Elite Bankruptcy Consulting Firms Battle It Out With Fraud and RICO ...

In Jay Alix, as assignee of AlixPartners, LLP v. McKinsey & Co., Inc., 2022 WL 163800 (2nd Cir., January 19, 2022) (click here for .pdf), two major competitors in the niche market of Bankruptcy advising to estates with a billion dollars or more of assets were in court against each other over lucrative consulting assignments. Alix sued McKinsey, three of its subsidiaries and several current or former employees under state law and the federal Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 USC §1961, et seq.

The amended complaint alleges that McKinsey secured lucrative consulting assignments in this market by knowingly and repeatedly filing disclosure statements in the Bankruptcy Court containing incomplete, misleading, or false representations concerning conflicts of interest. Alix alleges that this pattern of misrepresentations to the Bankruptcy Court resulted in injury to AlixPartners through the loss of engagements it otherwise would have secured and of substantial revenues those assignments would have generated, as well as through the loss of the opportunity to compete for them in an unrigged market… Alix alleges that AlixPartners was directly harmed by McKinsey’s conduct because, had McKinsey truthfully and timely disclosed its conflicts to the Bankruptcy Court, McKinsey would have been disqualified from obtaining at least some of the assignments it secured. In turn, Alix alleges that AlixPartners, because of its major presence in this niche market, would have been retained in at least some of the cases.

Alix also alleges a “pay-to-play” scheme under which McKinsey arranged meetings between its clients and bankruptcy attorneys in exchange for exclusive bankruptcy assignment referrals from those attorneys. Consistent with this scheme, Alix alleges that McKinsey offered to introduce AlixPartners to its clients if Alix would “drop the issues he had raised concerning McKinsey’s acknowledged pay-to-play scheme and its illegal disclosure declarations.”

The District Court dismissed Alix’s RICO claims for failure to show a causal connection between the alleged RICO violations and Alix’s injuries. See 470 F.Supp.3rd 310 (S.D.N.Y. 2020).  The Third Circuit reversed and found that the amended complaint adequately alleged proximate causation under RICO, and remanded the case.

In order to secure engagements, bankruptcy advisors must demonstrate that they “do not hold or represent an interest adverse to the estate” and are “disinterested persons” within the meaning of the Bankruptcy Code. 11 U.S.C. § 327(a); see also id. § 101(14).  When these requirements are satisfied, a bankruptcy professional may be retained “with the court’s approval.” Id. § 327(a). In addition, bankruptcy courts require that an application for retention be “accompanied by a verified statement of the person to be employed setting forth the person’s connections with the debtor, creditor, any other party in interest, their respective attorneys and accountants, the United States trustee, or any person employed in the office of the United States trustee.” Fed. R. Bankr. P. 2014(a). The statements requiring these detailed disclosures are submitted under penalties of perjury and are subject to the bankruptcy fraud statute. See 28 U.S.C. § 1746; 18 U.S.C. §§ 152(2)-(3).

Alix alleged that McKinsey violated the disclosure requirements in thirteen Bankruptcy cases by failing to disclose its connections by name in several of those cases, and McKinsey would have been disqualified from the cases had it made the appropriate disclosures and identified its connections. In other words, Alix contends that AlixPartners’s injury was a foreseeable and direct consequence of McKinsey’s failure to follow the law and a fraud on the Bankruptcy Court.  Alix also alleged that he met with two current or former McKinsey employees and told them that he was aware of a “pay to play” scheme whereby McKinsey would host meetings between its clients and Bankruptcy attorneys in exchange for exclusive referrals from those attorneys.  One of the McKinsey employees allegedly admitted the existence of the scheme and that their outside counsel confirmed its illegality, and requested that Alix refrain from taking legal action on the alleged scheme and allegedly fraudulent disclosure statements.  Alix further alleged that the McKinsey employee later offered an introduction to two potential clients, which Alix construed as “blatant attempted pay-offs and bribes” to silence him.

The District Court, although noting that the allegations were “indeed concerning,” dismissed the RICO claims because the allegations were insufficient to satisfy the proximate cause requirement.

The court concluded that “independent intervening decisions” of the trustees and the bankruptcy court rendered the causal connection between the alleged misconduct and injury “too remote, contingent, and indirect to sustain a RICO claim.” As to the pay-to-play  allegations, the court concluded that they too failed to meet the pleading standards and suffered from the same defects as the allegations concerning fraudulent disclosures because they did not sufficiently narrow the gap between the alleged fraud and the alleged resulting injury… First, the alleged harm to AlixPartners, it concluded, was directly caused by the decisions of the various debtors’ trustees not to hire AlixPartners rather than by McKinsey’s misconduct. Second and relatedly, the court concluded that the existence of several intervening factors rendered the relationship between the alleged fraud and injury too indirect and remote. Lastly, the court believed that there was “at least one ‘better situated’ party,” such as the U.S. Trustee, “who can seek appropriate remedies for the most direct consequences of McKinsey’s alleged misconduct.”

