Settlement with Ernst & Young seen near

Merry-Go-Round trustee seeks billions over bankruptcy case

April 20, 1999|By Scott Shane and Jay Hancock | Scott Shane and Jay Hancock,SUN STAFF

Ernst & Young International, one of the nation's top accounting and consulting firms, is negotiating an unusually large settlement of a Baltimore lawsuit charging it with fraud and incompetence in advising on the bankruptcy of the Merry-Go-Round clothing chain, according to several people involved in negotiations.

While the lawyers yesterday cautioned that the deal was not final, sources said the settlement of the suit filed by Merry-Go-Round bankruptcy trustee Deborah Hunt Devan is likely to be more than $150 million, which would rank it among the largest in state history.

Devan said yesterday a tentative settlement had been reached, but that "a few more wrinkles" remained to be worked out. Devan's attorney, Stephen L. Snyder, said later: "It honestly is not a done deal. There are issues that are outstanding."

Thomas L. Riesenberg, associate general counsel for Ernst & Young, would say only, "We do not have an agreement at this point."

Lawyers for both sides met yesterday in the chambers of Baltimore Circuit Judge Kathleen O'Ferrall Friedman.

While declining to disclose the size of the tentative settlement, Devan said she is "hopeful" that it would allow full payment of more than $80 million in so-called "administrative" claims that are to be first in line for any payments that emerge from Merry-Go-Round's remnants.

Administrative claimants include Merry-Go-Round's former vendors as well as 2,000 employees owed back pay. Employees would be "the big winners" from a settlement, she said.

`Civil death penalty case'

In recent weeks, Ernst & Young's attorneys have spoken in dire terms of the danger the case poses to the firm, saying that the trial should be delayed because of the high stakes. Devan is seeking $800 million in compensatory damages and $3 billion in punitive damages on behalf of the former employees and creditors of Merry-Go-Round Enterprises Inc.

"For Ernst & Young, this amounts to a civil death penalty case," Francis B. Burch Jr., chairman of Piper & Marbury LLP, the state's largest law firm, told Friedman in a hearing March 29. "If the plaintiff gets a fraction of the amount sought it will exceed both Ernst & Young's ability to pay and its ability to bond."

Burch added: "If a jury makes an award of even a fraction of the amount sought, it could threaten the future of Ernst & Young. Ernst & Young, in this country alone, employs 30,000 people and acts as an auditor for 2,500 public companies. So it is not simply a question of some abstract business organization's interests. It's a very real issue for a lot of people and for the national economy."

When Friedman declined to grant a postponement, Ernst & Young attorneys took the unusual step of asking the Court of Appeals, the state's highest court, to intervene and overrule her. The court refused last week, and with the trial set for April 26, settlement talks began in earnest.

The Ernst & Young case is the latest in litigation involving Merry-Go-Round, which sought protection from creditors under Chapter 11 of U.S. bankruptcy law in early 1994. A chain of 1,500 mall-based clothing boutiques once mobbed by teens across the country, the Joppa-based company was started by Harold Goldsmith and Leonard "Boogie" Weinglass in 1968.

It foundered in the early 1990s after Goldsmith died in an accident, Merry-Go-Round's fashions lost their appeal and the apparel industry suffered a long slump. The company's bankruptcy filing was supposed to grant it breathing room to reorganize. But it never recovered and closed its doors in 1996, leaving some $300 million in unpaid bills, paychecks and other claims.

Who pays those claims is at the heart of the lawsuit against Ernst & Young, the country's No. 3 accounting firm and an important management consultant to top corporations. Merry-Go-Round hired the firm in late 1993 to set up a recovery strategy, but the lawsuit alleges that Ernst & Young contributed to the chain's demise instead.

As bankruptcy trustee, Baltimore attorney Devan got the job of obtaining the highest possible payoff from Merry-Go-Round's remains for vendors, employees and other creditors. In her lawsuit, she asserts that Ernst & Young failed to reveal its relationship with Swidler & Berlin, the Washington law firm that recommended Ernst as a turnaround adviser. Swidler & Berlin was not named in Merry-Go-Round's lawsuit.

In addition, the suit alleges that Ernst & Young mishandled the reorganization, assigning inexperienced people to the case and moving too slowly to fix Merry-Go-Round's finances.

In court filings, Ernst & Young has said Devan was trying to "scapegoat" the firm for problems that began long before it was hired.

Suit raises fears

Although lawsuits against turnaround experts and other consultants have become more common in recent years, an Ernst & Young settlement of more than $150 million would send shock waves through the management consulting field, industry analysts said yesterday.

"I know the case has caused concern in the turnaround community," said Sam Gerdano, executive director of the American Bankruptcy Institute in Alexandria, Va. "They're afraid the case will suggest they should provide a warranty of success, which is impossible. This field is more art than science."

Bill Brandt, a Chicago turnaround consultant, said such lawsuits have proliferated because of the potential for large payoffs. "In the endless search for a deep pocket -- which is American law -- when you have these numbers at stake every lawyer takes a look," he said.

Devan is represented by Snyder and two of his partners, Arnold M. Weiner and Robert J. Weltchek, as well as former judge William H. Murphy Jr. and Larry S. Gibson, a University of Maryland law professor and prominent political consultant.

Ernst & Young's legal team includes Neil J. Dilloff and Joseph G. Finnerty Jr., both of Piper & Marbury, and Mark Gary of Mayer, Brown & Platt.

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