Court Orders Turnover of Attorney Files in Billion Dollar Case

Attorneys are entrusted with a lot of sensitive information. The attorney-client privilege exists to allow clients to speak candidly with their attorneys. However, when the same attorney represents multiple parties, the privilege may not be so absolute. In the case of In re Crescent Resources, LLC, No. 09-11507 (Bankr. W.D. Tex. 7/22/11), Bankruptcy Judge Craig Gargotta was asked to decide who could access the attorney files in a billion dollar dispute. You can find the opinion here.



What Happened



Crescent Resources was a real estate development and management organization. It was formed by Duke Energy Corporation to manage and develop approximately 300,000 acres of real estate owned by Duke. Crescent grew over the years, eventually operating about 100 projects through over 120 entities. In 2006, Duke, Crescent and several real estate investment entities entered into a series of transactions where the Crescent entities pledged their assets to secure a loan from Bank of America in the amount of $1.225 billion, much of which was upstreamed to Duke.



By June 2009, the Crescent entities had filed for chapter 11 in Austin, Texas. The Court confirmed a plan which created a litigation trust. The litigation trust sued Duke Energy Corporation, et al alleging that the 2006 transaction rendered the debtors insolvent. Shortly after filing suit, Dan Bensimon, the litigation trustee, filed a motion to compel a firm named Robinson, Bradshaw & Hinton, P.A. (RBH) to turn over its files with regard to work done for the debtors. RBH responded that it had concerns about Duke's rights to keep the files confidential. After five months of procedural wrangling, the Court conducted a hearing and took the matter under advisement.



The files at issue fell into three categories: 1) pre-2006 files from the period when Crescent was a subsidiary of Duke; 2) files related to the 2006 transaction (known as Project Galaxy); and 3) files subsequent to 2006 when Crescent was no longer a Duke subsidiary.



On July 22, 2011, the Court delivered its decision. Based on stipulations, it was largely clear that Crescent was a joint client with Duke for the pre-2006 files and was the sole client for the post 2006 files. That left the Project Galaxy files. The Court ruled that the Trust was a joint client and thus entitled to use the files in its litigation with Duke.



Turnover/Burden of Proof



Section 542 has two relevant subsections relating to turnover. Sec. 542(a) provides that a person in possession of property which the trustee may use, sell or lease shall turn over such property to the trustee. On the other hand, Sec. 542(e) provides that "(s)ubject to any applicable privilege . . . an attorney, accountant, or other person that holds recorded information . . . related to the debtor's property or financial affairs" can be ordered to "turn over or disclose such recorded information to the trustee."



The Court found that the Trust had the initial burden to establish that the files "related to the debtor's property or financial affairs." At that point, the burden would shift to Duke to show that there was an attorney-client privilege between Duke and the law firm. The Court also rejected arguments from Duke that the Trust's burden had to be met by clear and convincing evidence. Instead, it found that the preponderance standard applied.



Project Galaxy



Having established this framework, the Court, following the lead of the parties, apparently assumed that the Trust had met its burden to show that the files related to the debtor's property or financial affairs. As a result, the Court spent the rest of its opinion discussing whether the Trust was "a joint or sole client, or no client at all, of RBH with respect to the Project Galaxy files." Opinion, p. 13.



Duke made an interesting argument. It suggested that RBH represented Crescent prior to Project Galaxy and after Project Galaxy, but that Crescent was not represented at all during Project Galaxy.

The Trust argues that RBH represented Crescent Resources, while Duke would have the Court believe that RBH jointly represented Crescent Resources before the 2006 Duke Transaction and after the 2006 Duke Transaction, but not during the 2006 Duke Transaction. Duke further alleges that Crescent Resources was not represented by counsel at all during the 2006 Duke Transaction.

Opinion, p. 14.



The Court had to analyze North Carolina law to determine whether Crescent had an attorney client relationship with RBH. North Carolina considers the question to be primarily one of fact and does not rely on formalities.



The Trust was able to bring forward some pretty good evidence. In its application to be employed in the Crescent bankruptcy case, RBH stated that it had represented Crescent since 1986. It also presented an Opinion letter in which RBH stated that it had represented Crescent and certain of its subsidiaries in connection with the execution and delivery of a credit agreement. Finally, several of the RBH lawyers stated that they had represented Crescent in $1.5 billion credit transaction.



Duke argued that it retained RBH to represent it in the transaction and that everyone but Crescent was represented by counsel. Duke presented evidence such as the engagement letter and declarations from RBH lawyers. However, the Engagement Letter stated that the firm was engaged to represent Duke Energy (or any of its subsidiaries or affiliates)." All invoices were submitted to and paid by Duke. Furthermore, RBH said that it took its direction from Duke and not Crescent and that no one at Crescent ever said that they thought they were represented by RBH.



The Court weighed several factors under North Carolina law, finding that:



1. Crescent was not represented by other counsel;

2. Crescent had been represented by RBH in the past;

3. RBH had access to Crescent's confidential information;

4. The services were billed to Duke, not Crescent;

5. RBH represented Crescent after the transaction;

6. There was no withdrawal of representation.



Weighing these factors, the Court found that RBH did, in fact, represent Crescent during the Galaxy Project transaction.



