Muscle Improvement Inc.

OCR transcription for search; preserved printed pages are authoritative

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AUTHENTI€£

U.S. GOVER
INFORMA:

UeTey COURT
TERK, US, GANKAUE 1G) EORNIA
GENTAAL DISTRICT OF OA Terk
BY

In re:

Muscle Improvement, Inc.,

Muscle Improvement — Hawthorne, Inc.,
Muscle Improvement — Commerce, Inc.,
Abram Tavera and Ruth Tavera,

Muscle Training Corporation

Muscle Improvement Holding
Corporation,

Debtors.

Case 2:10-bk-12736-PC Doc 186 Filed 08/31/10 Entered 09/01/10 14:02:47
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ORIGINAL

UNITED STATES BANKRUPTCY COURT
CENTRAL DISTRICT OF CALIFORNIA

Case No
Case No
Case No
Case No
Case No
Case No

2 2:10-bk-12736SB
. 2:10-bk-12743SB
. 2:10-bk-12756SB
~ 2:10-bk-12765SB
. 2:10-bk-13087SB
~ 2:10-bk-13094SB

(consolidated under 2:10-bk-012736SB
for administrative purposes)

Chapter 11s
OPINION ON DISQUALIFICATION OF

COUNSEL FOR CREDITOR ALLSTATE
FINANCIAL GROUP, INC.

TED

ENT
PN
PO

Date:
Time:
Ctrm:
Floor:

July 13, 2070
11:00 a.m.
1575

15th

Des¢

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Case 2:10-bk-12736-PC Doc 186 Filed 08/31/10 Entered 09/01/10 14:02:47 Des
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l. Introduction

Chapter 11° debtors Muscle
improvement Inc. and five related entities
(collectively “Muscle Improvement’) move to
disqualify Haleh Naimi and her law firm as
counsel for creditor Allstate Financial Group,
Inc. (“Allstate”) on the grounds of conflict of
interest. Debtors contend that they provided
confidential information to Ms. Naimi when
they consulted with her about representing
them in these consolidated bankruptcy cases
(but declined to retain her). The court finds
that, under California law, Ms. Naimi must be
disqualified under the “substantial relationship”
test.

ll. Relevant Facts

Debtors have brought an adversary
proceeding against their principal creditor
Allstate on a number of claims, including
breach of contract and fraud. Allstate has
appeared through its counsel, Ms. Naimi.
Debtors now move to disqualify Ms. Naimi and
her firm, Advocate Solutions, tnec., from
representing Allstate or its representative,
John Michael, on conflict of interest grounds.
The disqualification motion is based on
two consultations that debtors had = with
Ms. Naimi prior to their bankruptcy filing,
in which they discussed retaining her to
represent them in these cases.

At the first meeting with Ms. Naimi,
the parties spent two hours discussing
Ms. Naimi’s prior bankruptcy experience and
debtors’ financial problems. John Michael
also attended this meeting. After the first
meeting, the debtors provided Ms. Naimi
several documents relating to their financial
condition. Following the first meeting,
Ms. Naimi sent a retainer agreement to the
debtors for signature. The retainer agreement
was never signed or returned.

' Unless otherwise indicated, al! chapter,

section and rule references are to the
Bankruptcy Code, 11 U.S.C.A. §§ 101-1532
(West 2009) and to the Federal Rules of
Bankruptcy Procedure Rules 1001-9036.

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The second meeting took place on
November 23, 2009. Ms. Naimi and debtors’
agents designated this meeting as a
“consultation,” for which Ms. Naimi_ billed
debtors $350. Debtors’ agents brought a
financial consultant, Brian Avaylon,” to the
second meeting to discuss their financial
condition. The debtors brought a file of
documents. Mr. Avaylon reviewed the
debtors’ financial affairs with Ms. Naimi and
together they examined documents in the file.
Ms. Naimi advised the debtors that it would be
better to attempt a workout rather than file
bankruptcy cases because it would be less
expensive. She also advised the debtors not
to make payments to their creditors that could
be considered preferential payments.* Neither
John Michael nor any other Allstate
representative attended this meeting.

Debtors ultimately chose not to
employ Ms. Naimi. Instead, they hired their
present bankruptcy counsel Robert Yaspan for
their chapter 11 bankruptcy cases. Allstate
then hired Ms. Naimi to represent Allstate’s
interests in these cases.

