FILED: NEW YORK COUNTY CLERK 12/11/2009 INDEX NO /2009 NYSCEF DOC. NO. 14 RECEIVED NYSCEF: 12/11/2009

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1 FILED: NEW YORK COUNTY CLERK 12/11/2009 INDEX NO /2009 NYSCEF DOC. NO. 14 RECEIVED NYSCEF: 12/11/2009 SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK X ABLECO FINANCE LLC, : : Index No /2009 Plaintiff : : - against - : : JOHN F. HILSON, MARIO J. IPPOLITO and : PAUL, HASTINGS, JANOFSKY & WALKER LLP, : : Defendants. : X FIRST AMENDED COMPLAINT Plaintiff Ableco Finance LLC ( Ableco ) alleges for its First Amended legal malpractice Complaint against John F. Hilson ( Hilson ), Mario J. Ippolito ( Ippolito ) and Paul, Hastings, Janofsky & Walker LLP (collectively Paul Hastings ) as follows: CLAIM FOR RELIEF (For Legal Malpractice Against All Defendants) 1. Plaintiff Ableco is a Delaware limited liability company, with a principal place of business at 299 Park Avenue, New York, New York. 2. In August 2008, BH S&B Holdings LLC ( BH ) asked Ableco to help finance its purchase of substantially all of S&B Industries Inc. s ( S&B ) assets with a $125 million secured loan (the Loan ). S&B operated the bankrupt Steve & Barry s retail clothing chain. 3. Ableco retained Defendant Paul Hastings, a large international law firm, which is a California limited liability partnership with an office at 75 E. 55 th Street, New York, New York and its partner Defendant Hilson to represent it. Hilson, an expert in financing transactions, had represented Ableco in hundreds of transactions over the prior fourteen years.

2 Hilson knew that Ableco insisted that he assign Paul Hastings lawyers who were expert in financing transactions to work with him on Ableco transactions. Hilson assigned his New York partner, Defendant Ippolito, to be the day-to-day leader of the Paul Hastings team under Hilson s supervision. 4. Ableco retained Paul Hastings to advise it concerning the impact of the terms of the acquisition agreements between S&B and BH on its proposed Loan, to negotiate and draft loan documents to memorialize the Loan and to render legal advice concerning the proposed Loan with particular emphasis on any legal risks to obtaining full repayment. 5. Paul Hastings knew that it was responsible for conducting legal due diligence on the BH/S&B acquisition agreements and advising Ableco whether those agreements posed legal risks to Ableco s ability to obtain repayment if BH failed. Because, as Paul Hastings knew, the Loan had to be papered and closed within days, Ableco insisted that Paul Hastings assign enough lawyers to ensure that it conducted thorough legal due diligence. Ableco personnel focused on the economic terms of the loan. 6. The Loan was to be made to a thinly capitalized entity that was buying the assets of a bankrupt retail clothing company in an economy that was suffering major disruptions in the housing and credit markets. To assure that its Loan would be repaid if BH failed, Ableco told Paul Hastings that it required a perfected first priority lien on, and a security interest in, S&B s entire inventory. Ableco had been advised that S&B s entire inventory was worth approximately $183.7 million at cost. 7. Paul Hastings drafted Ableco s Loan Commitment Letter, which recited that BH was to acquire substantially all of the assets of S&B. Paul Hastings included a provision stating that Ableco would only make the Loan if its Loan was secured by perfected - 2 -

3 first priority liens on substantially all now owned or hereafter acquired assets (including stock of subsidiaries) of [BH], including inventory having an aggregate Cost Value (as defined in the Acquisition Agreement) of no less than $183,700,000 immediately after giving effect to the Acquisition. Paul Hastings knew that BH would have to grant Ableco a perfected first priority lien on S&B s entire inventory to satisfy Ableco s requirement. 8. As Hilson and Ippolito knew, perfected first priority liens give a secured lender rights to its collateral superior to almost all other claims in a bankruptcy. A secured lender can exercise its rights against the collateral itself if the borrower defaults as BH did here shortly after the acquisition. Had Paul Hastings ensured that Ableco received a perfected first priority lien on S&B s entire inventory, then Ableco, as a secured lender would have had rights against all of the $183.7 million of inventory collateral to repay its $125 million Loan. 9. A bankruptcy debtor may not use cash in which a secured lender has a perfected security interest without the consent of the secured lender or an order of the Bankruptcy Court. This gives the secured lender enormous leverage. A secured lender comes ahead of all unsecured creditors with respect to its collateral and, with sufficient collateral, is far more likely to be repaid in full than an unsecured or partially secured creditor. 10. In representing a lender to the purchaser of the assets of a failed retail clothing business, Hilson and Ippolito knew that it was their paramount responsibility to make sure that BH granted Ableco perfected first priority liens on, and a security interest in, all of BH s assets, including S&B s entire inventory

