Court Lambastes Lawyers in their Handling of a Jamaican Immigrant’s Case

The ABA Journal reported yesterday on a New York based 2nd Circuit Court of Appeals decision that came down this week reopening the case of an immigrant who was scheduled for deportation and jailed for nine months (forcing his wife and child into a homeless shelter) when his initial counsel ‘failed spectacularly’ by misinforming him about the date of a scheduled hearing resulting is his failure to appear and then failing to tell him of either the missed hearing or the deportation order (citing The Associated Press). The appeals court wrote, “[i]n immigration matters, so much is at stake – the right to remain in this country, to reunite a family or to work…When lawyers representing immigrants fail to live up to their professional obligations, it is all too often the immigrants they represent who suffer the consequences.” The court went on to state, “[w]e appreciate that unfortunately, calendar mishaps will from time to time occur. But the failure to communicate such mistakes, once discovered, to the client and to take all necessary steps to correct them is more than regrettable – it is unacceptable. It is nondisclosure that turns the ineffective assistance of a mere scheduling error into more serious malpractice.”

Chief Judge Easterbrook Writes That Free Market Competition Trumps Equity’s Attempted Free Lunch Under the New Value Exception to the Absolute Priority Rule

A 7th Circuit opinion authored by Chief Judge Easterbrook last week had me again looking across the street at 203 North LaSalle and wondering whether the US Supreme Court will ever finally decide whether there is a “new value” exception to the absolute priority rule (which requires that when an unsecured creditor class objects to a plan of reorganization, it must be paid in full before junior claims or interests get anything).

The question of whether there’s a “new value” exception to the absolute priority rule (i.e., whether old equity can contribute new capital and receive new equity interests in the reorganized entity) was expressly left open by the US Supreme Court in Bank of America National Trust & Savings Ass’n v. 203 North LaSalle Street Partnership, 526 U.S. 434 (1999).  Before the case went to the Supreme Court, the 7th Circuit ruled in 203 N. LaSalle  that the oft-ignored decision in Case v. Los Angeles Lumber Products Co., 308 U.S. 106 (1938), provided the basis for the new value exception in cases where the equity interest holder contributes new value that is both reasonably equivalent to the value of the equity interest and necessary for the debtor’s successful reorganization.  In re 203 N. LaSalle St. P’ship, 126 F.3d 955 (7th Cir. 1997).  While refusing to specifically endorse a new value exception or “corollary” to the absolute priority rule, the Supreme Court in 203 N. LaSalle held: “[A]ssuming a new value corollary [exists], [then] plans providing junior interest holders with exclusive opportunities free from competition and without benefit of market valuation” violate the absolute priority rule.”  203 N. LaSalle, 526 U.S. at 458.

In In re Castleton Plaza, No. 12–2639, 2013 WL 537269 (7th Cir. Feb. 14, 2013), the 7th Circuit Court of Appeals faced an issue never before addressed by a Court of Appeals, that being whether “an equity investor can evade the competitive process by arranging for the new value to be contributed by (and the new equity to go to) an ‘insider’ [as defined in the Bankruptcy Code]”?  The 7th Circuit found no difficulty in answering this question with a resounding “NO”!  Notably, instead of chopping through the bramble bush of nuanced statutory interpretation, the Court’s opinion relied principally on broad bankruptcy policy objectives.  The Court stated:

In 203 North LaSalle the Court remarked on the danger that diverting assets to insiders can pose to the absolute-priority rule.  526 U.S. at 444.   It follows that plans giving insiders preferential access to investment opportunities in the reorganized debtor should be subject to the same opportunity for competition as plans in which existing claim-holders put up the new money….

