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Bankruptcy Attorney Ethics: Bankruptcy Trustee’s Gamble in Financing Litigation Backfires When Judge Finds Fraud

Feb 4, 2022

Bankruptcy trustees, as well as bankruptcy attorneys, should heed the precautionary lessons learned in Carickhoff v. Goodwin (In re Decade SAC LLC), 19-50095 (Bankr. D.Del. Dec. 27, 2021). In Goodwin, the bankruptcy estate ended up with a worst-case outcome for its adversary proceeding, where attorneys’ fees and expenses were paid for pursuant to a litigation finance agreement: a judgment for fraud and liability for compensatory and possibly punitive damages. This case brings up some of the ethical issues and pitfalls of a litigation finance agreement for bankruptcy attorneys and trustees alike.

The Sale of the Business and the Fraud

The debtor, Decade LLC, SAC (“Decade”), claimed to have purchased two companies founded by Aaron Goodwin, a top NBA agent, and his brother Eric Goodwin. The Goodwins agreed to sell the companies to Decade for $35 million; however they insisted on several terms, including that if Decade failed to make an installment payment, then the ownership of all player contracts would revert to Aaron Goodwin.

Decade agreed and gave the Goodwins a draft stock-purchase agreement including the essential terms. Meanwhile, Decade negotiated with a lender to finance the purchase, butlender insisted on removing the Goodwins’ essential terms from the agreement. Christopher Aden, a Decade principal, intentionally hid the removal of the essential terms from the Goodwins knowing that the Goodwins would walk away from the deal if they saw them.

When the deal closed, the Goodwins were not given the revised agreement but assured it remained the same, signed unattached signature pages, and were not invited to the in-person closing. Aden then attached the Goodwins’ executed signature pages to the revised stock-purchase agreement. Decade did not make any installment payments to the Goodwins and later filed a voluntary chapter 7 bankruptcy petition.

The Litigation Finance Agreement and the Adversary Proceeding

Apparently unaware of the problems with this transaction, the Chapter 7 trustee appointed in the Decade bankruptcy case entered into a litigation finance agreement with the lender. The agreement required the trustee to confer with the lender about the litigation. Although the trustee retained the right to direct the litigation, the trustee could not settle without the lender’s consent. In exchange for financing, the lender was granted a $25 million secured claim in the assets of Decade’s bankruptcy estate and the trustee released all claims against the lender.

The bankruptcy attorney filed an adversary proceeding against the Goodwins seeking a declaratory judgment that the Goodwin companies were estate assets. The Goodwins counterclaimed for fraud and sought a declaratory judgment that the stock-purchase agreement was unenforceable.

Following trial, the judge found that the estate was liable to the Goodwins for fraud, ordered compensatory damages, and held the Goodwins were entitled to seek punitive damages. The court also held that the stock-purchase agreement was unenforceable. Describing the trustee as “standing in the shoes of fraudsters” and the bankruptcy attorney as grossly negligent at best, the court admonished the trustee to abandon his pursuit of the Goodwins.

Takeaways for Bankruptcy Attorneys

The consequences of the trustee’s risks and the ethical implications of this case are significant. The bankruptcy trustee and bankruptcy attorney had ethical obligations to investigate the underlying facts before filing suit. Once they entered into a litigation finance agreement, however, the ethical situation became even more complicated and numerous questions arose.

Was there a conflict of interest in financing the litigation with a lender that had its own interest in the outcome of the litigation? If the lender did not have the right to refuse to settle, would the trustee and bankruptcy attorney have taken the litigation to trial? How could the bankruptcy attorney and trustee have handled this case differently to better serve the estate and their ethical obligations?

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