Turnaround firms watch Merry-Go-Round suit Rescuers may face more blame in failures

Legal affairs

December 07, 1997|By Mark Ribbing | Mark Ribbing,SUN STAFF

The $4 billion negligence and fraud lawsuit filed last week by Merry-Go-Round Enterprises Inc.'s bankruptcy trustee against Ernst & Young International Inc. could change the way ailing companies are served in the future, experts say.

The suit, which blames one of the largest and most prestigious accounting and consulting firms in America for Merry-Go-Round's demise, has captured the attention of the big firms and small boutiques that offer consulting or management assistance to companies in trouble.

Their concern is that a successful suit by the trustee could prompt other failed companies to go after the turnaround experts who tried and failed to resuscitate them. "Once somebody wins one, there are 50 other look-alikes who think that's a good way to make a fee," said Shaun K. Donnellan, president of Glass & Associates Inc., a highly regarded consulting firm based in Canton, Ohio.

As a result, said some analysts, restructuring consultants could become increasingly leery of making the prompt, risky decisions that a corporate rescue might require.

"It may make it more difficult to actually solve the crisis," said Richard Tilton, a New York attorney who has written widely on the bankruptcy process. "You're often being asked on very short notice to help a company in crisis. You often don't have ideal information, but you're being asked to make a decision. You're trying to do it quickly, and I think that if everybody's worried about being sued, they will be more cautious, and that will probably make it harder to reorganize." Some claim that a more litigious environment could cause restructuring consultants to shy away from certain cases unless they are offered additional money and additional protections against lawsuits. "For a few thousand or even million dollars in fees, you're not going to face the risk of going into court for a billion-dollar lawsuit," said Albert A. Koch, managing principal of Jay Alix & Associates, a national turnaround firm based in Southfield, Mich.


Koch said that although turnaround firms already commonly insist on indemnification provisions to limit liability for their business judgments, turnaround firms are often willing to handle a case even if a bankruptcy judge rejects such a provision. If the Merry-Go-Round suit succeeds, he said, "It would be much less likely that we'd be willing to proceed" without indemnification.

Randal Picker, who teaches bankruptcy law at the University of Chicago, said smaller turnaround firms might seek safety in numbers. "You could easily see consolidation in the industry to protect against a litigation wave," he said.

Not everyone believes that a successful suit would lead to broad changes. Harlan Platt, professor of finance at Boston's Northeastern University, said a victory for the trustee would have limited impact.

"I don't see it affecting the entire industry," he said. "I would imagine the majority of this work is done by smaller firms. There's not much sense in suing them. Litigants search for the deepest pockets."

In addition, observers say, there will always be a need for people who can come in like a trusty relief pitcher and bail a company out of a jam.

"I don't think this will dampen the industry. Companies will still have to ask themselves, 'Do I get help or do I not get help?' " said John M. Collard, president of Strategic Management Partners, an Annapolis turnaround management firm.

Nonetheless, many in the restructuring industry are looking at the suit warily. Sam Gerdano, executive director of the Alexandria,Va.-based American Bankruptcy Institute, said it will be "a much-watched case in the turnaround profession. If simply being unsuccessful is a cause for action, the cost of doing a turnaround just went up."

No standard

Observers say such a standard would be impossible, given the fact that turnaround experts work with companies already on the brink of failure. Gerdano said any suit must show that the consultant was negligent and that his or her actions actually caused the damage. Consultants, he said, should not bear the blame for the mistakes of a company's prior managers. "If a company was making buggy whips, it doesn't really matter who's doing the turnaround. It's just not going to succeed," he said.

The lawsuit asserts that Merry-Go-Round's ultimate demise was due less to merchandising bloopers than to Ernst & Young's negligence. Arnold Weiner, one of the attorneys who prepared the suit, filed in Baltimore Circuit Court, said Ernst & Young is simply getting its just desserts.

"A turnaround expert is the same as any professional that holds himself out to be an expert in a particular field. If they perform their services negligently or commit fraud in connection with their engagements, they can and should expect to be held accountable," he said.

However, experts say negligence may be difficult to define in a case involving a turnaround consultant, because there are no fixed standards governing the profession. The Turnaround Management Association, a professional organization, has a code of ethics for its 2,600 members (including some from Ernst & Young), but adherence is strictly voluntary. Ernst & Young, for its part, has said little about the case, issuing a brief official statement on Tuesday: "We were hired by Merry-Go-Round shortly before it filed for bankruptcy. We see absolutely no basis for any claim against us, and in no way can we be held responsible for any losses incurred as a result of its business decisions. We will vigorously defend ourselves."

Pub Date: 12/07/97

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