Nor does the rationale of 203 North LaSalle depend on who proposes the plan. Competition helps prevent the funneling of value from lenders to insiders, no matter who proposes the plan or when.  An impaired lender who objects to any plan that leaves insiders holding equity is entitled to the benefit of competition.  If, as [the debtor and insiders] insist, their plan offers creditors the best deal, then they will prevail in the auction.  But if, as [the objecting secured lender] believes, the bankruptcy judge has underestimated the value of [the debtor’s] real estate, wiped out too much of the secured claim, and set the remaining loan’s terms at below-market rates [via cramdown], then someone will pay more than $375,000 (perhaps a lot more) for the equity in the reorganized firm.

The judgment of the bankruptcy court is reversed and the case is remanded with directions to open the proposed plan of reorganization to competitive bidding.

But if the plan was confirmed, how is it that the direct appeal of the plan confirmation order to the 7th Circuit did not get mooted out through substantial consummation of the plan?  Simple.  The parties in this motion stipulated to entry of this order by the Bankruptcy Court, thereby staying the effectiveness of the confirmation order pending resolution of the issue on appeal.  Of course, since the only major creditor in the case was the senior secured lender (with a large unsecured deficiency claim) who was objecting to the plan, it had a lot more flexibility in respect of the bonding requirement necessary to stay the effectiveness of the confirmation order pending appeal.  Indeed, as the Court-approved disclosure statement demonstrates, the secured lender appealing the decision was virtually the only creditor of significance in this single asset real estate case.  As such the lender here really didn’t have much to lose by appealing the order since obtaining a stay of the confirmation order pending appeal likely would not have required it to dig very deep to come up with the funds necessary to post a bond and obtain a stay pending appeal.

Is this decision significant?  You bet, and I expect it to reverberate loudly as time progresses.  Before this decision, creative lawyers could reach into their trick bag and try to evade 203 N. LaSalle’s competitive bidding requirements by arguing that the statute doesn’t apply to “new value” contributors who held no equity interests prepetition.  They then could solicit the support of senior secured creditors and propose a “new value” plan acceptable to the secured lender that would call for “new value” contributions from friendly sources and thereby squeeze value to which the intervening unsecured class would be entitled under the absolute priority rule.  And since unsecured creditors in more complex business reorganizations—unlike secured lenders in single asset real estate cases—generally lack the financial incentive or wherewithal to obtain a stay of a plan confirmation order pending appeal, they are swiftly mooted out in the process, leaving equity to walk away with the value while unsecureds are left “holding the bag” (as our founding fathers were wont to say).

Now, however, with the 7th Circuit’s decision in the books, there’s no authority for filing such plans in the first place (at least in the 7th Circuit, though I expect other Courts and Circuits will follow its lead).  Of course, there’s always the hope that the Supreme Court will take this case up on appeal given how rarely such issues wind their way through the appeals process without getting mooted out along the way.  That was a good reason for the Court to take up RadLAX and is an equally good reason to take up this decision too (particularly since, as the 7th Circuit noted, “[b]ankruptcy judges have disagreed on the answer” to the question posed by the case).

Finally, it’s worth noting how a rather simple and seemingly straightforward Supreme Court decision like the one inRadLAX can never be underestimated.  To the 7th Circuit, RadLAX established a policy directive of “protect[ing] creditors against plans that would give competing claimants too much for their new investments and thus dilute the creditors’ interests.”  That’s the first time I’ve seen RadLAX being cited for such a broad policy objective.  It is a principle worth remembering, however, especially when responding to legal gimmickry that attempts to grind Bankruptcy Code provisions like trees in a wood chipper.  Such gimmicks simply won’t carry the day, regardless of their artfulness and basis in principles of statutory construction, where they undermine important policy objectives established in Supreme Court precedent.

Thanks for reading!

Can a Lawyer Be Held Accountable for Aiding & Abetting Their Client’s Wrongful Conduct?

Generally, lawyers believe that their sole duty is to their client – some may be surprised to learn that a lawyer can be sued by adverse parties for intentional torts, like aiding and abetting your client’s wrongful conduct. Here is an interesting case I have had in my research files on this topic. This decision specifically addresses the effectiveness of releases in a settlement agreement between an opposing party and the lawyers who represented the other side, however, it also contains interesting language about holding lawyers accountable for the wrongful acts of their clients. The ethical questions that arise from the facts are the compelling part of this case.

