In Re Vebeliunas
OPINION DISQUALIFYING COUNSEL TO CHAPTER 7 TRUSTEE
Concerns and fears of partisan bias in the House of Representatives and in the voting by Senators rocked the impeachment process of President William Jefferson Clinton. As it turned out, once the Senators viewed the evidence and gave it the weight they deemed appropriate, they did not vote along unified party lines but acquitted the President. I mention this only to illustrate what a destructive force bias can be if it is allowed to go unchecked and how important in the judicial and quasi-judicial arenas it is first to amass reliable evidence and only then to formulate an opinion. 1 In fact, the point in time when an opinion is formed is essential to the distinction between bias on the one hand and reasoned judgment on the other. Today, I address that very issue as it relates to the disinterestedness of counsel to the chapter 7 trustee on account of his clear expression of prejudice against the debtor before any § 341 or other examination of him by the trustee.
I.
A. Procedural History
Vytautas Vebeliunas, the debtor pro se in this converted chapter 7 ease, moved to disqualify Roy Babitt, the chapter 7 trustee assigned to his case, by reason of an alleged conflict of interest arising out of a prior representation of the debtor’s affiliate by the firm where Mr. Babitt is of counsel but which does not represent him in this matter. In a decision issued from the bench, I held that there was absolutely no basis in law or fact warranting the trustee’s disqualification for a conflict of interest or for any other reason, however, I instructed the trustee to engage substitute counsel because it had become apparent from the pleadings that his counsel, specifically Warren Graham of Warshaw Burstein Sehlesinger & Kuh (“Warshaw Bur-stein”), was not disinterested as required by § 327(a) of title 11 of the United States Code (the “Bankruptcy Code”). Warshaw Bur-stein expressed shock at my ruling, not only because the firm clearly did not appreciate it, 2 but because it claims it was not put on notice that I was going to raise and address what was in the papers but what the debtor did not address during his oral argument. Being a firm believer in due process and not wishing to deprive anyone of his or her right to be heard, I allowed Warshaw Burstein to respond in writing and then orally at a subsequent hearing. 3 I did this despite the fact that I regarded the issue of counsel’s disinterestedness to be sufficiently glaring from the papers submitted that adequate and sufficient notice of its existence was provided. However, that is only my opinion and reasonable minds do differ.
B. Background
1. The Lattingtown Question
Vebeliunas may or may not own a piece of property located in Lattingtown, New York, which was last valued at $4.5 million. When he filed his chapter 11 petition, Vebeliunas did not schedule the property, taking the position instead that it is owned by a trust in which he has a 20% interest. Several banks with liens against the property totaling less than $2 million moved to dismiss the chapter 11 case, asserting that Vebeliunas did indeed own the property but that they could pursue foreclosure in state court. Instead, because Vebeliunas may have significant unsecured
2. The Telephone Call With Monica Setikas
Prior to the debtor’s scheduled § 341 examination, 4 Vebeliunas’ assistant, Ms. Monica Setikas, telephoned Graham requesting information about the upcoming meeting. Her reason for calling, she claimed, was that Ve-beliunas had not received timely notice of it and that the notice he finally did receive contained inaccurate information. In response to her request, Graham allegedly told Ms. Setikas that he did not believe “anything the debtor said in this case,” that he was getting a court reporter and that Vebeliunas had better be at the meeting. This conversation was first brought to the court’s attention in Vebeliunas’ papers moving for the trustee’s disqualification. See Vebeliunas Moving Affidavit, ¶ 15. In his papers opposing the debtor’s motion, Graham recounts the same exchange as follows:
The Debtor’s suggestion in paragraph 15 of the Vebeliunas Affidavit that “Mr. Ba-bitt, without ever speaking to [him], has instructed his attorneys not to believe [him],” is also without any factual basis. The Debtor’s motion papers then go on to detail a conversation between Monica Seti-kas, an associate of the Debtor, and Warren R. Graham, a member of the Warshaw Burstein firm, and the author of these papers, quoting Mr. Graham as stating that he “did not believe anything Mr. Ve-beliunas said in this case.” While that quote is substantially accurate, the skepticism contained therein is entirely predicated on the record and the gross inconsistency of the Debtor’s position concerning ownership of the property, with among other things, his previous sworn statements. 5
See
Trustee’s Opposition, ¶ 19 (emphasis added). However, at the hearing, Graham testified that he did not remember the conversation with any specificity; with respect to his comment expressing his disbelief of Vebeliu-nas, Graham said he thought that he made that remark in connection with Vebeliunas’ claims of deficient notice. In their papers moving for reconsideration, neither the firm nor Graham makes any statement reflecting this position. In fact and significantly, the firm’s and Graham’s affidavits in opposition to disqualification continue to recount Graham’s remark to Monica Setikas as one expressing disbelief of anything the debtor had to say in the case generally.
