In re Leslie Fay Companies, Inc.
| Decision Date | 16 December 1994 |
| Docket Number | Bankruptcy No. 93-B-41724(TLB). |
| Citation | 175 BR 525 |
| Parties | In re The LESLIE FAY COMPANIES, INC., et al., Debtors. |
| Court | U.S. Bankruptcy Court — Southern District of New York |
U.S. Trustee for S.D.N.Y. by Arthur J. Gonzalez and Norma Ortiz, New York City.
Weil Gotshal & Manges by Harvey Miller and Alan B. Miller, New York City, for debtors and appearing pro se.
Wachtell, Lipton, Rosen & Katz by Chaim Fortgang, New York City, for Official Committee of Unsecured Creditors.
Lord, Bissell & Brook by Benjamin Waisbren, Chicago, IL, for Official Committee of Equity Security Holders.
DECISION ON UNITED STATES TRUSTEE'S MOTION TO DISQUALIFY WEIL, GOTSHAL & MANGES AS DEBTORS' COUNSEL AND TO IMPOSE AN ECONOMIC SANCTION AGAINST WEIL, GOTSHAL & MANGES
Rarely am I faced with a motion as troubling as this one, the United States Trustee's motion to disqualify Weil, Gotshal & Manges ("Weil Gotshal"), the debtors' counsel, from further representation of its clients and to deny the firm fees because of its failure to disclose what the United States Trustee ("U.S. Trustee") dubs disabling conflicts. The motion is predicated upon the report of an examiner who had concluded that Weil Gotshal was not disinterested when retained and had failed to reveal to the court the connections which led to his conclusion. I am in accord with the examiner's assessment, although I do not share his view that the appropriate sanction is limited to imposition on Weil Gotshal of a portion of the costs which he incurred investigating Weil Gotshal's status. Indeed, it is the nature of the sanction which is the troubling element here for, as the examiner found, Weil Gotshal has rendered services competently and loyally to the debtors, notwithstanding its derelictions in the area of disclosure, and the debtors undoubtedly will be harmed by Weil Gotshal's complete removal from the case some twenty months into the reorganization effort. This fear of harm to the debtors is shared by both official committees as well as the examiner.
The Leslie Fay Companies, Inc. ("Leslie Fay") is a large, publicly-owned corporation primarily engaged in designing, manufacturing, and selling women's dresses, suits, and sportswear. It is one of the few large American clothing manufacturers which still manufactures in the United States.
On January 29, 1993, Leslie Fay's controller, Donald Kenia, disclosed to senior management that he had been making unsupported entries into Leslie Fay's general ledger, resulting in a significant misstatement of its financial standing. Two days later, senior management informed Leslie Fay's board of directors (the "Board" or "Board of Directors") which in turn disclosed the existence of the false entries to the general public.
The Board directed its audit committee (the "Audit Committee") to conduct an investigation into the facts and circumstances surrounding the accounting irregularities. At the time, the Audit Committee was composed of three independent, non-management directors: Ira J. Hechler, a private investor; Ralph Destino, Chairman of Cartier, Inc.; and Michael L. Tarnopol, a senior officer at Bear Stearns & Co. ("Bear Stearns"). The Board then appointed Steven Friedman, the only other outside director of Leslie Fay, to join Hechler, Destino, and Tarnopol on the Audit Committee and in their investigation of the accounting irregularities. Friedman is a senior manager of Odyssey Partners L.P. ("Odyssey"), a large partnership that acts principally as a merchant bank.
Included in the Audit Committee's charter were the identification of all parties who may have been involved in the accounting irregularities and the consideration of possible legal claims that could be asserted on behalf of Leslie Fay. Toward those ends, the Audit Committee retained the accounting firm of Arthur Anderson & Co. and Weil Gotshal. Prior to its retention by the Audit Committee, Weil Gotshal had not done any work for Leslie Fay, whose general outside counsel was the law firm of Parker, Chapin, Flattau & Klimpl ("Parker Chapin").
In late February, 1993, the Audit Committee issued preliminary results of its work, announcing that Leslie Fay's 1991 profits had been overstated by over $12 million. Accordingly, the accounting firm of BDO Seidman ("Seidman"), Leslie Fay's independent auditors, officially withdrew its signature from Leslie Fay's 1991 financial statements. The Audit Committee had also learned by this point that Kenia's initial representation that he alone was responsible for the false entries was not true. As was later confirmed, the fraud reached to Leslie Fay's chief financial officer, Paul Polishan.
The consequences of this burgeoning scandal were calamitous to Leslie Fay. Lenders and suppliers froze its credit lines, and Leslie Fay was unable to secure the financing necessary for the continued operation of its business. This led to an expansion of Weil Gotshal's role to include advice on financial restructuring. On April 5, 1993, nine weeks into the Audit Committee's investigation, Weil Gotshal filed chapter 11 petitions on behalf of Leslie Fay and its affiliates (the group referred to for convenience as "Leslie Fay"). The same day, Weil Gotshal submitted an application for retention as counsel for the debtors in possession, which was approved by the Hon. Cornelius Blackshear of this court. The order contemplated that Weil Gotshal would continue in its work for the Audit Committee as part and parcel of its representation of the debtors. The U.S. Trustee, the only party in interest to receive notice, had indicated that he did not object to the retention.
By late September, the Audit Committee completed its investigation, and on September 27, 1993, it disclosed its findings to the Board of Directors. The Audit Committee concluded that there was no evidence that any member of the debtors' current2 senior management or the Board of Directors knew of or participated in the fraudulent entries, which it estimated totalled some $160 million. The Audit Committee also discovered, contrary to what was originally believed, that the accounting irregularities dated back to at least 1990. These findings were made public on September 29, 1993.
At just about this time, questions regarding Weil Gotshal's disinterestedness were raised by the official committee of unsecured creditors (the "Creditors' Committee"). A hearing on first interim fee applications had been set for November 4, 1993. Both the Creditors' Committee and the U.S. Trustee filed objections to Weil Gotshal's request for fees on the grounds that Weil Gotshal was not disinterested as required by 11 U.S.C. § 327(a)3 () and had failed to file a full and complete disclosure as required by Fed.R.Bankr.P. 2014.4
Weil Gotshal responded to the objections by asserting that it had met the Code's disinterestedness requirement and had fully satisfied its disclosure obligations in its retention affidavit. In addition, Weil Gotshal submitted a supplemental affidavit containing information regarding certain of its previously-undisclosed relationships that had been questioned by the Creditors' Committee.
The second task assigned to the examiner was to evaluate whether (i) there were any viable claims that could be asserted against any other parties in connection with the accounting irregularities that could increase the size of the chapter 11 estate and; (ii) whether the Audit Committee's work in that regard had been acceptable or if further investigating was necessary. I approved the appointment of Charles A. Stillman as examiner on January 18, 1994. Over the next six months, the examiner conducted a thorough investigation into Weil Gotshal's alleged conflicts and into the Audit Committee's investigation of the accounting irregularities.
The disclosure of the accounting irregularities in early 1993 prompted a flurry of litigation. Weil Gotshal represented the Audit Committee members with respect to some of these matters. Class actions were filed charging certain officers and directors, including members of the Audit Committee, with securities fraud (the "Securities Fraud Litigation"), on the grounds that, as members of the Audit Committee, they knew or should have known of the irregularities, and that the irregularities caused a precipitous drop in the price of Leslie Fay stock. Weil Gotshal represented the Audit Committee in these actions, negotiating an agreement to drop the members' names from the litigation, subject to certain conditions. In addition, a shareholder's derivative suit was commenced in state...
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