The Circuit reversed the District Court, and summarized its holding.

In general, we conclude that its analysis conflated proof of causation and proof of damages and that it did not draw all reasonable inferences in Alix’s favor. More specifically (and more importantly) we believe the district court gave insufficient consideration to the fact that McKinsey’s alleged misconduct targeted the federal judiciary. As a consequence, this case requires us to focus on the responsibilities that Article III courts must shoulder to ensure the integrity of the Bankruptcy Court and its processes. Litigants in all of our courts are entitled to expect that the rules will be followed, the required disclosures will be made, and that the court’s decisions will be based on a record that contains all the information applicable law and regulations require. If McKinsey’s conduct has corrupted the process of engaging bankruptcy advisors, as Alix plausibly alleges, then the unsuccessful participants in that process are directly harmed. The fact that this case invokes our supervisory responsibilities makes our resolution of it sui generis and of little, if any, application to “ordinary” RICO cases where these responsibilities are not front and center. But in light of these special considerations, we hold that Alix has plausibly alleged proximate cause with respect to all thirteen engagements. The fact that this case is not within the mine-run of civil RICO cases means that its proximate cause analysis differs somewhat from the analysis in cases such as Bridge v. Phoenix Bond & Indem. Co., 553 U.S. 639, 128 S.Ct. 2131, 170 L.Ed.2d 1012 (2008), Anza v. Ideal Steel Supply Corp., 547 U.S. 451, 126 S.Ct. 1991, 164 L.Ed.2d 720 (2006), or Empire Merchants, LLC v. Reliable Churchill LLLP, 902 F.3d 132 (2d Cir. 2018).

Alix sued after the assignments had already been awarded. Consequently, we need not speculate whether the Bankruptcy Judge and the Trustee would have thought an advisor was necessary. We know that they did think so in the thirteen bankruptcies at issue because they awarded assignments to McKinsey. It is certainly reasonable to infer that the Bankruptcy Court, the U.S. Trustee, and the parties involved who thought an advisor was needed in thirteen cases would continue to think so after learning that their selected advisor was ineligible because of fraud and that they would, at that point, make an alternative selection. And it is also a reasonable inference that, in making another selection, they would likely have awarded assignments to eligible firms in approximately the same ratio they had been using in the past. Of course, McKinsey might ultimately prove the existence of intervening factors, but that showing must await summary judgment or trial… If the thirteen assignments had not been awarded to McKinsey, it is entirely plausible that they would have been awarded to other advising firms, and the large advising firms would, following past practice, have received 75% of these assignments and resulting revenue (and that AlixPartners would have received a 24% share of these assignments and resulting revenue)…

The district court dismissed Alix’s RICO claims predicated on the pay-to-play scheme because it found that the allegations failed to meet the pleading and proximate cause standards. It concluded that the pay-to-play allegations were “devoid of any supporting specifics” and inadequate to meet the pleading requirements, and that even if they did, that they failed to show a sufficiently direct link between the allegedly unlawful conduct and injury. We disagree. We hold that Alix adequately pleaded bankruptcy fraud under Federal Rule of Civil Procedure 9(b) and that the allegations show a sufficiently direct link between the alleged fraud and injury. However, the amended complaint does identify several engagements that Alix believes had been influenced by the pay-to-play scheme. For example, it specifically alleges the influence of the pay-to-play scheme in the Alpha Natural Resources, NII Holdings, and Edison Mission Energy bankruptcies because AlixPartners was “never even asked to pitch for the work” despite its strong relationship with the debtors or extensive expertise in the relevant industries… The allegations in the complaint about specific cases, when combined with the unusually detailed allegations (see pp. 8-10) regarding Alix’s meetings with Barton, one of which allegedly led to Barton admitting McKinsey’s role and participation in an illegal scheme and supposed agreement to take steps to end that scheme, easily raise a strong inference of fraud…

At the motion to dismiss stage, Alix need only plausibly allege that the pay-to-play scheme proximately caused AlixPartners’ harm. We believe that the pay-toplay allegations are sufficiently robust to plausibly allege that the causal connection has been met. Whether Alix can substantiate his allegations is a question for summary judgment or trial, but at this juncture we find that the allegations are sufficient to allege proximate cause.

For purposes of this already-lengthy post, I have summarized and quoted the basic allegations and conclusions of the Court, and omitted much of the detailed legal analysis.

Scott Riddle’s practice focuses on bankruptcy and reorganization. Scott has represented businesses and other parties in Bankruptcy cases for almost 30 years.  You can contact Scott at 404-815-0164 or [email protected].  For more information, click here.