See
Warshaw Burstein Affidavit in Opposition to Disqualification, ¶ 12; Graham Affidavit Annexed to Warshaw Burstein Affidavit in Opposition to Disqualification, ¶ 7. In paragraph 7 of Graham’s affidavit, he goes through a detailed list of reasons, only one of which was the repeated claim of deficient notice, why “in frustration and exasperation, [he] spontaneously remarked that [Graham] did not believe anything [Vebeliunas] said.” Graham Affidavit Annexed to Warshaw Burstein Affidavit in Opposition to Disqualification, ¶7. If Graham had wished to clarify the context in which he remarked on the debtor’s credibility, he had several opportunities to do so before the
de novo
hearing. But he did not. Had Graham not changed his story when he testified, it would have been unnecessary to make a credibility determination. But I believe I have no choice now other than to render such a determination. I find Gra
In the most recent brief submitted by Warshaw Burstein in opposition to its disqualification, Warshaw Burstein attempts to justify Graham’s conclusions about the debt- or by stating:
it is respectfully urged upon this court that when a debtor swears to directly contrary facts on numerous occasions and transfers the same piece of property numerous times outside the chain of title, it is not essential for the Trustee, or his counsel, to “get his side of the story” prior to concluding that he has no credibility.
See Warshaw Burstein Affidavit in Opposition to Disqualification, ¶27. Graham also suggested that his frustration and exasperation with the debtor 6 “together with the Debtor’s status as a convicted felon gave [Graham] ample justification to doubt [Vebel-iunas’] credibility, and did not impose upon [Graham] an additional duty ‘to get his side of the story.’ ” See Graham Affidavit annexed to Warshaw Burstein Affidavit in Opposition to Disqualification, ¶ 8. Notwithstanding Graham’s statements, Vebeliunas has contended in court papers that the other parties in interest misapprehend the facts relating to the chain of title of the property and Vebeliu-nas further says that he has an explanation to support his own view of the documents to which Graham has referred.
II.
Counsel’s compliance with the disinterestedness requirement under § 327(a) not only applies at the time of retention but also throughout the case,
see In re Granite Partners, L.P.,
The crux of Warshaw Burstein’s argument is that neither the trustee nor trustee’s counsel need be disinterested vis-a-vis the debtor and that counsel had no duty to question the debtor before concluding that he is completely untrustworthy. Further, Warshaw Bur-stein argues, Graham was entitled to disbelieve the debtor pre-examination without compromising counsel’s disinterestedness should I find that that standard applies to the firm.
III.
I feel compelled to first put to bed any doubt as to Graham’s bias and how I reached the conclusion that he possessed one. The pertinent facts are simple. Prior to any examination of the debtor by the trustee or his counsel in connection with the chapter 7 case, Graham made an unequivocal statement to the effect that he believed Vebeliunas to be a liar. In his affidavits, Graham manifested a further belief that the debtor did not deserve the opportunity to explain himself because he is a convicted felon.
See
Graham
Warshaw Burstein and Graham contend that the comments to Ms. Setikas about the debtor were perhaps “impolitic” but not serious enough to raise a question as to counsel’s disinterestedness. An impolitic remark is an unwise remark. See id. During his conversation with Ms. Setikas, had Graham quipped “Vebeliunas probably threw out the notice I sent him,” that would have been an unwise and inappropriate remark, but not one indicating bias or prejudice. However, telling a debtor’s representative that you don’t believe a word the debtor says before you have spoken with the debtor is significantly more troubling. It indicates a predisposition not to trust, listen to, believe in or have confidence in that person.
I recognize that, factually at least, this case is unique, unlike any other reported decision. Whereas most of the decisions regarding the propriety of the retention of counsel involve a conflict of interest, this case admittedly does not address an actual, potential or apparent conflict; the debate that surrounds disqualifying conflicts of interest is not implicated here. Jurisprudential precedent on this topic therefore may only serve to guide me as I make inroads into what amounts to be pristine territory.
See Board of Education of the City of New York v. Nyquist,
IV.
The Bankruptcy Code sets forth a two-pronged test for the retention of estate professionals.
See
11 U.S.C. § 327(a); 11 U.S.C. § 101(14). In order for the trustee to retain professionals to represent or assist him or her in carrying out the duties spelled out under § 704 of the Bankruptcy Code, those professionals must meet both requirements.
