Archive for the ‘bankruptcy’ Category
Friday, December 20th, 2013
[Updated to reflect April 3, 2014 settlement]
In what may be one of the most significant cases involving the application of fraudulent conveyance laws and environmental liability, the bankruptcy court for the Southern District of New York held that Kerr-McGee had engaged in a fraudulent transfer when it spun off various assets in 2005 into a new firm, Tronox Incorporated (Tronox). The court found that Tronox was laden with overwhelming environmental and tort legacy liability that rendered it insolvent and undercapitalized on the date of formation. As a result, the court ruled that Kerr-McGee could be liable for damages ranging from $5 billion to $14 billon. The precise amount will be determined in later proceeding. In re Tronox Inc., 2013 Bankr. LEXIS 5232 (Bankr. S.D.N.Y12/12/13).
The dense 166-page opinion is packed with highly technical financial and legal analysis that can be mind-numbing to the non-business lawyer. However, it does contain some fascinating peeks into the world of corporate due diligence as well as some interesting statements about the application of the ASTM E2137 guide for estimating environmental liabilities and the relevance of financial disclosure statements to environmental liabilities in corporate transactions.
We discussed in a prior post a settlement of a class action lawsuit filed by shareholders alleging that the Registration Statement issued in connection with the Tronox Initial Public Offering (IPO) contained false and misleading statements. In contrast to the class action lawsuit, the accuracy of the financial statements were not relevant in the decision issued by the bankruptcy court because the lawsuit centered on the size of the legacy liabilities that Kerr-McGee imposed on Tronox and impact of those liabilities on the solvency of Tronox. Indeed, in an interesting aside, the court said that financial statements are of little use in a solvency analysis since generally accepted accounting principles (GAAP) require reserves only for claims that are “probable and reasonably estimable. More on disclosure later.
The Tronox litigation is an outgrowth of the 2009 chapter 11 bankruptcy petition filed by Tronox and 14 of its affiliates. Environmental and tort creditors filed proofs of claim for unliquidated amounts but where quantified totaled more than $6.9 billion. Tronox and subsidiaries Tronox Worldwide LLC, the successor to Kerr-McGee Corporation (“Old Kerr McGee”) and Tronox LLC (f/k/a Kerr-McGee Chemical LLC) filed an adversary complaint against Anadarko Petroleum Corporation (“Anadarko”) and several of Anadarko’s subsidiaries, including Kerr McGee Corporation alleging that through a multi-stage transaction completed in 2005, the defendants segregated valuable oil and gas exploration and production assets from billions of dollars of environmental, tort, and other liabilities. The Complaint asserted that the subsequent spinoff of the “cleansed” oil and gas assets acquired by Anadarko constituted an intentional or constructive fraudulent conveyance that left Tronox insolvent and undercapitalized because of the massive environmental and tort legacy liabilities.
As part of the plan of reorganization which was confirmed in November 2010, the claims of the three debtors were assigned to litigation trust (the “Trust”) that would pursue the lawsuit. The key to the reorganization plan was the Environmental Settlement Agreement (“ESA”) that created an environmental remediation trust funded in part by an equity offering of shares in the reorganized Tronox and in part by the Trust. The creditors that held environmental claims against Tronox, including the federal government, 11 states and the Navajo nation along with individual tort creditors agreed to relinquish their claims in exchange for the right to the proceeds recovered by the Trust. The environmental and tort claimants were named as beneficiaries of the Trust. The Trust subsequently sought $25 billion in damages relating to 2,000 sites across the United States. Meanwhile, the balance of the general unsecured creditors received stock in the reorganized Tronox that was now cleansed of the environmental legacy liabilities. According to the disclosure statement, the General Unsecured Creditors received a recovery of 58-78% on their claims.
Following is a detailed discussion of the transactions that are the heart of the $25B Litigation Trust lawsuit. The findings of facts are those recited by the court in its opinion. Old Kerr-McGee was founded in 1929 as an oil and gas exploration company. In the 1940s and 1950s, Old Kerr-McGee acquired refining, pipeline and marketing operation including more than 800 retail oil and gas outlets in 16 states. The company later acquired a mining and milling uranium operation, a wood treatment business, a manufacturer of ammonium perchlorate, a processor of radioactive thorium and a titanium dioxide pigment business.
As a result of these operations, Kerr-McGee had accumulated massive environmental liabilities associated with various lines of businesses including petroleum terminals, offshore drilling operations, gasoline stations, wood-treatment sites and agrochemical operations (“Legacy Liabilities”). The firm was a responsible party for more than 2,700 contaminated sites in 47 states. By 2000, the firm was spending an average of more than $160 million annually on remediation and employed more than 40 professionals in its Safety and Environmental Affairs (“S&EA”) Group just to manage the active environmental sites. During the six-year period ending in 2005, Old Kerr-McGee had settled approximately 15,000 claims of creosote tort liability for $72 million plus $26 million in defense costs and faced an additional 9,450 pending claims.
