The judge overseeing the bankruptcy of San Bernardino, California, on Thursday disqualified a law firm from representing a major bond insurer in the case, because she said some of its lawyers had "switched sides."
Federal Bankruptcy Judge Meredith Jury said the law firm of Winston & Strawn can no longer represent one of the city's creditors, bond insurer National Public Finance Guarantee Corp.
She ruled that because Winston recently hired attorneys who had worked on the case for Calpers - the state pension fund and a direct adversary of National in the proceedings - the entire firm of Winston & Strawn should be disqualified.
Calpers, America's biggest pension fund and San Bernardino's biggest creditor, had asked the judge to ban Winston & Strawn after it hired several attorneys who had been working for Calpers in the bankruptcies of San Bernardino and Stockton, another California city seeking Chapter 9 protection.
National, the municipal bond wing of MBIA, opposes Calpers in both bankruptcies.
The disqualification of a law firm in such a high profile case is rare, according to experts, and a major blow to National.
"Changing attorneys in the middle of a case is never easy. Changing attorneys in a high-stakes, high profile case is particularly tough," said Michael Sweet, a bankruptcy attorney with Fox Rothschild in San Francisco who is not involved in either the San Bernardino or Stockton cases.
Sweet said he now expects Calpers to seek disqualification of Winston & Strawn in the Stockton case.
"There is a lot of institutional knowledge that is going to be lost to National," Sweet said. With key hearings due in July and August that could decide San Bernardino's eligibility for bankruptcy, "new attorneys will be under the gun to learn the case quickly."
The recently hired attorneys had worked for K&L Gates, the firm representing Calpers in the San Bernardino and Stockton cases. The attorneys worked for Calpers on both cases.
Judge Jury noted efforts by Winston to "screen off" the attorneys from the case. But, she ruled, because of Calpers and National's inherently conflicting positions in the case, the attorneys could not switch firms without violating their duty of loyalty to the former client.
"I am compelled to disqualify the law firm," Jury said.
San Bernardino and Stockton are considered test cases in the battle over whether municipal bondholders or current and retired employees will absorb most of the pain when a state or local government goes broke.