4 Paul Hastings Failed To Advise Ableco That the Terms of The BH/S&B Agency Agreement Made It Impossible for Ableco To Get A Perfected First Priority Lien On S&B s Entire Inventory 11. BH entered into an Asset Purchase Agreement and an Agency Agreement with S&B pursuant to which it agreed that S&B would retain, and not transfer to BH, S&B s inventory in over 50% of S&B s stores. S&B hired BH as its agent to liquidate the inventory in those stores with BH to bear the liquidation expenses, including rents, payroll and other costs associated with running the stores. Although S&B granted BH a lien on the assets located at these liquidation stores, S&B s rights to the inventory and sales proceeds to secure payment of these expenses came ahead of BH s lien and were unlimited in amount. 12. It is indisputable that the Agency Agreement made it impossible for Ableco to receive a perfected first priority lien on a large portion of S&B s inventory. Obtaining such a lien was an absolute condition to Ableco making the Loan. 13. In patent dereliction of its professional obligation to Ableco, prior to the Loan closing Paul Hastings did not provide Ableco with a copy of the Agency Agreement, did not communicate the terms of the Agency Agreement to Ableco and did not advise Ableco that the Agency Agreement made it impossible for Ableco to satisfy its absolute requirement to making the Loan that it get a perfected first priority lien on S&B s entire inventory. 14. Prior to the Loan closing, Paul Hastings was aware of the existence of the Agency Agreement and understood that its pre-closing review of that Agreement was necessary to properly advise Ableco. Although the Agency Agreement created insurmountable collateral perfection issues, which Paul Hastings knew would cause Ableco to not make the Loan if it was made aware of them, Ippolito has admitted that prior to the Loan closing he did not advise Ableco that it would not get a perfected first priority lien on S&B s entire inventory

5 15. Because of Paul Hastings inexcusable negligence, Ableco made the Loan and to date has lost over $55 million, which would not have happened had it been properly advised by Paul Hastings. 16. Ableco first learned that it did not have a perfected first priority lien on S&B s entire inventory after BH filed for bankruptcy. On November 21, 2008, Ableco s bankruptcy lawyer reported to Ableco that S&B was claiming that it owned inventory in more than half of the stores and that Ableco did not have a perfected first priority lien on that inventory. 17. When Ableco contacted its lead counsel, Hilson said that he did not know whether Ableco had a perfected first priority lien on S&B s entire inventory. 18. Shortly thereafter, Ippolito called Ableco. Ippolito said that he was unaware of any perfection issues, but would look into it and get back to Ableco. Hilson as follows: 19. Contemporaneously, Ableco s bankruptcy counsel ed Ippolito and I m on a call with the Court, but here are the issues involving Steve & Barry s that we need immediate input on. Newco [BH] (Ableco s borrower/the purchaser) filed for chapter 11 earlier this week. Prepetition, [BH] failed to pay Expenses with respect to stores designated for liquidation ( Liquidating Stores ) and stores that have not yet been assumed by [BH] ( Bubble Stores ), and Oldco [S&B] (the seller) instructed the credit card companies to make payment of all collections from [BH s] stores to [S&B] (which the credit card company did). *** [S&B] is arguing that the inventory in the stores subject to the agency agreement belongs to [S&B] and not [BH] and that Ableco therefore does not have a lien on that inventory.... (Emphasis added) - 5 -

6 20. Ippolito responded two hours later: The merchandise and inventory at the Store Closing Locations (Liquidating Stores) was excluded from the purchased assets under the purchase agreement (the APA uses the term GOB Assets ) and is not the property of Newco [BH] (and therefore not directly subject to Ableco s lien). * * * In addition, Oldco [S&B] granted to [BH] a first priority lien on the GOB assets however the lien is subordinate to [BH s] obligation to pay Expenses. (Emphasis added) A copy of this exchange is attached hereto as Exhibit A. 21. On November 22, 2008, an Ableco executive ed Ippolito as follows: Mario, This is attached hereto as Exhibit B. As you can imagine, I have been extremely busy and have not had a chance to respond to this [proposed budgets from BH not including stores S&B claimed it still owned]. I find it hard to imagine that you did not bring this matter to my attention pre closing. I would never have recommended closing the deal if I knew we were not going to have a free and clear lien on all of the assets. It has also come to my attention that half of the leases are in [S&B s] name (both physical locations and capital equipment including the POS systems). Unless you pointed this out in an , I don t understand how you could not have made me aware of this. We never discussed this on the phone. If you did send me an , then please send it along as I can t locate it

