U.S. bankruptcy trustee objects to Mercy Hospital attorneys, interim management

IOWA CITY — Mercy Iowa City is facing another slew of objections related to its bankruptcy and proposed $20 million sale to the University of Iowa — including from hundreds of unsecured creditors still owed millions and the U.S. bankruptcy trustee overseeing the case, who called the hospital’s intended use of and payment to certain attorneys, firms and bankers concerning, unnecessary and a violation of bankruptcy code and Iowa law.

The trustee “has concerns of the necessity of the many professionals proposed within this and similar applications, especially considering the proposed stalking horse bid is a mere $20 million for substantially all of the assets,” Acting U.S. Trustee Mary R. Jensen wrote this week in an objection to Mercy’s request to keep using for interim management ToneyKorf Partners of New York City.

Jensen also objected to Mercy’s use of the McDermott Will & Emery law firm, the Nyemaster Goode firm, and H2C Securities — due to, among many reasons, conflicts of interest, objectionable payment proposals, lack of transparency and offensive protections.

In the 12 months before Mercy filed for Chapter 11 bankruptcy Aug. 7 — following years of financial decline and operational challenges — the 150-year-old community hospital paid those firms more than $7 million related to its restructuring and bankruptcy.

Proposed pay

On Aug. 23, post-bankruptcy, Mercy asked the court to OK its continued use of and payment to those firms throughout the ongoing proceedings.

That, according to its requests, includes paying Mercy’s Chief Restructuring Officer Mark E. Toney — founding member and senior managing director of ToneyKorf Partners — $950 an hour. It proposes paying ToneyKorf Managing Director James Porter $750 an hour for interim chief financial officer services for Mercy — capping his pay at no more than $105,000 a month.

The proposed pay structure also includes three other named ToneyKorf employees making between $300 and $650 an hour, some without monthly caps — like Toney’s unrestricted pay. And it allows additional personnel to be paid between $160 to $950 an hour.

On top of those rates, Mercy’s arrangement with ToneyKorf provides an opportunity for a $250,000 “success fee,” which the firm would win upon any sale resulting in Mercy’s continuation as a health care facility. The only way ToneyKorf could lose that success fee would be if Mercy closes “substantially all of the facilities and its operations and eliminates substantially all staff.”

“Payment of the success fee is inappropriate,” Trustee Jensen stated in court documents this week, objecting to ToneyKorf’s retention.

“The success fee has few parameters and is unclear when or how it is earned,” she wrote. “There is no temporal limitation, meaning the management team could theoretically stay in place and take months to effectuate a sale, and there would be no consequence reflected in the success fee.”

Per Mercy’s request, the fee would be paid “without any further application or approval by the court, allowing no oversight into its reasonableness.”

“Further, the amount of the success fee, taken in conjunction with the hourly rates to be expended throughout the life of this case, are not commensurate with the proposed bid price of only $20 million,” she said, noting “an inability of any party-in-interest being able to accurately analyze the reasonableness of the fee.”

Plus, she wrote, Mercy wants to pay ToneyKorf and the other firms going forward for work they did in the past.

“The majority of the work to prepare for the sale has been done pre-petition and should have been paid for pre-petition,” according to the trustee, whose job it is to “protect the integrity of the bankruptcy system by overseeing case administration,” according to the U.S. Department of Justice.

A hearing in bankruptcy court to discuss these issues and others is set for Wednesday in Cedar Rapids.

Conflicts of interest

The trustee’s objection to Mercy’s continued use of McDermott Will & Emery, of Chicago, hinges — for starters — on its conflicts of interest.

In addition to representing Mercy, the law firm also represents in “unrelated matters” the University of Iowa, aiming to buy Mercy’s assets, and Preston Hollow Community Capital — the hospital’s largest bondholder, which still is owed tens of millions.

In addition to owing Preston Hollow significant sums of money, Mercy has blamed it for inciting the bankruptcy and has threatened to sue it for sharing confidential information when it asked a judge to appoint a receiver to take over Mercy’s operations.

