Kaye Scholer and Capstone Advisory Group were wrong to identify well-known restructuring advisor Robert Manzo as an “employee” of Capstone rather than as an independent contractor, but that mistake should not force them to disgorge nearly $16 million in fees earned working on the Chapter 11 of former distressed-debt hedge fund GSC Group, they say.

“Mistakes were made,” Kaye Scholer partner Aaron Rubinstein wrote in a Jan. 28 response to motions filed by the U.S. Attorney in the case and Black Diamond Capital Management, which bought GSC’s assets last year in a Section 363 sale. “The disclosures in connection with the Capstone retention application and the Kaye Scholer retention application were not adequate…But any errors attributable to Kaye Scholer were not intentional.”

“The firm regrets these mistakes and the burden it has placed on the Court, the U.S. Trustee’s office, and the other parties,” Rubinstein continued. “Nonetheless, the severe sanctions sought against the firm are not warranted,” he said.

Rancorous process

GSC filed for Chapter 11 protection in Manhattan in August 2010, its portfolio deflated by the economic collapse of 2008. It was a particularly rancorous bankruptcy process, replete with name-calling and defamation suits, but the court ultimately approved a reorganization plan submitted by Black Diamond, the GSC creditor that won a Section 363 auction for GSC’s assets in July 2011, with an offer of about $235.7 million. GSC officially emerged from Chapter 11 on March 16 – Black Diamond took over a number of the firm’s investments, and the typical clean-up work left at the end of a large Chapter 11 was handed to a liquidating trustee, Robert Manzo.

Yet the case drags on. In early January, following a discovery made reviewing newly uncovered documents, the U.S. Trustee filed a motion seeking to eliminate and disgorge any fees paid to Kaye Scholer or Capstone, GSC’s financial advisor, alleging that they violated bankruptcy laws when they purposely failed to disclose that Capstone executive director Robert Manzo was, in fact, an independent contractor working via a fee-sharing agreement with the firm. The disclosure rules are designed to guard against fee inflation in Chapter 11 proceedings.

Black Diamond filed a joinder to the US Trustee’s motion, arguing that Capstone should never have sought its $3.25 million “success fee” related to the GSC case and that Manzo, through his limited liability company RJM1, should never have been appointed as trustee of GSC’s liquidating trust “due to irreconcilable conflicts of interest and breaches of trust.”

Together, Capstone and Manzo are seeking nearly $10 million in fees related to their work on the case, $5.65 million of which would go to Manzo alone, court records show.

The fog of restructuring

Kaye Scholer partner Michael Solow, who led the firm’s work for GSC, claimed not to have known of Capstone’s arrangement with Manzo at the time the GSC bankruptcy was filed, even though he personally advised Manzo on the contract when he started with Capstone in 2006, “as a favor.” Manzo and Solow are friends; they go on golfing trips together. But four years later, he says, he did not remember the specifics of that contract or even advising Manzo in the first place.

What’s more, the retention applications that mistakenly identify Manzo as an employee were drafted by other, lower-level lawyers at Kaye Scholer, who did not know of the contract. Solow, who at the time had an hourly billing rate of $1,050, was too expensive to deal with such routine motions, Kaye Scholer argues. That fell to partner D. Tyler Nurnberg ($700 per hour) and senior lawyer Matthew Micheli ($685 per hour), who oversaw day-to-day management of the case.

In his own response to the disgorgement motions, Manzo said that, “like any other highly experienced person working at a very senior level on a complicated bankruptcy matter,” his compensation would be “substantial.”

“There is no allegation – nor could there be – that Mr. Manzo himself was working for free,” his lawyers noted in their list of “undisputed facts” on the matter.

The U.S. Trustee and Black Diamond have fabricated a conspiracy among members of “a prestigious law firm – Kaye Scholer – Mr. Manzo, senior people at Capstone, and a number of other professionals, allegedly hatched and carried out in a supposed attempt to secure fees that would otherwise be unavailable to these professionals, all of whom have unblemished records and significant histories in major bankruptcy proceedings over the last three decades.”

You say potato…

Manzo, too, apologized for the inaccurate use of the word “employee,” but it was an error that in no way affected the work that he or Capstone did for GSC, he said. Capstone claimed in its defense motion that the firm in fact charged the estate less for Manzo’s services than Capstone paid to Manzo.

Capstone went on to attack the entire legal basis for the disgorgement motion, and to excoriate the Trustee for introducing details of Manzo’s intertwined personal and professional relationship with Solow, which it says are irrelevant – including the time Manzo filed a $20,000 expense report with Capstone to pay for a golfing trip to South Carolina via private jet, on Solow’s 50th birthday.

“Despite marshaling a seemingly endless stream of minutiae relating to all aspects of the Capstone-Manzo relationship, the [U.S. Trustee’s] motion does not discuss, other than in a single passing sentence, the only relevant question: was Mr. Manzo covered by Section 504(b)(1) of the Bankruptcy Code, which permits the sharing of fees among certain persons? The motion uses the phrase ‘fee sharing’ or its variations numerous times, without acknowledging that, in fact, fees can be and are routinely shared among parties that fit within the Section 504(b)(1) exception. Neither the language, the purpose, nor the interpretive history of Section 504 supports the Movants’ arguments.”

Capstone likened the situation to a law firm, which, for example, is not required to specify whether its retained lawyers are listed as a “partner,” an “equity partner,” or even a “contract partner.”

Not a trustworthy individual

Capstone also expressed surprise that the U.S. Trustee would pursue such a motion in this case, although it noted that Black Diamond’s motion is understandable given the bad blood between the firms. Black Diamond “resents Capstone’s efforts in the case, which resulted in Black Diamond paying $230 million more for [GSC’s] assets than it originally intended.” Capstone goes on to quote testimony from Black Diamond co-founder Stephen Deckoff, who, based on his dealings with Manzo in this case, called him “an absolute liar,” who is “not a trustworthy individual.”

The fee battle is just the latest in a long line of disputes over GSC’s demise. Last May, Manzo – in his capacity as liquidating trustee – filed a motion regarding a tax dispute in which he claimed that “Black Diamond has a history in these cases of having acted to remove professionals that resist its self-interested schemes.” (See, “Ernst & Young accused of conflict in GSC Group bankruptcy,” LCD News, May 24, 2012).

A hearing on the matter is scheduled for Feb. 11, before U.S. Bankruptcy Judge Shelley Chapman, in Manhattan. – John Bringardner