As previously discussed in ABI’s Ethics and Professional Compensation Committee’s November 2013 Newsletter,[1] fee-sharing and proper disclosures in connection with certain professionals’ retention applications became the central issue in the GSC Group Inc., et al. [2]chapter 11 cases. Although the November article sets forth the background in some detail, the salient facts are set forth herein again for convenience.
Case Background
GSC, a hedge fund, filed for chapter 11 protection in the U.S. Bankruptcy Court for the Southern District of New York in August 2010 and hired Kaye Scholer LLP as its counsel and Capstone Advisory Group LLC as its financial adviser. The Capstone engagement team was led by Robert J. Manzo. Capstone conducted a marketing process of the GSC’s assets, followed by a three-day auction at which the assets were sold to Black Diamond Capital Management LLC for approximately $235 million, significantly greater than Black Diamond’s initial stalking-horse bid of $5 million. Approximately eight months later, GSC confirmed its proposed liquidation plan and RJM1 LLC, a single-member limited liability company (LLC) that was operated by Manzo, became the debtors’ liquidating trustee.
Issues
On Jan. 30, 2012, Capstone filed a performance fee motion seeking a success fee of $3.25 million, or approximately 1.4 percent of the purchase price. The U.S. Trustee, among others, filed objections to the performance fee motion. Capstone responded by filing an amended performance fee motion, decreasing the requested amount from to $2.75 million. Additional objections were filed, including by Black Diamond.
On June 8, 2012, counsel for Black Diamond notified the court that during the course of the bankruptcy period, Capstone had not disclosed a fee-sharing arrangement with RJM LLC, a different single-member LLC that was operated by Manzo, and that Manzo was not an employee of Capstone, as represented in the Capstone retention, but rather was an independent contractor. Capstone’s fee arrangement with Manzo at the time of the GSC petition date provided that Manzo would receive, through RJM, (1) $125,000 per month, (2) 80 percent of Manzo’s fees generated in the GSC cases, and (3) the greater of two incentive plans, as defined in the agreement.
On Jan. 4, 2013, the U.S. Trustee filed a disgorgement motion, objecting to the retention of (1) Kaye Scholer and Capstone by the debtors on a retroactive basis, and (2) RJM1 as the liquidating trustee, arguing that the firms should not be retained because they did not comply with § 504 of the Bankruptcy Code by misrepresenting Manzo’s status as an employee of Capstone, and because Capstone failed to disclose its fee-sharing agreement with Manzo. The U.S. Trustee also alleged that Kaye Scholer failed to disclose that it had previously represented RJM and RJM1 and that it had “aided and abetted” Capstone’s violation of § 504. After negotiations with the three firms, the U.S. Trustee filed motions pursuant to Bankruptcy Rule 9019 for the approval of the settlement agreements. The court stated that the pending Bankruptcy Rule 9019 motions were procedurally improper and if the court was forced to rule, would be denied. The U.S. Trustee filed a notice of withdrawal for all Bankruptcy Rule 9019 motions, although it was subsequently able to negotiate a settlement with Kaye Scholer. Because the Bankruptcy Rule 9019 motions were withdrawn, and the U.S. Trustee was able only to negotiate a subsequent settlement with Kaye Scholer, the trial commenced in connection with the U.S. Trustee’s disgorgement motion with respect to Capstone and RJM1.
Post-Trial Memorandum Decision
Following a full bench trial, Hon. Shelley C. Chapman issued a decision on Dec. 12, 2013.[3] As explained in the introduction to her decision, the legal issues to be dealt with were as follows: (1) scope and meaning of § 504; (2) retained professional’s obligation to disclose its utilization and payment of an independent contractor under Bankruptcy Rules 2014 and 2016; and (3) appropriate remedies and sanctions for mistakes and misconduct.
Compliance with § 504
As a starting point, the court found that Manzo, acting as a part of Capstone, could be considered a “regular associate” or “member” of Capstone. Therefore, the fee-sharing arrangement was allowable under § 504(b)(1).
Obligations under Rules 2014 and 2016
Pursuant to Judge Chapman’s decision, “one of the policies behind Rule 2014 is to ensure that all professionals have run a ‘conflict check’ and made the resulting appropriate disclosures to the court, which enable the court to determine whether each professional has any adverse interest.”[4] In connection with Rule 2016, Judge Chapman stated that “one purpose of the requirement found in Rule 2016 is to disclose the existence of fee sharing, even if the ‘details of any agreement’ are not required to be disclosed, to ensure that no disclosure of connections falls through the cracks.”[5]
Capstone could not demonstrate that it had conducted the proper conflict search (not being able to locate their conflict check email) and the court disagreed with Capstone’s opinion that it did not have to disclose the existence of the fee sharing arrangement because, in Capstone’s opinion, “it was not bad fee-sharing” and was “de minimis.” The court stated that it was not Capstone’s legal decision to make.