Debtors now move to disqualify
Ms. Naimi and her firm from representing

2 Ms. Naimi contends that Mr. Avaylon’s
presence at the meeting prevented it from
being confidential, since he was a creditor of
the debtors. The court finds the evidence
insufficient to support this contention. Instead,
the court infers that Mr. Avaylon was part of
the debtors’ management and consulting team
for the purposes of dealing with their financial
problems.

3 Ms. Naimi disputes the debtors’ account of
what transpired at this second meeting. For
the purposes of this motion, the court finds this
dispute irrelevant. So Jong as the parties do
not agree as to what happened, the court must
credit the account of the debtors. Compare
Zimmerman —sV. Zimmerman {in re
Zimmerman), 16 Cal. App. 4th 556, 565 (1993)
(disqualification of counsel not required
because parties agreed that no confidential
disclosures were made in the preliminary
meeting).

{

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Case 2:10-bk-12736-PC Doc 186 Filed 08/31/10 Entered 09/01/10 14:02:47 Desa

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Allstate or John Michael on conflict of interest
grounds.

il. Analysis

Conflict of interest law is complex and
subtle. While a careful lawyer should not have
difficulty in complying with most of the
applicable rules of professional conduct,’
even sophisticated counsel trying toe comply
with the rules regarding conflict of interest
must make difficult and uncertain decisions.
In consequence, the disqualification of counsel
on conflict of interest grounds normally does
not reflect on counsel's integrity or
qualifications to practice law. See, e.g., fn re
Jaeger, 213 B.R. 578, 583-93 (Bankr. C.D.
Cal. 1997) (disqualifying large law firm for
representing conflicting interests).

The court finds that Ms. Naimi has a
conflict of interest that requires her
disqualification from representing Allstate in
this bankruptcy case.

A. Applicable Law

The federal courts in California do not
have their own ruies of professional conduct
for lawyers. Local Rule ("LBR") 2090-2(a) of
the Bankruptcy Court for the Central District of
California, which governs the professional
responsibility of attorneys practicing before
this court,” incorporates by reference the
district court's local rule 83-3.1.2, which
requires that attorneys comply with the
California Rules of Professional Conduct, as

* California Rules of Professional Conduct.
The California rules of professional conduct,
unlike those in all other states, are not based
on the Model Rules of Professional Conduct
promulgated by the American Bar Association.
In consequence, both the California rules and
the case law thereunder may differ from what
is found in other states.

5 LBR 2090-2(a) states: “An attorney who
appears for any purpose in this court is subject
to the standards of professional conduct set
forth in Local Civil Rule 83-3.1.2 of the district
court.”

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interpreted by California case law.
Accordingly, we turn to the applicable
California rules and case law to determine the
motion before the court. See, e.g., Jaeger,
213 B.R. at 583.

In addition, a courts power to
disqualify an attorney from appearing in a
particular case derives from the power of
every court to control the conduct of attorneys
practicing before it. See, e.g., Trone v. Smith,
621 F.2d 994, 999 (Sth Cir. 1980); People ex
rel. Dept. of Corporations v. SpeeDee Oil
Change Systems, inc., 20 Cal. 4th 1135, 1145
(1999). Ultimately, a court's decision to
disqualify an attorney is based upon the need
to maintain high standards of professional
responsibility. See id.

B. California Rules on Disqualification
for Conflicts of Interest

Rule 3-310 of the California Rules of
Professional Conduct requires an attorney to
avoid the representation of adverse interests.
Rule 3-310(E) states:

A member shall not, without the

informed written consent of the

client or former client, accept
employment adverse to the client

or former client where, by reason

of the representation of the client

or former client, the member has

obtained confidential information

material to the employment.’

See also Flatt v. Superior Court, 9 Cal. 4th
275, 283-84 (1994).

The chief fiduciary value protected
when an attorney represents successive

8 District Court Local Rule 83-3.1.2 states in
relevant part: “each attorney shall be familiar
with and comply with the standards of
professional conduct required of members of
the State Bar of California and contained in
the State Bar Act, the Rules of Professional
Conduct of the State Bar of California, and the
decisions of any court applicable thereto."

” Cal. Rules Prof. Conduct, Rule 3-310(E)
(2009). No written consent to Ms. Naimi’s
representation of Allstate has been offered in
this case.

