F.D.I.C. v. U.S. Fire Ins. Co.

• Decision Date: 12 April 1995
• Docket Number: No. 93-9189,93-9189
• Citation: 50 F.3d 1304
• Parties: FEDERAL DEPOSIT INSURANCE CORPORATION, as Manager for the FSLIC Resolution Fund, Plaintiff-Appellant, v. UNITED STATES FIRE INSURANCE COMPANY, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1304

50 F.3d 1304

FEDERAL DEPOSIT INSURANCE CORPORATION, as Manager for the FSLIC Resolution Fund, Plaintiff-Appellant, v. UNITED STATES FIRE INSURANCE COMPANY, Defendant-Appellee.

No. 93-9189.

United States Court of Appeals Fifth Circuit.

April 12, 1995.

Michelle Kosse, Manuel A. Palau, F.D.I.C., Washington, DC, for appellant.

Michael D. Farris, Karen A. Kohler, Vial, Hamilton, Koch & Knox, Dallas, TX, for appellee.

Appeal from the United States District Court for the Northern District of Texas.

Before REYNALDO G. GARZA, DeMOSS and BENAVIDES, Circuit Judges.

DeMOSS, Circuit Judge:

This is the second interlocutory appeal of an attorney disqualification order. In the underlying litigation, plaintiff-appellant, the Federal Deposit Insurance Corporation ("FDIC"), successor to the rights of Irving Savings Association ("Irving Savings"), seeks to recover on an insurance policy issued by defendant-appellee, the United States Fire Insurance Company ("U.S. Fire"). To establish certain of its affirmative defenses, U.S. Fire plans to call as witnesses Ann Kenney and Jeff Hurt, two of the attorneys representing the FDIC. U.S. Fire moved the district court to disqualify Kenney, Hurt, and their law firm, Leonard, Marsh, Hurt, Terry & Blinn, P.C. ("LMHT & B" or "the firm") asserting that the FDIC would be prejudiced if its attorneys served as both advocates and witnesses at trial. The district court granted U.S. Fire's motion to disqualify despite the FDIC's informed consent to the representation. In the first appeal, we remanded the cause for reconsideration in light of recent precedents. On remand, the district court granted U.S. Fire's motion a second time and ordered attorneys Kenney and Hurt, and LMHT & B, disqualified from representing the FDIC in this case. Once again, the FDIC appealed, challenging the disqualification of Hurt and the law firm, but not appealing Kenney's disqualification. We AFFIRM the district court's order as to the disqualification of Hurt. We VACATE the order to the extent that it disqualifies LMHT & B, and we REMAND the matter to the district court with instructions to deny the motion as to LMHT & B.

I. FACTUAL BACKGROUND

In December 1982, U.S. Fire issued a savings and loan blanket bond to Irving Savings. The bond insured against certain losses that the savings and loan might suffer, including those arising from the fraudulent or dishonest conduct of Irving Savings' employees. Under the terms of the bond, Irving Savings was covered for losses incurred through dishonesty only if it filed notice and proof of loss with U.S. Fire no more than 100 days after discovering the dishonesty.

In 1984 Irving Savings retained Hurt and LMHT & B to represent it in several out-of-state collection matters. Earl Hall, a deputy commissioner of the Texas Savings and Loan Department ("TSLD"), contacted Hurt on behalf of Irving Savings in late August. In September 1984, with the concurrence of Hall and the TSLD, Irving Savings formally engaged LMHT & B to help collect on some of its loans. The savings and loan, under the direction of the TSLD, turned over various loan transactions to Hurt within the next few weeks. On November 8, 1984, Hurt attended a meeting of the board of directors of Irving Savings. At this meeting, the directors discussed problem loans. According to the minutes of the meeting, Hurt notified the board that it appeared that various officers of Irving Savings had breached their fiduciary duties by making loans that were uncollectible. Hurt stated that in his opinion some of these loans had been uncollectible at the time they were made.

Hurt soon turned over day-to-day management of the Irving Savings collection effort to Kenney, then an associate with LMHT & B. By the first quarter of 1985, Kenney was Irving Savings' primary contact at LMHT & B, and the savings and loan was referring matters directly to her. One of Kenney's responsibilities was to serve as a conduit for information between Irving Savings, its out-of-state counsel, and another law firm employed by Irving Savings, Jenkins & Gilchrist. Ronald Rosener was Irving Savings' primary contact at Jenkins & Gilchrist.

Irving Savings retained John C. Eichman of Jenkins & Gilchrist in the spring of 1985 to investigate the possibility of a bond claim. On May 17, 1985, Eichman sent U.S. Fire a written notice of loss on behalf of Irving Savings. At Eichman's request, Kenney sent letters to Irving Savings' out-of-state counsel inquiring about potential bond claims. Kenney prepared a written summary, dated June 21, 1985, which contained information she had received from these out-of-state counsel, out-of-state publications, Irving Savings, and Jenkins & Gilchrist attorneys. Based on the information he received from Kenney and others, Eichman filed a claim with U.S. Fire alleging a covered loss arising out of the dishonesty of four Irving Savings employees. ¹ He prepared a proof of loss on behalf of Irving Savings and sent it to U.S. Fire on August 14, 1985.