Starting in 1990, oil and gas exploration and production (E&P) industry was undergoing significant consolidation with almost 80% of the independent North American oil and gas firms being acquired or merged into larger companies. While Old Kerr-McGee had attracted potential suitors during this time, they had all been scared away by the firm’s mammoth Legacy Liabilities.
The bankruptcy court concluded that was clear that the management of Old Kerr-McGee intended from the outset to free the valuable E&P assets from the Legacy liabilities, especially as this burden precluded Kerr-McGee from being an attractive merger. The court said the written record was also absolutely clear that freedom from Old Kerr-McGee’s legacy liabilities was a central consideration in the decision to split the two businesses and in the structure that was devised. The court observed that Lehman Brothers had advised Old Kerr McGee that that if the E&P business was spun-off, “potential exists to isolate E&P operations from historical [Old Kerr-McGee] environmental liabilities.” Indeed, the court pointed out that Anadarko had rejected an acquisition of Kerr-McGee in 2002 after concluding that the costs of remediating the firm’s 500 active contaminated sites and more than 1,000 inactive contaminated consumed most of its free cash flow. The court pointed out that Anadarko determined that, Kerr-McGee’s future environmental liability was “$BILLIONS” and there was “no end in sight for at least 30 more years.”
As a result, Kerr-McGee embarked on a two-step strategy in 2001 coined “Operation Focus” to make itself more attractive for acquisition by segregating the Legacy Obligations from the oil and gas business. In a series of 11 transactions, the firm formed a new “clean” parent company (“New Kerr-McGee”) along with a new “clean” subsidiary, Kerr-McGee Oil and Gas Corporation (“Oil and Gas Business”). A new holding company owned by New Kerr-McGee was formed, called Kerr-McGee Worldwide Corporation. Old Kerr-McGee, which was now a subsidiary of New Kerr-McGee, began to transfer billions of dollars of oil and gas assets to the Oil and Gas Business. Old Kerr-McGee then formed a new wholly-owned subsidiary, Kerr-McGee Chemical Worldwide LLC, and merged into it. Kerr-McGee Chemical Worldwide that became Tronox Worldwide LLC retained all of the legacy liabilities of Old Kerr-McGee. The court noted that the CEO of Kerr-McGee testified that the result of Project Focus was that “all of the businesses that were owned by the original Kerr-McGee were transferred out except for the chemical business.
One group of creditors was contractually protected against the transfer out of Old Kerr-McGee of the oil and gas assets — holders of approximately $2 billion in bonds that Old Kerr-McGee had issued approximately $2 billion in bonds. To obtain the consent of the bondholders to the transactions, Old Kerr-McGee covenanted that it would not divest itself of substantial assets unless the transfer involved “substantially all” of its assets and the recipient of those assets assumed its obligations under the bonds. Kerr-McGee represented that Old Kerr-McGee had “distributed substantially all of its assets to its parent” through Project Focus.
As a result of this restructuring, the Legacy Liabilities were only partially segregated since New Kerr-McGee still exercised control (and hence responsibility) over the legacy liabilities sitting in Old Kerr-McGee. The court said that most of the legacy liabilities derived from discontinued businesses and that when a discontinued business could not pay for expenditure, New Kerr-McGee recorded the net payable as an equity contribution or advance from the parent. In other words, New Kerr-McGee continued to pay all the environmental expenses and claims out of its centralized cash management system until the 2005 IPO.
After the E&P subsidiaries were transferred out of Old Kerr-McGee, the next step was to sever the Chemical Business and the Legacy Liabilities from New Kerr-McGee through either a sale or a spin-off. Kerr-McGee’s management requested Lehman Brothers update its analysis. In September 2004, Lehman advised management that there was a “window of opportunity” to separate the companies because of a hot market for chemical companies and high demand for TiO2. Lehman suggested a spinoff would be a better vehicle for a “clean separation” from the legacy liabilities because the environmental liabilities would have to be negotiated in a sale or leveraged buyout
In 2005, the New Kerr-McGee board authorized the company to divest the Chemical Business through sale or spinoff. Lehman identified 60 potential bidders, contacted 16 and 13 signed confidentiality agreements. The field was narrowed to four final bidders, who were given access to a virtual data room to perform due diligence. The data room established for the due diligence contained over 27,000 individual documents pertaining to over 300 contaminated sites. One of the finalists chose not to make a final bid in part because of the cost to diligence the legacy liabilities. Another firm made a final bid that assumed environmental liabilities only for currently operating sites. A third bidder proposed an asset purchase only for assets that are used in the operation of the chemical business. A fourth firm submitted a bid for the Chemical Business in the amount of $1.6B plus the assumption of certain environmental liabilities on the balance sheet (valued at $225MM) but excluded liabilities related to Wood Treatment facilities and the Manville site. Kerr-McGee rejected this proposal because it wanted a “cleaner” separation from the legacy liabilities. Later, another potential bidder was willing to bid $1.2 billion without the legacy liabilities but only $300MM if they were to be assumed. [Disclosure: We worked with a firm that provided a preliminary evaluation for one of the parties that had signed a confidentiality agreement but declined to submit a bid because of the legacy liabilities. This post discusses only the public information disclosed in the litigation and discussed by the court in its opinion.]
