Bankruptcy Court in New Mexico Says U.S. Trustee Is “Never, Ever, Ever, Getting … Together” with Debtor’s Counsel

Contributed by Jessica Diab

In a recent decision, In re Hart Oil & Gas, Inc., the United States Bankruptcy Court for the District of New Mexico reaffirmed that only in limited circumstances will a court approve the retainer of a professional as “special counsel” under section 327(e) of the Bankruptcy Code.
Pursuant to section 327(a) of the Bankruptcy Code, a trustee may formally retain a professional to represent or assist the trustee in carrying out the trustee’s duties so long as the professional is a “disinterested person” (as that term is defined in section 101(14) of the Bankruptcy Code) and the professional does not represent an adverse interest to the bankruptcy estate.  Section 327(e), on the other hand, enables a trustee to retain as “special counsel” an attorney that has represented the debtor (i.e., someone who is not a “disinterested person”), so long as the attorney is hired for a specific purpose other than representing the trustee in conducting the case and the attorney does not hold or represent an interest adverse to the bankruptcy estate “with respect to the matter on which such attorney is to be employed”.  The prime example of when a trustee might use section 327(e) is where the trustee would like an attorney who has represented the debtor in prepetition litigation, to continue working on the matter postpetition.  Among other reasons, the trustee may prefer to retain the attorney because he or she already is familiar with the facts of the case.  The same attorney might not be eligible for retention pursuant to section 327(a) because he or she might be owed fees and, therefore, would be a creditor of the estate and not “disinterested” for the purposes of the section 327(a).  While it might be easier for an attorney to be retained under section 327(e), In re Hart Oil & Gas, Inc., illustrates that the application of section 327(e) is limited and cannot be used to circumvent or sidestep the requirements set out under section 327(a).
Hart Oil & Gas, Inc., an oil and gas exploration company, filed for chapter 11 protection in the United States Bankruptcy Court for the District of New Mexico on September 25, 2012.  Initially, Hart Oil & Gas Inc. operated a debtor in possession.  On the petition date, the debtor filed an application to employ William F. Davis & Associates, P.C. as its counsel in the bankruptcy case and in all other matters in which the Hart Oil & Gas required counsel. The court subsequently entered an order approving the application.  On June 19, 2013, the Davis firm filed a fee application.  By June 24, 2013, a chapter 11 trustee was appointed in the debtor’s case.  Subsequently, the trustee sought to employ the Davis firm as special counsel to, among other things, assist the trustee in pursuing confirmation and the implementation of a plan and to prepare and file objections to claims.  While the trustee’s application to hire the Davis firm as special counsel was pending, the trustee filed certain documents in the bankruptcy case, including a liquidating plan, a draft disclosure statement and an objection to a motion for temporary allowance of certain claims for voting purposes.  As it turned out, and as the court found, all of the documents filed by the trustee had been prepared by the Davis firm.
The court denied the trustee’s motion to employ the Davis firm under section 327(e).  In its opinion, the court found that there was no “special purpose” for the retention other than to assist the trustee in conducting the case. The court stated that the prohibition in section 327(e) against special counsel “conducting the case” includes assisting with formulating and negotiating a plan and disclosure statement; liquidating the estate; and the process of objecting to claims.  The court also concluded that the Davis firm represented an interest adverse to the estate.  The court found that (i) the Davis firm continued to represent the debtor even after the appointment of the trustee, and (ii) the debtor was potentially solvent and therefore, there was a potential for a full payment to creditors.  The Davis firm’s continued representation of the potentially solvent debtor meant that it represented an interest adverse with respect to the proposed representation of the estate because, where the debtor is potentially solvent, the debtor possesses a pecuniary interest in its own estate.  In such a case, it is the trustee who is tasked with the role of representing the estate’s interests and the debtor’s counsel who continues to represent the interests of the debtor.  Because these two interests could be adverse, it would be a conflict of interest for one attorney to represent both parties in a bankruptcy case.  In fact, the court observed that granting the trustee’s motion would lead to a violation of New Mexico’s Rules of Professional Conduct, namely the rule that precludes an attorney from representing clients that hold an interest adverse to that of a current or former client without having received informed consent, confirmed in writing.  In case you’re curious, creditors are now voting for either the trustee’s liquidating plan (prepared with the assistance of the Davis firm) or a competing plan which was filed by an Ad Hoc Committee.
In re Hart Oil & Gas Inc. serves as a friendly reminder that section 327(e) will be interpreted narrowly.  In its decision, the court prevented the “special counsel” exception from swallowing the rule in section 327(a) that precludes a trustee from retaining a debtor’s current counsel to assist with general administration of the estate.  Importantly, the decision also demonstrates that courts will apply section 327(e) in a particularly narrow fashion where the debtor may still have an interest in the estate.