Appropriate Remedies and Sanctions
Pursuant to their final fee application, Capstone sought fees of approximately $5.95 million and expenses of approximately $254,000. In determining Capstone’s allowable fees and expenses, the court determined that the following three components were applicable:
- reasonableness under § 330 of the Bankruptcy Code and the amended guidelines for fees and disbursements for professionals in Southern District of New York bankruptcy cases;
- remedy for Capstone’s failure to adhere to Rule 2016; and
- Capstone’s entitlement to a performance fee of $2.75 million (reduced from $3.25 million).
Section 330 Reductions
The court reviewed Capstone’s time detail and noted issues with approximately $360,000 of fees related to Capstone timekeepers other than Manzo. As a result, the Court disallowed 10 percent of the disputed fees (or $36,000).
The court then reviewed Manzo’s time detail. Manzo did not use Capstone’s time-entry system, but instead kept manual records in a daytimer. On a monthly basis, Manzo would send his aggregate daily hours to Capstone, then re-write the details into a grid. Manzo would reconstruct his time descriptions using time details of other Capstone timekeepers and Kaye Scholer attorneys. The court determined that Manzo’s timekeeping methods were “nonstandard” and did not reflect the “best practices.” The court also determined that there was a great deal of “lumped” entries. As a result, the court reduced Capstone’s fees by 20 percent (or $520,000). The court also reviewed Capstone’s expenses of approximately $254,000 and determined that approximately $43,000 was not reasonable[6].
Rule 2016 Reductions
In her decision, Judge Chapman noted that Capstone maintained its position, insisting that the disclosure issues were just “form over substance.” Capstone never acknowledged that it had made a mistake representing Manzo as an employee or failing to disclose the fee-sharing arrangement. As a result, the court determined that Capstone should not receive the $367,000 that was still due them and, in addition, disgorged $600,000 in fees.
Performance Fee
As Capstone had agreed to withdraw its performance fee motion pursuant to the withdrawn Rule 9019 settlement motion, the court determined that any performance fee should be denied.
Liquidating Trustee (RJM1)
Black Diamond had alleged certain breaches of fiduciary duty by Manzo/RJM1 as the liquidating trustee. The court, not opining on the alleged breaches, found that Manzo was “unsuitable to continue to execute the trust in this case.”[7] Therefore, the court’s appointed successor trustee would have the authority to investigate Manzo’s conduct as liquidating trustee, as well as review Manzo’s fees and expenses incurred as the liquidating trustee.
Kaye Scholer
The court agreed with the settlement reached with the U.S. Trustee whereby Kaye Scholer would reduce their fees by $1.5 million.
Conclusion
The results in this case are a stark reminder that disclosure in any bankruptcy case is absolutely critical. Even though the relationship and sharing agreement was deemed to be not problematic on their own, Judge Chapman disallowed $4.27 million in fees for Capstone, inclusive of the proposed performance fee, and $1.5 million for Kaye Scholer for failure to disclose those facts in the first place. The court also reserved consideration of Manzo’s fees (and conduct) as liquidating trustee for the successor trustee. Judge Chapman wrote in her conclusion that “the real culprit … was not any particular individual party; rather, it was complacency. Hopefully, the GSC saga will serve as a reminder to professionals of the need to be painstakingly vigilant and diligent when screening for conflicts, preparing disclosures, and recording time.” This is a valuable reminder for all professionals.
[1] See www.abiworld.org/committees/newsletters/ethics-and-professional-compens… (the “November Newsletter Article”).
[2] Case No. 10-14653 (SCC) Southern District of New York in re: GSC Group, Inc., et al.
[3] Case No. 10-14653 (SCC) Southern District of New York in re: GSC Group, Inc., et al.
[4] Case No. 10-14653 (SCC) Southern District of New York in re: GSC Group, Inc., et al.
[5] Case No. 10-14653 (SCC) Southern District of New York in re: GSC Group, Inc., et al.
[6] Case No. 10-14653 (SCC) Southern District of New York in re: GSC Group, Inc., et al.
[7] Case No. 10-14653 (SCC) Southern District of New York in re: GSC Group, Inc., et al.