A golf course developer filed a complaint against his former partner’s attorneys, Jenner & Block, who had drafted a settlement agreement providing the terms for the developer’s partner to acquire his interest in the partnership, accusing them of aiding and abetting a breach of fiduciary duty, aiding and abetting a scheme to defraud, and aiding and abetting a scheme of fraudulent inducement. The firm moved to dismiss the complaint, first claiming the developer had previously released his claims against them, and secondly, contending that the aiding and abetting claims failed to state a claim upon which relief could be granted. The trial court agreed with Jenner & Block and dismissed the complaint. On appeal, the Illinois Appellate Court reversed and remanded the trial court’s decision.

In early 1991, Thomas Thornton (the developer) and James Follensbee (the former partner) formed a limited partnership for the purpose of developing an Illinois farm as a residential community and golf course. Thornton contributed the land and agreed to fund the endeavor until it was able to secure investors and Follensbee contributed his expertise and experience as an architect and engineer. Thornton received a 75% ownership interest in the partnership and Follensbee received 25% with an additional right to be compensated for working as the partnerships general manager.

Three and a half years later, Thornton had expended cash and incurred debt of over $8 million on behalf of the partnership. Follensbee had tried to recruit investors and develop the course into a PGA Tournament Players Course – which would lead to substantial economic benefits for the partners. After discussion with possible investors, Follensbee communicated to Thornwood that it was not going to be possible to develop the land into a PGA Tournament Course. However, unbeknownst to Thornton, Follensbee continued negotiations with the PGA. During this time Thornton expressed concern over the amount of money and debt he had incurred on the project and the lack of possible investors and Follensbee offered to buy-him-out of the partnership. Follensbee retained Jenner & Block to assist him in acquiring Thornton’s interest. Jenner & Block had also participated in Follenbee’s negotiations with the PGA. At the time of the offer and subsequent sale of Thornton’s interest, no one informed Thornton that his share was most likely to be worth much more in the near future because of the deal Follensbee was working on with the PGA. Shortly thereafter, the parties entered into a settlement agreement and Thornton signed two separate releases – one releasing Follenbee and one releasing Jenner & Block.

Thornton did not become aware of the negotiations with the PGA until almost four years after the releases had been signed. He then commenced this lawsuit. In reversing the trial courts dismissal of the complaint, the appellate court found the Jenner & Block Release contained sweeping, general language and so it could not be construed to release the claims made by Thornton against the firm because those claims were unknown to Thornton when he signed the release and he could not have contemplated the claims when he signed it.

Additionally, the court found that Illinois [like many states] recognizes claims against lawyers for conspiring with their clients for a wrongful purpose. In making this decision, they noted that Illinois had never recognized the cause of action against a lawyer for aiding and abetting, but the court saw no reason why such a claim could not be recognized.

I think this case is interesting because of the ethical questions the facts raise as to what duties and responsibilities a lawyer has to a party on the other side of a transaction or litigation. These ethical issues are thoroughly discussed in the ABA article, “What Gets Lawyers Sued” Representative Cases on Aiding and Abetting, Conflicts of Interest, Drafting Errors & Unauthorized Practice of Law, here. Was it Jenner & Block’s responsibility to inform Thornton that Follensbee had continued negotiations with the PGA, or was it Thornton and his attorneys’ duty to inquire into what negotiations were taking place and question Follensbee’s motives in the buy-out? These are interesting ethical questions that a lawyer must consider when they are dealing with a less-than-forthcoming client. The lawyer must ask himself or herself, does my silence or inaction lead to my liability? The detail in Thorton that really seemed to stick with the court was the fact that Follensbee and Thornton were partners, and as the general partner, Follensbee owed fiduciary duties to Thornton. In the court’s eyes, Jenner & Blocks alleged aiding and abetting of Follensbee’s breach of fiduciary duties raised the lawyers to conduct to an actionable level.