Barry M. Klayman and Mark E. Felger

In In re Old BPSUSH, Case No 16-12373-KJC (Bankr. D. Del. June 20, 2019), U.S. Bankruptcy Judge Kevin J. Carey of the District of Delaware resolved a dispute over control of attorney-client and work-product privileges applicable to information generated in an investigation conducted on behalf of the corporate debtor’s former audit committee. He held that, in accordance with the confirmation order, plan and liquidation trust agreement, the audit committee’s privileges vested in the liquidation trust and the reorganized debtors on the effective date of the plan, and the liquidation trustee, in his capacity as litigation representative for the liquidation trust and the reorganized debtors, had the exclusive power and authority to assert or waive the privileges.

In August 2016, the audit committee for Performance Sports Group Ltd. retained independent counsel to conduct an internal investigation relating to issues raised by the company’s external auditor concerning whether senior financial management could be relied upon with respect to financial reporting and certifications. Counsel then engaged a forensic accounting and consulting firm to assist in the investigation. Together they collected over 6.6 terabytes of data and over 4.5 million documents, interviewed multiple witnesses, performed various financial analyses, and communicated regularly with the audit committee.

In May 2016, the company’s stockholders commenced a class action securities lawsuit against the company alleging that it made false or misleading statements and engaged in accounting manipulations. In October 2016, the company and its affiliates filed voluntary petitions for relief under Chapter 11. The following March, the law firm and the consulting firm made a presentation to the audit committee and the SEC. The debtors paid approximately $6.3 million to the law firm and the consulting firm for work they performed in connection with the investigation.

In December 2017, the Bankruptcy Court confirmed the debtors’ plan of liquidation and approved the liquidation trust agreement and the formation of the liquidation trust. Thereafter all of the debtors’ assets, including “retained causes of action,” were vested jointly in the reorganized debtors and the liquidation trust. The liquidation trustee was appointed litigation representative for both the reorganized debtors and the liquidation trust.

The liquidation trustee requested the investigation records of the law firm and the consulting firm. They provided the liquidation trustee with the “non-privileged factual information” requested by the trustee, and claimed that the remaining materials were subject to the work product privilege.

The liquidation trustee filed a motion to compel the law firm and its consultants to turn over all documents concerning their investigation for the audit committee and to find that all right, title and interest in any privilege or immunity applicable to the documents were controlled exclusively by the liquidation trustee. In response, the law firm argued that the audit committee was organized as an independent body, created and governed by a separate charter, with the right and power to engage independent counsel with separate attorney-client privileges and other protections, and therefore those privileges did not transfer to the liquidation trustee upon confirmation.

The liquidating trustee had moved pursuant to Section 542(e) of the Bankruptcy Code, which provides that the court may order those with custody of documents and other books and records relating to the debtor’s property or financial affairs to turn over or disclose them to the trustee. The law firm initially argued that Section 542 was not operative post-confirmation. However, the plan provided for the retention of Section 542 claims as part of the retained causes of actions. Carey held that when Section 542 claims are expressly preserved in a confirmed plan, those claims may be pursued post-confirmation by the estate’s representative appointed for such purpose.

The larger question was whether the liquidation trustee succeeded to the privileges of the former audit committee. Carey concluded that the record of the confirmation hearing left this issue open. The proposed confirmation order had provided that all the debtors’ right, title and interest in any privileges related to the retained causes of action would be vested in the liquidation trust and the reorganized debtors. The equity committee had requested language in the order that would have made it clear that this included the rights of the debtors’ board of directors and audit committee in any privileges. The plan proponents countered that the debtors were conveying all the privileges that the debtors had the ability to transfer, and convinced the equity committee to leave to a later time any issues that might arise with respect to what privileges were or were not vested in the trust.

In resolving the issue, Carey noted the general principle that when a bankruptcy case is filed, the actor whose duties most closely resemble those of management should control the the debtor’s privileges in bankruptcy, unless such a result would interfere with policies underlying the bankruptcy laws. The law firm argued that this case was different, because the debtors’ board of directors granted the audit committee the authority to engage independent counsel and the debtor was never the law firm’s client.

Both the liquidating trustee and the law firm cited to cases from the Southern District of New York that reached opposite results. In BCE West, a 2000 decision, a judge in the Southern District held that, because a special committee was a separate and distinct group from the board of directors, with separate legal representation, the privilege afforded it was not the privilege of the corporation, but rather the privilege of the special committee. As a consequence, the plan trustee did not control it and could not waive it.

In China Medical Technologies, a 2015 decision, the SDNY court decided that a foreign representative/liquidator owned the audit committee’s privileges, regardless of the committee’s pre-bankruptcy independence. Since the committee was established by the debtor’s board of directors, it was a “critical component of [the  debtor’s] management infrastructure.” The decision also rejected the argument that transferring the privileges to the representative/liquidator would have a chilling effect on attorney-client communications; the effect would be no greater than in the case of a solvent corporation, where individual officers and directors always run the risk that successor management might waive the corporation’s attorney-client privilege.

Carey cited with approval the China Medical court’s conclusion that the turnover of an audit committee’s attorney-client communications to a trustee or liquidator in bankruptcy would not impede the monitoring and oversight functions of a truly independent audit committee. “If anything,” Carey quoted from China Medical, “the pre-bankruptcy interests of an audit committee are aligned with the interests of a trustee or liquidator in bankruptcy.” He concluded that the trustee appointed as the representative of a corporate debtor controls the privileges belonging to an independent committee established by the corporate debtor. Here, upon confirmation, the plan transferred control of the former audit committee’s privileges to the liquidation trustee.

There was one remaining issue that Carey had to resolve. The law firm argued that it did not have to turn over documents that were subject to the work product doctrine. The China Medical court had held that counsel could assert the work product doctrine, and the liquidator could not waive the protection unilaterally. Carey cited Supreme Court precedent that the work product rule may not be invoked to withhold from a client or former client work product created in representing that client. Since the liquidating trustee now stood in the shoes of the audit committee as the law firm’s client, the law firm could not assert the work product doctrine to withhold materials from the trustee.

In that regard, Carey had to decide whether the law firm had to turn over all of its files to the liquidating trustee or could withhold internal materials. Carey considered the competing lines of authority regarding an attorney’s duty to release files to a client or former client. The majority rule (followed in Delaware) is that the client is entitled to receive the entire file, with very narrow exceptions for, among other items, law-firm documents reasonably intended only for internal review. The minority rule, the “end product” approach, holds that the client has no right to a lawyer’s internal work product, as opposed to the attorney’s external work product.

Carey opted to follow the majority, “entire file” approach. He concluded that the law firm must produce the entirety of the investigation records to the liquidating trustee, except for those firm documents intended only for internal law office use. Draft factual and legal memoranda must be turned over as part of the entire file, even if they were only circulated within the firm. Communications between the firm and individual audit committee members also had to be turned over to the liquidating trustee and did not fall within the internal document exception.

Carey’s decision validates the turn over order as an important tool in arming bankruptcy trustees, reorganized debtors, and post-confirmation liquidating trustees with information helpful to pursue retained causes of action. The decision also underscores the importance of dealing with the issue of rights to ownership of information, causes of action, and privileges and immunities in the confirmation plan and order.

Barry M. Klayman is a member in the commercial litigation group and the bankruptcy, insolvency and restructuring practice group at Cozen O’Connor. He regularly appears in Chancery Court.

Mark E. Felger is co-chair of the bankruptcy, insolvency and restructuring practice group at the firm.