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Case 2:10-bk-12736-PC Doc 186 Filed 08/31/10 Entered 09/01/10 14:02:47 Desa

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clients is client confidentiality. See, e.g., id.
at 283; see also, CAL. BUS. & PROF. Cope
§ 6168(e)(1} (West 2008) (requiring an
attorney, “{t]lo maintain inviolate the
confidence, and at every peril to himself or
herself to preserve the secrets, of his or her
client.") The purpose of such protection is
to permit counsel to give a client the best
advice possible. To enable such advice, it is
necessary for the client to disclose all relevant
information, including information that
the client does not want to be made public.
The need to protect an earlier client's
confidential information may require that the
attorney be disqualified from a
contemporaneous or subsequent
representation of another client. See, eg.,
Speedee Off, 20 Cal. 4th at 1146 (1999).
Thus, the protection of the confidentiality of
such communications is fundamental to our
legal system. See id.®

A court decision on this issue must be
a pragmatic decision that focuses on the
nature and quatity of the former
representation. See, ée.g.,.Jessen v. Hartford
Casualty ins. Co., 111 Cal. App. 4th 698,
706 (2003). The court must exercise special
care in making such a decision where the
attorney was only consulted about possible
retention in a case but was not retained.

® In addition to the protection of confidential
communications, our legal system imposes on
attorneys an obligation of loyalty to their
clients. fd. As the California Supreme Court
stated in Speedee Oil.

Attorneys have a duty to maintain
undivided loyalty to their clients to
avoid undermining public
confidence in the legal profession
and the judicial process [citations
omitted]. The effective functioning
of the fiduciary relationship
between attorney and client
depends on the client's trust and
confidence in counsel.

ld. However, the duty of loyalty is not invoked
in this case because of the fleeting nature of
Ms. Naimi’s relationship with the debtors and
the fact that they declined to retain her. See
id. at 1147.

Page 4 of 7

C. Application to Existing Clients

A court may not require an attorney to
disclose confidential information (which may
include privileged information) for examination
by the court to determine whether a
subsequent representation is adverse to an
existing or former client. The disclosure of
such information would make public the client
confidences and secrets that are entitled to
protection. Thus, courts must use a substitute
approach to determine whether an attorney
has received confidential information material
to employment adverse to a client.

The substitute approach adopted by
the courts is the “substantial relationship" test.
This test governs disqualification motions
under Rule 3-310(E). See, e.g, Flatt, 9 Cal.
4th at 283; Kirk v. First American Title Ins. Co.,
183 Cal. App. 4th 776, 796 (2010); Jessen,
114 Cal. App. 4th at 708. Under the
substantial relationship test, the subject matter
of an attorney’s current representation is
considered substantially related to the subject
matter of the attorney's prior representation
ifany information that was materia! to the
evaluation, prosecution, settlement, or
accomplishment of the prior representation is
also material to the evaluation, prosecution,
settlement, or accomplishment of the current
representation. Jessen, 111 Cal. App. 4th
at713. Where a_ substantial relationship
between the subject of the prior and the
current representations is shown, access to
confidential information by the attorney in the
course of the first representation (which is
relevant, by definition to the second
representation), is presumed and
disqualification of the attorney's representation
of the second client is mandatory. Fiatt, 9 Cal.
4th at 283.

To prevail under the substantial
relationship test, the former client must satisfy
two elements: (1) the subject matter of the
attorney's current representation is
substantially related to the subject matter of
the attorney's earlier representation of the
former client: and (2) the attorney's eazlier
representation of the former client was one in
which confidential information would ordinarily
be disclosed. Jessen, 111 Cal. App. 4th at
709-10; see also City and County of San
Francisce v. Cobra Solutions, inc., 38 Cal.4th
839, 847 (2006); Henriksen v. Great Am. Sav.
& Loan, 11 Cal. App. 4th 109, 113-14 (Cal. Ct.

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App. 1992). A former client who establishes
both of these elements creates an irrebuttable
presumption that the attorney possesses
confidentia! information. See, e.g., Jessen,
111 Cal. App. 4th at 708.° The court must
then order disqualification. See id.

D. Application of Rule
Where Counsel is Not Retained

Rule 3-310(E) applies principally to a
lawyers actual engagements for separate
clients with possibly differing interests. In this
case, Ms. Naimi was not retained to represent
the debtors. Nonetheless, because of the
initial consultation, Ms. Naimi is now subject to
disqualification from representing Allstate,
another party in interest.

Under California rules, the relationship
of attorney and client is established prima
facie at the time of preliminary consultations
with a view toward retention, even if actual
retention does not materialize. /d., Perkins v.
West Coast Lumber Co., 129 Cal. 427, 429
(1900).

