20-10990-mew Doc 177 Filed 07/13/20 Entered 07/13/20 09:28:01 … · 2020-07-13 · when it was sent, and that it was booked that day on the company’s general ledgers as “prepaid

BROWN RUDNICK LLP Robert J. Stark Sigmund S. Wissner-Gross Kenneth J. Aulet BROWN RUDNICK LLP Seven Times Square New York, New York 10036 Tel: 212-209-4800 [email protected] [email protected] [email protected] Counsel to Extreme Horse Limited

KLESTADT WINTERS JURELLER SOUTHARD & STEVENS, LLP Tracy L. Klestadt 200 West 41st Street, 17th Floor New York, New York 10036-7203 Tel: 212-972-3000 [email protected] BUCHALTER A Professional Corporation Bernard D. Bollinger, Jr. Paul S. Arrow 1000 Wilshire Blvd., Suite 1500 Los Angeles, California 90017 Tel: 213-891-0700 [email protected] [email protected] Counsel to Ashford Textiles, LLC

UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK --------------------------------------------------------------X : Chapter 11 In re: : : Case No.: 20-10990 (MEW) THE NORTHWEST COMPANY, LLC, et al.1 : : (Jointly Administered) Debtors. : : Re: Docket Nos. 63, [168] --------------------------------------------------------------X

REPLY OF EXTREME HORSE LIMITED AND ASHFORD TEXTILES LLC IN SUPPORT OF THEIR MOTION TO APPOINT AN EXAMINER OR A CHAPTER 11

TRUSTEE

1 The Debtors in these Chapter 11 cases, along with the last four digits of each Debtor’s federal tax

identification number, are: The Northwest Company, LLC (8132) and The Northwest.com LLC (1339).

20-10990-mew Doc 177 Filed 07/13/20 Entered 07/13/20 09:28:01 Main Document Pg 1 of 19

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TABLE OF CONTENTS

PRELIMINARY STATEMENT .....................................................................................................1

REPLY .............................................................................................................................................7

i. The Debtors’ Have Failed To Meet The Stringent Requirements To Moot The Appointment Of A Trustee For Pre-Petition Misconduct ....................................................7

ii. The Movants Will Establish Cause Exists For The Appointment of A Trustee ..................9

iii. The Movants Will Establish A Trustee Is In The Interests Of Creditors ...........................12

iv. Remaining Issues ...............................................................................................................14

CONCLUSION ..............................................................................................................................15


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TABLE OF AUTHORITIES

Cases Barnhill v. Johnson,

503 U.S. 393 (1992) .................................................................................................................. 10

Chisum v. Campagna, No. 16 CVS 2419, 2019 WL 1873574 (N.C. Super. Apr. 25, 2019) ........................................ 13

In re Deena Packaging Indus., Inc., 29 B.R. 705 (Bankr. S.D.N.Y. 1983) ........................................................................................ 10

In re Nw. Co., No. 20-10990 (MEW), 2020 WL 2121269 (Bankr. S.D.N.Y. May 1, 2020) ........................... 14

In re Sanders, No. 99 B 9876, 2000 WL 329574 (Bankr. N.D. Ill. Mar. 2, 2000) .................................... 10, 11

In re Shotwell Landfill, Inc., 2014 WL 4377721 (Bankr. E.D.N.C. 2014) ........................................................................... 8, 9

In re The 1031 Tax Grp., LLC, 22 374 B.R. 78 (Bankr. S.D.N.Y. 2007) ................................................................................. 7, 8

Tradex Corp. v. Morse, 339 B.R. 823 (D. Mass. 2006) ............................................................................................ 10, 11

Statutes 11 U.S.C. § 1104 (a)(1) ........................................................................................................... 10, 11

N.C. Gen. Stat. § 57D–3–03 (2014)........................................................................................ 13, 14


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Extreme Horse Limited (“Extreme Horse”) and Ashford Textiles LLC (“Ashford” and,

together with Extreme Horse, the “Movants”) by and through their undersigned counsel, hereby

submit this reply (the “Reply”) to the objection filed by the Debtors (the “Debtor Objection,”

Docket No. 168), the Committee (the “Committee Objection,” Docket No 170) and the joinder

filed by Ross Auerbach and Northwest Textiles Holdings LLC (the “Joinder,” Docket No. 171)

(collectively, the “Objections”) to the Joint Motion of Extreme Horse Limited and Ashford

Textiles LLC for the Appointment of an Examiner or, in the Alternative, a Chapter 11 Trustee

Pursuant to Bankruptcy Code Section 1104 (the “Examiner/Trustee Motion,” Docket No. 63)

and respectfully state as follows:

PRELIMINARY STATEMENT

1. The discovery taken to date in support of the Examiner/Trustee Motion has

confirmed grave, serial misconduct by Ross Auerbach – including falsified schedules submitted

to this Court – that requires the appointment of a Chapter 11 Trustee. While Auerbach’s pre-

filing misconduct is staggering, Debtors’ argument that they have somehow reined him in since

filing for Chapter 11 is contradicted by Auerbach’s certifying of false bankruptcy schedules in an

effort to hide his fraud from the Court. This alone, as set forth below, requires appointment of a

Trustee, particularly where Auerbach continues to operate as the sole manager of Debtors. Not

surprisingly, the Debtors fail to address, let alone defend, this misconduct. Further, the Debtors’

Objection fails to address the correct legal standard for the appointment of a Chapter 11 trustee.

The other objections filed do not remedy this failure.

2. The evidence in support of the Trustee motion will establish, among other

misconduct, the following:


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Ross Auerbach has systematically looted the Debtors for years, to such a degree that nobody is certain of the extent of his undisputed debts to the company. Mr. Auerbach made a habit of spending corporate funds on indisputably personal expenses and charging much of such expenses to a non-interest bearing “loan account.” While the Debtors disclosed in their filings before this Court that Mr. Auerbach owes at least $3.4 million, this figure does not include expenses that are contained in a multi-million dollar “suspense” account that have never been allocated. These unallocated expenses include, for example, tuition payments for Mr. Auerbach’s daughter. Both Mr. Auerbach and the Debtors’ CFO, Mr. Jolson, testified that nobody is sure how much Mr. Auerbach actually owes. See Declaration of Uriel Pinelo, Esq. (the “Pinelo Decl.”), submitted herewith, at Exhibit 1 (Transcript of Deposition of Robert Jolson at 63:23-64:11 (“Jolson Tr.”); see also Exhibit 2 (Transcript of Deposition of Ross Auerbach at 147:14-148:7 (“Auerbach Tr.”). In total, including these unallocated expenses, Mr. Auerbach may owe the Debtors in excess of $5.5 million dollars. Further, the Debtors, controlled by Mr. Auerbach, have not demanded immediate repayment of those amounts.

To conceal this “suspense” account, for years the Debtors have made a practice of simply allocating the expenses in the account according to an arbitrary formula between Ross Auerbach’s personal loan account, and a “holding” expense account that is falsely treated as legitimate expenses of the company at the end of any reporting period (i.e., December 31) and reversing that amount the next day (i.e., January 1). However, in one case over $860,000 of Auerbach’s expenses were permanently allocated to this “holding” account, and due to accounting issues caused by these “temporary” transactions, vanished – eliminating them from ever being reviewed and allocated to the proper expense accounts (or more likely, Ross Auerbach’s personal loan account).

Ross Auerbach has made a habit of mischaracterizing his personal expenses as corporate expenses, such that they are not charged against his “loan account” but are instead falsely reclassified as corporate expenses. In one especially egregious example, Mr. Auerbach caused the Debtors to book over $53,000 of his spending at a high-end men’s clothing store as “Office Supplies” rather than book it to his personal loan account. In other instances, Mr. Auerbach falsely represented that his family ski trip to Vail was a trip with Ashford to claim it as a business expense, when in fact no Ashford representative attended that trip. Mr. Auerbach has also required the company to pay for his country club membership, and the maintenance fees on a privately owned apartment. As a result, his loan account reflects only the tip of the iceberg of improper diversion of corporate funds. Further, this improper activity may have resulted in improper tax filings, which may explain why the Debtors have been unable to file a tax return for any year beyond 2017.

Ross Auerbach ordered his CFO to pay fraudulent $9,700 “consulting” invoices every month for years, to an entity known as David Harrison LLC. In total, over $300,000 in fraudulent invoices were issued. This entity never provided any consulting services whatsoever: it has no employees. What it does own is a multi-million-dollar residence (near Auerbach’s Long Island residence) that Ross Auerbach claims to have


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needed for late-night meetings that allegedly could not be conducted at Northwest’s nearby Roslyn offices or his home. Mr. Auerbach did not even disclose to his CFO – or to this Court – that he is the manager and ultimate owner of David Harrison LLC.

Ross Auerbach testified under oath to, and caused the Debtors to file before this Court, a frivolous complaint alleging a $5 million “loan” to Extreme Horse. This claim is contradicted by every single piece of relevant documentation, which reflect that the wire to Extreme Horse was characterized as for “PREPAID INVENTORY” when it was sent, and that it was booked that day on the company’s general ledgers as “prepaid inventory.” Moreover, the company’s CFO testified under oath no such loan existed. Jolson Tr. at 179:14-184:4. Not a single document exists that memorializes such a loan – or even suggests that it existed. Nor is it listed in the Debtors’ Chapter 11 filings. When pressed for an example of such an undocumented loan ever happening in any other circumstance, Mr. Auerbach testified only to a single payment an order of magnitude lower – to Ashford, whom he owed tens of millions of dollars to at the time.