See Martin,
Unlike the “adverse interest” prong of the test, disinterestedness is delineated in the Bankruptcy Code. So far as relevant here, § 101(14)(E) of the Bankruptcy Code, more commonly known as the catch-all clause,
see Granite,
Warshaw Burstein does not deny that it must be disinterested but takes issue with whether it must be so vis-a-vis the debtor, since the latter is not named in the statute. See 11 U.S.C. § 101(14)(E). Only if I determine that the debtor is owed such a duty need I address the second question, which is whether Graham’s bias constitutes a lack of disinterestedness under the second prong of § 327(a).
A. Must Warshaw Burstein Be Disinterested As To The Debtor?
1. The Debtor As A Potential Equity Security Holder
Counsel’s obligation to be disinterested runs to the parties in interest.
See Marvel,
Pursuant to § 726(a)(6), if all of Vebeliunas’ obligations are satisfied, he will be entitled to any surplus proceeds generated by the liquidation of the Lattingtown property.
8
Thus, this debtor should be considered a party in interest,
see
Collier, ¶ 502.02[2][c] at 502-14;
McCorhill,
2. “Or For Any Other Reason”
Separate and apart from whether or not Vebeliunas can be considered tantamount to an equity security holder under § 101(14)(E), there is a strong argument to be made that the “or for any other reason” language at the end of that subsection is intended, as noted by Collier,
10
to permit
B. Standards of Disinterestedness
Courts examine the goals and purposes of the disinterestedness requirement in order to understand the full contours of that concept. To be disinterested is “to prevent even the appearance of a conflict irrespective of the integrity of the person or firm under consideration.”
In re Codesco,
Any determination regarding Graham’s disinterestedness would not be complete without also taking into account the fiduciary duties he has as counsel to the chapter 7 trustee. A trustee in bankruptcy,
see King v. United States,
Moreover, as an attorney admitted to practice in the State of New York, Graham is subject to the American Bar Association’s Code of Professional Responsibility, specifically Canons 5 and 9, which require that a lawyer exercise independent judgment on behalf of his client and that “a lawyer should avoid even the appearance of impropriety.” Model Code of Professional Responsibility, Canons 5 and 9 (1997). Without a doubt, this case differs from the archetypical conflicts case which gives rise to consideration of the Canons. Canon 5 applies by analogy, a situation which is not so unfamiliar in the bankruptcy context because the Canons of Professional Responsibility are not an exact fit in cases involving potentially hundreds of parties and shifting alliances.
See
Gerald K. Smith, “Standards for the Employment of Professionals in Bankruptcy Cases: A Re
Most courts acknowledge that to be disinterested also requires an attorney to heed the admonition contained in Canon 9.
See Martin,
C. Counsel Is Not Disinterested
Just because there is no conflict of interest does not mean that the disinterestedness standard has not been violated and that there has not been a breach of the Canons of the Code of Professional Responsibility. Where there is a conflict, the fear is that counsel’s attention and loyalty are divided by the dual representation or that counsel is swayed by an economic or personal interest so that one party is favored over another.
See generally Leslie Fay,
Another reason why this case is different from the more typical one is, for lack of a better term, the direction of the bias. While the
ratio decidendi
of most cases dealing with conflicts of interest centers on the actuality or eventuality that counsel will favor or is favoring one party over another, there is a flip side to this coin. Where one party is actively or purposely favored, another party becomes disfavored. Thus, whether counsel is disfavoring one party over another is equally significant to a court’s reasoning in determining whether or not counsel is disinterested. The reason the latter construct is probably less often discussed is because the natural course of events assumes the former:
Graham’s attitude is impossible to reconcile with counsel’s fiduciary duties to the debtor as well as his duty to avoid even the appearance of impropriety and to exercise independent judgment. Graham is not disinterested as to Vebeliunas as Graham is required to be, either because Vebeliunas is potentially akin to the class of equity security holders under § 101(14)(E) or because Graham fails the disinterest test pursuant to a more expansive reading of that subsection’s last clause. His bias impairs “the high degree of impartiality and detached judgment expected from [counsel to the trustee]” during a case. Collier, ¶ 327.04[3][a] at 327-30; see supra n. 11. Without a doubt Graham has leapfrogged right over the mere appearance of impropriety to land four-square on impropriety itself. This is not a situation where ethical concerns are raised by circumstantial evidence. There is direct evidence of actual bias and prejudice against the debtor. Warshaw Burstein was retained to assist the trustee in performing his duties, such as spearheading the investigation of the financial affairs of the debtor and counseling the trustee to oppose the debtor’s discharge, if advisable. See 11 U.S.C. § 704. Graham has a fiduciary duty on behalf of the trustee, the estate and the debtor to carry out these tasks impartially. This is why he must be disinterested. In explaining why counsel for a chapter 11 trustee needed to be disinterested, the court in Philadelphia Athletic Club explained:
This, of course, ... (was) quite sensible, for it would be anomalous indeed to require a trustee to be aloof from all connection with the debtor or its management, yet permit the trustee’s attorney, who would necessarily be active in furthering the trustee’s duties of investigation, management, prosecution, development of plans and the like, to have a close relationship with the debtor, its management or associates.
