Winston disqualification flap raises issue: What is direct conflict?

June 3, 2013

Remember the motion by California’s public employees’ retirement system to disqualify Winston & Strawn from representing the bond insurer National Public Finance (the muni bond wing of MBIA) in the Chapter 9 bankruptcies of two California cities, Stockton and San Bernardino? Calpers’s lawyers at K&L Gatesargued last month that under California law, Winston must automatically be disqualified from representing National because it hired a K&L partner who had represented the pension fund, which is in direct conflict with the bond insurer over priority of payouts by the bankrupt municipalities.

Winston & Strawn filed National’s response on Friday in the San Bernardino case. As you’d expect, the filing disputes many of the particulars of Calpers’s account of Winston’s hiring of Felton Parrish, a former K&L partner who billed more than 350 hours on Calpers matters. According to Winston & Strawn, no one at K&L Gates – including lead Calpers lawyer Michael Gearin – suggested that the pension fund would seek to disqualify Winston until weeks after Winston established an ethical wall and Parrish moved over to his new firm. Despite Calpers’s inflammatory hyperbole, Winston argued, there was nothing “secretive and misleading” about Parrish’s “routine lateral move.” Nor was Parrish doing anything wrong when he forwarded Calpers material to his personal account when he worked at K&L Gates; according to Winston & Strawn, he was just making it easier to work on documents from home. Winston and its client accuse Calpers of gaming the disqualification process to deprive National of its longtime lawyers at Winston & Strawn, who are among the most experience in the country in Chapter 9 cases.

It’s always juicy to dig into these disqualification disputes, but this case also raises an issue of much wider significance than whether Calpers mischaracterized Winston & Strawn’s hiring process and ethical wall. Under California precedent in the 2010 case of Kirk v. First American Title Insurance, a lateral partner’s knowledge is presumptively imputed to his or her new firm, but the firm can rebut that presumption by showing that it walled off confidential information. There’s one big exception, though. In the “extreme” circumstances in which a lawyer switches from one side to another while a case is under way, that direct conflict means the new firm is automatically disqualified regardless of any ethical walls or other protections it has erected.

Calpers had asserted that the pension fund and National are in direct conflict in the Stockton and San Bernardino bankruptcies. As you know, Calpers believes that under state law, California municipalities must meet their pension obligations before paying other creditors. Muni bond insurers, of course, have vigorously rebutted Calpers, which they regard as just another creditor competing for scarce resources. In the Stockton bankruptcy, Calpers and National were on opposite sides of a contested hearing over whether the city – which had sided with Calpers – was eligible to seek protection under Chapter 9. In the San Bernardino case, which has progressed more slowly, National opposed a Calpers motion to lift the automatic stay on litigation to bring an enforcement action against the city, but that’s been the full extent of head-to-head confrontation between the pension fund and the bond insurer.

Winston & Strawn’s motion, which was filed in the San Bernardino case, argues that such glancing engagement does not amount to the sort of “extreme” direct conflict that requires disqualification, particularly because Calpers is not even an official party in the Chapter 9. According to National, there is no precedent holding that two parties in a bankruptcy that haven’t asserted any claims against one another are in direct conflict.

“The court should reject Calpers’ attempt here to gain tactical advantage through expanding the disfavored remedy of disqualification beyond the circumstances recognized by any California court,” Winston said.

Winston & Strawn asserts that if Calpers’s theory of direct conflict were to prevail, bankruptcy lawyers would essentially be imprisoned at their firms. Big bankruptcies involve “dozens of major international law firms” representing clients in a web of relationships, the motion said. Lawyers would be unable to move between those firms if Calpers is right about direct conflicts. “A lawyer situated like (Parrish) could effectively be rendered unemployable,” Winston said. “The duties of confidentiality and loyalty are not meant to be a prison from which a lawyer cannot escape.”

It will be interesting to see if Winston & Strawn takes the same position when it files a response to Calpers in the Stockton case, where the divergent views of its bond insurer client and Calpers have been much more overt. In response to my question about Stockton, a firm representative sent an email statement: “We believe there is no basis to disqualify the firm in the San Bernardino case, nor any other case. We will contest the motion vigorously and continue to represent National Public Finance Guarantee Corp.”

A Calpers representative sent an email statement: “In both the City of Stockton and City of San Bernardino bankruptcy cases, National Public Finance has consistently taken the position that the debtor cities must impair the obligations owed to Calpers and to its members. This is directly contrary to the position of Calpers in these actions; therefore, Calpers and National are in direct conflict in these actions.”

(This post has been updated to include comment from Calpers.)

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