Peculiar Parting from Protocol: U.S. Trustee’s Objection to Debtors’ Application to Retain Management Consultants under Section 363(b) Shot Down in SDNY

A recent decision from the United States Bankruptcy Court for the Southern District of New York ratifies a procedure often used for the employment of financial consultants by corporate debtors and the applicability of the “Jay Alix Protocol” in connection therewith.

In the Chapter 11 case of In re Nine West Holdings, Inc., et al., the debtors filed an application to retain Alvarez & Marsal North America, LLC (“A&M”) to provide an interim CEO and other management personnel to the debtors. The debtors sought the retention of A&M pursuant to Section 363(b) of the Bankruptcy Code, which applies a business judgment standard in evaluating a debtor’s proposed use of its money.

The Office of the United States Trustee (the “UST”) filed an objection to the application, arguing that A&M and the interim CEO are “professional persons” within the meaning of the Bankruptcy Code, such that their retention must be considered only under Section 327(a). Section 327(a) applies a more stringent standard than the relatively permissive business judgment rule applicable under Section 363(b). The UST argued that because the interim CEO had previously served on some of the debtors’ subsidiaries’ boards of directors, he and (by extension) A&M could not meet the disinterestedness requirement of Section 327(a).

The debtors and A&M, supported by other significant stakeholders in the case, vehemently disagreed with the UST’s objection. They pointed out that distressed management consultants have been retained under Section 363(b) in many bankruptcy cases. A&M cited to 37 other cases in which A&M itself had been retained under Section 363(b), noting that the UST objected to A&M’s retention in only one of those cases. The debtors and A&M also argued that the UST was ignoring the “Jay Alix Protocol,” the UST’s own national policy which has been in place for some fourteen years and directs debtors to seek retention of consultants like A&M under Section 363(b).

In her July 2 opinion, Judge Shelley Chapman noted that the UST was “seemingly ignoring this mountain of precedent,” and that the UST’s attempt to distinguish cases involving a consultant CEO rather than a CRO was “nonsensical.” With respect to the Jay Alix Protocol, the Court found that the UST’s surprising departure from the Protocol “lacks intellectual honesty and consistency.” The Court ultimately found that A&M’s retention would not violate the Protocol and granted the debtors’ application. Judge Chapman was sensitive to the economic and operational realities of the case.  She noted that removing A&M personnel from management positions they had held for the past four years, three of which were pre-bankruptcy, would likely have a disastrous effect on the debtors’ efforts to reorganize.