United States Trustee Rebuked by New York Bankruptcy Judge for Objecting to Retention of Nine West Interim CEO

For at least the past 14 years while the so-called “Jay Alix Protocol” has been in effect as a national policy of the Office of the United States Trustee (“UST), and prior to that in a handful of decisions, interim Chief Financial Officers, Chief Restructuring Officers and other interim officers for Chapter 11 companies that are typically supplied by financial advisory firms were regularly retained with bankruptcy court approval under Bankruptcy Code §363(b), as opposed to the stricter §327(a) which governs the retention of “professional persons.” This was in recognition of the fact that because such interim officers are commonly hired before a bankruptcy is filed, they would fail the “disinterestedness” standard of §327(a), which requires that to be a “disinterested person” and thus retained under that section, one must not have been a director, officer or other employee of the debtor within the two years prior to the bankruptcy filing. 11 U.S.C. §101(14)(B).

In the case of In re Nine West Holdings, Inc., 2018 WL 3238695 (Bankr. S.D.N.Y. July 2, 2018), the UST surprisingly reversed course and objected to the §363(b) retention of an interim CEO and other supporting personnel that were supplied for Debtor, Nine West and its affiliates, by the financial advisory firm Alvarez and Marsal (“A&M”). The interim CEO, Ralph Schipani, had been engaged in that capacity for four years prior to the Nine West bankruptcy and was also engaged nominally as a director of one Nine West affiliate that was also a Chapter 11 debtor. The UST argued that because Schipani and the other A&M personnel were hired to play a central role in the corporate reorganization, they are “professional persons” and must be retained pursuant to §327(a), not §363(b). Retention under §363(b) merely requires that hiring the professional in question is within a debtor’s sound business judgment, which in turn requires a finding that the decision was made on an informed basis, in good faith, and in the honest belief that it is in the best interests of the company.

In a highly critical decision, Bankruptcy Judge Shelley Chapman resoundingly rejected the UST’s position, which was revealed to have been taken largely because the retention ran afoul of footnote three of the Jay Alix Protocol due to Schipani’s prepetition service as a director of one of Nine West’s affiliates. Footnote three provides, in summary, that §363(b) could not be used to retain a financial advisor if any principal, employee or independent contractor of the financial advisory firm served as a director of the debtor or an affiliate within two years of the bankruptcy filing. Judge Chapman characterized the UST’s position as one “that would unquestionably visit damage on this case, this company, and its creditors,” and criticized the UST for “choos[ing] compliance with a footnote over the interests of every creditor in this case.”

On the substantive issue of whether A&M and interim officers such as Schipani can be retained under §363(b), Judge Chapman first cited the compelling bankruptcy policy that if §327 were the only path to retention of such professionals, troubled companies would be denied their services at a time when they are needed the most because in most cases, these professionals would have been hired as officers prior to the bankruptcy filing and would thereby fail the “disinterestedness” test of §327  Id. at *8.

Turning next to the statutory issue of whether the A&M professionals were “professional persons” within the meaning of §327, Judge Chapman adopted the view expressed in In re Sage Crest II, 2011 WL 134893 (D. Conn. Jan. 14, 2011) (Underhill, J.): “that ‘officers responsible for the day-to-day business of the debtor stand in contrast to professionals hired for the sole purpose of reorganizing the debtor organization’.” Nine West, at *10 (quoting Sage Crest II, at *7) (emphasis original in Nine West opinion). In other words, a “professional person” within the meaning of §327 was held to be one who plays a central role in the administration of the bankruptcy, as opposed to someone who provides services that would be necessary irrespective of the bankruptcy case. Id.

Here, Judge Chapman found that although Schipani and the other A&M personnel were involved in bankruptcy-related services, such as completing bankruptcy schedules and monthly operating reports, as well as assisting with asset sales and the negotiation and documenting of debtor-in-possession financing, such services were of the type that would be performed in a Chapter 11 case by officers who were not specially hired by the debtor. Thus, since their essential focus was on running the business, the A&M professionals were held not to be professional persons within the meaning of §327 and could be retained under §363(b).

The Nine West decision is significant because mostly all of the authority for the retention of financial advisory services of the type at issue in the case is anecdotal, i.e., based on orders issued in other cases that were not subject to written decision and analysis. In this respect, it is somewhat of a landmark decision in the Second Circuit that may now be used to retain crisis management and financial advisors with less opposition on the legal issue presented.