Last Thursday, a Delaware Bankruptcy Court disqualified two law firms from representing an Official Committee of Unsecured Creditors based on their conduct in soliciting proxies from creditors who were not existing firm clients. In re Universal Building Products, No. 10-12453 (Bankr. D. Del. Nov. 4, 2010), involved an extreme fact pattern but it may nonetheless have a substantial effect not only on the selection of professionals for future Committees but also on the appointment of creditors to Committees, at least in Delaware.
The two law firms in question worked through a Chinese intermediary to “cold call” the Chinese creditors of Universal Building Products in order to encourage them to provide proxies for the Committee formation process. Based in part on those proxies, the two law firms were selected as Committee counsel. The Debtor and the Committee quickly clashed on the direction of the case, and when the Debtor became aware of the Committee solicitation process, the Debtor sought to disqualify the two Committee law firms on three grounds: (1) violation of rules 7.3 and 8.4 of the Delaware Rules of Professional Conduct; (2) failure to adequately disclose connections with parties in interest as required by Bankruptcy Rule 2014(a); and (3) failure to be disinterested as required by sections 1103(a) and 328 of the Bankruptcy Code.
The law firms objected on a number of grounds, including that other law firms seeking the Committee assignment had engaged in similar conduct. Unpersuaded, the Bankruptcy Court jettisoned the two law firms based on the first two of the three grounds asserted by the Debtors. The Court concluded that the use of an intermediary to cold call creditors who were not existing clients was an ethical no-no, and that the law firms’ disclosures about the terms of their engagement should have disclosed the solicitations. In response to the law firms’ plea that other law firms had engaged in the same conduct, the Bankruptcy Court invoked the time-honored legal maxim of “two wrongs don’t make a right.”
From a broader perspective, the most important aspect of the Universal Building Products decision is not that the Court whacked two law firms upside their heads for improper solicitation. In fact, the most important aspect is not even any of the holdings of the Court. Instead, it is the Court’s self-styled “Further Recommendations” at the very end of the decision. There, after stating that all professionals (not just law firms) are required to disclose if they use intermediaries to solicit creditors’ proxies, the Court recommends that the US Trustee “might consider amending the questionnaire it sends to prospective committee members to include questions whether they were solicited by anyone in connection with the case.” This has the potential to put prospective Committee members and prospective professionals into a deep freeze. The US Trustee has broad discretion as to who it appoints to a Committee. While the court’s recommendation is borne out of a legitimate concern for the improper solicitation of proxies from non-clients, one could easily see the US Trustee taking it a step further in particular cases by deciding not to appoint to the Committee any creditor who has been solicited by any professional prior to the Committee formation. This potential problem would be compounded by the fact that US Trustees typically do not give reasons as to why they do or don’t appoint particular creditors to a Committee. Whether this actually comes to pass, we shall see, but in the meantime, we suggest that professionals only call clients and do not solicit proxies even from creditors who are clients. We further suggest that creditors be very wary of calls from professionals if those creditors want to be appointed to a Committee. When in doubt, which is exactly where we are until there is some experience under our belts with the Court’s recommendation, caution should be the rule.