Ross Auerbach has filed false statements with this Court under penalty of perjury. The Statement of Financial Affairs [Docket Nos. 117, 118] fails to list payments made by the Debtors to David Harrison LLC in the year before the bankruptcy in its list of payments made to or for the benefit of insiders. Mr. Auerbach, who signed this document, knew (and his CFO claims to have not known) that all payments made to David Harrison LLC were payments to or for his benefit, and at least two such checks were honored by the Debtors within the one-year period. Further, the Statement of Financial Affairs lists a $40,000 payment to Mr. Auerbach and a $35,000 payment to the Debtors’ CFO for “T&E Reimbursement.” Yet the bank records for those wires clearly state they were “BONUS” payments. Further, Robert Jolson, the Debtors CFO, confirmed the payment to him was a retention bonus payment – and that part of that payment was an undisclosed $10,000 retention bonus payment to the Debtors’ comptroller (not listed at all on the Statement). However, because these payments were falsely characterized as “reimbursement” payments on the general ledgers of the Debtors, no tax withholdings were made.

3. Further, there is substantial reason to be concerned that the Debtors’ financial

records are no longer reliable and have been tampered with. The Debtors general ledger files

produced in this case reflect a very concerning, and unexplained, anomaly. All general ledger

files before 2020 “roll forward” correctly – i.e., the ending balance of an account (such as Mr.

Auerbach’s personal loan account) at the end of one month matches the beginning balance in that

account in the next month, and all changes correspond to “journal entries” that indicate what

changes were made to the account. Not so for 2020: after the first general ledger file (containing


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dates from January 1, 2020 through February 28, 2020) there is a disconnect: Mr. Auerbach’s

loan balance is approximately $2 million2 at the end of February 28, 2020 – and negative $1.4

million3 in the general ledger file for February 29, 2020, and the general ledger file beginning on

March 1, 2020, with no corresponding journal entry. This is not the only inconsistency: a debt

owed by the estate of Shay Auerbach (which is now an LLC controlled by Ross Auerbach) to the

Debtors of approximately a quarter of a million dollars also vanishes without a trace.

4. Finally, it appears no effort is being made to review the multi-million dollar

“suspense” account to determine how many additional personal expenses of Ross Auerbach

remain in that account. Although the Debtors’ CFO testified – under oath – that such a process

was ongoing and he expected results by July 3, 2020,4 it appears this was not true. Mr. Auerbach

testified nobody has asked him to review any of his spending to explain what was personal and

what was not; and when the Movants requested that the Debtors turn over all such documents

relating to any such allocation process, the Debtors responded (after July 3) that no relevant

documents existed that had not already been produced in productions that occurred well before

July 3. Against the foregoing litany of misconduct, the Debtors offer up only three real

responses.

5. First, they (briefly) challenge the sufficiency of the allegations made before

discovery, yet ignore each of the issues enumerated above that they are well aware of from

depositions and document discovery. Each of these issues is well documented and will be

proven at trial.

2 This amount is smaller than the undisputed $3.4 million owed by Mr. Auerbach to the Debtors because of transactions on December 31,

2019 and January 1, 2020 that allocated $1.4 million of expenses to Mr. Auerbach’s loan account at the end of 2019, and immediately reversed them on January 1, 2020.

3 Meaning that the Debtors would owe Mr. Auerbach $1.4 million. Note that this amount is very similar to the reallocated expenses described above, but not exactly the same: $1,357,153.92 was reallocated out of Mr. Auerbach’s loan account into “suspense” on January 1, 2020, while on February 29, 2020 the general ledger files produced to the Movants reflect a purported debt to Mr. Auerbach of $1,357,219.08. As a result, the similarity of the two numbers appears to be a coincidence.

4 Jolson Tr. at 74:6-77:25.


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6. Second, they urge this Court not to follow Congress’ mandatory command that

the court shall appoint trustee for cause, including “fraud, dishonesty, incompetence, or gross

mismanagement of the affairs of the debtor by current management”5 by claiming that doing so

will cause the Debtors’ liquidation. Yet this argument is similarly unconvincing. The Debtors

state both that they anticipate “multiple” stalking horse bids that will result in a sale motion

being filed “within a matter of days” – and in the very next paragraph suggest that if a Chapter

11 Trustee is appointed their DIP lender and secured creditor (CIT) will abort that process and

liquidate the Debtors at a loss. No explanation, let alone a commercially reasonable one, is given

why their DIP Lender would engage in such self-defeating behavior.

