## Facts

- SONICblue, Inc. manufactured and sold electronic products.
- SONICblue raised $75 million through a bond (senior notes) issuance that was later purchased by three institutional bondholders.
- Pillsbury Winthrop Shaw Pittman LLP (Pillsbury) served as SONICblue’s counsel and, in connection with the bond issuance, delivered a written opinion letter to the bondholders regarding the bond documents.
- SONICblue later filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Northern District of California.
- The bankruptcy court approved Pillsbury’s retention as counsel for the debtor in possession.
- Pillsbury filed multiple disclosures addressing potential conflicts under Bankruptcy Rule 2014, but none disclosed the prior opinion letter issued to the bondholders.
- During the Chapter 11 case, Pillsbury assisted SONICblue in taking positions that challenged the bondholders’ claims.
- The bondholders asserted that, because Pillsbury had issued the opinion letter, Pillsbury was required to defend and indemnify them for losses caused by SONICblue’s challenge to their claims.
- Pillsbury shifted work on the bondholder dispute to counsel for the official unsecured creditors’ committee, but Pillsbury did not file a supplemental disclosure identifying the conflict created by the opinion letter and indemnity demand.
- Motions were filed seeking, among other relief, disqualification of Pillsbury and appointment of a Chapter 11 trustee (with conversion to Chapter 7 raised as an alternative).

## Issues

1. Whether Pillsbury could remain employed as debtor’s counsel under 11 U.S.C. § 327(a) given its prior opinion letter to major creditors whose claims the debtor was disputing and the resulting risk of divided loyalty.
2. Whether Pillsbury’s failure to disclose the opinion letter and related conflict information violated Fed. R. Bankr. P. 2014 and justified disqualification.
3. Whether the court should appoint a Chapter 11 trustee under 11 U.S.C. § 1104(a) (and, alternatively, whether conversion to Chapter 7 was warranted) based on conflicts, nondisclosure, and loss of confidence in the debtor-in-possession’s administration.

## Decision

- The court disqualified Pillsbury as counsel for the debtor in possession under 11 U.S.C. § 327(a).
- The court found Pillsbury’s Rule 2014 disclosures were inadequate because they failed to reveal the opinion letter relationship and the resulting conflict concerns.
- The court appointed a Chapter 11 trustee under 11 U.S.C. § 1104(a).
- The court declined to convert the case to Chapter 7, selecting Chapter 11 administration under an independent trustee instead.

## Legal Principles

- Under 11 U.S.C. § 327(a), counsel for a debtor in possession must be “disinterested” and must not hold or represent an interest adverse to the estate.
- A law firm’s prior role in a transaction that later becomes disputed in the bankruptcy—especially where the firm gave an opinion directly to creditors—can create a disabling conflict when the debtor challenges those creditors’ claims and the firm faces potential exposure or competing duties.
- Fed. R. Bankr. P. 2014 requires complete and candid disclosure of a professional’s connections with the debtor, creditors, and other parties in interest; the duty is continuing and requires updates when new facts create or reveal conflict risks.
- The bankruptcy court, not the professional, decides whether a connection is significant; omission of a connection may itself warrant disqualification, apart from proof of actual harm.
- Assigning a particular dispute to separate counsel may not cure a firm-wide conflict where the conflict can affect case strategy, advice to management, or the willingness to investigate claims tied to the firm’s prior work.
- A Chapter 11 trustee may be appointed for cause or when doing so best serves creditors and the estate, including when conflicts and nondisclosure impair trust in debtor-in-possession governance.

## Conclusion

In re SONICblue held that debtor’s counsel’s undisclosed prepetition opinion letter to key bondholders, combined with the debtor’s later challenge to those bondholders’ claims and an asserted indemnity obligation, created conflict and disclosure problems that required counsel’s removal; to restore confidence and protect the estate, the court appointed a Chapter 11 trustee and declined to convert the case to Chapter 7.


In re SONICblue, 2007 WL 926871 (2007)