Appeal from an order of the United States District Court for the Eastern District of New York, Chief Judge Jacob Mishler, reversing orders of the Bankruptcy Court and reinstating the appellee law firm as special counsel for the debtor-in-possession in the prosecution of a state court action against several of the appellants. Reversed.
Before Lumbard, Smith and Mulligan, Circuit Judges.
This is an appeal from an April 6, 1979 order of the United States District Court for the Eastern District of New York, Chief Judge Jacob Mishler. That order reversed two orders of the Bankruptcy Court, Parente, J., dated May 23, 1978 and October 27, 1978, which had revoked the authority of the appellee, the law firm of Shaw & Levine, to act as special counsel to the Bohack Corporation (Bohack), a debtor-in-possession under Chapter XI of the Bankruptcy Act, 11 U.S.C. §§ 701-799 (1976), to prosecute an action in the New York Supreme Court, Queens County (The Bohack Corporation v. Gulf & Western Industries, Inc., et al., Index No. 159 52/77 ). Most of the appellants here are the defendants in the pending state action.*fn1 The order of the district court is hereby reversed.
On July 30, 1974 Bohack filed a petition for an arrangement under Chapter XI in the District Court for the Eastern District of New York. Bohack was a supermarket chain which at the time had inventory discrepancies and losses totaling some $22 million of its $32 million book inventory, massive delinquent obligations to its suppliers, as well as large unpaid tax obligations. On September 20, 1974, on the application of Franklin E. Knobel, Bohack's Chairman, and the affidavit of J. Stanley Shaw, a partner in Shaw & Levine, Bankruptcy Judge Parente authorized the debtor to retain Shaw & Levine as special counsel. J. Stanley Shaw's affidavit represented that he had previously acted as counsel for Bohack in numerous proceedings and pending lawsuits. A list of these matters was appended to his affidavit. The Knobel affidavit set forth Inter alia the deponent's belief that Shaw's retention would be in the best interests of the estate and creditors by reason of his experience in the debtor's affairs.
On February 24, 1977 Judge Parente modified his order of September 20, 1974 and authorized Shaw & Levine to "investigate, and, if appropriate," prosecute an action against Gulf & Western Industries, Charles Bluhdorn "and such other defendants as may be appropriate" for damages caused to Bohack as a result of the Gulf & Western tender for stock of the Great Atlantic & Pacific Tea Company (A&P). The affidavit of Knobel attached to the application for this modification recited that Shaw had conducted an extensive investigation into the overstatement of inventories of the debtor. That inquiry disclosed that events surrounding Gulf & Western's tender for A&P stock possibly caused a severe curtailment of Bohack's credit lines with merchandise suppliers, which placed Bohack in an extremely precarious financial position. Further investigation revealed that Charles G. Bluhdorn, Chairman of Gulf & Western and the major stockholder of Bohack, may have used his position to facilitate the takeover in a way that contributed substantially to Bohack's collapse. According to the Knobel affidavit, there was a "conceivable concerted plan, orchestrated by Bluhdorn to take over A&P which resulted in the detriment of Bohack's stockholders." On the basis of the modified order Shaw & Levine commenced the state court action on November 18, 1977, seeking damages of $86 million against Gulf & Western, Bluhdorn, and the appellants whom we have described in footnote 1.
On December 12, 1977 the appellants moved the Bankruptcy Court to reconsider its previous orders appointing the firm of Shaw & Levine as special counsel to Bohack on the ground, Inter alia, that a conflict of interest between Shaw and Bohack precluded the firm from representing the debtor-in-possession in any matter before the Bankruptcy Court. Judge Parente's opinion dated May 2, 1978 rejected the appellants' motion insofar as it sought revocation of the September 1974 order initially approving the appointment of Shaw & Levine as special counsel.*fn2 However, the court did grant the appellants' motion in part Judge Parente modified the February 24, 1977 order by revoking the authority of Shaw & Levine to represent Bohack in the state court action. The bankruptcy judge found it inconceivable that Bluhdorn could manipulate the Bohack board without the knowledge of its Chairman Franklin E. Knobel, who was not named as a defendant and who was also a close personal friend and business associate of Shaw. Accordingly, the bankruptcy judge directed the creditors' committee to recommend replacement counsel subject to review and approval of the court. The propriety of the reversal of that part of the order by Chief Judge Mishler is the sole issue on this appeal.
A threshold question is presented by the appellees' motion to dismiss this appeal as interlocutory. Section 24(a) of the Bankruptcy Act, 11 U.S.C. § 47(a), vests the Courts of Appeals with jurisdiction to hear appeals from either final or interlocutory orders in "proceedings in bankruptcy," but if the order involves "controversies arising in proceedings in bankruptcy" it is appealable only if it is final within 28 U.S.C. § 1291 or is otherwise independently appealable. Lesser v. Migden, 328 F.2d 47, 48 (2d Cir. 1964); Hillcrest Lumber Co. v. Terminal Factors, 281 F.2d 323, 325 (2d Cir. 1962).*fn3 The distinction between a proceeding in bankruptcy and a controversy arising in a proceeding in bankruptcy is one which even Judge Friendly has found "obscure and indefensibly confusing." Chemical Bank v. Slaner, 591 F.2d 139, 144 (2d Cir. 1978). However we need not enter that thicket since we have held that orders granting or denying attorney disqualification motions, if shown to taint the underlying trial, are directly appealable. W. T. Grant Co. v. Haines, 531 F.2d 671, 678 (2d Cir. 1976); Silver Chrysler Plymouth, Inc. v. Chrysler Motors Corp., 496 F.2d 800 (2d Cir. 1974) (en banc). Appellee argues that any taint here involves a state court trial from which no appeal to this court will lie. The argument is self-defeating. If the bankruptcy judge's order is beyond ultimate appellate review here, that is all the more reason to consider it a final disposition appealable under section 24(a) of the Bankruptcy Act. Aside from this, Shaw & Levine was not simply appointed by the client/debtor-in-possession but was in effect appointed by the Bankruptcy Court as well. If as found here, a conflict of interest has emerged, then not only is the state court action tainted but the supervisory power of the Bankruptcy Court which authorized the action "if appropriate" is compromised. The resolution of this issue is therefore necessary at this juncture. The order in our view is clearly appealable.
