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Counsel Disqualified From Representing Both Debtor and CEO Accused of Embezzlement

Wednesday, August 21, 2013
By Stephanie M. Acree

Counsel for a debtor's former CEO who was alleged to have embezzled from the debtor was disqualified from representing both the CEO and the debtor July 23 by the U.S. District Court for the Eastern District of New York (Pergament v. Ladak, E.D.N.Y., No. 1:11-cv-02797-ARR-MDG, 7/23/13).

Judge Marilyn D. Go found that the evidence presented regarding an embezzlement counterclaim against the CEO, though scant, was sufficient to establish that it was possible the CEO would be liable to the debtor, and therefore the CEO's counsel could not represent him in the counterclaim while also representing the debtor in the debtor's bankruptcy. 

Contrary Interests

Eugene Nifenecker was the CEO, president, and sole shareholder and director of Manhattan Signs & Designs Ltd. (MSD). On June 10, 2011, Nifenecker and MSD commenced an action against M.S. Signs Inc. and its officers, Murtaza Ladak and Kevin Cherashore, who were also former officers and employees of MSD. The complaint alleged that Ladak and Cherashore had breached their fiduciary duty and defrauded MSD by retaining payments from MSD customers. Subsequently, in an amended complaint, Nifenecker was removed as a plaintiff.

In their answer to the complaint, Ladak and Cherashore alleged that it was Nifenecker who had appropriated the customer payments and they filed counterclaims against MSD and Nifenecker for unpaid wages. An involuntary Chapter 7 petition was filed against MSD on Feb. 17, 2012. Marc Pergament was appointed as the Chapter 7 trustee and was substituted as plaintiff in the action against Ladak and Cherashore. The defendants moved to dismiss Joseph Sferrazza and his firm, Sferrazza & Keenan (S&K) as counsel for Nifenecker. The defendants claimed there was a conflict of interest arising from S&K's prior representation of MSD as well as S&K's concurrent representation of MSD in MSD's bankruptcy. The defendants argued in their disqualification motion that S&K should not be permitted to represent Nifenecker and MSD concurrently because Nifenecker was likely guilty of embezzling funds for MSD and so their interests were directly contrary.

The trustee supported the disqualification of S&K to ensure S&K's undivided loyalty to MSD in the bankruptcy, but he acknowledged the evidence against Nifenecker was not conclusive. 

Prior Representation

The court said that in evaluating whether or not counsel should be disqualified, it must weigh the client's right to have the counsel of his choice against the need to maintain the integrity of the adversary process. The court said that disqualification would be warranted only if the attorney's conduct “tends to taint the underlying trial” and that any doubt would be resolved in favor of disqualification.

The defendants first argued that S&K should be disqualified because S&K had previously represented MSD and its affiliate, SolarSmart, of which Nifenecker was the also the CEO and sole shareholder. The court said that in cases of successive representation, a former client may disqualify an attorney from representing a different client if: 

  1. “ the moving party is a former client of the adverse party's counsel; 
  2. there is a substantial relationship between the subject matter of the counsel's prior representation of the moving party and the issues in the present lawsuit; and 
  3. the attorney whose disqualification is sought had access to, or was likely to have had access to, relevant privileged information in the course of his prior representation of the client.” 

In this case, the first factor was clearly not satisfied. The court also found that there was not a “substantial relationship” between the prior and current cases, which requires that the issues be “identical” or “essentially the same.” The court said S&K's prior representation of MSD concerned “discrete financial transactions” that were in no way related to Nifenecker's alleged embezzlement from MSD. Therefore, the court found that S&K's prior representation of MSD did not support disqualification. 

Rules of Professional Conduct

Regarding S&K's concurrent representation of MSD and Nifenecker, the court said that under Second Circuit law, it is prima facie improper for an attorney “to represent one existing client in a matter adverse to another existing client.” The court also said that in these cases, the attorney bears the burden of showing that there will be “no actual or apparent conflict in loyalties or diminution in the vigor of his representation.”

Furthermore, Rule 1.7 of the New York Rules of Professional Conduct precludes lawyers from engaging in “representation [that] will involve the lawyer in representing differing interests.” However, under certain circumstances this prohibition can be overcome if the attorney has a reasonable belief that he can “provide competent and diligent representation to each affected client” and the clients consent to the concurrent representation. 

Allegations Not Farfetched

In order to determine if adversarial interests actually existed between MSD and Nifenecker, the court looked to the evidence provided by the defendants. The defendants alleged that Nifenecker received cash payments from several MSD customers and did not report the payments as income, and provided evidence that at least one customer, Crib City, was known to be a cash customer. The court found that the evidence presented by the defendants was “not sufficient to prove that Mr. Nifenecker was the person who absconded with payments intended for MSD” but that “since [Nifenecker] had knowledge of at least some cash transactions with Crib City and, as the CEO of the company, was likely to have been aware of the production of the large signs for Crib City, defendants' contention is not entirely farfetched.”

The court said that while it was aware of the potential tactical use of the defendants' counterclaim and motion to disqualify and while it was a “close question, particularly in light of the timing of defendants' motion,” nevertheless the court concluded that the “defendants' allegations that Mr. Nifenecker was aware of the cash payments intended for MSD … suffice[d] to establish a potential conflict of interests between MSD and Mr. Nifenecker” because “Mr. Nifenecker could 'ultimately be liable' to MSD for the alleged misconduct.”

Furthermore, because the trustee had the authority to consent to the concurrent representation on MSD's behalf, but elected to support the motion for disqualification, the court said that S&K must be disqualified. Accordingly, the court disqualified Sferrazza and S&K as counsel for Nifenecker.

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