7. Further, to the extent that Mr. Auerbach has sufficient influence with CIT to cause

them to make such a commercially unreasonable threat, thus seeking to put a gun to the head of

the estate if this Court appoints a trustee, that threat is empty. In the event that a trustee is

appointed and as a result CIT refuses to provide further DIP financing to Northwest, Ashford

will fund an amount necessary for Northwest’s continued post-petition operations through the

closing of a sale, on a senior secured basis in an amount not to exceed $5 million.

8. Third, the Debtors (and Mr. Auerbach in particular) suggest they will mount a

transparent distraction: that they will assert that “Allen Guo … was aware of and participated in

the very conduct they now complain about.” Debtor Opposition at 2. The primary support for

this diversion is that Mr. Guo was provided with a Northwest credit card. Mr. Guo has never

disputed that he is responsible for any personal expenses charged to that card and any amounts

that he owes (which is significantly less than the amounts the Debtors claim he owes) are minor

5 11 U.S.C. § 1104(a).


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in comparison to Mr. Auerbach’s multi-million dollar misconduct.6 Mr. Auerbach claims that

Mr. Guo accompanied him on several vacations, to specified locations – but left unsaid are the

numerous vacations to Vail where Mr. Auerbach falsely claimed Mr. Guo attended and charged

the company for those private, Auerbach family vacations. Joinder ¶ 12; Auerbach Tr. at

141:24-144:18. Mr. Auerbach also disingenuously alleges that Mr. Guo enjoyed “countless stays

at a private apartment in the St. Regis Hotel in New York paid for by the Debtors” – but this

apartment was Ross Auerbach’s private apartment, which he compelled the Debtors to pay all

maintenance fees for in exchange for allowing Northwest to (occasionally) use that apartment for

visiting business partners – and Northwest was not charged for those stays. See Auerbach Tr. at

38:12-41:22. To the extent these and other contentions about Mr. Guo and Ashford have any

relevance whatsoever to the Motion – and most plainly do not – they support removal of Mr.

Auerbach.

9. Finally, the Debtors – and the Committee – claim that whatever misconduct Mr.

Auerbach may have engaged in previously, his hands have now been bound sufficiently so that a

Chapter 11 trustee is not required. These arguments are misguided. Mr. Auerbach remains as

the “current management” of the Debtors – indeed, he is the sole manager, with (nearly)

unrestricted power over the Debtors. Both the case law, and the practical realities, are clear:

nothing short of complete, irrevocable removal of Mr. Auerbach (and any of his management

involved in his misconduct) from any involvement with the Debtors is sufficient.

10. The bottom line is that enough is enough. Mr. Auerbach has systematically

looted the Debtors for millions of dollars, and serially manipulated their books and records to

6 The amounts the Debtors allege that Mr. Guo owes the Debtors, approximately $80,000, include numerous charges made by Ross

Auerbach, not by Mr. Guo, that Mr. Auerbach claimed to be for the benefit of Mr. Guo and should be charged to him. Given that Mr. Auerbach made a habit of claiming Mr. Guo’s involvement to charge his personal expenses to the company, and falsely represented Mr. Guo’s presence on a private jet (and sought to charge Mr. Guo for part of that flight he was not on), Mr. Guo has reasonably demanded the opportunity to review all of the charges for which he is purportedly responsible, and will refuse to pay expenses falsely attributed to him. He will, however, pay all legitimate debts to Northwest in full.


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minimize this activity. Mr. Auerbach has refused to come clean with this Court, seeking to hide

payments made to himself and other insiders. While the Committee suggests that little is left to

investigate, this is plainly not the case – every expense Mr. Auerbach has charged to the

company will need to be scrutinized (and indeed expenses others, such as his assistant, charged

to the company for his personal expenses), and further work remains to be done to determine if

other Auerbach companies received payments on faked invoices like David Harrison LLC. The

Court should not permit Mr. Auerbach to continue to control the Debtors during that process, and

this Court should remove Mr. Auerbach and appoint a Chapter 11 trustee.

REPLY

11. The Objections raise various factual and legal arguments why they allege that the

Motion should not be granted. Their factual arguments are wrong, as will be demonstrated by

the evidence that the Movants will present. Their legal arguments are similarly meritless.

i. The Debtors’ Have Failed To Meet The Stringent Requirements To Moot The Appointment Of A Trustee For Pre-Petition Misconduct

12. The Debtors, and the Committee, assert that whatever misconduct may have

occurred, sufficient safeguards have been put in place to avoid the appointment of a trustee.

They are wrong. As long as the individuals – largely, but not solely, Ross Auerbach – who

conducted that misconduct remain as “current management” appointment of a trustee is

mandatory. None of the thin “safeguards” come close to meeting this standard.

