O.C. Bankruptcy’s Legal Morass Could Last Years : Courts: Many of state’s largest law firms are involved. Some feel litigation explosion can still be avoided.

A panel of grim-faced business people from across the nation, stunned by Orange County’s sudden bankruptcy filing, arrived in Santa Ana days later to hire a law firm that could recover hundreds of millions of dollars owed them by the county.

In a ninth-floor conference room overlooking the tony South Coast Plaza commercial center, a couple of dozen attorneys and their junior partners made lengthy sales pitches about their legal acumen--turning up the volume on their charm and handing out color brochures that described strategies for untangling the financial debacle.

“It seemed like every bankruptcy lawyer on the West Coast was there,” recalled Chris Taylor, vice president at Coto de Caza, a development firm owed $13 million by the county. “These guys were all jockeying for position, claiming the same successes. I saw more attorneys that day than I hope to see for the rest of my life.”

The so-called beauty contest of attorneys held Dec. 16 by the creditors was but one instance of a raging competition among law firms for key jobs in the Orange County bankruptcy, which has quickly developed into a historic business opportunity for lawyers.

The unprecedented scale of the financial meltdown in Orange County threatens to become an equally unprecedented legal morass that could take years to unravel. Ultimately, it could run up legal fees of several hundred million dollars, much of which will be borne by local taxpayers, according to attorneys and government officials.

School districts, cities, water authorities, sewage districts, building contractors, banks, bondholders, security firms and the county itself, among many others, all have hired high-powered law firms for the coming battle.

More than a third of the 50 largest law firms in the state have landed jobs representing parties in the bankruptcy case, according to a Times survey. Indeed, the six largest law firms in California are all involved.

Just eight weeks into the bankruptcy, hundreds of attorneys at their word processors have pounded out more than 500 pleadings and other notices now entered in the bulging files of federal and state courts.

The Orange County bankruptcy and nearly two dozen related class actions, criminal probes and regulatory investigations are rapidly gaining momentum, leading experts to predict that more legal actions are inevitable.

“The litigation costs are going to eat everybody alive,” said Jeffrey Chanin, a financial adviser to the creditor committee in the Orange County bankruptcy. “What we have seen so far is just the tip of the iceberg. There will be cross suits, side suits, criminal suits, auditor suits. Every lawyer west of the Mississippi is going to have a suit.”

Of course, attorneys neither caused the losses nor are they capable of solving the bitter dispute without first getting all the parties to compromise. And it isn’t just lawyers adding to the cost. Financial advisers, accountants and auditors, as well as public relations specialists, have secured jobs at the sidelines of the bankruptcy.

“People think unless they have an attorney representing their interests, somebody else is going to get the better of them,” lamented Orange County Supervisor Marian Bergeson. “It is like wildfire. I don’t know how to stop the hemorrhaging.”

Interviews with key attorneys in the bankruptcy indicate a litigation explosion can still be avoided in the next several weeks, if a quick and widely accepted plan for paying off the $1.7-billion investment loss is reached.

U.S. Trustee Marcy Tiffany, a Justice Department official with broad responsibilities in administering bankruptcy cases, is stretching to the limit of her authority under Chapter 9 of the Bankruptcy Code to contain litigation costs.

Bruce Bennett, the county’s lead bankruptcy attorney, remains optimistic that a litigation explosion can be avoided, citing unspecified recent developments that have raised his hopes. But he acknowledges that it is far too early to predict what will happen.

“Some lawyers fight for the sake of fighting,” Bennett observed. “I don’t see any of those lawyers in this case, with one exception.” Bennett declined to identify the rogue lawyer, adding, “I have to get along with everyone.”

But for the Orange County bankruptcy not to disintegrate into a mass of bitter litigation, several hundred parties must reach a quick consensus on apportioning and paying for the loss.

Rapidly mounting evidence of wrongdoing in the county treasurer’s office and the potential for future criminal charges in the case further raise doubts that groups who lost money will be forgiving.

Unforeseen issues, such as orders by federal regulators, could delay resolution of the bankruptcy for years.

When LTV Corp., for example, filed for bankruptcy in 1987, it never anticipated that a federal lawsuit over its pension plan would cause a seven-year delay--and eat up $200 million to $300 million in various attorneys fees, LTV spokesman Mark Tomasch said.

If the investment pool participants--the cities, schools and various government districts--squabble among themselves or attempt to declare the county a trustee that violated their interests, the number of suits could explode, Tiffany said.

“This case is either going to resolve quickly or disintegrate,” she said. “I am hoping for the best but expecting the worst.”

Indeed, it appears that positions in the case are hardening with the county’s refusal to bear the full loss and a rising dissatisfaction among creditors with the county’s practices.

“Fiscally, the county can’t accept the loss,” said Bergeson, the supervisor. “We couldn’t pay the police and fire departments.” As for rising discontent and distrust among creditors, she adds: “Why would they be happy? This is a miserable situation.”