The Court relied on North Carolina law to find that "where two or more persons employ the same attorney to act for them in some business transaction, their communications to him are not ordinarily privileged inter sese." The Court also relied upon its own decision in In re Bounds, 443 B.R. 729 (Bankr. W.D. Tex. 2010), a case in which I represented the debtor subsequent to the events in the opinion.



In the end, the Court found that Crescent was a joint client and could use the files in its litigation with Duke but not otherwise.



The Court's order has been appealed and is subject to a stay pending appeal. As a result, it may be a while before the Trustee finds out what, if anything, is contained in the law firm's files. However, given the effort that Duke is taking to keep the files confidential, it may well be interesting.



I think the take away from this case is that if you are doing a billion dollar deal, make sure that everyone has their own counsel. It will be more expensive and may be more difficult, but at least your privileged will be protected.



Disclosure: My firm has engaged Dan Bensimon as a consultant and expert in several cases. Indeed, I would go so far as to say that he is a friend of the firm and an all around good guy. However, we do not represent him in the Crescent case and this post is based solely on my reading of Judge Gargotta's 39-page opinion. If you want to know as much as I do, read the opinion for yourself.

Preserving Causes of Action In Plans

These days, defendants are getting more aggressive about repelling suits from bankruptcy estates. From jurisdictional squabbles based on Stern v. Marshall to judicial estoppel to failure to preserve a cause of action in a plan, the plaintiff’s road to judgment is just more difficult than it used to be. However, two recent decisions are examples of suits which avoided being detonated by clever challenges. In Matter of Texas Wyoming Drilling, Inc., No. 10-10717 (5^th Cir. 7/21/11), a chapter 7 trustee prevailed against a claim that the former debtor in possession had failed to failed to make a “specific and unequivocal” reservation of claims and defeated a judicial estoppel claim. In Crescent Resources Litigation Trust v. Burr, No. 11-1013 (Bankr. W.D. Tex. 7/22/11), a litigation trust created by a plan defeated a defense that claims had not been adequately preserved. (There was another very interesting decision released in the Crescent case the same day about turnover of files from the debtors’ former attorneys. Because that case does not retention language under a plan, I will save that one for another day). You can find the opinions here and here.

The Disclosure Statement Wins Out

The Debtor in Texas Wyoming filed for chapter 11 relief and confirmed a plan. The plan provided for preservation of “Estate Claims.” The Disclosure Statement defined “Estate Claims” as claims arising under Chapter 5 of the Bankruptcy Code and included a chart listing potential claims, including “Various pre-petition shareholders of the Debtor” who might be sued for “fraudulent transfer and recovery of dividends paid to shareholders.”

The Debtor then sued its former shareholders to recover dividends paid under a fraudulent conveyance theory. The defendants sought to dismiss the action claiming that: (a) the Plan did not include a “specific and unequivocal” reservation of claims, (b) the disclosure statement did not name the parties who could be sued; and (c) the Debtor did not disclose the claims in its schedules.

Under Fifth Circuit precedent, a plan must “specifically and unequivocally” retain a cause of action. In re United Operating Company, 540 F.3d 352 (5^th Cir. 2008). If the claim is not adequately reserved, then the post-confirmation debtor lacks standing to pursue it.

When the plan failed, the case was converted and the chapter 7 trustee pursued the claims. The Bankruptcy Court denied the defendants’ motion, but certified a direct appeal to the Fifth Circuit. The Fifth Circuit, in an opinion authored by Edith Brown Clement, made short work of the defendants’ claims.

The Fifth Circuit found that it was permissible to consult the disclosure statement to see whether claims had been adequately disclosed. The Court stated:

We observe that the disclosure statement is the primary notice mechanism informing a creditor’s vote for or against a plan. See 11 U.S.C. § 1125. Considering the disclosure statement to determine whether a post-confirmation debtor has standing is consistent with the purpose of In re United Operating’s requirement: placing creditors on notice of the claims the post-confirmation debtor intends to pursue. (citation omitted). In light of the role served by the disclosure statement, the purpose behind the rule in In re United Operating, and the fact that, in similar contexts, courts routinely consider the disclosure statement to determine whether a claim is preserved, we hold that courts may consult the disclosure statement in addition to the plan to determine whether a post-confirmation debtor has standing.

Opinion, pp. 6-7.

While the language in the Plan was generic, the language in the Disclosure Statement identified claims arising under Chapter 5 and stated that pre-petition shareholders were at risk for being sued for recovery of dividends. That was enough to satisfy the “specific and unequivocal” requirement under prior Fifth Circuit precedent.

The Fifth Circuit also rejected the argument that failure to list the claims in the schedules would bar the claims under the doctrine of judicial estoppel. The Court noted that there was no inconsistent position taken since the Disclosure Statement specifically identified the claims.

The defendant’s argument founders on the first requirement because TWD did not take clearly inconsistent positions. As explained above, TWD’s plan and disclosure statement retained the right to pursue the Avoidance Actions. Because TWD explicitly retained the same claims against the defendants that the trustee is now pursuing, there is no inconsistency in its position.

