What Happens When a Mediated Settlement Falls Apart? Some Not-Good Things (In re Blue Dog)

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Falling Apart

By:  Donald L. Swanson

Have you ever wondered what happens when disputing parties reach a mediated settlement agreement that requires further documentation—and then the settlement falls apart? What actually happens is often not-good.

Here is an actual example, from a bankruptcy case, of what happens. The opinion is Blue Dog at #99 Inc. v. BP 399 Park Avenue LLC (In re Blue Dog at 399 Inc.), Adv. Proc. 15-01097, Doc. 77 (Bankr. S.D.N.Y., July 21, 2017). And it’s something we should all consider.

An Almost-Successful Mediation

The Seyfarth law firm had been hired by Debtor, with Bankruptcy Court approval, as special litigation counsel to sue a landlord for wrongful eviction. The Seyfarth firm filed the lawsuit and prosecuted it to eve of trial, at which time a mediation occurred.

At the conclusion of mediation, the mediator recited terms of a settlement and asked the parties if they understood and agreed to such terms. The parties responded affirmatively.

Things Deteriorate: The Law Firm’s Motion to Withdraw

Things go downhill after that, and the law firm files a Motion to Withdraw (Doc. 62) as Debtor’s counsel. Such Motion contains the following representations.

A couple weeks after the mediation session, Debtor’s equity owner, Elizabeth Slavutsky, advised the law firm that she wanted “to take a position” that the law firm felt “was inconsistent with the terms of the settlement,” and the law firm determined that it “could not, in good faith, support” her position.

Meanwhile, communications between the law firm and Slavutsky broke down:

–Slavutsky “ignored some of” the firm’s communication efforts; responded to others “so ambiguously” that the law firm found it “impossible” to “discern Debtor’s position”; and “never clearly answered” the law firm’s “direct inquiries” on her position.

–Then, Slavutsky instructed Debtor’s general bankruptcy counsel, “without the Seyfarth firm’s knowledge,” to present “a revised settlement proposal” to landlord’s counsel that was “inconsistent with Seyfarth’s advice and prior proceedings.”

–Seyfarth’s subsequent efforts to communicate with Ms. Slvutsky met with no response, until Ms. Slavutsky advised the Seyfarth firm that it, (i) “no longer has authority” to discuss the case on Debtor’s behalf, and (ii) “should withdraw as counsel.”

Fees became an issue:

–“Ms. Slavutsky has failed to pay Seyfarth for its work on this matter for some time”;

–“Currently, outstanding invoices . . . exceed $500,000”; and

–“Ms. Slavutsky has not responded to Seyfarth’s repeated attempts to discuss the payment of its outstanding invoices.”

Seyfarth firm’s Motion to Withdraw also contains a request that the Bankruptcy Court “enforce its retaining lien pursuant to New York common law on the files related to this matter” until payment of Seyfarth’s fees is assured.

Things Get Worse: Bankruptcy Court’s Ruling on Motion to Withdraw

The Bankruptcy Judge’s written ruling (Doc. 77) on the Motion to Withdraw picks up the narrative with the following information.

–Further Details

Details of Debtor’s engagement of the Seyfarth law firm, based on a written agreement and Court filings, are:

–Seyfarth law firm was retained to represent the Debtor, Blue Dog, in litigation against BP 399 Park Avenue LLC.;

–“Blue Dog would be its client,” but “Blue Dog itself would have no obligation to pay Seyfarth’s fees”; and

–Instead, Seyfarth agreed to “look only to Blue Dog’s equity owner, Elizabeth Slavutsky, for payment” of its fees.

After the apparently-successful mediation, Mz. Slavutsky and the Seyfarth firm had a falling out: “something went wrong . . . the deal fell apart . . . and a serious rift” developed, resulting in the Motion to Withdraw.

–Two Issues

“Two issues have arisen in connection with the proposed withdrawal”:

–“First, Seyfarth . . . asks permission to assert a so-called retaining lien on the files that it holds, and wants to refuse to turn over those files” to debtor and its general counsel, “unless and until Seyfarth is paid the amounts it is owed.”

–“Second, Seyfarth . . . contends that terms that were outlined in open court that day are legally binding upon the Debtor, Blue Dog, and should be enforced by me.”

Multiple documents (e.g., engagement letter, application for engagement approval, and law firm’s Affidavit) all “made clear, in numerous ways,” that the Seyfarth law firm:

–“would represent the Debtor, but that it would do so without cost to the Debtor and with the understanding that it could look only to Ms. Slavutsky for payment of its fees”; and

–would be paid its fees “for acting as special litigation counsel for Debtor” by “Elizabeth Slavutsky personally” and that Ms. Slavutsky would not have a claim for reimbursement from the Bankruptcy Estate.

