Willkie Removal in Bankruptcy Case Is Lesson in Ethics’ Limits

Willkie Farr & Gallagher LLP’s disqualification as bankruptcy counsel for brand manager Franchise Group Inc. is a lesson for Big Law firms that ethical walls and conflicts counsel won’t always solve larger issues over impartiality.

The ruling from Judge Laurie Selber Silverstein of the US Bankruptcy Court for the District of Delaware severing a large company from its preferred Chapter 11 counsel is rare, but it signals to other law firms that building in ethical walls much earlier is key to keeping their lucrative debtor counsel positions.

Willkie’s prior work with Franchise Group’s ex-CEO Brian Kahn and investment adviser B. Riley Financial Inc. on various matters that have become central to the bankruptcy raised conflict concerns that ultimately doomed its role in the case. The heart of the bankruptcy surrounds claims related to a soured 2023 take-private transaction involving all three parties.

Silverstein’s ruling shows that ethical walls are fine if they’re put in place before there’s a problem, said Nancy Rapoport, a University of Nevada, Las Vegas law professor. But not afterward.

“Law firms have to think proactively every time they take on a new matter whether there is a risk that representing one client will cause the firm to want to pull its punches on behalf of a different client,” Rapoport said.

Franchise Group, which operates companies like Pet Supplies Plus, Vitamin Shoppe, and Buddy’s Home Furnishings, filed for bankruptcy in November 2024. It siloed four separate groups of Willkie attorneys from one another as they handled interactions involving the company, Kahn, and B. Riley, but there were staffing overlaps, Silverstein noted.

Willkie didn’t immediately respond to a request for comment.

‘Sends Up a Flare’

Like many conflicts decisions, Silverstein’s ruling deals with the narrow facts that arose in Franchise Group’s case, said Ashley London, director of bar studies and assistant professor of law at Duquesne University.

So while the ruling will likely have limited precedential value, there’s nonetheless a lesson for law firms.

“What I hope is that this case sends up a flare that warns large law firms that ethical walls need to be put up sooner rather than later,” London said.

The Justice Department’s bankruptcy watchdog and a lender group argued that Willkie’s prior work for Kahn and B. Riley rendered the firm too conflicted to represent the company in bankruptcy. Kahn led Franchise Group in the controversial take-private deal worth about $2.6 billion that also involved B. Riley, which acquired a stake of about 31%.

Wood pellet maker Enviva Inc. faced a similar conflict situation last year. Vinson & Elkins LLP was prevented from becoming bankruptcy counsel by a judge in the US Bankruptcy Court for the Eastern District of Virginia despite saying it had built ethical walls for its attorneys.

Vinson, which also represented the company’s largest equity holder in unrelated matters, was later allowed to serve as special counsel.

Clifford J. White, a former director of the US Trustee’s office, said he’d been excited about the Enviva decision. But it hasn’t had the chastening effect on law firms he’d hoped it would have in what he called the “battle to rein in the loose conflicts standards that too often prevail” in large corporate bankruptcies.

Nonetheless, White called Silverstein’s ruling a victory, saying in an email that it “contrasts with the more lenient results we often see in mega-chapter 11 conflicts disputes.”

The ruling also highlights that even with conflicts counsel in place, big issues like negotiating a bankruptcy plan is a core function of main counsel, Rapoport said. Conflicts counsel—lawyers brought in to handle smaller matters that lead counsel is conflicted out of—is intended to deal with a need for the “person-power” of Big Law in major bankruptcies, she said.

Large law firms represent so many clients that it’s impossible to find one that doesn’t have any conflicts, she said.

“What I’ve been seeing, starting with really broad advance conflicts waivers and continuing in cases like this one, is a Big Law philosophy that ethics rules can be finessed by client agreement alone,” Rapoport said. “I’m seeing a trend toward pretending that conflicts aren’t a ‘thing’ for lawyers to worry about any more, and that troubles me.”

Delaware Safe

Despite the ruling, Delaware won’t become a less desirable forum unless there are more decisions disqualifying counsel in the district, White said.

Other Delaware bankruptcy court judges have recently approved employment when there were accusations of conflicts.

Milbank LLP, in October 2024, was approved as lead counsel for media content delivery company Edgio Inc. by Judge Karen B. Owens. Milbank withdrew its representation of Edgio’s officers and directors in pending shareholder securities litigation, allowing the firm to gain Owens’ nod.

Silverstein, a former Potter, Anderson & Corroon LLP partner who took the bench in 2015, has been willing to buck law firm requests before.

That includes her denial of a Brown Rudnick LLP attorney’s request to increase his hourly fees by 50%, from $1,000 to $1,500, and her rejection of a Boy Scouts of America personal injury counsel coalition’s request for $21 million in fees.

Silverstein’s Franchise Group ruling also highlights a decades-long conflict between statutory and nonstatutory standards governing conflicts of interest that’s sometimes confusing and can allow lawyers to rely on standards that are more loosely enforced, London said.

Lawyers are subject to both the statutory rules in the bankruptcy code, the ethical rules governing lawyer conduct from the American Bar Association, and Delaware’s rules of professional conduct, she said.

“Interpreting these rules is like unpacking a colorful set of Russian nesting dolls, only to find that the center isn’t there,” London said. “It’s empty.”