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Transparency Is Key: The Importance of Disclosure in Bankruptcy

Firms targeting fellow restructuring professionals’ disinterestedness to gain leverage

Transparency and disclosure are pillars of the bankruptcy system. Companies going through chapter 11, as debtors, are required to publicly report information they would rather keep private. So are the professionals (lawyers, financial advisors, accountants, etc.) that are retained by court order and payed from the assets of the bankruptcy estate. Bankruptcy Rule 2014(a) requires estate professionals to disclose all their connections with “the debtor, creditors, any other party in interest, their respective attorneys and accountants [and certain other parties].” Disclosure is essential for a judge to weigh whether a firm is “disinterested” and does not hold “an interest adverse to the estate” as required by section 327(a) of the Bankruptcy Code. An estate professional’s failure to report conflicts adequately can have serious consequences, including denial of retention, disgorgement of fees, sanctions, and, in extreme cases, even prison time.

In Alpha Natural Resources, Inc.’s chapter 11 bankruptcy (case number 15-33896, pending in the U.S. Bankruptcy Court for the Eastern District of Virginia) a restructuring management firm is facing serious consequences for potential Rule 2014 violations. The potential violations surfaced amidst bad blood between restructuring professionals.

Jay Alix owns AlixPartners, which specializes in corporate restructuring consulting.  Alix has accused McKinsey Recovery and Transformation Services (a competitor of AlixPartners) of failing to disclose adequately its connections in the Alpha case. Alix bought some unsecured debt in the Alpha case in order to have standing to object to McKinsey’s retention. McKinsey, a restructuring consultancy founded in 2010, responded that (a) its long-standing policy is to protect clients’ confidential information and, summarily, (b) the firm isn’t aware of any conflicts of interest.

According to the U.S. Trustee, McKinsey is the only professional firm to claim contractual confidentiality as a shield to providing conflict transparency. McKinsey alleges that Alix is pursuing his objection only to force McKinsey from the chapter 11 advisory business. Nevertheless, complete disclosure is a statutory obligation and McKinsey’s position opens it up to objections. If Alix’s objection succeeds, McKinsey could be denied retention or required to disgorge its advisor’s fees. According to court filings, some of McKinsey’s advisors bill $1,075.00 an hour.

The fuel for this fire could be the fact that six experts from AlixPartners have been lured to join McKinsey’s roster and more may follow.

Professionals pressuring professionals for failure to disclose appears in the Caesars Entertainment Operating Co.’s bankruptcy cases (administratively consolidated under case number 15-01145, pending in the U.S. Bankruptcy Court for the Northern District of Illinois). Noteholders in the Caesars cases have alleged that the debtors’ lawyers – Kirkland & Ellis LLP – failed to disclose the firm’s involvement with the debtors’ decision to forego pursuit of fraudulent transfer actions against the parent company before commencing the bankruptcy cases (an examiner appointed in the cases has since found the fraudulent transfer actions to be “strong”). The court in the Caesars cases has been urged to find that Kirkland & Ellis was not disinterested, but has so far declined to do so.

The Bankruptcy Code and Rules require estate professionals who are paid from the estate to make all appropriate disclosures and to continue to do so throughout the course of their retention. Complete transparency may forestall retention litigation and prevent the highly negative outcomes of disgorgement or sanctions.

About Tricia Schwallier

Tricia Schwallier is a restructuring associate in the Chicago office of Kirkland & Ellis LLP. Tricia’s practice focuses on all aspects of corporate restructuring, bankruptcy and insolvency.

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Tricia Schwallier

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