In re Kelton Motors, Inc., Bankruptcy No. 88-00255.

CourtUnited States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court —District of Vermont
Citation109 BR 641
Decision Date08 December 1989
Docket NumberBankruptcy No. 88-00255.
PartiesIn re KELTON MOTORS, INC., Debtor.

J. Meyers, White River Junction, Vt., for Kelton Motors, Inc. as debtor-in-possession (DIP).

M. Teachout, and D. Moore, Teachout, Brooks, Moore & McNally, Norwich, Vt., J. Bodoff, Kaye, Fialkow, Richmond & Rothstein, Boston, Mass., for United Sav. Acceptance Corp. and Dartmouth Banking Co. (creditors).


FRANCIS G. CONRAD, Bankruptcy Judge.

Creditors move1 to disqualify DIP's counsel because his "Rule 2016(b)" statement disclosed he had received attorney fees for services rendered prior to DIP's subsequent conversion to a debtor under Chapter 7, 11 U.S.C. §§ 101, et seq., from the DIP's sole shareholder, officer, and spouse. Creditors urge us to adopt a per se rule to forbid this type of arrangement because it creates a presumption of a conflict of interest between DIP, DIP's counsel, and DIP's principals. In an appropriate case there may be merit to Creditors' position. We decline their request in this instance because this arrangement was disclosed to the Court, the corporate debtor consented to it, and, it was understood by DIP's principal that counsel's duty of undivided loyalty was owed only to the DIP. Moreover, the adoption of a per se rule would effectively deprive future small corporate bankrupt debtors from obtaining competent counsel of choice.

On October 27, 1988, Creditors and others filed an involuntary Chapter 7 petition against Kelton Motors, Inc. (Kelton). On December 21, 1988, Attorney Meyers (Meyers) entered his appearance on behalf of Kelton and answered the involuntary petition. After several rounds of legal maneuvering, Kelton sought leave to withdraw its answer to the involuntary petition and consented to the entry of an Order of Relief. On motion of Kelton, the case was converted to one under Chapter 11 of Title 11, United States Code. 11 U.S.C. § 706(a).

On February 21, 1988, Mr. Kelton, DIP's president, officer, and sole shareholder, filed an application to employ Meyers as the DIP's attorney, under a general retainer. We granted the application.

On April 17, 1989, Meyers filed his Rule 2016(b) statement and represented:

Prior to the filing of this statement, the debtor has not paid any fees toward the undersigned Meyers. However, Carl E. Kelton, Sr. and Shirley Kelton, personally, have paid the sum of $22,500 for services rendered to date.

Id., page 1 (brackets supplied). Shortly thereafter, Creditors filed a motion to disqualify Meyers as DIP's counsel. On May 31, 1989, we granted a motion filed by DIP to convert to a case under Chapter 7. After a June 6, 1989 hearing on the Creditors' motion to disqualify Meyers, we took the matter under advisement.

We have not overlooked the possibility that DIP's conversion to Chapter 7 may have mooted this decision. Despite the mootness problem posed by DIP's Chapter 7 conversion, we believe the ethical and legal ramifications of Meyers' representation of the DIP remain very much alive and are subject to our continuous scrutiny. Because we believed this issue may surface again in this jurisdiction, and could escape a judicial ruling because of case conversion, its importance to the Vermont bankruptcy bar, and with the consent of all parties, Creditors agreed not to withdraw their objection to Meyers' representation of the DIP.

Creditors concede that Meyers fully disclosed the fact that he was paid by DIP's principals. Creditors also concede that "we're making no claim that Mr. Meyers has not (sic) done anything wrong or that he has in any way acted improperly." June 6, 1989 transcript, page 4-5. Creditors claim, however, that Meyers' acceptance of payment from DIP's principal created a relationship warranting Meyers' disqualification as DIP's counsel on the basis of potential, if not actual, conflict and divided loyalty under the applicable provisions of the Bankruptcy Code and State Code of Professional Responsibility.

Mr. Meyers holds or represents an interest adverse to the estate and/or is not a disinterested person in that the fees for his services have been paid by the president and sole shareholder of the DIP and his wife. Such payment puts into question the ability of Mr. Meyers to exercise independent judgment on behalf of the DIP and to act for the interests of the DIP and the estate rather than the interests of Mr. Kelton and the Kelton family.

Creditors' "Motion To Disqualify Meyers As Counsel For DIP," page 2 (brackets supplied). June 6, 1989 transcript, pages 10-11.