On July 21, 1986, Jenkins & Gilchrist turned over representation of Irving Savings on the bond claim to LMHT & B. From that date until December 10, 1987, Kenney acted as the liaison between Irving Savings and U.S. Fire's retained counsel, the Law Offices of Paul Vernon. In August or September 1986, Vernon turned over the investigation to his associate Mike Duray.

The parties disagree about how to characterize what happened next. Kenney was not immediately forthcoming with all of the paperwork requested by Duray. On the ground that they contained privileged communications, she redacted portions of the minutes of Irving Savings' board of directors meetings before sending them to Duray. Kenney did not provide copies of some other documents specifically requested by Duray. She also delayed executing an amended reservation of rights agreement for several months despite Duray's repeated inquiries. Duray and U.S. Fire accuse Kenney of deliberate obstruction and bad faith. Kenney and the FDIC characterize her conduct as innocent error or oversight.

II. PROCEDURAL BACKGROUND

On December 10, 1987, Irving Savings filed a complaint in the district court, alleging that U.S. Fire had breached its contractual obligations under the blanket bond. U.S. Fire answered the lawsuit and denied liability under the bond. Shortly thereafter Irving Savings was declared insolvent and the Federal Savings and Loan Insurance Corporation ("FSLIC") was named as receiver.

U.S. Fire filed a motion to disqualify Kenney and Hurt as counsel for the FSLIC on the ground that they might be called as witnesses. On July 21, 1989, Irving Savings amended its complaint to include an allegation of a breach of duty of good faith. In its second amended answer, U.S. Fire asserted 21 affirmative defenses, including three that are relevant to the issue of attorney disqualification: comparative bad faith, discovery, and takeover. Appellant FDIC was formally substituted for the FSLIC as plaintiff in the litigation on January 3, 1990. Three weeks later, U.S. Fire filed a supplemental motion to disqualify counsel for the FDIC.

In June 1991, the district court held a three-day evidentiary hearing on U.S. Fire's motions to disqualify the FDIC's counsel. At the hearing, U.S. Fire called as witnesses Robert Nelson, the former executive vice-president and treasurer of Irving Savings, and Duray, Kenney, and Hurt. Irving Savings cross-examined each of the witnesses, and additionally, midway through its cross-examination of Kenney and just before the hearing was recessed at the end of the second day, Irving Savings called as a witness Robert DeHenzel, senior attorney in the FDIC's professional liability section. DeHenzel testified that he was familiar with both the motion to disqualify FDIC's counsel and the testimony of the previous three witnesses. As the FDIC supervisor responsible for the instant action, DeHenzel verified that the FDIC consented to the continuation of LMHT & B as counsel despite U.S. Fire's argument that the FDIC might be prejudiced by the continued representation of the firm. Notwithstanding this consent, after the evidentiary hearing, the district court signed an order granting U.S. Fire's motion to disqualify Kenney and Hurt, and the law firm LMHT & B.

Pursuant to 28 U.S.C. Sec. 1292(b), the district court granted certification and we granted leave for an interlocutory appeal. After briefing and oral argument, we vacated the order of the district court and remanded the matter for reconsideration in light of In re American Airlines, Inc., 972 F.2d 605 (5th Cir.1992), cert. denied --- U.S. ----, 113 S.Ct. 1262, 122 L.Ed.2d 659 (1993), and In re Dresser Industries, Inc., 972 F.2d 540 (5th Cir.1992).

On remand, the district court again ordered that Kenney, Hurt, and LMHT & B be disqualified as counsel for the FDIC. The district court based its analysis of U.S. Fire's disqualification defenses--bad faith, discovery, and takeover ²--on joint application of three different canons of ethics, the Texas Disciplinary Rules of Professional Conduct ("Texas Rules"), ³ the American Bar Association Model Rules of Professional Conduct ("Model Rules"), ⁴ and the ABA Model Code of Professional Responsibility ("Model Code"). ⁵ Although these rules promulgate conflicting standards, the lower court concluded that all three required disqualification of the FDIC's counsel.

U.S. Fire bases its bad faith defense on Kenney's conduct during the claim investigation. Finding that Kenney may be called as a witness on behalf of the FDIC, the district court disqualified her under Texas Rule 3.08(a), Model Rule 3.7(a), and Model Code DR 5-102(A). Additionally, predicated on the charge of bad faith, the district court concluded that Model Rules 1.7(b) ⁶ and 1.10(a) ⁷, regarding conflict of interest, Model Code DR 5-102(A), and "questions of ethics and judicial integrity" required disqualification of the entire firm.

U.S. Fire...