7 22. Three days later, Ippolito responded: I understand that Kevin Genda spoke to John Hilson yesterday and asked that I provide you with my understanding of the treatment of the bubble stores under the order, the APA and the agency agreement. I then learned that [S&B], [BH] and Ableco had entered into a joint stipulation resolving the objections raised by [S&B] in its motion objecting to the liquidation/sale plan. Given the joint stipulation, I did not think you required any further information from me. If this is not the case please let me know. Ippolito s is attached hereto as Exhibit C. 23. Ippolito neither identified an nor claimed that he had a telephone conversation in which he told Ableco that the Agency Agreement prevented Ableco from getting the perfected first priority lien on S&B s entire inventory that was an absolute condition to it making the Loan. The absence of such an or telephone conversation from Paul Hastings November 20, 2009 Motion to Dismiss (the Motion ) confirms that Paul Hastings never advised Ableco of the legal consequences to it of the Agency Agreement. A copy of Paul Hastings Memorandum of Law in support of its Motion is attached hereto as Exhibit D. 24. Had Paul Hastings advised Ableco that it would not get a perfected first priority lien on S&B s entire inventory, a material condition to Ableco s commitment to lend would not have been met, and Ableco would not have made the Loan. 25. To date, Ableco has a realized loss of over $55 million on this Loan and has no prospect of collecting any significant additional money. 26. Paul Hastings s malpractice in failing to advise Ableco of the Agency Agreement s impact on Ableco s requirement that it have a perfected first priority lien on S&B s entire inventory is evidenced by the judicial admissions contained in its Motion

8 27. The Motion completely ignores the Agency Agreement. Rather, the Motion argues that because there was a purchase price adjustment mechanism based on the value of S&B s entire inventory, Ableco faced no harm if the inventory was worth less than $183.7 million. (Ex. D at 2, 6, 20-21) 28. Paul Hastings was hired to read and understand all of the BH/S&B acquisition agreements and to render legal advice to Ableco concerning whether their terms made it impossible for Ableco s conditions to making the Loan to be satisfied. Even today, Paul Hastings ignores the fact that it failed to advise Ableco that the Agency Agreement made it impossible for Ableco s conditions to be met, which constitutes clear evidence of its professional failure. 29. Paul Hastings also argues that because the requirement of a perfected first priority lien on S&B s entire inventory worth no less than $183.7 million at cost set forth in the Commitment Letter Paul Hastings drafted does not appear in the subsequent Loan documents that Paul Hastings drafted, this lien was not really a required term. Paul Hastings asserts that the Loan documents it drafted for Ableco contain an integration clause and that the Commitment Letter was supersede[d] and its terms, including the perfected first priority lien requirement, were no longer operative. (Ex. D at 2, 7-8, 17-18) 30. It would be generous to describe this argument as disingenuous, coming as it does from fiduciaries -- a law firm defendant and two of its partners who are experts in their field. 31. On August 25, 2008, before the Loan was made, Paul Hastings advised Ableco that because the requirement for a perfected first lien on S&B s entire inventory worth no less than $183.7 million at cost was in the Commitment Letter, there was no need to put it in the - 8 -

