Big Ex-Clients Start Suing Big Law Firms

Ex-Client Sues Paul Hastings for $55 Million in Soured Loan
The New York Law Journal by Nate Raymond - December 14, 2009

A financing unit of Cerberus Capital Management L.P. has sued Paul, Hastings, Janofsky & Walker, claiming the law firm gave it bad advice in connection with a loan the private equity firm made last year to a company looking to bring retailer Steve & Barry's out of bankruptcy. Ableco Finance LLC, a unit of Cerberus with more than $6 billion under management, filed an amended complaint Friday in Manhattan Supreme Court against its former lawyers seeking more than $55 million it said it lost because of the $125 million loan. Ableco claims it would never have made the loan last year if the Paul Hastings team had advised it that the buyer would not have rights to all of Steve & Barry's inventory, which Ableco understood would back the loan. "No competent, diligent finance lawyer would have put his client in such a vulnerable position," Ableco's complaint reads in part. A spokesman for Paul Hastings, which is represented by Paul Spagnoletti at Davis Polk & Wardwell, said the firm looked forward to defending itself in court. "Paul Hastings adheres to the highest standards of professionalism and integrity in the representation of its clients, and its representation of Ableco in this matter was no exception," the spokesman said. "It's unfortunate that Ableco has chosen to sue its longtime legal adviser to recoup business losses caused by the economic downturn." Both a spokeswoman for Cerberus and Ableco's lawyer, Stuart Shapiro at Shapiro Forman Allen & Sava, declined to comment. The case, Ableco Finance LLC v. Hilson, 650618/2009, before Acting Supreme Court Justice Shirley Kornreich (See Profile), was first filed in October.

Ableco's decision to sue Paul Hastings marked the end of what the company said in court papers was a 14-year relationship with John F. Hilson, a Los Angeles-based corporate partner at Paul Hastings. Mr. Hilson had represented Ableco in "hundreds" of transactions. In August 2008, Ableco retained Mr. Hilson and Mario Ippolito, a Paul Hastings partner in New York, to represent it in financing a buyer looking to purchase assets out of the Steve & Barry's bankruptcy. Steve & Barry's had filed for Chapter 11 in the Southern District Bankruptcy Court in July 2008. Bay Harbour Management, a private equity firm specializing in buying distressed companies, sought to purchase the retailer's assets out of bankruptcy and turned to Ableco to help finance the deal with a $125 million loan. Bay Harbour set up a portfolio company for the transaction called BH S&B Holdings. It was a difficult time to make a loan, given "an economy that was suffering major disruptions in the housing and credit markets," Ableco said in its complaint. To ensure it got paid back in full, Ableco said it told Paul Hastings lawyers to require a first priority lien on Steve & Barry's entire inventory, which Ableco estimated to be worth $183.7 million. Language agreeing to a first priority lien made it into the commitment letter drafted by Paul Hastings, and Ableco agreed to make the loan.

But according to the complaint, Ableco had not been advised about an earlier agreement between Bay Harbour and Steve & Barry's that would have made a right to the entire inventory impossible. Bay Harbour's earlier agreement with Steve & Barry's left the retailer with control of more than 50 percent of its stores. While the estate had given Bay Harbour a lien on the assets at these stores, the estate kept priority rights to the inventory and sales proceeds that came ahead of that lien. As a result, Ableco claimed it was in fact impossible for it to receive its lien on a large portion of Steve & Barry's inventory. Ableco said Paul Hastings did not provide a copy of the earlier agreement between Bay Harbour and the retailer's estate, nor communicated its terms, before Ableco made the loan. With the economy worsening, the company created by Bay Harbour, BH S&B Holdings, began to struggle and it filed for Chapter 11 bankruptcy in the Southern District in November 2008. It was not until the BH S&B bankruptcy filing that Ableco learned that Steve & Barry's estate claimed it owned the inventory in more than half the stores and Ableco did not have a first priority lien. An Ableco executive confronted Mr. Ippolito at Paul Hastings almost immediately. "I find it hard to imagine that you did not bring this matter to my attention pre closing," Paul Lusardi, a senior vice president of Cerberus Capital and at Ableco, said in a November 2008 e-mail. "I would never have recommended closing the deal if I knew we were not going to have a free and clear lien on all of the assets." The bankruptcy by the Bay Harbour affiliate also put at risk $28.5 million in loan repayments Ableco received in the 90 days before the Chapter 11 filing. As a result, Ableco said it entered into a "very costly" settlement. Paul Hastings, in a motion to dismiss filed in November, said Ableco is trying to blame its lawyers for decisions it made in a bad economy. "In bringing this lawsuit, [Ableco], a sophisticated lender, is trying to hold its attorneys liable for its own bad business decisions and any losses that may arise from them, not from any breach of duty by the attorneys," Paul Hastings said in the motion. Nate Raymond can be reached at nraymond@alm.com.