from the bank management entirely, and prohibited further expansion of the relationship between USNB and Westgate. The Order contained a prohibition against any loans, extensions of credit or renewals thereof to Westgate, except in accordance with prudent banking practices. This mechanism was designed to keep both USNB and Westgate afloat since at that point it was clear that Westgate would have extreme difficulty in obtaining loans from other lending institutions, and USNB could not continue without Westgate. The Bankruptcy Judge said that the law firm representing USNB and Westgate choose the course it did in an effort to preserve both companies, and looked only to their mutual interests and financial interdependence. Had its primary aim been to preserve Westgate, perhaps it would have perceived the potentials involved in Westgate severing its ties with USNB and seeking the resolution of its problems in another way, such as in Reorganization proceedings under Chapter X.
Pursuant to the Cease and Desist Order, an Administrative Committee of USNB was subsequently set up. The Administrative Committee's functions were to oversee the activities of USNB with respect to the loans brought into question by the Comptroller and to implement their orderly and ultimate collection. Thus, Westgate was no longer able to obtain the favored treatment it had in the past when loans were granted under Smith's direction. By this time, the aims of the Comptroller of the Currency as far as revamping the financial obligation structure from Westgate to USNB was obviously antagonistic to the interests of Westgate. When the firm saw the course the Comptroller was insisting upon, it should have disclosed this as a potential conflict area to the Westgate Board of Directors.
Multiple Representation at SEC Hear ings . . . The court observed that the multiple representation question was complicated by the SEC's "sequestration rule." 17 C. F. R. § 203.5, 203.7. Under the SEC regulations, if a corporation wanted counsel to appear with each of its officers, counsel could do so if representing the corporation. If representing the individual alone, counsel could be barred from further participation in the proceedings. This rule, while promoting the effectiveness of the SEC investigation, leads to the dangers inherent in multiple representation of clients with potentially conflicting interests. The law firm's expert witness testified that it was common practice, in 1973, for attorneys to represent officers and directors as individuals and as agents of the company before the SEC. Accordingly, the court concluded that the law firm met the appropriate standard of care in connection with the multiple representation of two individuals and the corporation before the SEC. Although the courts have constantly indicated the dangers of multiple representation even in this situation, the bankruptcy judge said "so long as the sequestration rule exists so will the problem, and the likelihood will remain that attorneys appearing before the SEC will continue to represent multiple clients."
Malpractice . . . The duties that the law firm had were at least; the duty of undivided loyalty to its clients; the duty to fully and fairly represent each client wiht unimpeded and unimpaired independence of judgment; and the duty to advise each client of its own best course. The court rejected the argument that litigation is the only situation where the duty of undivided loyalty comes into play. The SEC investigation and the Comptroller investigation and the resulting lawsuits were considered by all involved as an adversary proceeding. In the opinion of the court, the duty of undivided loyalty and the dangers inherent in representing multiple clients with potentially conflicting interests were just as real in the Westgate-USNB situation as in cases involving litigation.
During the course of the firm's representation of USNB, it became clear that a conflict had arisen. USNB was being forced to change its ways with respect to the Westgate loans and obligation. This was so clear and material that this prospective change in former practices should have been fully disclosed by the law firm to the Board of Directors of Westgate in order that they could evaluate the potential conflict. The facts that should have been disclosed were that the Comptroller of the Currency required no more lending to Westgate, and consequently that USNB was committed to a course which whould restructure the obligations from Westgate to the Bank and which would require indemnification from Westgate of the obligations of other corporations, all in the process of orderly and ultimate liquidation of all obligations frim Westgate to the Bank. Disclosure to the Chairman of the Board alone was insufficient. Disclosure and informed consent of the full Board of Directors to the firm's continued representation of USNB was required. Absent that, the firm should have withdrawn immediately from the representation of USNB.
However, the trustee's case failed insofar as malpractice was concerned since they did not establish any causal connection between the firm's breach of duty and the damages which were sustained. It was "pure speculation" to conclude that the course taken by Westgate would have been any different had there truly been undivided loyalty or disclosure of all the facts. It was too speculative to determine whether or not independent counsel would have recommended some other course of action or, if he had, that such recommendation would have been followed. In fact all indications were that everyone then thought that the interest of USNB and Westgate were so interwined that it is doubtful that the course of events would have changed and a different path have been followed. Further, the law firm had nothing to do with the lending transactions themselves, the area in which the trustees contended that Westgate sustained major damages.
Fees . . . The court found that the firm was entitled to compensation for their services up until the time that they breached the standards of professional conduct. It was not entitled to compensation for services rendered from the time the conflicting interests became apparent until the time the conflicting interests disappeared with the failure of USNB. An award of fees to the firm for the period when it represented clients with conflicting interests without disclosure and consent would have been contrary to public policy. See Bankruptcy Rule 10-217 at ¶ 20,597.