13. As cited in the Motion, the standard to evade a trustee motion by replacing the

wrongdoers is a stringent one: to escape mandatory appointment of a trustee through replacing

past management with new management, debtors bear the burden of proof to show that new

management is “independent, unconflicted, and in no way beholden” to the prior management.

See In re The 1031 Tax Grp., LLC, 22 374 B.R. 78, 88-90 (Bankr. S.D.N.Y. 2007). Cases where


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this stringent standard were met involve the existing manager of the LLC “irrevocably

transfer[ing] management authority” to new management, by removing the old manager and

appointing a new manager. Id. at 88-89. Further, such new management must be “in no way

beholden” to prior management, including by ensuring that the wrongdoer is unable to fire or

replace the new manager, and the new manager does not report to or receive instructions from

the wrongdoer. Id. at 85, 88.

14. The Debtors have utterly failed to meet these requirements here. Ross Auerbach

remains the sole manager of the Debtors. No CRO or other new manager has been appointed.

No irrevocable transfer of Mr. Auerbach’s authority has been made. Mr. Auerbach’s

misconduct, as a result, continues: he has caused the Debtors to provide incorrect information to

this Court (signed and verified by Mr. Auerbach personally) regarding insider transfers. The

Debtors’ books and records reflect material errors in Mr. Auerbach’s loan account. No action

appears underway to determine the full extent of Mr. Auerbach’s debt to the company – or to

collect on that debt. And those in charge of the financial systems – the Debtors’ CFO and

Comptroller – are the same individuals who received undisclosed and tax-free “retention

bonuses” the day before the bankruptcy. Although the Debtors and the Committee claim that

Clear Thinking Group plays an oversight role, it has clearly failed both pre and post petition to

play that role.

15. No case cited by the Debtors supports their argument that these thin safeguards –

well below what was accepted by the bankruptcy court in 1031 Tax Group - eliminate a finding

of cause. The Debtors characterize In re Shotwell Landfill, Inc. as standing for the preposition

that despite claims of serious misconduct by the debtors’ principal, “cause did not exist to

appoint a chapter 11 trustee when an independent estate professional controlled the debtor’s


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disbursements.” Debtors’ Objection ¶ 51. This summary does not accurately reflect the holding

of the case. In Shotwell, the Court found that the movants “have not offered credible evidence of

fraud, deceit, and self-dealing” as its basis for rejecting a finding of “cause.” In re Shotwell

Landfill, Inc., 2014 WL 4377721 *8 (Bankr. E.D.N.C. 2014). In other words, the Court

concluded that the movants failed to prove their claims, not that the appointment of an

independent professional to monitor disbursements eliminated a finding of “cause.”

ii. The Movants Will Establish Cause Exists For The Appointment of A Trustee

16. The Debtors suggest that the Movants cannot meet their burden to show “cause.”

As described above, the Movants have ample evidence to show cause exists, and will

demonstrate such at an evidentiary hearing that more than meets the standard for the appointment

of a trustee.

17. Of note, however, the Debtors make several incorrect arguments regarding the

standard for “cause” and the effects of a finding of “cause.” First, the Debtors cite Shotwell to

suggest that even where fraud is present, courts may decline to appoint a trustee. Debtors’

Objection ¶ 48. Yet as described above, Shotwell does not stand for this proposition: instead it

stands for the undisputed proposition that it is not enough to allege fraud: you must prove it. As

the Shotwell court notes immediately after the sentence quoted by the Debtors, “[i]f, however,

the court determines that cause exists, appointment of a trustee is mandatory.” Shotwell at *3.

18. Further, Mr. Auerbach’s false statements to this Court that have been exposed by

discovery constitute independent “cause” – both his mischaracterization of the “bonus” payments

made on the eve of bankruptcy, and the failure to list payments to David Harrison LLC that were


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honored within one year of the filing.7 A failure to provide accurate schedules and statement of

financial affairs has been deemed sufficient “cause” under Section 1104(a)(1) for the

appointment of a trustee. See, e.g., In re Deena Packaging Indus., Inc., 29 B.R. 705, 708 (Bankr.

S.D.N.Y. 1983) (finding debtor’s omission of rental income and brokerage liability from the

original and amended petitions met “cause” requirement under section 1104(a)(1))); In re

Sanders, No. 99 B 9876, 2000 WL 329574, at *4 (Bankr. N.D. Ill. Mar. 2, 2000)

(“Misrepresenting the facts of a debtor's financial situation constitutes grounds for the

appointment of a trustee.”) (citing In re Foundry of Barrington Partnership, 129 B.R. 550

(Bankr. N.D. Ill. 1991)); Tradex Corp. v. Morse, 339 B.R. 823, 834 (D. Mass. 2006) (upholding

lower court decision to appoint a trustee when trial record demonstrated inaccurate and

inconsistent financial statements made by the debtor and its principal controverted by tax returns

and testimony).