In considering whether a
representation was one in which an attorney
would ordinarily acquire confidential
information, a court must consider the nature
and extent of the attorney's involvement with
the former client. See H.F. Ahmanson & Co.
v. Salomon Bros., Inc., 229 Cal. App. 3d 1445,
1455 (1991). As an initial matter, a court must
presume that an attorney acquired confidential
information if the attorney gave legal advice to
the client. See Jessen, 111 Cal. App. 4th 698
at 709-10. Absent such a showing, a court
must look at whether the attorney was in such

® Courts have justified the irrebuttable

presumption of knowledge of confidential
information as a rule of necessity, “for it is not
within the power of the former client to prove
what is in the mind of the attorney. Nor should
the attorney have to ‘engage in a subtle
evaluation of the extent to which he acquired
relevant information in the first representation
and of the actual use of that knowledge and
information in the subsequent representation.”
Global Van Lines, Inc. v. Superior Court, 144
Cal. App. 3d 483, 489 (Cal. Ct. App. 1983)
(quoting from Developments in the Law:
Conflicts of interest in the Legal Profession, 94
Harv. L. REV. 1244, 1318 (1981)).

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a position vis-a-vis the former client that the
attorney was likely to receive confidential
information. See id. at 710-11.

In this case, the = substantial
relationship test is clearly moet. First,
Ms. Naimi consulted with debtors with respect
to the same case in which she is now
representing Allstate, the principal creditor.
Furthermore, the subject matter is essentially
the same as the case before the court, and
thus is substantially related.

Second, the consultation with the
debtors was one in which confidential
information would ordinarily be disclosed.
While a potential client would not ordinarily
disclose all of the confidential information
relating to a case, there would ordinarily be an
important measure of disclosure of confidential
information. Indeed, the debtors present
evidence in this case that they presented
substantial confidential information to
Ms. Naimi at the second meeting and received
legal advice from her on several subjects.

Ms. Naimi tries to rebut the
presumption that confidential information was
disclosed during the second meeting. She
contends (and debtors dispute) that she only
received financial information which, given the
bankruptcy filings, is now public information.
She further argues a former client's
information is not confidential for conflict-of-
interest purposes if it is already available to
the adverse client or if the former client has
reason to believe that the attorney would
share the information with the adverse client.
See Christensen v. U.S. Dist. Court, 844 F.2d
694, 698-99 (9th Cir. 1988).

Under California law, such rebuttal is
impermissible. ° See, e.g., Jessen, 111 Cal.
App. 4th at 708. Courts have justified the
irrebuttable presumption of knowledge of
confidential information as a rule of necessity,
“for it is not within the power of the former
client to prove what is in the mind of the
attorney. Nor should the attorney have to
‘engage in a subtle evaluation of the extent to

© Ms. Naimi seeks discovery against debtors
to help build a case that she did not receive
confidential information from them in the
second meeting. Because the presumption is
irrebuttable, no such discovery could lead to
the discovery of relevant information.

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which he acquired relevant information in the
first representation and of the actual use of
that knowledge and information in the
subsequent representation.” Global Van
Lines, inc. v. Superior Court, 144 Cal. App. 3d
483, 489 (Cal. Ct. App. 1983) (quoting from
Developments in the Law: Conflicts of interest
in the Legal Profession, 94 Harv. L. Rev.
1244, 1318 (1981)). Thus, the court must
order disqualification. See id.

In light of the foregoing, it is
immaterial whether Ms. Naimi actually
obtained confidential information in the course
of her meeting with debtors’ agents. The two
dispositive issues are whether the subject
matter of their meetings is substantially related
to the subject matter of this case, and whether
Ms. Naimi’s relationship with debtors was one
in which confidential information would
ordinarily be disclosed. Here, the undisputed
facts resolve both of these issues in favor of
debtors. The court finds that movants have
met their burden to show that Ms. Naimi must
be disqualified. ""

The subject matter of Ms. Naimi’s
current representation of Allstate, a creditor
and adverse party, is substantially related to
the subject matter of Ms. Naimi’s meetings
with debtors’ agents. The subject matter of the
meetings included debtors’ financial condition.
That information is now material to the
prosecution of this bankruptcy case.

In making this ruling, the court
disregards the first meeting with Ms. Naimi.
Because John Michael attended the first
meeting on behalf of Allstate, Allstate already
had access to all the information that debtors
disclosed at the first meeting. Thus, none of
that information is confidential with respect to
Allstate.

