Counsel Beware: 327(e) Special Purpose Representation Not Applicable Where Counsel Did Not Previously Represent the Debtor

Contributed by Evan Lederman
The recent decision by the United State Court of Appeals for the Eighth Circuit in In re M&M Marketing, LLC, No. 10-2118, 2010 WL 4104681 (8th Cir. Oct. 20, 2010), could prove troublesome for attorneys and law firms seeking to be employed for a limited purpose under section 327(e) if they did not previously represent the debtor.  Applying a literal interpretation of section 327(e), the Eighth Circuit ruled that by its plain terms section 327(e) only applies to an attorney who has previously represented the debtor, and if such requirement is not met, then the attorney must satisfy the more stringent requirements of section 327(a) (which does not limit the purview of conflicts to a specific matter) to be retained.  The M&M Marketing decision is at odds with other courts, including the United States Court of Appeals for the Second Circuit, which have applied the conflict standards of section 327(e) to attorneys who have not previously represented the debtor.

In M&M Marketing, the trustee administering the bankruptcy estates sought to employ attorney David Skalka and the Crocker Huck Law Firm for a limited purpose as “special counsel” to assist the trustee in connection with investigating preference and avoidance actions against certain creditors of the debtors.  Skalka, however, represented certain other creditors in the bankruptcy cases who were potential targets of separate fraudulent transfer actions and also represented relatives of the principal owner of the debtors.  A creditor filed a motion to disqualify Skalka based on Skalka’s purported conflicts of interest.  Specifically, the creditor argued that Skalka should be disqualified because the interests of Skalka’s other clients in the case were adverse to the debtors’ estates because they received (allegedly) fraudulent transfers, and Skalka was not “disinterested,” as required by section 327(a), because he represented relatives of M&M’s principal owner.  Skalka and the trustee, on the other hand, argued that Skalka’s employment did not create any conflicts because Skalka was hired for the limited purpose of pursuing claims against only a single creditor for which no conflict existed. The United States Bankruptcy Court for the Southern District of Nebraska agreed with Skalka and denied the creditor’s motion, but the Bankruptcy Appellate Panel reversed, and the Eighth Circuit affirmed the BAP decision.
In overturning the bankruptcy court decision, the BAP focused on the question of whether it was appropriate to narrow the inquiry of potential conflicts based on the allegedly limited scope of Skalka’s employment.  To answer this question, the BAP looked squarely to the language in section 327(e) because it is the “only bankruptcy code section that explicitly permits a court to consider conflicts solely with regard to the matter for which the attorney is to be employed.”  Section 327(e) refers only to “an attorney that has represented the debtor.”  In applying section 327(e), the BAP ruled that by its plain terms, section 327(e) applies only to attorneys who have previously represented a debtor, and because nothing in the record indicated that Skalka was previously employed by either of the debtors, Skalka’s employment must meet the more stringent requirements of section 327(a).  Section 327(a) imposes essentially two conditions that must be met for an attorney’s employment:  (1) the attorney must be “disinterested” as that term is defined in section 101(14), and (2) the attorney cannot hold or represent an interest adverse to the estate.  Here, because Skalka did not satisfy the general conflict requirements set forth in section 327(a) based on his other representations in the cases and could not avail himself of the more limited requirements of section 327(e), the BAP and Eighth Circuit ruled that Skalka’s employment was precluded.
As noted above, while other circuits have allowed special purpose representations by applying the standards in section 327(e) even when there was not a previous debtor representation, this decision reminds attorneys that a literal interpretation of section 327(e) could preclude such a representation if the attorney is otherwise conflicted under section 327(a), especially in the Eighth Circuit.  Literal application of the section also would mean that section 327(e) is not available for the employment of other professionals, such as accountants, for a special purpose.
Debtors, particularly in large cases, often use section 327(e) as a basis for the adoption of special, more streamlined, procedures to apply to the debtor’s retention of “ordinary course professionals.”  Under the typical procedures for ordinary course professionals, the proposed professional need only submit an affidavit to the effect that the professional meets the standards of section 327(e).  Literal application of section 327(e), however, would limit this procedure to prepetition professionals employed by the debtor and would mean that any professional, even if its engagement is wholly unrelated to the bankruptcy case, would have to comply with the more stringent requirements of section 327(a) either if the professional was not an attorney or if the professional had not been employed by the debtor prior to the petition date.