Of Shoes and Fees When Advice to Creditors Is Advice to the Debtor

Of Shoes and Fees When Advice to Creditors Is Advice to the Debtor

Journal Issue: 
Column Name: 
Journal Article: 
Charles H. Taylor was probably the nation's first great basketball star. During an 11-year professional career that began when the Great War ended, he played for such bygone pro clubs as the Akron Firestones and New York Celtics, and led the Buffalo Germans to a world championship in the 1920s. For the rest of his life he was an international ambassador of basketball, coaching the U.S. Air Force team during World War II and later touring Europe and South America giving basketball clinics for the U.S. State Department. He was an innovator, too; Taylor is credited with creating the first basketball without laces, produced by Wilson Sporting Goods in 1935. But none of this is why anyone who isn't a basketball historian knows Charles H. Taylor.

In 1921, barely out of his teens, Taylor convinced the Converse Rubber Shoe Co. to create a shoe designed specifically for basketball. Taylor designed the sole tread, ankle support and other features of the legendary and ubiquitous basketball sneaker that would bear his name—Chuck Taylor. By 1955, Converse's canvas, high-top All-Stars—everyone calls them "Chucks" now, as everyone did then—had become the best-selling shoe in the United States and adorned the feet of virtually every serious basketball player, and lots and lots of everyone else, for decades. Taylor and his Chucks came to epitomize Converse, a company that began its existence in 1908, inauspiciously, with a rubber winter boot called the "Jiffy," described in ad copy as "the last word in an automatic-fastened gaiter." By the end of 2000, more than 650 million pairs of Chucks had been sold. It wasn't enough.

On Jan. 22, 2001—hours after the L.A. Lakers beat the Miami Heat 103-92 in a game in which not one player wore a pair of Chucks—Converse filed a chapter 11 petition in Delaware. Less than two months later, Footwear Acquisition Inc. submitted the winning bid to purchase Converse's assets—including the venerated Chuck Taylor All-Star brand—for $117.5 million. The sale generated a not-insignificant recovery for unsecured creditors, and since there were no more shoes to sell, one of the only things left to do was sue the professionals.

The very idea that a pre-petition group of creditors can persuade a debtor to hire a financial advisor to render services to those creditors...did not come as a surprise to the bankruptcy court.

In September 2004, Converse's post-confirmation liquidation trust moved for summary judgment on its complaint to recover $162,000 in pre-petition payments Converse made to Chanin Capital Partners. An ad hoc committee of Converse's secured noteholders had persuaded Converse to hire Chanin as the committee's financial advisor in November 2000. Judge Mary Walrath's decision1 denying summary judgment highlights important issues about whether a distressed company derives a tangible benefit from the rendering of financial advice to the company's creditors. In that case, the question of this benefit arose in three contexts: (1) whether Chanin received more than it would have received in a liquidation for purposes of the fifth element of a preference under Bankruptcy Code §547(b)(5), (2) whether the contracting for this benefit was in the "ordinary course of business" for purposes of the preference defense under Code §547(c)(2), and (3) whether this benefit constituted "reasonably equivalent value" such that the pre-petition payments were not fraudulent transfers under Code §548(a)(1)(B)(i).

Reduced to its essence, Chanin's argument was simple: The entire purpose of Chanin's engagement was to analyze Converse's assets, formulate a process to sell those assets and maximize value for creditors. That Chanin technically worked for the ad hoc committee was at once meaningless and significant: meaningless, because the identity of Chanin's client did not change the ultimate goal of the engagement, and significant, because Converse's own interests were exactly aligned with those of its creditors (i.e., to maximize the value of Converse's assets). Stated differently, if Converse believed that a sale of its assets to the highest bidder was the optimal way in which to protect and advance the interests of Converse's creditors—and, because Converse was insolvent, its principal fiduciary duty was to its creditors2—then hiring a professional to work toward that goal was exactly what Converse should have done. And how better to ensure that the professional's advice is efficiently and effectively given to the ultimate beneficiaries of that advice than to make those beneficiaries (Converse's senior-most creditors represented by the ad hoc committee) the professional's client?

In this way, Chanin argued, Converse received much the same benefit from Chanin's services as did Chanin's putative client, the ad hoc committee. This makes sense. Converse received this benefit in the same way and at the same time as its creditors, at least as long as Converse's preferred method of maximizing creditors' recoveries—a sale of Converse's assets—matched the creditors' preferred method of maximizing creditors' recoveries. Because it appears that Converse never settled on another restructuring alternative, both its goals and its methodology matched those of its creditors. Under this circumstance, what difference did it make who Chanin's technical client was? Converse paid Chanin's fees because Converse derived real benefit from Chanin's work.