Creditors proffer the following paraphrased facts in support of their disqualification motion that Meyers "cannot possess the independence of thought required of counsel for a debtor-in-possession" which is needed to investigate the dealings of Mr. Kelton, the Kelton family, DIP, and related Kelton family businesses:

1. Mr. Kelton and his family are shareholders of at least eight other Vermont corporations. Millions of dollars have circulated among and between these corporations. Issues of fraudulent conveyances, preferential transfers, and substantive consolidation may arise in this case;
2. Mr. Kelton arranged loans for friends and relative from various financial institutions for fictitious sales of vehicles. Mr. Kelton is under a grand jury investigation and during a State Court deposition, claimed the privilege of self incrimination; and
3. Meyers attended a pre-bankruptcy State Court deposition of the principal\'s spouse and appeared to represent the spouse.

Id., pages 2-4; Creditors' "Memorandum of Law In Support of Motion To Disqualify Meyers as Counsel For DIP," pages 1-2; June 6, 1989 transcript, pages 5-8.

Creditors sum their objection:

. . . in a circumstance in which Mr. Meyers as counsel for the Debtor Corporation is obliged to investigate the facts and circumstances involving possible preferences, fraudulent conveyances, improper transfers between the corporations and so forth, you can imagine the conversation in which Mr. Meyers asks Mr. Kelton for information; says: It\'s my duty to find this information; Mr. Kelton says: It\'s your duty? Who paid you anyway? And Mr. Meyers is unable to complete the conversation by saying: I was paid by the Corporation and it\'s my duty to the Corporation and to the Bankruptcy Court to investigate these matters on behalf of the Creditors in the Bankruptcy Court.

June 6, 1989 transcript, pages 10-11.

Meyers objects to a per se rule that prohibits a debtor's principal from ever paying a debtor-in-possession's attorney fees. Specifically, Meyers claims that he does not have a material interest that is adverse to the estate and that he is a "disinterested person" within the meaning of 11 U.S.C. §§ 101(13)(E) and 327(a), infra. He acknowledges § 327's requirement of a "disinterested person" holding no "interest adverse to the estate" governs his qualification as DIP's attorney.

Meyers flouts the Creditors' objections. He informs us that DIP's principal has retained independent counsel. Meyers' presence at Ms. Kelton's State Court deposition was at the consent of the independent counsel who was unable to attend. Moreover, Meyers was present not as counsel for the deponent, but as DIP's counsel. Meyers wanted to control unwarranted disclosures of corporate information to Creditors because of a pending lawsuit by DIP against Creditors. Meyers' "Memorandum in Opposition To Motion To Disqualify Meyers As Counsel for DIP" ("Meyers' Memorandum"), pages 1-2; June 6, 1989 transcript, pages 15-16.

Meyers represents:

I\'ll tell you the conversation as you know that I\'ve had with my clients in all of these cases. You can pay me but my loyalty is to this Debtor, this Corporation. If there\'s a conflict of interest between representing you and the Debtor, so long, Mr. Kelton . . . so long, whoever it is. It\'s goodbye.
I represent the Debtor, period. If you want me to represent the Debtor you got to pay me, second period. What would be the difference if he Mr. Kelton lent the money to the Corporation and then they (sic) pay me?

June 6, 1989 transcript, pages 12-13.

Meyers distinguishes cases cited by Creditors which appear to announce a per se rule to prohibit the arrangement under review because of: the consent and disclosure to his client; the understanding that Meyers' loyalty was only to the DIP; the lack of any reimbursement arrangement; the lack of actual conflict; the absence of simultaneous representation of a bankruptcy debtor and a principal; no services were rendered to the principal; and, the presence of independent counsel on behalf of the principal. Meyers' Memorandum, pages 2-6.

Lastly, Meyers urges us not to adopt a per se rule because:

Inevitably, many small corporations faced with the type of financial difficulties plaguing average Chapter 11 debtors, are not in a position to easily afford to retain competent bankruptcy counsel out of their already scarce operating funds. The amount of legal work required to undertake such reorganization cases requires a substantial enough retainer to permit an attorney to undertake the responsibility of handling such a case. If the payment of a retainer by other than the corporate debtor itself is completely prohibited, many potential corporate debtors whose businesses may be saved by a reorganization proceeding will be unable to retain counsel and the relief available under the Bankruptcy Code will in effect be denied them.

Id., pages 6-7. June 6, 1989 transcript, page 15.

The issues before us is whether § 327 and/or applicable State ethical rules require us to adopt a per se rule prohibiting a Chapter 11 debtor-in-possession's employment of an attorney where it is disclosed that his fees had been paid by the DIP's insider/principal?

11 U.S.C. § 1107, Rights, powers, and duties of debtor in possession, provides in pertinent part:


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