“In other words, McDermott represents the two primary parties in this case in matters outside of this bankruptcy,” according to the trustee. “While these representations were disclosed, McDermott did not provide information describing what the ‘unrelated matters’ concern.”

And it still hasn’t, despite repeated requests from court officials.

On Thursday, the day after the trustee filed objections Wednesday, a partner with McDermott Will & Emery — Felicia Perlman — filed a court declaration aimed at addressing concerns and “certain requests for additional information.”

In her declaration, Perlman did not disclose any more details about the sort of representation it has provided Preston Hollow and the UI. Instead, she shared billing information — noting her firm has billed Preston Hollow for less than $45,000 this year and the university about $26,350 in 2023.

Both Preston Hollow and the UI have signed waivers allowing McDermott to represent other clients, she reported. And the firm has an “ethical wall” in place preventing sharing among attorneys representing the opposing entities.

But the trustee called that “inadequate.” The bankruptcy has been filed, a purchase agreement has been negotiated, and no one can confirm what has taken place behind the scenes to date.

“The proposed ethical wall may prevent future information sharing, but the extent of any damage is unclear given the monthslong negotiations and discussions that occurred pre-petition between the three parties at issue,” she wrote.

Plus, the amount McDermott wants to be paid and the way it wants to be paid “violates the Bankruptcy Code and Rules” and could be challenged going forward.

“The McDermott application and attached engagement letter attempt to impermissibly remove a significant amount of funds from the estate and prevent fee review by this court and all parties as mandated by the code,” the trustee wrote.

McDermott currently is holding a $762,000 “advance payment retainer” in such a way that is “meant to put the retainer funds out of the reach of Mercy’s creditors.”

“By taking an ‘advance payment retainer’ disallowed under Iowa law, McDermott has potentially made itself a defendant to a potential adversary proceeding,” according to the trustee, noting Mercy or a trustee could attempt to recover payments made up to two years before a petition is filed.

“As a defendant directly adverse to (Mercy), it is unlikely McDermott would choose to advise (the hospital) on this tactic. Even so, McDermott cannot adequately advise (Mercy) on their rights and responsibilities in an adversary proceeding.”

Foundation help?

Friday afternoon, a committee of unsecured creditors filed its own objection to certain aspects of the ToneyKorf and McDermott retentions, including the terms — or lack thereof — related to the success fee.

“Given that the proposed stalking horse bid from the University of Iowa is only $20 million, which is less than one third of (Mercy’s) asserted secured debt and allegedly the same amount that the University of Iowa offered to acquire Mercy Hospital at the beginning of this year, and that University of Iowa is reported to have previously made an offer to acquire Mercy Hospital for a purchase price of $605 million, the court, the committee and other parties … cannot fairly determine at this early stage of these cases whether a sale of the hospital for $20 million should be considered a ‘success’ that warrants the payment of any additional fee — let alone $250,000,” according to the committee’s objection.

That group also urged Mercy to tap its nonprofit foundation for resources as it moves through the bankruptcy while trying to continue operations and patient care.

According to hospital budgets that have been submitted to the court, Mercy is projecting a negative cash flow topping $5.5 million through Sept. 22 — amounting to a weekly cash burn of $800,000. During that period, Mercy plans to liquidate $4.3 million of unencumbered investments, even as the foundation holds nearly $18 million.

“The debtors must explain to the court, the committee and all parties in interest why they have not, and are not immediately requesting (and, if necessary, compelling) funding from the foundation to help finance their operations,” according to the committee’s objection. “It is axiomatic that a chapter 11 debtor has a duty, on behalf of creditors, to protect and preserve assets, and the committee is concerned that (Mercy has) yet to demonstrate how they are acquitting such duty in connection with funding from the foundation.”

Vanessa Miller covers higher education for The Gazette.

Comments: (319) 339-3158; vanessa.miller@thegazette.com