Even if the county and the cities in the investment pool compromise to accept the loss, many other parties--such as bondholders--are likely to continue to press damage claims. It is also widely expected that the county will expand its suit against Merrill Lynch and Nomura Securities to include other brokers that sold it securities. The uncertainties and inadequacies of the Chapter 9 federal Bankruptcy Code itself may add to the litigation costs.

William S. Lerach, a San Diego attorney who has filed several class-action lawsuits on behalf of bondholders, said he expects his suits will continue, regardless of whether the county avoids a default.

Some investors have already sold their Orange County bonds at a loss, Lerach said. In addition, he pointed out, the county’s bankruptcy has increased the perceived risk facing investors, driving up the interest rates on county securities and driving down their value for existing bondholders.

Asked if the county can find a plan that offsets all of these claims, Lerach said, “I hope they can, but I doubt they will.”

Adds Frank Nunes, another attorney bringing a class action case: “Everybody is sounding so acrimonious that it is a cause for concern. Everybody is finger-pointing and nobody is willing to take responsibility. It will be a long, drawn-out litigation.”

Bennett Murphy, a Latham & Watkins attorney representing bondholders, said the county could “do a lot to contain litigation by working with the creditors on a day-to-day basis,” but so far he doesn’t see the cooperation he had hoped for.

Not surprisingly, the county itself is among the biggest spenders in the legal area, already budgeting about $12 million for litigation costs over just a six-month period--roughly the cost of building a new elementary school on prime land in south Orange County.

Orange County’s decision to file two bankruptcies--one for the investment pool and one for the county itself--has increased legal representation drawn to the battle. An estimated $2 million to $3 million per month is being spent by the committees for lawyers and advisers, according to various attorneys and U.S. trustee Tiffany.

Those costs do not include the massive spending by the independent parties. As many as half of the 186 cities and government entities in the investment pool have retained outside attorneys to assist their in-house counsels. Banks, bondholders, trustees and individual vendors have hired scores of additional attorneys.

The brokerage houses may be among the biggest legal spenders. Merrill Lynch, which is being sued by the county and bondholders for selling 70% of the county’s high-risk investments, has tapped three powerful law firms to defend itself.

Merrill Lynch spokesman James Wiggins declined to say how much the firm is spending on the case, but high legal expenses are not unusual at Merrill. In 1994, it spent $367 million on legal and other professional fees.

Even brokers who haven’t yet been sued have retained counsel. The Orange County offices of Paul, Hastings, Janofsky & Walker were recently retained by a broker who expects to be sued but whose identity remains confidential. Any disclosure about the client’s identity “would be a virtual invitation for a suit,” said Donald Morrow, a partner at the firm.

A lot of lawyers, sensitive to negative public perceptions about their profession, express ambivalence about the whole mess--thankful for the business but lamenting the pain that schools and other public service agencies will suffer from the coming battle.

“It’s a damn good source of business,” said Richard Marshack, a Santa Ana attorney representing the vendors subcommittee. “But it is unfortunate. My kids go to a school that may not have enough money for next fall.”

Marshack, however, is one of the few attorneys in the bankruptcy case who live in Orange County. Ironically, much of the taxpayer money for legal representation is going to firms in Los Angeles, San Francisco, New York and elsewhere because Orange County firms have conflicts of interest in representing clients in the bankruptcy, Marshack said.

Tiffany, the U.S. trustee for Southern California, is seeking to hold the line on litigation expenses by forcing a number of the creditor and pool investor committees to pay for attorney expenses out of their own pockets, instead of billing the county.

When Chapter 9 was amended only last year, Congress left some gaping holes in defining exactly how much compensation attorneys are entitled to and who is supposed to pay, forcing Tiffany to revert to practices more clearly spelled out in corporate reorganizations under Chapter 11.

For example, Congress neglected to incorporate into Chapter 9 the fee guidelines administered by the U.S. trustee. Moreover, Section 503 of Chapter 9 appears to leave open to question whether every individual creditor and investment pool member can bill their legal expenses to the county.

Chapter 11 does not allow such billings, limiting legal expenses only to the attorneys directly representing the creditor committee. Tiffany interprets Chapter 9 language to mean the same, but the interpretation is open to challenge.

“I am not saying it is a foolproof argument,” she said.

If her reading is not upheld, it would mean hundreds of attorneys could end up billing Orange County taxpayers for their work. Eventually, any attorney can petition the court for payment from the county, based on an argument that they made a “substantial contribution” to the case.

Litigation costs in complex cases, such as the Orange County bankruptcy, have risen quickly throughout the nation, particularly where many parties seek recoveries from multiple defendants, said Debra Hensler, a RAND Corp. analyst regarded as one of the nation’s top experts on complex litigation.

“You are going to see extremely large legal expenses,” Hensler said of Orange County. “It is common sense. You don’t need RAND to know this.”

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