Relevant Document:Decision
On Monday, July 2, in the
Nine West bankruptcy cases, Judge Shelley Chapman issued a written, for-publication version of her June 28 bench decision reinforcing the widely accepted practice of permitting debtors to retain distressed management consultants in the ordinary course pursuant to section 363(b) of the Bankruptcy Code, and not as “professional persons” under Bankruptcy Code section 327(a).
Specifically, after
a June 28 hearing, Judge Chapman approved
the debtors’ application to retain Alvarez & Marsal North America LLC, or A&M, to provide Ralph Schipani as interim CEO and certain additional personnel to the debtors under section 363(b) of the Bankruptcy Code, overruling the sole objector - the U.S. Trustee. The decision notes that six statements supporting the application were filed by creditors or creditor groups
“representing virtually all levels of the Debtors’ capital structure” (emphasis added).
Judge Chapman’s decision that A&M’s retention can be authorized under section 363(b) relies heavily on the so-called
Jay Alix Protocol which was adopted by the UST 14 years ago in a single case and has developed, according to Judge Chapman, into “a national policy adopted by the U.S. Trustee whereby the U.S. Trustee assents to - indeed, directs - the retention of distressed management consultants by a debtor pursuant to section 363 of the Code as long as the firm complies with certain requirements contained in the Protocol.”
As outlined in the opinion, the UST - to the extent it addressed the Jay Alix Protocol at all - asserted that permitting a retention thereunder was entirely subject to the UST’s discretion. Judge Chapman writes that the UST’s apparent attempt to sidestep the protocol in this case “lacks intellectual honesty and consistency” and would create an untenable situation where “virtually every senior executive of every chapter 11 debtor would have to be retained under section 327(a).”
Also criticized by the court is what Judge Chapman says is the apparent position of the UST that “only the U.S. Trustee, and not the Court, has discretion to create an ‘exception’ to the Code’s requirement that professional persons be retained pursuant to section 327 rather than pursuant to section 363;
i.e., that it is only permissible for the Court to approve a section 363 retention if the U.S. Trustee approves.”
“This cannot be,” according to the opinion, which says “[i]f the U.S. Trustee believes he can, through the Protocol, green-light an ‘exception’ to section 327(a) - which the Protocol clearly does - then
he cannot arbitrarily revoke such protocol without notice and inflict substantial harm on professionals and debtors who have acted in reliance on over fourteen years of precedent with respect to A&M and other similar advisory firms” (emphasis added).
The UST
argued that both A&M and Schipani are professional persons whose retention must be approved exclusively under Bankruptcy Code section 327(a), and that the application must be denied because A&M cannot satisfy section 327(a)’s disinterestedness requirement. The debtors and A&M, however, emphasized that distressed management consultants frequently are retained pursuant to section 363(b) and that the objection “directly contradicts the U.S. Trustee’s national policy over the last 14 years of explicitly assenting to retention applications for management consultants pursuant to section 363(b) in similar circumstances.” Moreover, the debtors and A&M insisted that, “in the context of these cases, A&M is not functioning as a ‘professional person’ as such term is used in section 327(a)” and that its retention may thus be approved under section 363(b).
Under section 363(b), the decision explains, debtors have “broad discretion to ‘use, sell, or lease, other than in the ordinary course of business, property of the estate,’ so long as such use is supported by a good business reason.” The decision notes that the debtors and A&M cited “numerous decisions and orders from [the Southern District of New York] and other districts in which courts have relied on section 363(b) to authorize debtors to retain management consultancy firms, including where a firm’s personnel were expected to fill key officer roles and manage the debtor’s day-to-day business.” In addition, the decision continues, they list 37 bankruptcy cases in which A&M has been retained as a management consultant pursuant to section 363. The court emphasizes that, with one exception, the UST “did not object in any of the cited cases to the debtor(s)’ request to employ the advisors, consultants, and/or chief restructuring officers pursuant to section 363(b) of the Code nor press the position taken here today that such retentions could only proceed under section 327.”
