A palpably angry bankruptcy judge excoriated the U.S. Trustee in New York for abandoning the so-called Jay Alix Protocol by contending that management consultants hired before bankruptcy cannot fill executive roles after a chapter 11 filing if the firm does not satisfy the strictures of the disinterestedness test.
However, a spokeswoman for the Department of Justice told ABI that the U.S. Trustee Program has not changed its policy.
In her July 2 opinion, Bankruptcy Judge Shelley C. Chapman of Manhattan said that forcing the debtor to jettison crisis managers who had been on board for four years before bankruptcy “would put the success of the entire reorganization at risk,” producing “an absurd result, to say the least.”
Four years before filing under chapter 11, Nine West Holdings Inc., formerly known as Jones Apparel Group, had hired Alvarez & Marsal North America LLC to provide the company with an interim chief executive and other management personnel. At the time, the company had given no thought to bankruptcy. Judge Chapman said that A&M was to provide “vital management services” and oversee “virtually all aspects of their day-to-day operations.”
Before bankruptcy, the chief executive provided by A&M had served as a director for several of the company’s subsidiaries. He was not a director of the parent company.
On filing under chapter 11, the company submitted an application to retain A&M under Section 363(b) to continue managing the debtor’s daily operations. Section 363(b) gives a debtor in possession the power to use, sell or lease property of the estate.
The U.S. Trustee objected, contending that A&M could only be retained as a professional under Section 327(a). The U.S. Trustee evidently believed that the firm was not disinterested under Section 101(14) and thus did not qualify for retention under Section 327(a), perhaps on account of the CEO’s service as a director of subsidiaries.
Creditors up and down the capital structure uniformly opposed the U.S. Trustee and urged the court to approve A&M’s retention, Judge Chapman said.
In her 31-page opinion designated for publication, Judge Chapman overruled the U.S. Trustee’s objection and approved A&M’s retention under Section 363(b) to provide the debtor with an interim CEO and additional managerial personnel.
Judge Chapman focused her opinion on the Jay Alix Protocol, promulgated in the Southern District of New York 14 years ago. It appears on the website of the U.S. Trustee Program. To read the Protocol, click here.
Judge Chapman explained that the Protocol, now national policy, was developed to allow chapter 11 debtors to retain their pre-petition crisis managers by engaging the firms under Section 363(b), rather than under Section 327(a), where they might fail the disinterestedness test. The Protocol has four principal requirements: (1) The firm may serve in only one capacity; (2) the retention must be under Section 363(b), and the retained firm must disclose all relationships to show that it is not otherwise disinterested; (3) the firm must file monthly reports subject to court review; and (4) the persons providing services must be approved by and act under an independent board of directors.
Until the Nine West case, Judge Chapman said the U.S. Trustee had not objected to dozens if not hundreds of retentions over the last 14 years “where such consultants have purportedly followed the Protocol.” She said the U.S. Trustee’s objection “fails to mention the Protocol at all, let alone A&M’s compliance in all material respects with each of its requirements.” Instead, she said that the U.S. Trustee “makes the unequivocal statement that . . . ‘[a] debtor cannot use Section 363(b) to employ a professional person.’”
Judge Chapman said that the purpose of the Protocol “has not been violated by A&M here,” because the CEO provided by the firm had not been a director of the parent corporation and thus was not in a position to approve his or his colleagues’ pre- or postpetition retention and compensation.
For 14 years, Judge Chapman said, “the crisis and interim management industry has relied on the implicit consent of the U.S. Trustee that such firms can be retained . . . pursuant to Section 363 rather than Section 327 if they meet the requirements of the Protocol.” By suddenly objecting in the Nine West case, she said the U.S. Trustee is “implying that there was clear error in every case in which a bankruptcy court has in the past approved” retentions under the Protocol.
“The only explanation” for the “stunning reversal of policy,” Judge Chapman said, was the chief executive’s “de minimis board service; the economic disruption that his departure would cause is of no concern to the U.S. Trustee.” Blocking the firm’s engagement, she said, “could . . . put the success of the entire reorganization at risk.”
The Protocol, according to Judge Chapman, has allowed the “[e]ngagement of management consultancy firms prior to a bankruptcy filing and their continuing retention postpetition [to enable] companies to achieve business continuity during their darkest hour.” If only Section 327 and its strict disinterestedness requirement were available, she said that “previously provided firm personnel . . . must be jettisoned when a company files chapter 11 . . . .”
Having decided that Section 327(a) was not the only pigeonhole, Judge Chapman ended her opinion by finding that A&M was not providing services of a professional because “they could have been performed by existing company personnel.” Since the engagement also satisfied the business-judgment rule, she approved the retention under Section 363(b).
In response to an inquiry from ABI, Nicole Navas Oxman, a spokeswoman for the Department of Justice, said in an email that the “U.S. Trustee Program has not changed its legal position as reflected in the Jay Alix Protocol.” A “key provision” in the Bankruptcy Code, she said, “requires that professionals not have served on the Board of Directors. As stated in court, we believe that provision was violated in this case.”