9 Loan documents Paul Hastings was negotiating and drafting. The Commitment Letter contains a condition that the Borrower have Merchandise (as defined in the Acquisition Agreement) having an aggregate Cost Value (as defined in the Acquisition Agreement) of no less than $183,700,000. We had slipped the certification [as to the value of the Merchandise being acquired] into the Funds Flow as an added assurance. However, given the company s [BH s] sensitivity to the effect that a certification would have on a potential purchase price adjustment in the Company s favor, we are being asked to delete the certification. I think we can be satisfied with the fact that it is a condition in the commitment letter and acquiesce. Please advise. (Emphasis added) A copy of this Paul Hastings is attached as Exhibit E. 32. Paul Hastings Motion, which asserts that the Loan documents it drafted did not grant Ableco an enforceable legal right to a perfected first priority lien on S&B s entire inventory, constitutes a judicial admission by Paul Hastings that its contemporaneous contrary legal advice to Ableco that it was protected by its Commitment Letter was wrong. (Ex. D at 2, 6, 17-18) 33. Paul Hastings knew that getting a perfected first priority lien on S&B s entire inventory was an absolute condition to Ableco s willingness to make the Loan. That Paul Hastings admits that it wrote that paramount condition out of the Loan documents, while falsely assuring Ableco that it still had that legal right, constitutes an irrefutable admission that it committed malpractice. 34. Paul Hastings also asserts that because the Loan was initially a demand loan, Ableco was free to demand repayment and avoid injury. (Ex. D at 3, 14-15, 20-21) Paul Hastings does not explain how Ableco could have avoided injury by demanding repayment of an - 9 -

10 under-collateralized Loan whose proceeds had already been spent to close the acquisition or how Ableco was supposed to know that it did not have a perfected first priority lien on S&B s entire inventory given that Paul Hastings did not advise it that the Agency Agreement had that impact until after BH had filed for bankruptcy. 35. Paul Hastings also argues that the fact it forwarded a draft of the Asset Purchase Agreement to Ableco relieved Paul Hastings of its obligation to provide legal advice concerning the impact of that Agreement s terms on the Loan -- the very service for which Ableco retained Paul Hastings. (Ex. D at 17-18) Paul Hastings did not even argue, nor could it, that its failure to provide a copy of the Agency Agreement or to advise Ableco of the impact of that Agreement on its Loan could be excused. Paul Hastings Failed To Advise Ableco About The Legal Risks It Faced Because Of The Loan Documents Paul Hastings Drafted 36. As Hilson and Ippolito well-knew, when a lender finances the acquisition of a retail business, it is essential that the purchaser have a perfected first priority lien on credit card receivables and controls the accounts into which the proceeds of those receivables are deposited. 37. Paul Hastings was charged with protecting Ableco s ability to get its Loan repaid by ensuring that BH had a perfected first priority lien on credit card receivables and their proceeds and control over the bank accounts into which the proceeds of the credit card receivables were deposited. 38. It was essential to Ableco to have such control to ensure that no creditor could come ahead of it with respect to those credit card receivables and that they could be used to repay the Loan

11 39. Paul Hastings legal due diligence obligations required that it understand which company controlled the bank accounts into which the proceeds of credit card receivables were deposited and advise Ableco if those arrangements posed any risk to Ableco s ability to have its Loan repaid. 40. Paul Hastings has admitted that it failed to perform its due diligence obligations. Ippolito wrote on November 21, 2008, long after the Loan closed: (Ex. A, emphasis added) We learned after the closing that Newco [BH] was using Oldco s [S&B s] credit card processing numbers to process credit card transactions. The agency agreement provides [BH] with the right to do this for the GOB sales but not for other locations. I am not aware of any formal agreement for use of the credit card processing numbers for non-gob stores 41. Paul Hastings knew, because it drafted Ableco s Commitment Letter, that Ableco required that its Loan be secured by perfected first priority liens on substantially all now owned or hereafter acquired assets, which included credit card receivables and their proceeds. 42. Prior to BH s bankruptcy, Paul Hastings did not advise Ableco that pursuant to the Agency Agreement S&B retained control of the credit card receivables and the bank accounts into which their proceeds were deposited. S&B used those accounts to pay itself thereby depriving Ableco of those funds -- the very harm that Paul Hastings was retained to protect Ableco against. 43. Ableco would not have made the Loan and lost over $55 million had Paul Hastings advised it that it did not have a perfected first priority lien on all of BH s assets, including credit card receivables and the bank accounts into which the proceeds thereof were deposited