Opinion, p. 9.

This holding is a victory for common sense interpretation versus the magical view that any failure to disclose evaporates the claim.

The take away from Texas Wyoming is that careful drafting at the disclosure statement stage may avoid creditor heartaches down the road.

Court Chooses the Categorical Approach

The Crescent Resources case involved 122 related debtors who filed a chapter 11 bankruptcy in Austin in 2009. On December 20, 2010, the Court confirmed the Debtors’ Revised Second Amended Plan of Reorganization. A major feature of the plan was creation of a Litigation Trust. One claim pursued by the Trust was against Edward Burr, a former insider of the Debtors. The claims involved two transactions:

1. Payment of $1.925 million to Burr in April 2007 to cover his personal tax liabilities; and

2. Payment of $4.5 million in cash plus forgiveness of $71 million in debt owed to Crescent in November 2007 in return for termination of his employment and conveyance of a 20% interest in one of the debtors.

The Trustee alleged that the transfers constituted fraudulent conveyances under state and bankruptcy law. The Defendant sought to dismiss the claims, asserting that the plan had not “specifically and unequivocally” reserved the claims and asserting failure to plead fraud with specificity.

The Defendant raised two arguments with regard to retention of claims: 1) that the plan failed to disclose that the Trust would pursue claims against him personally; and 2) that if the overall description was sufficient, that the plan failed to preserve claims for turnover pursuant to 11 U.S.C. §542.

The Plan provided that:

The Litigation Trust Assets shall include, but are not limited to, those Causes of Action arising under Chapter 5 of the Bankruptcy Code including those actions which could be brought by the Debtors under §§ 544, 547, 548, 549, 550, and 551 against any Person or Entity other than the Litigation Trust Excluded Parties.

Causes of Action was defined to mean “any and all Claims, Avoidance Actions, and rights of the Debtor, including claims of a Debtor against another Debtor or other affiliate.”

It is clear that neither the Plan, the Trust Agreement or the Disclosure Statement specifically referred to Mr. Burr or referred to claims for turnover under 11 U.S.C. §542.

The opinion contains an excellent discussion of the cases interpreting United Operating. At the conclusion of its discussion, the Court summarized as follows:

(W)hile the Fifth Circuit has not defined what “specific and unequivocal” means, cases have interpreted different plan language on case-by-case bases which this Court can use as guideposts with which to judge the plan language at issue here. Courts have held that listing causes of action by code section is sufficiently “specific and unequivocal.” (citations omitted). The courts have also held that a generic blanket reservation is insufficient. (citations omitted).

The cases in the Fifth Circuit all cited United Operating. United Operating, in making its holding, also discussed that one of the purposes of bankruptcy is to “secure prompt, effective administration and settlement of all debtor‟s assets and liabilities within a limited time.”(citation omitted). In order to facilitate this resolution of the estate, “a debtor must put its creditors on notice of any claim it wishes to pursue after confirmation.” (citation omitted). It is for this reason—notice to creditors—that the Fifth Circuit determined that the retention language needed to be “specific and unequivocal.” (citation omitted).

This Court agrees with the reasoning behind those cases applying what has been referred to as the “Categorical Approach,” and adopts the test established in Texas Wyoming Drilling to determine if the plan language meets the “specific and unequivocal” requirement. (citation omitted). That test, again, was to make a determination “whether the language in the [p]lan was sufficient to put creditors on notice that [the debtor] anticipated pursuing the [c]laims after confirmation.” (citation omitted). If so, the language meets the “specific and unequivocal” requirement.

Opinion, pp. 21-22.

The Court found that the reference to “state fraudulent transfer law claims” was not specific and unequivocal because it did not refer to a specific code cite. The Court went on to find that a reference to “Causes of Action arising under chapter 5 of the Bankruptcy Code, including those actions which could be brought by the Debtor under §§544, 547, 548, 549, 550, and 551” was sufficiently detailed so that “a creditor could not feign surprise that the Trust would pursue a claim under Section 542.”

Conclusion

Taken together, Texas Wyoming and Crescent Resources set a fairly low bar for preserving claims and causes of action under a plan. Both cases take a pragmatic attitude, essentially relying on a surprise standard. From a policy standpoint, it is about fairness. If a creditor is being asked to vote on a plan, it should be clear whether that person runs the risk of being sued. In Texas Wyoming, the Disclosure Statement clearly signaled that the Debtor intended to sue former shareholders who had received dividends. In Crescent Resources, the language could have been stronger, but it wasn’t really surprising that an insider who had received large transfers prior to bankruptcy would be sued.

While the Court found that the Crescent language was sufficient, it would have been stronger if it had referred to “Causes of Action arising under chapter 5 of the Bankruptcy Code, including those actions which could be brought by the Debtor under §§542, 543, 544, 545, 547, 548, 549, 550, 551, 552 and 553 which may be brought against any entity receiving a transfer from any of the Debtors during the four years prior to bankruptcy, including but not limited to insiders, employees, officers, and equity holders of the Debtors.”