In re AUREAL, INC., etc., Debtor-in-Possession.

No. 00-42104 T Chapter 11United States Bankruptcy Court, N.D. California
June 28, 2000

MEMORANDUM OF DECISION RE EMPLOYMENT OF ACCOUNTANTS
TCHAIKOVSKY, Judge

Aureal, Inc. (the “Debtor”), a chapter 11 debtor-in-possession, seeks to employ PricewaterhouseCoopers LLP (“PWC”) as its accountants and financial advisors in connection with the above-captioned bankruptcy case. The Office of the United States Trustee (the “UST”) and Creative Technology, Inc. (“Creative”), a creditor engaged in litigation with the Debtor, object to PWC’s employment. They contend that PWC’s past, present, and contemplated future employment by Creative disqualifies PWC from being employed by the Debtor pursuant to 11 U.S.C. § 327. For the reasons stated below, the Court overrules the objection in part and sustains it in part. Whether the Debtor may employ PWC depends on PWC’s willingness to forego providing a portion of its proposed current and contemplated future services to Creative. The UST also objects to PWC’s request that it be employed on a nunc pro tunc basis. The Debtor filed its chapter 11 petition on April 5, 2000. The Debtor’s application to employ PWC was not filed until May 4, 2000. The Debtor represented that it delayed filing the application in an attempt to resolve this employment dispute with Creative and the UST. The Court is satisfied with this explanation given the slight delay. The Court is also satisfied with the notice of the application given to creditors. Thus, if PWC may be employed by the Debtor, it may be employed on a nunc pro tunc basis.

In the PWC employment application, the Debtor stated that it wished to employ PWC for a variety of purposes, including to assist in the sale of its business as a going concern. The application disclosed various connections with interested parties which the Debtor contended were not disqualifying. The only controversial connection is the services performed and to be performed by PWC for Creative.

The PWC employment application disclosed that PWC performs audit and tax work for (“Creative”) and its subsidiaries. It disclosed that PWC has also been engaged by Creative as technical consulting experts in litigation against the Debtor. Finally, the application disclosed that PWC may assist Creative in making an offer for the purchase of all or a portion of the assets of the Company. The employment application stated that an “ethical wall” had been created by PWC and would be maintained to ensure that PWC’s involvement with Creative was kept separate from its involvement with the Debtor.

The UST and Creative objected to the Debtor’s employment of PWC under these circumstances. They contended that PWC’s past, present, and contemplated future services for Creative gave it an interest adverse to the Debtor. As a result, they contended, PWC was not disinterested as required by 11 U.S.C. § 327(a).

The Debtor and PWC contended that PWC was and is disinterested. They emphasized the difference between an accountant’s role and an attorney’s, at least when an accountant is performing auditing services. Whereas an attorney owes its primary duty to its client, in performing auditing services, an accountant owes its primary duty to the public.

Furthermore, ethical rules governing accountants circumscribe what other services an accountant can perform for a client without losing the independence necessary to continue to perform auditing services. PWC’s general counsel had concluded that serving as a consulting expert in connection with Creative’s litigation with the Debtor and assisting Creative in connection with the purchase of the Debtor’s assets fell within the zone of these permitted services. PWC and Creative described the contemplated services in connection with the purchase of the Debtor’s assets somewhat differently. PWC described the services as “due diligence.” Creative described them as “providing advice concerning the proposed purchase.” However, the Court is satisfied that there is no meaningful difference between these two descriptions for purposes of this application. Since the additional services that PWC provides to Creative do not compromise its independence in accordance with ethical standards governing accountants, they should not be deemed to create a conflict of interest for bankruptcy purposes.

Section 327(a) of the Bankruptcy Code provides that, subject to the other subsections of that section, “the trustee, with the court’s approval, may employ one or more . . . accountants . . . that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee’s duties under . . . [title 11].” No one contended that PWC itself “holds” an interest adverse to the estate. The Court interprets this phrase to require that PWC itself have an economic interest adverse to the estate. The Court does not consider PWC’s interest in getting paid for its services a sufficiently direct economic interest to disqualify it from employment by the Debtor under this provision. Clearly, Creative does “hold” an interest adverse to the estate. Therefore, the Debtor and PWC focused their argument on whether PWC “represents” Creative. They contended that it does not.

The Court concludes that this focus is misdirected. First, section 327(a) also requires that PWC be a “disinterested person.” Section 101(14) contains an exhaustive definition of the phrase “disinterested person.” The only portion of the definition arguably applicable to PWC is section 101(14)(E). Section 101(14)(E) states that a “disinterested person” means a person that “does not have an interest materially adverse to the interest of the estate. . . .” Second, as noted above, section 327(a) is subject to section 327(c). Section 327(c) provides that “a person is not disqualified for employment under this section solely because of such person’s employmentby or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest [emphasis added].” Thus, even if the services provided and to be provided to Creative by PWC do not qualify as representation, PWC has clearly been employed and proposes to continue to be employed by Creative. Pursuant to 11 U.S.C. § 327(c) and § 101(14)(E), the Court finds the critical issue presented by this dispute not to be whether PWC represents Creative but rather whether the services provided by PWC to Creative create a conflict of interest with the Debtor and the estate.

