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* Law firm Kaye Scholer, financial adviser Capstone admit inadvertent 'mistakes'
* Firms presented contractor as Capstone employee
* Regulator seeks to strip firms of $10 mln in fees
* GSC went bankrupt in 2010, sold assets to Black Diamond
By Nick Brown
NEW YORK, Jan 29 (Reuters) - Law firm Kaye Scholer and financial adviser Capstone admitted on Monday to making "mistakes" during the bankruptcy of investment management firm GSC Group Inc, but said they should not have to forfeit more than $10 million in fees earned from their work.
Bankruptcy watchdog the U.S. Trustee Program is seeking to void the firms' fees because of their mischaracterization of Robert Manzo, a Capstone contractor who was presented to the bankruptcy court as a direct employee.
Kaye Scholer served as legal counsel to GSC in bankruptcy, while Capstone was the company's financial adviser.
In court papers filed earlier this month, the Trustee, the Justice Department's bankruptcy regulatory arm, said the firms covered up Manzo's contractor status and fee-sharing arrangement with Capstone, which may have served to inflate their fees.
The trustee said professionals in the case also covered up a longstanding personal and professional relationship between Manzo and Kaye Scholer partner Michael Solow, which may have posed a conflict of interest in the case.
Capstone, Kaye Scholer and Manzo hit back on Monday, saying in court papers the dispute comes down to one "inaccurate word."
The parties acknowledged a round of Mea Culpas for calling Manzo an "employee," but maintained that the mistakes did not harm GSC or cost its creditors any payback.
"Mistakes were made," Kaye Scholer said in a filing in U.S. Bankruptcy Court in Manhattan, conceding its partners were listed on court papers that presented Manzo as a Capstone "employee."
Kaye Scholer said most of its partners did not know that Manzo was actually a contractor, while Solow, who saw a draft of the employment contract, "did not remember" its details.
Capstone, for its part, admitted in court papers on Monday that executive director Edwin Ordway "incorrectly" presented Manzo as an "employee."
But the firms also noted that GSC's eventual sale to lender Black Diamond Capital Management, which fetched $235 million, was successful.
"No creditor was hurt by Capstone's efforts in this case," Capstone said in court papers.
Manzo is well-established in the restructuring world, having advised on major cases for more than 25 years, including those of fallen brokerage firm Refco and auto giant Chrysler. In the case of GSC, which went bankrupt in August 2010, Manzo was in charge of liquidating certain of the company's assets in the wake of its sale.
Most fee-sharing agreements are barred by bankruptcy rules, in part out of concern that firms might inflate their fees to make up for the cost of sharing. In GSC's case, Manzo was entitled to nearly all of the fees he billed, as well as 15.5 percent of the fees billed by Capstone and a percentage of any so-called "success fee" the firm collected after the case, according to court papers.
He has earned about $4 million in the case, more than half of Capstone's total bills, court papers show.
But Manzo said in a court filing on Monday that fraud was not his intention.
He joined Capstone as a contractor, rather than employee, partially to avoid potential "awkward relationships" associated with reporting to people who had previously reported to him, he said.
Capstone's partners had previously worked for a firm Manzo had started, and Manzo said he thought it would be "best for and best for me" if he neither reported to, nor directly managed, those partners at Capstone.
If he had thought the arrangement would impose "a series of additional obligations on himself, ... he would have used another term to describe" it, his lawyers, from Willkie Farr & Gallagher, said in court papers.
GSC, founded by former Goldman Sachs Group Inc partner Alfred Eckert III, went bankrupt in the wake of a liquidity squeeze and declining asset values brought on by global recession. Black Diamond acquired its assets in 2011.
Black Diamond, as well as certain GSC creditors, have supported the Trustee's effort not only to strip the firms of the roughly $10 million already collected, but bar Capstone from attaining its requested $2.75 million success fee, $1.65 million of which would go to Manzo.
A hearing on the matter is set for Feb. 11.
The case is In re GSC Group Inc et al., U.S. Bankruptcy Court, Southern District of New York, No. 10-14653.