A $55 million lawsuit by a unit of Cerberus Capital Management L.P. can proceed against Paul, Hastings, Janofsky & Walker over allegations the firm gave faulty advice on a loan made in connection with a private equity firm’s 2008 acquisition of bankrupt retailer Steve & Barry’s.
In a decision filed last week, Manhattan Supreme Court Justice Shirley Kornreich said Paul Hastings had “conclusively rebutted” Cerberus’ lending arm’s claim that it would not have made a $125 million loan if it knew the recipient, an affiliate of Bay Harbour Management L.C., was acquiring less than all of Steve & Barry’s inventory. But the judge said the law firm had not shown that it accurately advised the Cerberus affiliate on acquisition documents and their impact on the loan’s security.
“Any negligence on the part of [Cerberus] in reviewing the underlying documents is merely a factor to be assessed in mitigation of damages,” Kornreich wrote.
She called other allegations of negligence by the Cerberus finance unit, Ableco Finance LLC, sufficient for the suit to move forward. The judge said submitted documents do not answer whether Paul Hastings negligently failed to advise Ableco of potential risks arising from the loan in the event of a bankruptcy by the Bay Harbour affiliate.
Paul Spagnoletti of Davis Polk & Wardwell, who represents Paul Hastings, said his client would appeal. Stuart L. Shapiro, a lawyer for Ableco at Shapiro Forman Allen & Sava, declined to comment.
The suit against Paul Hastings in particular paints a picture of the perils of deal financing in the financial crisis of 2008.
Ableco, a financing affiliate of private equity giant Cerberus with more than $6 billion under management, turned to Paul Hastings partners John F. Hilson and Mario J. Ippolito in August 2008 to advise it on providing a $125 million secured loan to a company established by Bay Harbour called BH S&B Holdings.
The Bay Harbour affiliate was looking to buy most of the assets of S&B Industries Inc., which operated clothing retailer Steve & Barry’s, which was in bankruptcy. Ableco said Hilson had advised it on hundreds of transactions over 14 years.
At the time the thinly capitalized BH S&B Holdings made the $163 million acquisition of the Steve & Barry’s assets, the housing and credit markets had caused major problems in the economy. Ableco said it told Paul Hastings it would need a perfected first priority lien on Steve & Barry’s entire inventory, which was worth $183.7 million.