Fourth Circuit says no conflict of interest in law firm's appointment

CHARLESTON – A federal appeals court has found no conflict of interest in a bankruptcy trustee’s appointment of a law firm that represented another party in a separate debt collection action against one of the bankrupt partnership at issue's general partners.

The U.S. Court of Appeals for the Fourth Circuit heard the appeal from the U.S. District Court for the Northern District of West Virginia at Martinsburg. The three-judge panel of Diana Gribbon Motz, Allyson K. Duncan and Robert E. Payne issued the unpublished per curiam opinion on April 11. The vote was unanimous.

The appeal arose from the bankruptcy proceeding of Bon-Air Partnership and the sole issue on appeal was whether a conflict of interest arose when the trustee appointed a law firm that represented another party in a separate debt collection action against one of Bon-Air’s general partners, Alex Rahmi.

Bon-Air filed for Chapter 7 Bankruptcy on Nov. 11, 2009, and Rahmi signed the petition as a general partner. Bon-Air’s primary asset was approximately 130 acres of land in Charles Town and the property was valued in the petition at $750,000.

The entire debt of the bankruptcy estate was $793,162.42 and the debt was held almost entirely by two creditors who had loans secured by the subject property. Jefferson Security Bank, one of the creditors, moved to lift the automatic bankruptcy stay so that it could enforce its deed of trust and initiate foreclosure proceedings to sell the property.

The trustee, Robert Trumble, believed he could secure a higher value through a private sale and he filed a Motion to Sell in response. He attached an offer to purchase the property, dated March 10, 2010, for $1.2 million.

Rahmi objected to the Motion to Sell, asking to court to delay the sale in order for the trustee to continue to market the property and raise the selling price. Trumble then filed a notice to allow an upset bid auction to be held immediately on its Motion to Sell.

A day prior to the hearing, the court continued the hearing, stating it would grant the trustee “up to six months” to market the property before allowing Jefferson Security Bank to seek a foreclosure sale.

“The next day,” the opinion says, “Rahmi sought to dismiss the bankruptcy proceedings. Both Trustee and the creditors objected, and the court denied the motion, reasoning that Rahmi had already repeatedly attempted to delay the sale of the subject property in a deliberate effort to avoid satisfaction of Bon-Air’s creditors - by filing successive bankruptcy petitions and using other delay tactics in those cases - and because Rahmi proffered no alternatives to Trustee’s concrete offers to purchase.”

On July 6, 2010, the bankruptcy court approved the trustee’s employment of his law firm - McNeer, Highland, McMunn and Varner - as special counsel. The law firm had also been representing Wells Fargo Bank in an unrelated action to collect an outstanding debt of $208,000 from Rahmi.

Rahmi did not object to the law firm’s appointment at that time.

The property sold for $3 million at auction on September 2, 2010, and the bankruptcy court approved while neither the debtor nor Rahmi objected. After debts, commissions and expenses were paid, more than $1.8 million was deposited into an interest-bearing account on behalf of the estate and for future distribution to Bon-Air partners, including Rahmi.

On April 1, 2011, Rahmi filed a Motion to Remove Trustee for Conflict of Interest based on the law firm’s involvement in both actions concerning him. The bankruptcy court denied the motion and Rahmi initially appealed to the district court, but then voluntarily dismissed the appeal.

Rahmi then filed a Motion to Amend Judgment and to Invalidate Foreclosure Sale, arguing that the Trustee was not disinterested and had violated his fiduciary duty by selling the property at an inadequate price. Rahmi asserted the property was worth $16.2 million based on real property assessments of surrounding properties that he presented for the first time.

The bankruptcy court denied the motion and Rahmi appealed to the district court. The district court affirmed the order of the bankruptcy court, rejecting Rahmi’s conflict of interest arguments and issuing both an order denying interlocutory appeal and the opinion on the same day.

Rahmi appealed to the Fourth Circuit.

At oral argument before the Fourth Circuit, Rahmi’s counsel clarified that he did not seek to have the sale set aside by the court and only contested the bankruptcy court’s finding that no conflict of interest existed. He asked the court to overturn that finding and remand for “whatever consequences might flow from that,” according to the opinion.

“Although Rahmi confusingly presents several different arguments regarding the impact of the law firm’s alleged conflict of interest,” the court wrote, “we need not parse them because they all necessarily fail at the first step: there was no actual conflict of interest.

“At the most basic level, the separate debt collection proceeding was against Rahmi as an individual, while the bankruptcy proceedings dealt with the property of the partnership - an unrelated matter.

“As the district court observed, under West Virginia law, ‘property acquired by a partnership is property of the partnership and not of the partners individually.’

“Thus, the fact that the law firm represented Wells Fargo in an action against Rahmi personally is not an interest ‘materially adverse’ to the partnership’s bankruptcy estate, and Rahmi’s arguments to the contrary are far too attenuated to gain traction.

“Rahmi’s speculative chain of inferences could just as easily lead us to conclude that Wells Fargo (and its counsel) would have had an interest in obtaining the highest possible sale price for the subject property, to ensure that Rahmi possessed sufficient funds to fully satisfy his personal debt to Wells Fargo. Accordingly, we find no grounds for a conflict of interest here.

“Furthermore, assuming for the sake of argument that a conflict did exist, Rahmi was aware of such conflict from the outset but failed to raise the issue until after the (apparently disfavorable) sale was affirmed.

“Rahmi has been unable to articulate any way in which Trustee’s disqualification at this stage of the proceedings would impact the bankruptcy court’s disposition of the estate.”