At the hearing on the application, the UST cited four cases in support of its position that PWC’s services for Creative disqualify it from employment by the Debtor: In re Micro-TimeManagement Systems, Inc., 102 B.R. 602 (Bankr.E.D.Mich. 1989); In re CVC, Inc., 120 B.R. 874 (Bankr.N.D.Ohio 1990);In re Trust Amercia Corp., 175 B.R. 413 (Bankr.M.D.Fla. 1994); and In re Thrifty Oil Co., 205 B.R. 1009 (Bank. S.D. Cal. 1997). In a supplemental brief, the UST cited two additional cases: In re Aircraft Instrument Development,Inc., 151 B.R. 939 (Bankr.D.Kan. 1993) and In re MichiganGeneral Corporation, 77 B.R. 97 (Bankr.N.D.Tex. 1987). PWC contended that the cases cited by the UST were all factually distinguishable. PWC did not have an opportunity to comment on the two cases first cited by the UST in its supplemental brief since the parties’ supplemental briefs were submitted simultaneously. However, the Court has read and considered these additional cases.

The Court agrees with PWC to some extent. The remainder of the supplemental response is not particularly helpful due to its focus on the meaning of the term “representation” in 11 U.S.C. § 327(a). As noted above, the Court has concluded that this issue is not determinative of the outcome of this dispute. Most of the cases cited involved fee applications, not an employment application as does this case. In several of the cases, the professionals had not disclosed, or at least not fully disclosed, the nature and extent of the potentially disqualifying connections. There is no such failure to disclose in this case. In several of the cases, the accountant had clearly “represented” the debtor-in-possession or committee by negotiating with third parties. In one instance, the accountant served as a chapter 11 trustee. PWC has not played any such role on behalf of Creative nor does it propose to do so in the future.

However, the cases do provide some guidance. The Thrifty Oil
and Aircraft Instrument Development courts concluded that an accounting firm may concurrently represent a debtor-in-possession or creditor’s committee and perform auditing services for a creditor or other party with an interest adverse to the estate. The Court agrees that this dual employment does not constitute an actual conflict of interest and is therefore permissible pursuant to 11 U.S.C. § 327
(c).

Although presenting a somewhat different issue and not addressed by any of the cases cited, the Court concludes that the tax work performed by PWC for Creative is also not disqualifying as long as PWC does not serve as an advocate for Creative in tax litigation. In obtaining tax work from accountant, Creative is not pursuing an end adverse to the Debtor.

At the other end of the issue spectrum, the Trust America
court concluded that, if a proposed concurrent representation of a debtor-in-possession or committee, on the one hand, and a creditor, on the other, would represent an actual conflict of interest, creating an “ethical wall” would not solve the problem. Trust America, 175 B.R. at 421. Again, the Court agrees with this conclusion.

However, the Court must still decide whether PWC’s proposed services for Creative, other than audit and tax services, do create a conflict of interest. The cases do not assist the Court in making this determination. Instead, the Court must consider the questions from a practical point of view. From this vantage point, the Court concludes that serving as Creative’s consulting expert in litigation against the Debtor and advising Creative in connection with the purchase of the Debtor’s assets would pose a conflict of interest with its representation of the Debtor.

Certainly, in both capacities, as a professional, PWC must give its most objective professional opinion to Creative. Presumably, Creative is counting on PWC’s doing so. Nevertheless, by providing these opinions to Creative, PWC is assisting Creative in matters that are adverse to the Debtor and the estate. The dual employment would present a problem of divided loyalty. Moreover, Creative may be required to give PWC confidential information in order to obtain its professional opinion. Creative may have concerns about whether that information will be kept confidential. As the case law recognizes, an “ethical wall” is not always effective despite the professional’s best intentions. Id. The difficulty of ensuring that such protective measures are effective is greater when the dual employment is concurrent than when it is successive. For this reason, the Court agrees with case law that an “ethical wall” may resolve a conflict in the latter instance but not in the former.

CONCLUSION
For the reasons stated above, the Court concludes that the Debtor may employ PWC only if PWC: (1) agrees not to continue serving as Creative’s consulting expert nor to provide Creative with advice concerning the purchase of the Debtor’s assets and (2) maintains and “ethical wall” to preserve the confidentiality of any information obtained as a result of any such services for Creative in the past. The Debtor shall submit an order granting or denying its application, as appropriate. If the order seeks approval of the employment of PWC, it shall be accompanied by a declaration from an appropriate representative of PWC, agreeing to the foregoing conditions.