Big Law partners are looking at a ruling that sent shock waves through the bankruptcy world as a lesson rather than a serious threat to their model of representing both private equity sponsors and their distressed portfolio companies.
The fallout comes in the wake of a ruling in the Eastern District of Virginia this month that declared Vinson & Elkins could not represent wood-pellet maker Enviva Inc. in its bankruptcy case due to the law firm’s longstanding relationship with Riverstone Investment Group LLC, a private equity firm that held 43% of Enviva’s publicly traded shares.
Given how commonly law firms represent private equity sponsors and their related companies in Chapter 11 proceedings, concern swirled that firms could face a sort of Sophie’s choice: Represent private equity companies on their dealmaking, or try to keep their bankruptcy teams intact. That tradeoff would have a fairly obvious answer for most firms as private equity deals are a much larger business.
But being forced to make that choice would require aggressive challenges by the US Trustee, a Department of Justice bankruptcy watchdog. Similar rulings would have to be made in other courts, considering companies have broad choice in selecting their bankruptcy venue. Or the issue could ultimately be defined by a US Supreme Court ruling, such as a recent ruling that severely limited third-party releases from lawsuits in bankruptcy cases, according to lawyers and law professors.
“We should all be paying attention to what’s happening here because it’s instructive,” said a partner at a major firm who requested anonymity to protect relationships amid a sensitive issue.
Vinson & Elkins declined to comment on the case.
Build the Wall
Lawyers and academics largely viewed the Enviva ruling as a result of specific facts that Vinson & Elkins could have tried to avoid.
For example, law firms manage the potential for conflicts by setting up teams inside the firm composed of lawyers who represent the private equity backer and others who represent its portfolio company. The lawyers are walled off from communications.
Vinson & Elkins did not originally propose an ethical wall to separate lawyers who had worked for both clients. When Judge Brian F. Kennedy first removed the firm from the case in May, he said an ethical wall was “an impossibility” in the case, given the firm currently had lawyers working for both Riverstone and Enviva.
In a motion to reconsider, Vinson & Elkins looked to correct the judge, saying the firm and the company “appear to have created the misimpression” that a wall was impossible. The firm proposed a wall that would keep partners out of the Enviva case if they’d worked more than 12.5 hours for Riverstone.
The firm proposed other structures it said would eliminate the potential for bias, including a “plan evaluation committee” and changes to partners’ compensation for Riverstone-related matters.
The judge saw it as too little too late, again rejecting its application to work for Enviva in July, ruling the new measures were insufficient.
The ruling was a shock at least in part because judges often give parties wide discretion to choose their lawyers.
Vinson & Elkins had advised Enviva for over a decade. The firm also represented Riverstone in unrelated matters, earning about $14 million in fees for that work in 2023, or 1.4% of the firm’s revenue that year, according to court documents. Riverstone, for its part, is represented in the bankruptcy case by Weil Gotshal & Manges.
The ruling has not yet been appealed, and it appears the company will hire new counsel.
But future rulings could wind up before appeals courts or the Supreme Court, said Bruce A. Markell, a former bankruptcy judge who’s now a professor at Northwestern University Pritzker School of Law. If clearer lines made it harder for law firms to represent private equity-backed companies in bankruptcy, law firms with large private equity practices would likely choose to shed their restructuring matters, he said.
“Law firms have a risk appetite just like clients have a risk appetite for this,” Markell said, adding that the issue grows out of “blurry lines” related to disinterestedness. “What a lot of the people who are crying this is the end of private equity representation overlook is: There are no certainties here.”
Lasting Impact
The ruling in the Eastern District of Virginia is still likely to have an impact. It will make the court an unlikely place for prominent bankruptcy firms to file new, private equity-related cases. And it could force firms to take more seriously the ethical implications around the business model of representing companies in Chapter 11 cases that have financial relationships with private equity clients.
“I don’t think the Enviva ruling is saying the business model of Big Law isn’t going to work anymore,” said Nancy Rapoport, a bankruptcy law professor at the University of Nevada, Las Vegas. “The message of Enviva is you don’t get to ignore your state ethical responsibilities just because you’re in federal bankruptcy court.”
As the role of private equity has grown, law firms have ridden their dealmaking to new heights. But the business of strapping companies with high debt loads always had a bankruptcy tie-in. Kirkland & Ellis, the largest law firm by revenue, is perhaps best-known for a “cradle to the grave” relationship with private equity and its distressed assets, but the practice is fairly common among firms with the largest restructuring practices.
To represent companies in Chapter 11 cases, law firms must prove they are “disinterested,” meaning they don’t represent parties with interests adverse to their client. That is often the wire that a preexisting private equity relationship can trip, since a private equity firm’s interests can diverge from those of the debtor, for instance in situations where a law firm has helped devise corporate transactions for the private equity sponsor’s benefit that may be subject to investigation or unwinding during a bankruptcy.
Still, law firms have commonly passed that test, even in the Eastern District of Virginia. There, Milbank in 2019 overcame a challenge to its representation of Gymboree, despite the law firm’s relationships with Goldman Sachs and Bank of America, which were listed by Gymboree as an equity holder and lender, and a banker and lender, respectively.
A more recent case has provided some optimism for Big Law firms.
Kirkland in May survived a challenge in a New Jersey bankruptcy court to represent bankrupt genetic medical test manufacturer Invitae Corp. A group of unsecured creditors and the US Trustee challenged the representation based on Kirkland’s work on behalf of creditor Deerfield Management Co. in matters outside of Invitae’s bankruptcy.
Ultimately, law firms aren’t facing a “mortal threat” to their private equity-related bankruptcy business, Rapoport, the UNLV professor, said.
“You’re talking about all of these lawyers who are at the top of their game and who are incredibly creative,” she said. “They just have to operate within the rules. But they’re going to find ways to do it.”