12 44. Had Paul Hastings read the underlying transaction agreements, as it was required to do, it would have discovered this fundamental defect. Paul Hastings failure to do so and properly advise Ableco constituted malpractice. 45. It is critical to any lender that it obtains a perfected security interest with respect to any bank account used by the borrower to repay the loan to avoid a claim that Loan repayments from such bank accounts made within 90 days of a bankruptcy filing by the borrower are voidable preferences. As Hilson and Ippolito knew, a lender is protected against a preference claim if it obtains control account agreements from the borrower at the time the loan is closed or a commitment at closing that the borrower will sign control account agreements over the borrower s bank accounts and such an agreements are entered into within thirty days. 46. Paul Hastings did not protect Ableco by obtaining such agreements or a commitment to timely enter into such agreements from BH. 47. Paul Hastings did not advise Ableco that its failure to obtain such agreements subjected Ableco to the risk that any Loan repayments made to it by BH would be deemed preferential transfers if BH filed for bankruptcy within ninety days of the repayment. 48. Paul Hastings failure to advise Ableco of the legal risks to it inherent in the Loan documents Paul Hastings negotiated and drafted constitutes malpractice. 49. When BH filed for bankruptcy, the official unsecured creditors committee appointed in the bankruptcy case indicated that the $28.5 million in Loan repayments that BH made to Ableco within 90 days of the filing might be subject to recovery as a voidable preference. If the bankruptcy court declared the repayment a voidable preference, Ableco would have been required to repay $28.5 million to the bankrupt estate and would have been at risk of losing many millions of those dollars in addition to the over $55 million loss it has incurred. To

13 avoid that significant risk flowing from Paul Hastings failure to timely obtain perfected first priority liens, Ableco was forced to enter into a very costly settlement. 50. No competent, diligent finance lawyer would have put his client in such a vulnerable position. Prior to the Loan closing, Paul Hastings did not advise Ableco of the risks of not obtaining a timely agreement to enter into control account agreements from BH and of the voidable preference risk to loan repayments from its failure to do so. 51. Ableco would not have made the Loan had it been advised that it faced a voidable preference risk with respect to Loan repayments out of BH s accounts and would not have lost over $55 million. 52. As Ableco s expert attorneys, Paul Hastings had a duty to represent Ableco with the reasonable care, skill, and diligence possessed and exercised by the ordinary expert financing attorney in similar circumstances. 53. Paul Hastings duties required it to inform itself of all available information material to its ability to give Ableco legal advice about the legal risks to the repayment of the $125 million Loan. Paul Hastings was required to read and understand both the underlying acquisition agreements between BH and S&B and Ableco s agreements (or lack of agreements) with BH. 54. Paul Hastings has admitted that it did not read and understand the underlying acquisition agreements and did not accurately give Ableco legal advice concerning the legal risks their terms posed to Ableco obtaining repayment of the Loan. 55. Paul Hastings did not advise Ableco about the legal risks posed by the Loan agreements Paul Hastings drafted

14 56. Paul Hastings did not advise Ableco: (i) that the terms of the Agency Agreement made it impossible for Ableco to acquire a perfected first priority lien on S&B s entire inventory; (ii) that by signing the Loan documents that Paul Hastings drafted, which omitted the requirement that it get a perfected first priority lien on S&B s entire inventory and all of BH s assets, Ableco was giving up its legal right to such a perfected first priority lien; (iii) that Paul Hastings legal advice that it was not necessary to include a requirement in the Loan documents Paul Hastings drafted for a perfected first priority lien on S&B s entire inventory and all of BH s other assets because the requirement was in the Commitment Letter was flatly wrong; (iv) that Ableco did not have a perfected first priority lien on credit card receivables and the bank accounts into which the proceeds of those receivables were deposited; and (v) that repayments of the Loan to Ableco would be deemed voidable preferences if BH filed for bankruptcy because Paul Hastings did not timely obtain, or require BH to commit to enter into, control account agreements. 57. As a direct and proximate result of the Paul Hastings negligent failure to read the underlying acquisition agreements and to give Ableco legal advice concerning the legal risks these agreements and the Loan agreements Paul Hastings drafted posed to Ableco s ability to obtain repayment of its Loan, Ableco made the $125 million Loan to BH and has incurred a loss of over $55 million on the Loan. 58. Ableco would not have made the Loan had Paul Hastings provided it with proper legal advice

15 Defendant be entered: WHEREFORE, Ableco respectfully requests that a judgment against each a. for compensatory damages in an amount to be determined at trial, but in excess of $55 million, plus costs and pre-judgment interest; b. for the fees and expenses paid in connection with the Loan, including the legal fees and expenses paid to Paul Hasting; Dated: New York, New York December 11, 2009 c. for attorneys fees, costs and disbursements of this action; and d. for such other and further relief as this Court deems just and proper. SHAPIRO FORMAN ALLEN & SAVA LLP /s/ Stuart L. Shapiro Michael I. Allen 380 Madison Avenue New York, NY (212) Attorneys for Ableco Finance LLC

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