19. In Deena Packaging, the court appointed a trustee for cause under Section

1104(a)(1) when the debtor, a manufacturer in default on its mortgage that filed for bankruptcy

to stay a foreclosure sale, failed to disclose leases generating rental income obtained one month

post-petition. 29 B.R. 705 (Bankr. S.D.N.Y. 1983). Though the debtor amended its voluntary

petition by filing additional schedules and a statement of financial affairs, it failed to disclose

both the leases and the brokerage fees due when rental income was received by the debtor. Id. at

706. The court characterized the debtor’s omissions as violations of disclosure requirements

under the Bankruptcy Act that amounted to “dishonest conduct for the purposes of section

1104(a)(1).” Id. at 708.

7 The relevant date is when checks were honored, not issued. See Barnhill v. Johnson, 503 U.S. 393 (1992) (a transfer made by check is

deemed to occur on the date the check is honored). At least two checks were honored during the one-year lookback period. More were issued during this period, though it is unclear if they were ever honored.


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20. In Sanders, the court appointed a trustee for cause under Section 1104(a) when

the individual chapter 11 debtors mischaracterized certain claims on their schedules and

statement of financial affairs as “client refunds” and omitted a state court proceeding in which

the state court entered an order two weeks prior to the petition date permanently enjoining one of

the debtors from offering services and advice for compensation to people who had existing

foreclosure proceedings and from giving advice regarding forbearance plans and mortgage

reinstatements and bankruptcies. 2000 WL 329574, at *2 (Bankr. N.D. Ill. Mar. 2, 2000). The

court rejected the debtors’ explanations for the misstatements and found their testimony not

credible and held that the lack of truthfulness warranted the appointed of a trustee under Section

1104(a)(1). Id. at *4.

21. On appeal from the bankruptcy court’s order appointing a trustee, the court in

Tradex Corp. v. Morse, affirmed the appointment of trustee when the debtors’ schedules did not

include all of the debtors’ assets, liabilities, and payments made to insiders, and the submitted

schedules were “contradicted by the testimony of [debtor’s wife] and tax returns not filed until

the eve of the hearing held by the bankruptcy judge.” 339 B.R. 823, 834 (D. Mass. 2006). The

court also found relevant the existence of a grand jury investigation and civil suits against the

debtor’s principal in connection with the debtor company and other business dealings which the

bankruptcy judge was aware of. Id. at 835 (“It would be inconsistent with the discretion and

equitable powers afforded a bankruptcy court judge not to permit him to add such knowledge

and experience to the balance.”).

22. The false statements by Mr. Auerbach – mischaracterizing payments to himself

and other insiders as reimbursement when, in fact, such payments were bonuses; and failing to


12

disclose payments made based on falsified invoices to his secret shell company – independently

meet the standard for “cause” set forth above, mandating the appointment of a trustee.

iii. The Movants Will Establish A Trustee Is In The Interests Of Creditors

23. The Debtors and the Committee principally argue that a Trustee is not in the

interests of creditors because (a) CIT will declare a default if the Examiner/Trustee Motion is

granted, forcing the company into liquidation, and (b) that no management deadlock exists,

because the Debtors intend to disregard Extreme Horse’s consent right, as a member of the

Debtors, with respect to a sale of all or substantially all assets of the Debtors. Both are incorrect.

24. The Debtors rely on “information and belief” that CIT will declare a default under

the DIP if the Examiner/Trustee Motion is granted.8 This Court has already expressed its

skepticism that CIT would simply declare a default if a chapter 11 trustee was appointed that did

not threaten its interests – and the Debtors offer no explanation how a trustee would threaten

CIT’s interests. See [April 23 Transcript] 67:19-22 (“I will presume that the lender will be using

its rights here to protect only the lenders' interests, that it's not going to just say, you know, Mr.

Auerbach is my brother-in-law and I will pull my loan if there's a trustee.”) If the sale process is

as far along as the Debtors claim, then declaring a default would not be in the lenders’ interests.

25. Ashford is the largest creditor in these cases: no one has a greater interest in

ensuring a substantial recovery to creditors than Ashford. Ashford alone holds more debt than

the entire Committee – and unlike four members of the Committee9 has no prospects of payment

on its claim outside a distribution to creditors. Ashford is not a competitor of Northwest and

gains nothing by Northwest being forced into liquidation. As a result, the unfounded allegation –

8 The Debtors appear to assert that CIT will declare a default if an examiner is appointed. It is unclear on what basis as the appointment of an

examiner without expanded powers is not an event of default under the DIP. See Schedule 17.1 of DIP Factoring Agreement, attached as Exhibit B to Debtors’ Motion For Entry Of Interim And Final Orders (I) Authorizing The Debtors To Sell Post-Petition Accounts And Obtain Secured Financing (II) Granting Adequate Protection And Related Relief, And (III) Scheduling A Final Hearing [Docket No. 11].