Recognizing this value was the capstone of Chanin's successful defense of the preference and fraudulent-transfer action. The question of Converse's receipt of real value from Chanin's work provided Chanin with three arguments to defeat summary judgment on the avoidance action. First, Chanin's services could constitute a meaningful contribution to Converse's reorganization efforts during its chapter 11 case, thereby garnering administrative expense priority status for Chanin's fees. As the bankruptcy court noted, "services rendered before the filing of the bankruptcy petition may be entitled to administrative claim status so long as the services provided a substantial contribution to the reorganization efforts during the pendency of the chapter 11 case."3 Again, if Converse's reorganization goals were aligned with those of its creditors, then Chanin's financial advisory services aimed at accomplishing those goals—whether rendered to the creditors or to Converse—would have "directly benefited the post-petition reorganization efforts." The plaintiff trust, of course, disputed Chanin's factual allegations regarding whether Converse received any direct benefit from Chanin's services to the ad hoc committee, but a factual dispute was all the bankruptcy court needed to deny summary judgment. Whether Chanin's fees would be entitled to administrative expense priority if they had not been paid pre-petition is critical inasmuch as Code §547(b)(5) is concerned. Under that subsection, a transfer to a creditor is not avoidable as a preference unless the transfer enables the creditor to receive more than that creditor would have received under a chapter 7 liquidation had the transfer not been made. Section 547(b)(5) sets forth a necessary element of a preference; if Converse's liquidation trust could not prove that Chanin had received more than it would have received in a chapter 7 liquidation, the preference action would fail. Because Converse's estate was never alleged to be administratively insolvent—in other words, administrative expense claims would have been entitled to payment in full even in a chapter 7 liquidation—what Chanin received (payment in full) was exactly what it would have received (payment in full) had it asserted an administrative expense claim for the pre-petition fees in a chapter 7 liquidation of Converse's estate. Thus, based entirely on the concept that Chanin's services to the ad hoc committee conferred a cognizable benefit to Converse's reorganization efforts, Chanin was able to articulate a triable issue of fact regarding whether Chanin's fees would have been given administrative expense priority and, therefore, whether Chanin received more than it would have received in a liquidation.

Chanin's second argument—pertaining to an "ordinary course" defense to the avoidance of a preference—also relied centrally on the concept that services rendered to the ad hoc committee conferred a real benefit to Converse. Under Code §547(c)(2), a recipient of a preferential transfer may assert an affirmative defense by showing that the transfer paid a debt that the debtor incurred "(A)...in the ordinary course of business or financial affairs of the debtor and the transferee; (B) made in the ordinary course of business or financial affairs of the debtor and the transferee; and (C) made according to ordinary business terms...." The overarching concept of "ordinary" was crucial to the liquidation trust's argument in favor of summary judgment against Chanin. There's nothing "ordinary," the trust argued, about a sneaker company paying fees to its creditors' financial advisor. But that argument ignores the rather common-sense fact that it is certainly in the ordinary course of a financially distressed company's "business or financial affairs" to seek professional advice as part of its restructuring efforts. In establishing the three elements to the "ordinary course" affirmative defense, Chanin had to deal squarely with this concept; Chanin was halfway home if it could convince the bankruptcy court that it was in the ordinary course of Converse's business to seek financial advisory services in a distressed situation. Chanin would stumble rounding second, however, unless it could also show that Converse actually received financial advisory services that were technically rendered to Converse's senior creditors. (After all, it seems unlikely that the ordinary course of a debtor's business would include paying for professional advice rendered to someone else and that it didn't receive.) That Chanin was able to establish a triable issue of fact that Converse actually received tangible benefit from Chanin's services gave the bankruptcy court enough reason to deny summary judgment on the preference claim.

Chanin's third argument, also based on the same concept that value to the ad hoc committee was value to Converse, helped Chanin defeat summary judgment on the trust's fraudulent-transfer claim as well. Code §548(a)(1)(B)(i) requires a showing that the debtor "received less than reasonably equivalent value in exchange for" the transfer. Converse's payment of $162,000 in pre-petition fees to Chanin could be avoided as a fraudulent transfer unless Converse received "reasonably equivalent value" for those fees. By the time the bankruptcy court reached this element of the trust's fraudulent-transfer case, the triable issue of fact had already been made clear: The value of Chanin's services, inuring as it did to Converse despite that the ad hoc committee was Chanin's putative client, could constitute reasonably equivalent value for the $162,000 in fees Converse paid. Again recognizing at least the factual possibility that Converse received actual benefit from Chanin's services to the ad hoc committee, the bankruptcy court denied summary judgment on the trust's fraudulent-transfer claim.

The very idea that a pre-petition group of creditors can persuade a debtor to hire a financial advisor to render services to those creditors—while still conferring sufficient benefit to the debtor so as to warrant the debtor's payment of the advisor's fees—did not come as a surprise to the bankruptcy court. The arrangement is not uncommon, and other courts have declined to allow avoidance actions to bring those arrangements into question.4 It is hardly blasphemous to suggest that the ideal restructuring process is a collaborative process, where the accomplishments of one constituency can and do benefit all constituencies. Protecting creditors' financial advisors from later attack when they are paid by the debtor is but one way to encourage and implement that ideal restructuring model.

And it makes sense in Converse's case, too, since the company was more than once the beneficiary of services rendered to someone else. One of those times was on March 2, 1962, when 25-year-old Wilt Chamberlain helped the Philadelphia Warriors defeat the New York Knicks 169-147. That game will forever be remembered because Chamberlain—in only his third NBA season—scored 100 points to set a scoring record that no one expects will ever be broken. Few, however, remember that Chamberlain's performance helped inspire millions of American children and teens to wear the basketball shoes Chamberlain wore that night. They were Converse All Stars.


1 "Memorandum Opinion," Argus Management Group v. Chanin Capital Partners LLC (In re CVEO Corp.), Case No. 01-0223, Adv. Proc. No. 03-54130 (Bankr. D. Del. Jan. 24, 2005). Return to article

2 Editor's Note: This may be different from the duty owed by its directors and officers; see "Is the Tide Turning on D&O Claims?," p. 1. Return to article

3 Memorandum Opinion at 6, citing Lebron v. Mechem Fin. Inc., 27 F.3d 937, 943-44 (3d Cir. 1994). Return to article

4 The Converse court cited Pummill v. Greensfelder, Hemker & Gale (In re Richards & Conover Steel Co.), 267 B.R. 602 (8th Cir. BAP 2001), noting that the appellate panel there found no fraudulent transfer where the pre-petition ad hoc creditors committee's counsel was paid by the debtor. Return to article

Bankruptcy Code: 
Journal Date: 
Friday, April 1, 2005