Philadelphia Athletic Club,
D. Disinterestedness Aside, Counsel Should Be Removed
At least one court has found that disinterestedness need not be the exclusive test when evaluating the propriety of an attorney’s retention.
16
In
In re Kurtzman,
Indeed, section 327(a) vests the authority for “approval” within the sound discretion of the Court. That authority would be eviscerated were the Court required to approve counsel who met the technical test for disinterest but was ill-suited for other reasons such as, for example, inexperience.
Id.
at 542. Recognizing that the Third Circuit’s decision in
Marvel
limited disqualification of an attorney on the basis of conflicts of
Marvel, however, did not bar considerations other than conflict of interest in a court’s determination of whether to appoint an attorney as trustee’s counsel under § 327(a). Thus, while disinterestedness and the absence of conflicts may be central to the inquiry, they are by no means exclusive.
Id.
Applying that rationale to this case, I believe Graham is ill-suited to serve as the trustee’s counsel because of his expressed prejudice against the debtor.
Cf. Plaza Hotel,
V.
Without question, I am vested with the authority to disqualify counsel where there is evidence of lack of disinterestedness or an ethical violation justifying such a sanction.
See Cheng v. GAF Corp.,
In this regard, “disqualification has been ordered only in essentially two kinds of cases: (1) where an attorney’s conflict of interests in violation of Canons 5 and 9 of the Code of Professional Responsibility undermines the Court’s confidence in the vigor of counsel’s representation, or, more commonly, (2) when the attorney is at least potentially in a situation to use privileged information concerning the other side through prior representation ...”
Nyquist,
However, while separating a client from his or her chosen counsel will undoubtedly cause disruption, “where the choice of counsel must be approved by the court as appropriate, such that the integrity of the judicial process is implicated, the cost and delay of replacing counsel with a conflict of interest may be outweighed.”
Leslie Fay,
I have found Graham to be lacking in disinterestedness. To reach this conclusion, I have considered the standards of disinterestedness, the fiduciary duty imposed on counsel as an officer of the court, and the Code of Professional Responsibility. Adopting the analogy between the estate and a client that I suggested before, Graham’s prejudice clearly clouds and will continue to cloud his independent judgment when making decisions regarding estate matters in violation of Canon 5, particularly with respect to decisions involving the investigation which he is conducting, the likely Latt’ugtown property litigation and whether to oppose the debt- or’s discharge. Inasmuch as Graham is biased, he has also, by definition, committed the “lesser included offense” of not avoiding even the appearance of impropriety. The breach of Canon 9 is premised on Graham’s very real manifestation of impropriety and is not based on any “horrible imaginings alone.”
Martin,
VI.
The only remaining issue is whether the whole firm must be disqualified or whether, as the firm requests, only Graham need be removed. The general rule is that when one member of a firm is disqualified, all members of that firm must be similarly disqualified.
See United States v. Reynoso,
SETTLE ORDER on the debtor and the trustee consistent with this decision.
Notes
. I wish only to use this event in history to describe the potential evils of bias. I express no position whatsoever on the impeachment of President Clinton.
. After the hearing, I received a scathing letter from Edgar Booth of Warshaw Burstein, asserting that my ruling had impugned the integrity of not only Graham, but himself and, ultimately, the whole firm. That leap of logic, or illogic, continues to mystify me. Moreover, I am not impugning Graham’s integrity as an attorney appearing in this court. What I am saying is that he has exhibited in this case an unfortunate bias which demands his removal.
.I have treated this matter de novo, rather than as a motion for reconsideration, inasmuch as Warshaw Burstein questioned whether it received due process the first time round.
. To date, no § 341 examination has taken place.
