An Extra-Marital Affair Just Derailed the Caesars Casino Bankruptcy

The bankrupt operating unit hired financial adviser Melissa Knoll and her team in 2014 to help probe creditor allegations that its parent, Caesars (CZR), stripped away its best hotels and left behind a mountain of debt. Caesars has denied these allegations.

In a little-noticed ruling from the bench in Chicago on March 16, a judge said that Knoll’s team’s work was “tainted” by an affair that she had with a lawyer for parent company Caesars, the target of her investigation.

“She was sleeping with the enemy,” Judge Benjamin Goldgar said on March 16. Goldgar, who is overseeing the bankruptcy, said he could never be sure Knoll had not shared information with the lawyer for Caesars, and as a result he said the investigation by the bankrupt unit would have little value.

“Because the investigation is tainted in this way, there isn’t any point in pursuing it,” the judge said.

In a statement issued by her attorney, Knoll said that her work and that of her team on the bankruptcy case “was beyond reproach, competent, complete and unbiased.”

The lawyer for Caesars, Vincent Lazar, did not respond to requests for comment. His law firm, Jenner & Block, declined to comment. The judge’s decision to discard Knoll’s investigation comes at a critical time in the 15-month bankruptcy.

The operating unit is seeking confirmation by Sept. 15 of a revised bankruptcy plan, which it said in court papers it would present by April 4.

“It complicates an already complex case when the meter is running very, very fast,” said Douglas Baird, a professor at the University of Chicago Law School.

Earlier this month, an independent court examiner appointed by Goldgar concluded that the operating unit had up to $5.1 billion in potential claims against its parent and others .

The bankrupt unit in court documents called Knoll’s team “critical to the debtor’s success.”

Knoll’s team was supposed to complete their investigation by reviewing and incorporating the examiner’s conclusions into a revised bankruptcy plan. The bankrupt operating unit’s special governance committee was also expected to use the results of the investigation to help prove the plan was fair and reasonable to any hold-out creditors.

The Caesar’s bankruptcy has pitted some of the most aggressive investors on Wall Street against each other. Junior bondholders, led by the Appaloosa Management hedge fund, want to show that parent company Caesar’s private equity owners, Apollo Global Management and TPG Capital Management, benefited from the alleged asset-stripping.

Apollo and TPG have denied these allegations.

Knoll, a former president of the American Bankruptcy Institute who billed $950 an hour on the Caesars case, was involved with Lazar when she was hired in August 2014, according to court records.

In February 2015, a month after the unit filed for Chapter 11 bankruptcy protection, Knoll filed a declaration with the court listing potential conflicts of interest as part of the court process for approving her team’s employment. However, she did not disclose the relationship with Lazar, who was by then officially representing Caesars.

Then, at a bankruptcy conference at a Michigan resort, the pair had “a chance encounter in a social setting” with an attorney for the Office of the U.S. Trustee, a government watchdog that polices conflicts in bankruptcy, according to court documents.

About two weeks later, Knoll’s employer, the now-defunct Mesirow Financial Consulting, disclosed the relationship to the court and said Knoll had been removed from the case.

That prompted a six-month investigation by the U.S. Trustee, which resulted in a reduced fee request for Knoll’s team and new disclosures about the handling of Knoll’s potential conflict.

Still, at the March 16 hearing, called to consider the fee request, Goldgar said, “We’ll never know for sure what happened here.”