Restructuring

Contributed by Frank Grese
The scope and application of the common interest privilege can become an issue in chapter 11 cases given the various constituencies with their various interests and shifting alliances.  The common interest privilege is an extension of the attorney-client privilege that allows two or more parties facing a common opponent to share privileged information without waiving their right to assert the attorney-client privilege.
In a recent ruling In re Cherokee Simeon Venture I, LLC, Judge Kevin Gross of the United States Bankruptcy Court for the District of Delaware provided further guidance on the application of the common interest privilege.  At issue in Cherokee was whether the debtor and the debtor’s manager have a common interest in the defense against a secured creditor’s motion to dismiss the bankruptcy case for bad faith such that the communications between the parties are privileged.
Background
Cherokee involved a debtor whose sole asset was an 89 acre parcel of contaminated property that was subject to complex environmental remediation.  The property was deeded to the debtor by Zeneca Inc. in 2002 when it was believed that all remediation issues were resolved; however, in 2006, regulatory authorities reopened the remediation.  Zeneca remained liable for a significant portion of the additional remediation expenses.  Indeed, Zeneca continued to be actively involved with the debtor.   Pursuant to an operating agreement with the debtor, Zeneca was the manager of the debtor and appointed the debtor’s authorized representative.  The debtor filed for bankruptcy protection in October, 2012, and beginning in January 2013, Zeneca became the debtor’s sole financing source, having provided the debtor with a $75,000 loan after EFG-Campus Bay, LLC, the debtor’s primary secured creditor, refused to allow the debtor to use cash collateral.
The Motions to Dismiss and the Fight About Common Interest
In April 2013, Zeneca decided to stop funding the debtor’s chapter 11 case leading the debtor to file a motion to dismiss its case.  Separately, EFG also sought to dismiss the chapter 11 case as a bad faith filing.  At the time Judge Gross issued his opinion, the only remaining issue in dispute was whether the case should be dismissed for bad faith.  In its motion to dismiss, EFG alleged that the bankruptcy case was commenced solely for Zeneca’s benefit so Zeneca could retain control over the property to manage and potentially reduce its remediation expenses.  On cross-examination of the debtor’s representative, counsel for EFG asked questions with respect to how Zeneca and the debtor developed plans for litigation strategy and cross-examination at the hearing of EFG’s witness.  Counsel for the debtor and Zeneca objected to these questions on the grounds that such communications were protected by the common-interest privilege.  Specifically, Zeneca and the debtor claimed that, in preparation for the hearing on EFG’s motion to dismiss, they developed a common defense strategy based on communications between the debtor’s representative, debtor’s counsel, and Zeneca’s counsel.
EFG argued that the common interest privilege does not apply to communications involving the debtor’s representative because the privilege only protects communications between counsel for different clients (i.e., it does not apply to communications of one client representative to attorneys of another party in matters of common interest).  The court quickly dismissed this argument by quoting precedent in the Third Circuit stating that the common interest privilege protects “communications between a client and its attorneys and attorneys of another client.”
EFG also argued that even if the privilege applies to communications between one client and counsel for the other, it was effectively destroyed given that the debtor’s authorized agent was appointed by Zeneca (i.e., Zeneca’s agent was present while the debtor’s agent communicated with Zeneca’s counsel).  Citing no case law in support of its argument, EFG asserted that if the parties wanted the protection of the common interest privilege, then an independent authorized representative should have been chosen for the debtor.   The court rejected this argument and, in fact, found that the authorized representative’s connection to the debtor and Zeneca was in itself evidence of a close relationship associated with the common interest privilege.  The court also cited precedent stating that the common interest privilege protects “communications between individuals and entities and counsel for another person or company when the communications are part of an on-going and joint effort to set up a common defense strategy.”
Finally, EFG argued that because Zeneca is also a large creditor of the debtor, it cannot share a common interest with the debtor because it must be presumed to have legal interests that are in conflict with the interests of the debtor and its estate.  The court dismissed this argument finding that it runs contrary to established precedent holding that the common interest privilege still applies even where parties’ interests are adverse in substantial respects, but aligned with respect to others (we’ve blogged in the past about bankruptcy court decisions reaching a similar conclusion on this point – see here and here).
After rejecting each of EFG’s arguments, the court found that the common interest applied to the communications in question between the debtor and Zeneca and their respective counsel, as they were in furtherance of their common effort to prosecute the bankruptcy case and defend against EFG’s bad faith filing claim and for the purpose of developing privileged legal strategies related to EFG’s motion to dismiss and to prepare for the hearing on the motion.
The Cherokee court is not the first court to find the common interest privilege applicable to parties whose interests could be adverse in some respects but not others.  Indeed, prior to Cherokee, the common interest privilege has been applied between a debtor and (i) an ad hoc committee, (ii) a prepetition future asbestos claims representative, (iii) a creditors committee, and (iv) an affiliate company.  In addition to reaffirming that the privilege applies to communications between a client and its attorneys and attorneys of another client, Cherokee serves as yet another example where courts have found that parties whose interests are substantially adverse in many respects can still have a common interest for a specific purpose.