Further, “there was no indication, or even any hint, in the retention agreement or in the retention motion papers that the Seyfarth firm’s work for the Debtor, or the Debtor’s access to the firm’s files, was conditioned on payments by Ms. Slavutsky.”

The Seyfarth law firm contends “that it is entitled to a so-called common law retaining lien on its files, and as a result it has not turned over those files to Blue Dog or to Blue Dog’s other counsel.”

Seyfarth also contends “that I should hold” that the mediating parties “are bound by the terms” of the mediated settlement, including the part that “Debtor’s estate would be responsible for any unpaid fees owed to the Seyfarth firm,” subject to the usual application and Court approval process.

–There Is No Binding Deal

The Bankruptcy Court determins that the mediated settlement is not a final agreement.

–The mediated arrangement, (i) “was to be documented,” and (ii) was to include “a revised retention order for the Seyfarth firm” with “the new payment arrangement” and a “separate order permitting the withdrawal of the Seyfarth firm” and turnover of its files.

–“I made it very clear . . . that I would not approve any proposed arrangement that day and that any proposed settlement would have to be submitted for approval in a motion with notice to all creditors and an opportunity to object.”

–“United States Trustee made quite clear that it had only been willing to support the proposed settlement on the condition that files would be turned over in a very short time, if not immediately.”

–“I had not considered the proposed settlement to be a complete and done deal and that the terms of the proposed settlement had not yet been approved by me. No settlement arrangement has been submitted for approval by motion of the Debtor, and the Debtor did not send notice to creditors.”

–The Seyfarth firm concedes that unresolved details existed on which “the parties ultimately were unable to reach an agreement,” but it still contends that “the debtor is legally bound by the terms of the agreement that were outlined” at the mediation conclusion and “has filed a motion asking me to approve those settlement terms under Rule 9019 of the Federal Rules of Bankruptcy Procedure,” to which the United States Trustee and at least one creditor has objected;

–The Seyfarth firm argues that Debtor, “is bound” by the settlement even if Court approval is still needed, “has no right to try to back out of the deal” and “should be barred from complaining about the deal.” The Court rejects this argument on two grounds,

First, the terms announced in open court “were not even a full expression” of the agreement, “let alone a full and legally binding statement of such terms.” The Court distinguishes the occasional case where parties “expressly stated and acknowledged their intent to be bound by terms” announced in open court by noting: “that was not the case here.”

Second, “I am troubled by Seyfarth’s suggestion that” a settling debtor “is barred from speaking up” if it “no longer believes the settlement is a good idea.” Since the debtor “acts as a fiduciary in a bankruptcy case,” it “has a duty of candor to the Court” based upon “a reasonable exercise of the debtor’s business judgment.” Not only does a debtor have a “right” to tell the court what it thinks, “it has an ongoing duty to do so.” The Court acknowledges cases, (i) in which “a debtor has had a change of heart” but the court “decides that the debtor should be bound” anyway, and (ii) “in which a debtor should be required to present a settlement for court approval,” even if it “has had a change of heart.” But, the Court declares that a debtor must be able, in all events, to “inform the court of the debtor’s own current view.”

–The Court then concludes, “I do not approve of the proposed terms of settlement” because “they are unreasonable and not in the best interest of the estate or its creditors,” and such terms would be rejected “even if the debtor itself had been bound by it and even if the debtor itself had continued to pursue that settlement.”

–There Is No Retaining Lien

The Bankruptcy Court rejects the law firm’s retaining lien request. Here is its reasoning.

–“New York courts have recognized that clients have ‘an expansive general right . . . to the contents of the attorney’s file, upon termination of the attorney-client relationship,’ and that such right is not subject to a work product privilege.”

–But a common law exception exists “for the assertion of a so-called retaining lien” that permits an attorney to “obtain a lien ‘on a client’s files, papers, and property in the attorney’s possession’ unless the client satisfies its obligation to pay fees.” A common law retaining lien exits “until the client has satisfied the client’s own payment obligations.”

–In this situation, “the client has no payment obligation”: the only payment obligation is that of Ms. Slavutsky, individually. “In short, Seyfarth wants to assert a lien on the Debtor’s files in order to secure an obligation owed by another party.” It may not do so.

–“In theory,” Debtor “might have agreed to the assertion of a retaining lien in the event that Ms. Slavutsky did not pay the Seyfarth firm’s fees.” But that did not happen.

Conclusion

Dispute resolution processes are often messy and ineffective. The foregoing is an example of a messy process that, ultimately, fails for Debtor’s special litigation counsel, who is out a bunch of effort and fees and other things of value.

There are lessons from this example for us all. And the experiences of this case should be reviewed and tucked in to the backs of all our minds as a point of reference for dealing with future events.

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

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