“Seemingly ignoring this mountain of precedent,” writes Judge Chapman, the UST nonetheless contended that “there is ‘a limited body of case law under which courts have approved the retention of restructuring professionals under section 363 and section 105(a).’” Unpersuaded by the UST’s arguments, the court called the UST’s attempt to distinguish Schipani’s CEO role in the Nine West bankruptcy cases from his CRO role in prior engagements “nonsensical.”
As outlined by the opinion, the Jay Alix Protocol allows retention of crisis managers under section 363 where the following requirements are met:
“(a) the firm sought to be retained must serve in only one capacity (i.e., as either a financial advisor, crisis manager, claims agent, or investor); (b) the firm’s retention application must be filed under section 363 of the Bankruptcy Code and the application must disclose the firm’s relationships with interested parties and make other disclosures showing the firm is otherwise disinterested; (c) the firm must file monthly staffing reports, which must be subject to Court review; and (d) retention of persons furnished by the firm must be approved by and act under the direction of an independent board of directors.”
In light of the protocol - which the opinion notes is not binding law but instead represents settled practice - Judge Chapman says “[t]he U.S. Trustee’s position that section 363(b) cannot provide the basis for retention of distressed management consultants such as A&M here
lacks intellectual honesty and consistency” (emphasis added).
The opinion blasts the UST for failing to mention the protocol at all, “let alone A&M’s compliance in all material respects with each of its requirements” (emphasis added). Judge Chapman writes that at the hearing, the UST’s office admitted that the “true origin” of the objection is “A&M’s alleged non-compliance with footnote three of the Protocol, given Mr. Schipani’s service as a director of a lone Debtor entity within two years prior to the Petition Date.”
Judge Chapman rejects any argument that the Jay Alix Protocol was not followed:
“Returning to first principles, the Court finds that the purpose of the Protocol - preventing a consultant from using its position in one capacity to benefit itself in another capacity - has not been violated by A&M here. As emphasized by the Debtors in their Reply, while Mr. Schipani did in fact serve as a director on a single subsidiary board within two years of the Petition Date, neither he nor any other A&M employee has ever served on the parent boards responsible for approving the prepetition or postpetition retention or compensation of A&M.”
The court continues:
“... Mr. Schipani’s service on certain subsidiary boards was done at the discretion and under the direction of the parent boards and primarily involved what can fairly be characterized as ministerial duties and approvals of transactions he had previously vetted in his role as an officer. Accordingly, the circumstances surrounding the concerns which led to the development of the Protocol - avoiding undue influence by a director in the hiring of professionals - are simply not present here, and the Court finds that A&M has complied with the core requirements of the Protocol in all material respects.”
What is more, Judge Chapman writes, the crisis and interim management industry has “relied on the implicit consent of the U.S. Trustee that such firms can be retained in a bankruptcy case pursuant to section 363 rather than section 327 if they meet the requirements of the Protocol, and the industry has developed its business model based on the understanding that the U.S. Trustee would enforce this policy consistently and fairly.” According to the opinion, it would be “starkly inequitable” to permit the UST to “now reverse course in this case.” Judge Chapman adds “
the U.S. Trustee has chosen to take a position that would unquestionably visit damage on this case, this company, and its creditors; he chooses compliance with a footnote over the interests of every creditor in this case” (emphasis added).
After finding that “nothing” stops the debtors from relying on section 363(b) to seek authorization for the retention of A&M and Mr. Schipani, Judge Chapman then concludes based on the record before her that the requirements of section 363 have been met. “The Debtors have demonstrated that retention of A&M and Mr. Schipani is clearly in the best interests of the Debtors, their estates, and their creditors, and, for all of these reasons, the Court declines to second-guess the business judgment of the parent board with respect to this decision,” Judge Chapman writes.
Turning to section 327 and whether it must apply, “the Court declines to find here that Mr. Schipani and A&M are ‘professional persons’ as such term is utilized in section 327(a) of the Code” because their roles “are focused on running the business.” This is “largely work that the officers and managers of any bankrupt entity would have to do in the ordinary course” and “[i]t would be an absurd result if their work in such roles was sufficient to render them ‘professional’ ‘persons’” because if that were the case “
virtually every senior executive of every chapter 11 debtor would have to be retained under section 327(a)” and “
this simply cannot be” (emphasis added).