. The banks seeking dismissal of the case had asked, when the case was retained, that the state court receiver for the property also be retained. They ultimately withdrew that request in favor of having the trustee administer the property, which, by the way, is income producing. Vebeli-unas countered with an assertion that the trustee could not administer the property because it did not belong to the debtor's estate. Graham probably extrapolated from Vebeliunas’ petition and his opposition to the request for the trustee to administer the property as well as from documents which the banks showed Graham from the time when their mortgages were granted that Vebeliunas was not credible, despite the fact that Graham had not yet asked Vebeliunas if there was any explanation for what Graham saw as inconsistencies.
. I do not mean to suggest that the debtor is the cooperative, easy-going sort. Graham's frustration and exasperation may be quite legitimate. The issue, however, is not whether Graham has good reason for disliking Vebeliunas.
. Quoting Walter Moberly, the dictionary gives a particularly apt illustration of the word's meaning: "The most pernicious kind of bias consists in falsely supposing yourself to have none.”
. Since standing is limited to parties in interest,
see Licensing by Paolo, Inc. v. Sinatra (In re Gucci),
. The lack of precision in the statute may well be due to Congress’ desire to have one standard of disinterestedness apply to professionals for all sorts of debtors' estates be they corporate, partnership or natural persons.
. In its discussion of the term disinterested person as defined in § 101(13) — -now renumbered § 101(14) — of the Bankruptcy Reform Act of 1978, Collier states:
The enunciated elements provide a minimum standard for the guidance of the court in its appointments, and insure that the persons employed shall have the essential character of independence and disinterestedness which is required. These elements do not, however, establish an exclusive standard. As was the case under pre-Code bankruptcy practice, (continued by virtue of the "catchall” provision of clause (E)), if a court deems a particular person’s associations to be prejudicial to disinterestedness, it may reject him even though those associations do not come strictly within the purview of section 101(13). Thus, the phrase "or for any other reason" permits the court to find a particular person lacking in disinterestedness for reasons other than the non-exclusive statutory guidelines.
As noted above, clause (E) may be termed a "catch-all clause," and it seems broad enough to include anyone who in the slightest degree might have some interest or relationship that, would even faintly color the independent and impartial attitude required by the Code and Bankruptcy Rules. The reasons supporting this extensive inclusion are the same, of course, as those previously recounted. Indirect or remote, as well as direct, associations or affiliations may engender conflicting loyalties.
It is clear, therefore, that the definition of disinterested person in paragraph (13) promotes the policy that as a general principleprofessionals engaged in the conduct of a bankruptcy case should be free of the slightest personal interest which might be reflected in their decisions concerning matters of the debt- or’s estate or which might impair the high degree of impartiality and detached judgment expected of them during the course of administration.
1 Collier Bankruptcy Manual, § 101.13(1981).
. The following cases are examples of courts using the "high degree of impartiality and detached judgment" language quoted above or its slight variation "faintly color the independent and impartial attitude required by the Code," also from the same Collier Bankruptcy Manual excerpt, to elucidate disinterestedness:
Crivello,
. This language is only slightly modified in the current edition of Collier on Bankruptcy. See 4 L. King, Collier on Bankruptcy, ¶ 327.04[3][a] at 327-30 (15th ed. rev. 1996).
. Obviously, both chapter 7 and chapter 11 trustees are officers of the court. Many of the cases discussing the fiduciary duties of a trustee and his or her counsel are those involving chapter 11 trustees, which, independently under the Bankruptcy Code, must be disinterested. See § 1104(b). Although that may not be a requirement for a chapter 7 trustee elected by creditors, it is a requirement for an interim trustee who becomes a permanent trustee under § 702(d) because interim trustees are required to be disinterested under § 701(a)(1). Such is the case here. Accordingly, those cases describing the fiduciary duties of counsel to a disinterested trustee also apply here.
. New York has not adopted the newer American Bar Association's Model Rules of Professional Conduct but adheres to the Model Code of Professional Responsibility.
. Although the word "disinterestedness” is employed in this sentence, it is clear from the context that the Third Circuit intended interestedness or lack of disinterestedness. In this vein, because I find Graham has demonstrated bias, my holding that he is not disinterested on that basis does not run afoul of the teachings of
Marvel.
The Third Circuit in
Marvel
acknowledged a
per se
rule for disqualification of counsel holding an actual conflict of interest, a rule for discretionary disqualification of counsel with a potential conflict of interest and a prohibition against disqualification of counsel based on an appearance of conflict alone.
See Marvel,
. If one reads the last clause of § 101(14)(e), "or for any other reason,” broadly, as I believe is its proper construction, then Kurtzman could come within the failure of disinterestedness.
. Another reason motions for disqualification are frowned upon is that they are often interposed for tactical reasons.
See Nyquist,