With respect to the second meeting,
however, the court finds that Ms. Naimi likely
received confidential information. Following
the first meeting, Ms. Naimi requested and
received documents pertaining to debtors’
financial condition. At the second meeting, Mr.
Avaylon showed these documents to Ms.
Naimi while discussing debtors’ financial

'' In addition, even if (contrary to California
law) rebuttal were permitted, the court finds
that Ms. Naimi has not successfully rebutted
the debtors’ evidence that they did disclose
confidential information to her.

Page 6 of 7

condition. Additionally, Ms. Naimi charged a
legal fee to debtors for this meeting at her
hourly rate as an attorney. Thus, Ms. Naimi
was in a position to review debtors’ private
documents and to listen to debtors’ agents
and financial consultant speak extensively
about debtors’ financial condition.

Ms. Naimi argues that the presence of
Mr. Avaylon at the second meeting prevented
any information provided to her from being
confidential. The court is not persuaded.
Unlike John Michael, it appears to the court
that Mr. Avaylon was acting as debtors’
financial consultant, rather than as a
representative for a potentially adverse party,
and was part of debtors’ financial team. Thus,
he was within the sphere of confidentiality for
the debtors. Accordingly, Mr. Avaylon’s
presence at the second meeting did not
destroy debtors’ reasonable expectations of
confidentiality.

IV. CONCLUSION

This court holds that an attorney must
be disqualified on conflict of interest grounds
ifthe attorney meets with a client under
circumstances in which confidential
information would likely be disclosed, and the
attorney subsequently represents an adverse
client in a substantially related matter, even if
the former client never employed the attorney.

For the foregoing reasons, this court
grants debtors’ motion to disqualify Haleh
Naimi from representing Allstate Financial
Group, Inc. or its representative, John
Michael. The court does not address the
issue of disqualification of Ms. Naimi’s law
firm, Advecate Solutions, Inc., because there
is no indication that her firm desires to
represent Alistate without her participation.

Dated: August 30,2010 ANIA 89 JTL

a

A
VA Hon. Safquel L. Bufford
United Stat¢s|Bankruptcy Judge

—=

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Case 2:10-bk-12736-PC Doc186 Filed 08/31/10 Entered 09/01/10 14:02:47 Desa
Main Document Page 7 of 7

NOTE TO USERS OF THIS FORM:

1) Attach this form to the last page of a proposed Order or Judgment. Do not file as a separate document.

2) The title of the judgment or order and all service information must be filled in by the party lodging the order.
3) Category I. below: The United States trustee and case trustee (if any) will always be in this category.

4) Category Il. below: List ONLY addresses for debtor (and attorney), movant (or attorney) and person/entity
(or attorney) who filed an opposition to the requested relief. DO NOT list an address if person/entity is listed in
category |.

NOTICE OF ENTERED ORDER AND SERVICE LIST

Notice is given by the court that a judgment or order entitled (specify) OPINION ON
DISQUALIFICATION OF COUNSEL FOR CREDITOR ALLSTATE FINANCIAL GROUP, INC. was
entered on the date indicated as “Entered” on the first page of this judgment or order and will be
served in the manner indicated below:

l. SERVED BY_THE COURT VIA NOTICE OF ELECTRONIC FILING (“NEF"} - Pursuant to
controlling General Order(s) and Local Bankruptcy Rule(s), the foregoing document was served on
the following person(s) by the court via NEF and hyperlink to the judgment or order. As of August 30,
2010, the following person(s) are currently on the Electronic Mail Notice List for this bankruptcy case
or adversary proceeding to receive NEF transmission at the email address(es) indicated below.

Robert M. Yaspan, Esq. ryaspan@yaspanlaw.com
United States Trustee ustpregion16.la.ecf@usdoj.gov
Russell Clementson, Esq. russell. clementson@usdoj.gov
LI Service information continued on attached page

Ii. SERVED BY THE COURT VIA U.S. MAIL: A copy of this notice and a true copy of this judgment
or order was sent by United States Mail, first class, postage prepaid, to the following person(s} and/or
entity(ies) at the address(es) indicated below:

CJ Service information continued on attached page

lll. TO BE SERVED BY THE LODGING PARTY: Within 72 hours after receipt of a copy of this
judgment or order which bears an “Entered” stamp, the party lodging the judgment or order will serve
a complete copy bearing an “Entered” stamp by U.S. Mail, overnight mail, facsimile transmission or
emait and file a proof of service of the entered order on the following person(s) and/or entity(ies) at
the address(es), facsimile transmission number(s), and/or email address(es) indicated below:

CT] Service information continued on attached page

ADDITIONAL SERVICE INFORMATION (if needed):