(Published) - In re U.S. Bentonite, Inc., Ch. 11 Case No. 13 20211-MER (Bankr. D. Wyo. Sept. 3, 2015) (Violation of supplemental disclosure requirement of FED. R. BANKR. P. 2014(a)).

The issues before the Court were whether an attorney representing the debtor who accepts a position with a creditors' firm during the pendency of the bankruptcy case creates a connection that must be disclosed; whether total or partial denial of compensation is warranted for the non-disclosure; and whether the settlement agreement reached in this case during the time of the alleged conflict was fair and equitable and in the best interests of the estate. To resolve these issues, the bankruptcy court first examined the employment standards of 11 U.S.C. § 327(a). In furtherance of the disinterestedness prong of § 327(a) and the fiduciary duties counsel for the debtor owes the estate, FED. R. BANKR. P. 2014(a) requires counsel for debtors to disclose any connections that have the potential of creating a conflict of interest. These disclosure requirements under Rule 2014(a) continue after the initial application to employ is approved. The bankruptcy court agreed with the broad construction of Rule 2014(a), and the conclusion that Rule 2014(a) creates a continuing obligation for counsel to advise the court when such a connection arises during the representation of a debtor-in-possession. The required supplemental disclosure allows the court, not counsel, to determine whether a conflict exists and counsel remains disinterested under § 327(a). Failing to make a supplemental disclosure robs the court the power to make such a determination.

In this case, the court determined the attorney's acceptance of a position with creditors' counsel in the midst of settlement negotiations involving the same creditors should have been disclosed and counsel failed to do so. The Court held counsel for a debtor-in-possession has an ongoing fiduciary duty to supplement initial employment disclosures with any connections that arise that create potential conflicts. After determining there was a violation of Rule 2014(a), the court turned to the available remedies for such a non-disclosure. In the Tenth Circuit, the failure to supplement initial disclosures when a connection with the potential to create a conflict arises warrants total denial and/or disgorgement of compensation. However, the bankruptcy court has the discretion to determine whether total or partial denial of fees is appropriate based on the facts of a case. Here, the court determined only partial denial of fees from the date the connection (when the associate accepted a position with the creditor's firm) arose was proper. Finally, with respect to the settlement agreement, the bankruptcy court found the agreement was not tainted. Based largely on the evidence from the other creditors, the court determined the settlement agreement resulted in a fair and equitable allocation of the remaining assets, and debtors had no real stake in the outcome. Thus, the court concluded the settlement agreement was in the best interests of the estates under the Rule 9019 standard, with one amendment. The court reduced the administrative claim for debtors' counsel under the settlement agreement consistent with the denial of part of the firm's fees.