9 The Committee has three licensors, whose claims will likely be paid as part of an assumption and assignment of their license agreements, and Standard Fiber LLC, which


13

made both by the Debtor and (less understandably) by the Committee – that this motion is being

pursued for parochial reasons unique to Movants and in opposition to the interests of creditors is

false.

26. Because of Ashford’s interest in a successful and value-maximizing resolution of

these cases – which, for the avoidance of doubt, requires the removal of Ross Auerbach –

Ashford is willing to put its money where its mouth is. As stated above, in the event that a

trustee is appointed and as a result CIT refuses to provide further DIP financing to Northwest,

Ashford will fund an amount necessary for Northwest’s continued post-petition operations

through the closing of a sale, on a senior secured basis in an amount not to exceed $5 million.

27. The Debtors misread North Carolina law to assert that they may sell all or

substantially all of the assets of the Debtors without Extreme Horse’s consent, and thus deny any

management deadlock exists. This argument relies on a fundamental misreading of the statute.

North Carolina law requires the consent of all members to “[o]ther than in the ordinary course of

business, transfer in one transaction or a series of related transactions all or substantially all of

the assets of the LLC prior to the dissolution of the LLC.” N.C. Gen. Stat. § 57D–3–03. The

Debtors read this provision to require that a dissolution of the LLC be part of the transaction for

this section to apply. Debtors’ Objection ¶ 69 (“the Debtors are not dissolving and N.C. Gen.

Stat, § 57D-3-03 is thus inapplicable.”) That is not what the statute says: the requirement is

merely that such a sale happen prior to the dissolution of the LLC (as opposed to as a part of the

dissolution or after the dissolution). As the Debtors have not dissolved (and as the Debtors

repeatedly argue, will not dissolve), then such a sale will take place prior to the dissolution of the

LLC and thus may not take place without Extreme Horse’s consent. See, e.g., Chisum v.

Campagna, No. 16 CVS 2419, 2019 WL 1873574, at *15 (N.C. Super. Apr. 25, 2019)


14

(upholding jury verdict for breach of fiduciary duty as a result of a sale of all assets of an LLC

without approval of a member, on the basis that such sale violated N.C. Gen. Stat, § 57D-3-03,

when no aspect of that sale dissolved the LLC and the LLC remained undissolved as of the date

of the verdict).10 Far from disproving Extreme Horse’s consent rights, the repeated arguments of

the Debtors that no dissolution of the Debtors is envisioned as part of this bankruptcy confirms

it.

28. The Committee makes the assertion that the right of Extreme Horse to block a

sale of the Debtors “has already been refuted in this case” and cites to the Debtors’ opposition to

the motion of Extreme Horse to dismiss these bankruptcy proceedings. Yet the Court, in

denying that motion, was explicit: “Whether the Debtor does or does not need unanimous

consent in order to propose a sale is not an issue that is before me today.” In re Nw. Co., No. 20-

10990 (MEW), 2020 WL 2121269, at *5 (Bankr. S.D.N.Y. May 1, 2020).

iv. Remaining Issues

29. The Committee challenges the standing of Extreme Horse to bring the

Examiner/Trustee Motion. See Committee Objection ¶¶ 28-36. The Committee alleges that,

notwithstanding that the Debtors certified in their Chapter 11 filing that Extreme Horse owned

20% of Northwest, that Extreme Horse does not have an equity interest. The reasoning is not

elucidated, but appears to revolve around the contention that Extreme Horse has not supplied

(because Northwest has never requested) $5 million in inventory.11 No explanation of how this

10 The court later granted a motion to dissolve the corporation, but that motion was not granted when the jury returned its verdict and thus

could not have been considered as part of the verdict. The jury verdict was returned August 15, 2018, and the court granted the resolution for judicial dissolution on October 11, 2018. Id. at *2-3.