Appellees raise the related argument that the appellants have no standing to raise the disqualification question since their interests are not adversely affected by the state court litigation. At first blush this position has some plausibility. If the question were simply whether state court defendants might properly bring an action in a federal court to disqualify counsel for plaintiff in the state court action because he has failed to join as a co-defendant someone whom the defendants consider to be an indispensable or necessary party, there would be little difficulty in rendering an answer in the negative. But the question posed as appellees would have it does not raise the issue actually before the bankruptcy judge. Counsel for the plaintiff in the state court action was not simply nominated by the debtor but was confirmed by order of the Bankruptcy Court which authorized the state action if appropriate. The interest of the Bankruptcy Court does not terminate with the approval of counsel its supervision over the debtor's estate continues until the termination of the bankruptcy proceedings. That court has the inherent jurisdiction to reconsider its own orders. Feldman v. Trans-East Air, Inc., 497 F.2d 352, 355 (2d Cir. 1974). As Chief Judge Mishler pointed out, "(i)n the face of serious charges of improper conduct, the bankruptcy court had the obligation to inquire, Sua sponte, into the propriety of Shaw & Levine continuing in the role of special counsel."
In any event, several appellants do have standing. As the bankruptcy judge noted, Gulf & Western Industries, Charles G. Bluhdorn, and Don F. Gaston are listed as creditors in Schedule A-3 filed by the debtor-in-possession. They allege that their pecuniary interests will suffer through the depletion of estate assets in the form of fees paid for the continued retention of Shaw & Levine as special counsel. Loss of assets is certainly an adverse effect upon the interests of creditors, and is unquestionably related to the bankruptcy proceeding. See Ceramco, Inc. v. Lee Pharmaceuticals, 510 F.2d 268, 271 (2d Cir. 1975). The fact that the creditors' committee opposes replacement of Shaw & Levine and even appeared on this appeal to urge that point cannot constitute a waiver of the rights of these individual creditors.*fn4 We conclude therefore that the order before us is appealable and that the standing argument raised by appellees is groundless. Accordingly, we come to the merits of the appeal.
The bankruptcy judge bottomed his removal of Shaw & Levine as special counsel in the Queens County action upon an analysis of the charges in the complaint. The gravamen of the state action is that the appellants engaged in a conspiracy to acquire control of A&P with the concomitant purpose and ultimate effect of accomplishing Bohack's financial demise. In essence the complaint charges that Bluhdorn manipulated the Bohack board of directors so that Bohack would become in effect a subsidiary of Gulf & Western and Bohack's management would replace A&P's managerial personnel. Joseph Binder, then Bohack's president, was further allegedly induced by Bluhdorn to attack A&P's marketing and pricing policies thus causing A&P, a large retail food chain, to retaliate by influencing Bohack's suppliers to tighten its credit lines. Moreover the complaint alleges that the defendants in the state court action compelled Bohack to issue convertible debentures for the purpose of calling in outstanding shares. The defendants' alleged intention in so doing was to take Bohack private, "thus hopefully escaping the scrutiny of the appropriate regulatory agencies with respect to conflicts and irregularities under the applicable securities and antimonopoly statutes of the Federal and State governments." Appellants urge that the charges in the Queens County action are frivolous, scandalous, illogical, and inconsistent. They may well be. But it is not our function to decide the merits of the state court action. Our concern is whether the Shaw firm was the proper counsel to undertake the investigation of the alleged conspiracy and to decide whether litigation was justified. We are fully persuaded that the answer to that question is in the negative. This conclusion is almost compelled by an examination of the complaint. It alleges a manipulation of the Bohack board of directors, the chairman of which was at all relevant times Franklin E. Knobel. Yet he was not named as a defendant. In fact he verified the complaint. This rather glaring omission becomes suspect upon inquiry into Shaw's relationship with Bohack. Shaw and Knobel are admittedly close personal friends and business associates. Shaw represented Bohack prior to the filing of the Chapter XI petition, and is now special counsel to the debtor-in-possession. Pursuant to orders of the Bankruptcy Court, Shaw has taken over the management of a major real estate facility of Bohack, and has become a substantial secured creditor of the debtor. Finally, Shaw has been a director and assistant secretary of Bohack since late 1975. He and Knobel are the only remaining officers of the debtor. Even Shaw's law firm concedes that his personal ties with Knobel and financial stake in Bohack are "unusual."
Shaw nevertheless takes the position that in his professional judgment Knobel is not a proper party defendant and was innocent of any wrongdoing. That again may well be. The point, however, is that such a determination must be made by the counsel who is in a position to make an independent judgment. As the foregoing summary of Shaw's entanglement with Bohack and Knobel amply demonstrates, Shaw is obviously in no such position. The best interests of the debtor will undoubtedly be jeopardized unless impartial ...