Bankruptcy Update Blog

Bankruptcy Court Rules Section 327 Inapplicable to Certain Management Consultant Retentions

Section 327(a) of the Bankruptcy Code imposes restrictions on the employment of professionals to assist a trustee, requiring that such professionals “not hold or represent an interest adverse to the estate” and be “disinterested persons.” Section 363(b) permits the trustee, after notice and a hearing, to “use, sell, or lease, other than in the ordinary course of business, property of the estate,” and does not impose restrictions on employment comparable to those of section 327(a). On Monday, in In re Nine West Holdings, Inc., Case No. 18-10947 (SCC), Judge Shelley C. Chapman of the Bankruptcy Court for the Southern District of New York considered the relationship between those provisions in deciding on an application to retain a management consultancy firm that had already been assisting the debtors prior to the bankruptcy petition. Judge Chapman held that the application was properly considered under section 363(b) rather than section 327(a). Applying the business judgment standard under 363(b) rather than the more stringent standard under 327(a), Judge Chapman approved the application.

The debtors, Nine West Holdings, Inc. and several of its affiliates, filed an application under section 363(b) to retain Alvarez & Marsal North America, LLC (“A&M”) to provide them with an interim CEO and other personnel, and to appoint Ralph Schipani, one of A&M’s personnel, as interim CEO of Nine West Holdings. A&M and Schipani had been retained over four years earlier to provide management services for the debtors and their non-debtor affiliates. A&M was engaged to manage day-to-day operations and to supplement in-house functions, and its initial engagement took place three years before the company began to consider filing for bankruptcy. Schipani served in various officer roles across the businesses, and served on the board of certain subsidiaries, including one that is a debtor in the case. The court found that his role on these boards was administrative and did not involve substantive decision-making; the boards did not hold meetings and his actions were limited to signing consents to implement the decisions of the parent board.

The U.S. Trustee filed an objection, arguing that the retention application should be considered under section 327(a) rather than section 363(b), because the A&M personnel would play a central role in the debtors’ reorganization. Section 327(a) requires that professionals be “disinterested persons,” and “disinterested person” is defined in section 101(14) of the Bankruptcy Code to exclude (among others) anyone who, “within 2 years before the date of the filing of the petition,” was a “director, officer, or employee of the debtor.” A&M personnel had served as officers and directors for some of the debtors within that period. Thus, the U.S. Trustee argued that A&M and Schipani were not disinterested and could not be retained.

The debtors and A&M argued in response that 363(b) applied rather than 327(a). They pointed to a substantial body of case law approving the retention of management consultants under 363(b). They further argued that 327(a) did not apply to management consultants who were initially employed prior to the bankruptcy petitions for general management assistance not related to bankruptcy, and that applying 327(a) in that context would harm creditors and the estate by requiring the debtors to replace longstanding management and disrupt managerial continuity. They also pointed to the Jay Alix Protocol, a longstanding nationwide policy of the U.S. Trustees under which the U.S. Trustee assents to the retention of management consultants under section 363 as long as certain conditions are met. The debtors generally complied with the conditions, with the exception that a footnote of the Protocol does not permit retention of a firm if one of its principals, employees, or independent contractors has served as a director of the debtor. The debtors nonetheless argued that, given the limited role Schipani had as a director, they had complied in substance with the Protocol.

The bankruptcy court agreed with the debtors. The court emphasized the harm it would do to the estate if the debtors had to replace their management precisely at a moment where management services are most needed. It noted that the U.S. Trustee’s approach would make it more difficult to retain management consultants the more deeply they had been involved in the business’s operations prior to the bankruptcy petition, which only posed greater problems for continuity. The court characterized the Jay Alix Protocol as primarily being concerned with the risk of conflict of interest where an advisory firm serves in more than one capacity, and held that no such risk was present here, where the decisions concerning retention were made by the parent boards without any involvement of A&M, and where Schipani’s director service had been so ministerial.

As far as section 327, the bankruptcy court pointed to case law holding that the test for the applicability of section 327 was whether a professional was hired for the purpose of reorganizing the company or assisting it through the bankruptcy process. Such professionals are distinguished from persons simply hired to carry out the day-to-day operations of the company, the tasks that would be necessary even if no bankruptcy petition had been filed. In applying this test, the bankruptcy court emphasized that A&M had been retained years before the bankruptcy and that it continued to provide the types of services it had provided prior to the bankruptcy. Insofar as A&M’s services involved supporting the bankruptcy process, its services were the types of services that in-house employees and officers typically do in a bankruptcy context. Thus, the bankruptcy court held that 327 was not applicable, and approved the retention application because the debtors had good business reasons for the retention.