11 The exact circumstances of the Extreme Horse investment in Northwest are not germane to Extreme Horse’s standing, but the underlying facts are these. Prior to May 2017, there had been discussions about Ashford or any other party linked to Ashford investing in Northwest, in order to buy out Auerbach’s former partner, Itochu. Because Mr. Auerbach repeatedly failed to pay amounts due to Ashford when promised, Ashford and Extreme Horse were both unwilling (and indeed, unable, due to the cash crunch caused by Mr. Auerbach’s serial non-payment) to invest cash in Northwest. In May of 2017, under circumstances that remain somewhat unclear (as there appears to be no written communications regarding this payment) Mr. Auerbach wired $5 million to Extreme Horse’s bank account in a wire transfer that contained, in the reference field, “CK21704 PREPAID INVENTORY[.]” At that time, Extreme Horse had reached no agreement with Northwest or Ross Auerbach for such prepaid inventory. Ross Auerbach then requested that Extreme Horse return the funds to Northwest


15

fact is legally relevant is provided, and this argument should be summarily rejected. However,

the Court need not delve into this unexplained assertion further: no challenge to the standing of

Ashford is made, and thus the standing of Extreme Horse is irrelevant to the Motion.

30. Both the Debtors and the Committee challenge the need for the appointment of an

examiner. This issue, too, is moot: as the evidence that Extreme Horse and Ashford will present

at trial will show, this case requires the appointment of a Chapter 11 trustee. If a trustee is

appointed (as Movants submit is required), the appointment of an examiner would be

unnecessary. However, to the extent that the Court denies the appointment of a Chapter 11

Trustee, an examiner would still be appropriate and required under the circumstances. The

Debtors and the Committee repeatedly assert that the Committee, through the motion that the

Debtors and Committee filed in an (unsuccessful) attempt to moot this motion and block Ashford

and Extreme Horse from obtaining discovery, can conduct an investigation itself. The

Committee conducting a routine 2004 investigation is no substitute for an examiner in these

cases, just as it is no substitute for the appointment of a Chapter 11 trustee.

CONCLUSION

31. Based on the foregoing, the Examiner/Trustee Movants respectfully request that

the Court appoint a Chapter 11 trustee pursuant to Section 1104 of the Bankruptcy Code or, in

the alternative, an examiner.

Textiles. Extreme Horse did not fully understand the purpose of these transactions, but believed that it was necessary to cooperate to assist Mr. Auerbach, and believed that doing so would enable Mr. Auerbach to begin to pay down Northwest’s enormous debt to Ashford (and thus enable payment to Ashford Mills, a Chinese corporation owned in part by the husband of Extreme Horse’s principal, Pan Dong Mei who supplied goods to Ashford). About a month later, Mr. Auerbach emailed Pan Dong Mei the two agreements at issue to give Extreme Horse a 20% interest in Northwest. Pan replied that they had discussed this investment, but were unable to make a cash investment at this time which is why they had immediately returned the $5 million that Mr. Auerbach had wired Extreme Horse, and declined to sign. Mr. Auerbach then informed Pan that he was not seeking a $5 million cash investment, he would accept $5 million in future trade, but asked her to sign the documents immediately so that he could make dividends on the equity interests (which never occurred). As a result of, and in reliance on, these written representations Extreme Horse signed the two documents (the Capital Contribution Agreement and the Redemption Agreement) on June 9, 2019 (not May 7, 2017 as the Debtors have repeatedly claimed) and emailed the signature pages to Ross Auerbach. The net effect of those agreements was to give Extreme Horse an interest in Northwest Textiles, which was then immediately converted into an interest in Northwest by transferring some of Northwest Textiles’ interest to Extreme Horse. Extreme Horse was unaware (and remains unaware, even after discovery) of the reason that Mr. Auerbach needed their assistance in this ‘round-tripping’ of $5 million, rather than simply declaring a dividend to Northwest Textiles. No demand for the $5 million in inventory has ever been made; nor have any documents containing such a demand been produced by the Debtors (despite specific requests for such documents).


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Dated: July 13, 2020 New York, New York Respectfully submitted,

/s/ Sigmund S. Wissner-Gross Robert J. Stark Sigmund S. Wissner-Gross Kenneth J. Aulet BROWN RUDNICK LLP Seven Times Square New York, New York 10036 Tel: 212-209-4800 [email protected] [email protected] [email protected] Counsel to Extreme Horse Limited - and - /s/ Tracy L. Klestadt Tracy L. Klestadt KLESTADT WINTERS JURELLER SOUTHARD & STEVENS, LLP 200 West 41st Street, 17th Floor New York, New York 10036-7203 Tel: 212-972-3000 [email protected] Counsel to Ashford Textiles, LLC - and - /s/ Bernard D. Bollinger, Jr. Bernard D. Bollinger, Jr. (pro hac vice) Paul S. Arrow (pro hac vice) BUCHALTER A Professional Corporation 1000 Wilshire Blvd., Suite 1500 Los Angeles, California 90017 Tel: 213-891-0700 [email protected] [email protected] Counsel to Ashford Textiles, LLC


Documents

20-10990-mew Doc 177 Filed 07/13/20 Entered 07/13/20 09:28:01 … · 2020-07-13 · when it was sent, and that it was booked that day on the company’s general ledgers as “prepaid