In a May 8, 2017 ruling, the Delaware Bankruptcy Court denied the official committee of unsecured creditors from accessing certain documents withheld from production based on the attorney-client privilege. Despite the purpose underlying the committee’s creation, the court distinguished the role of the committee from that of a bankruptcy trustee and barred the production of privileged documents in the absence of a finding of insolvency. This ruling hampers the ability of a creditor’s committee to root out fraud and potentially recover money for the benefit of the bankruptcy estate.

Haggen, Inc. and its affiliates filed petitions for relief under Chapter 11 of the Bankruptcy Code. During the bankruptcy case, the official committee of unsecured creditors obtained derivative standing to pursue an adversary action against the officers and directors of the debtors, the debtors’ majority shareholder and certain non-debtor affiliates.  The committee filed suit, alleging, among other things, fraud.  In support of its claims, the committee served written discovery requests.  Both the debtors and the defendants withheld ** a significant number of documents from their productions based on the attorney-client privilege.  The committee argued that it should be entitled to review the privileged documents on account of its derivative standing, because the debtors themselves would have been able to access these documents had the debtors not possessed a conflict of interest and filed suit.

The bankruptcy court concluded that the debtors and defendants could withhold documents from the committee that were protected from disclosure under the attorney-client privilege.  In reaching this conclusion, the court analyzed three decisions concerning the application of the attorney-client privilege.  First, in Commodities Futures Trading Comm’n v. Weintraub, the United States Supreme Court held that a chapter 7 trustee may waive the protections of the attorney-client privilege as to communications which preceded the bankruptcy filing.  The bankruptcy court reasoned that the Supreme Court’s holding in Weintraub did not aid the committee, because a creditor’s committee is acting on behalf of creditors whose interests could differ from that of the bankruptcy estate.  This divergence of interests justified a limited application of Weintraub.  Next the bankruptcy court analyzed the Fifth Circuit’s holding in Garner v. Wolfinbarger, which allowed shareholders to view privileged documents upon showing cause.  The Fifth Circuit identified certain criteria for determining whether cause existed, and the bankruptcy court analyzed the committee’s request in light of the Garner factors.  Despite its initial finding that the committee satisfied the Garner criteria, the bankruptcy court upheld the attorney-client privilege based on the Third Circuit’s holding in In re Teleglobe Comm’n Corp.  In Teleglobe, the Third Circuit permitted the production of privileged documents only where the debtor was insolvent at the time of the relevant communication.  The Third Circuit explained, and the bankruptcy court concurred, that insolvency was the critical factor, because in the absence of insolvency, no party owed a fiduciary duty to creditors, and thus, no breach could have occurred. 

Applying Teleglobe, the bankruptcy court found that the committee failed to put forth evidence of the debtors’ insolvency at the time of the privileged communications.  The court cited to the record to support its decision, specifically the debtors’ access to a $200 million line of credit and $100 million in cash on hand seven months prior to the bankruptcy filing.  While the court found the debtors’ sudden decline into bankruptcy interesting, the cause of the decline was speculative and incapable of satisfying the Teleglobe standard.  Accordingly, the bankruptcy court denied the committee access to privileged documents potentially capable of establishing its claims.

The case referenced above is Official Committee of Unsecured Creditors of HH Liquidation, LLC, et al. v. Comvest Grp. Holdings, LLC, et al. (In re HH Liquidation, LLC, et al.), Adv. No. 16-51204 (KG) (Bankr. D. Del. May 8, 2017).