According to the court, New Kerr-McGee proceeded with the spin-off because it could dictate the terms of the deal, avoid any third-party due diligence and eliminate any standard representations and warranties regarding its environmental liabilities. To effectuate the spinoff, New Kerr McGee incorporated Tronox as the holding company for the Chemical Business and the Legacy Liabilities. While New Kerr-McGee retained an attorney to represent the interests of the Chemical Business, New Kerr-McGee limited the attorney’s participation, disregarding his substantive comments and excluding him from meetings after he raised concerns on behalf of his client.
Tronox and New Kerr-McGee entered into a series of agreements that culminated in a Master Separation Agreement (“MSA”). The court held it was undisputed that the terms of the MSA were dictated by Kerr-McGee, noting that the MSA stated that “Parent will, in its sole and absolute discretion, determine all terms of the Separation. Tronox shall cooperate with Parent in all respects to accomplish the Separation and shall, at Parent’s direction, promptly take any and all actions necessary or desirable to effect the Separation.” The court said that Kerr-McGee CFO was chairman of Tronox’s Board and it was undisputed that New Kerr-McGee exercised control over Tronox’s decisions to enter into significant transactions and the ability to prevent any transactions it did not believe were in New Kerr-McGee’s best interests.
Kerr-McGee arranged for Tronox’s financing that resulted in Tronox becoming indebted for an advance of $200MM and a revolving line of credit of $250MM that was provided by a group of lenders on a secured basis. Tronox also issued unsecured notes of $350MM at an interest rate of 9.5 % (increased from 7% initially contemplated). The net cash proceeds were $537.1MM after expenses. New Kerr-McGee also received approximately $26MM in cash, which represented all of Tronox’s cash in excess of $40 million. The court said New Kerr-McGee had deemed $40MM as adequate cash for the new company but found the record was not clear on how that amount was reached.
In addition, the parties negotiated an Assignment, Assumption & Indemnity Agreement (Indemnity Agreement) that provided that the Tronox would be solely responsible for all of the legacy liabilities except for those liabilities directly associated with the “currently conducted” E&P operations. While the Indemnity agreement was being finalized, EPA demanded that New Kerr-McGee reimburse the agency for approximately $179MM in response costs incurred at the Manville Superfund site. New Kerr-McGee denied liability and amended the Indemnity Agreement to provide that Tronox was obligated to indemnify New Kerr-McGee for any Legacy Liabilities Tronox had been required to assume and that were imposed on New Kerr-McGee. The court found that Tronox did not receive any consideration in exchange for assuming these liabilities or agreeing to indemnify New Kerr-McGee. Indeed, the court observed, to eliminate the risk that Tronox (i.e., the Chemical Business) could potentially seek contribution from New Kerr-McGee for the Legacy Liabilities following a sale or spin-off, New Kerr-McGee backdated the Indemnity Agreement so that it was purportedly effective as of December 31, 2002.
New Kerr-McGee did agree to provide Tronox with a limited indemnity expiring in 2012 of up to $100 million, covering 50% of certain environmental costs actually paid above the amounts reserved for specified sites for a seven-year period. The bankruptcy found that the indemnity was illusory since New Kerr-McGee knew that the Tronox would not have sufficient cash flow to spend the reserved amounts and thus trigger the indemnification. The court explained that to access the indemnity, Tronox had to spend $200K more than the existing environmental reserve for each individual site. However, the Tronox started its separate existence with a mere $40 million and never had enough cash to trigger the reimbursement obligation. Indeed, when the bankruptcy petition was filed, Tronox had received less than $5 million from Kerr-McGee under the MSA.
Upon execution of the master separation agreement, New Kerr-McGee received 100% of the Tronox stock. In November 2005, New Kerr-McGee sold 17.5 million shares of Tronox Class A shares in an IPO which generated $225MM in proceeds. The results were disappointing to Kerr-McGee because Tronox had been marketed as a specialty chemical company but because the market considered it a commodity business, the stock traded at a lower multiple. After the IPO, New Kerr-McGee continued to hold 56.7% of Tronox’s outstanding common stock. The Class A Tronox stock issued to the public had only 11.3% of the combined voting power of all outstanding issues.
Less than three months after the completion of the Tronox spin-off, Anadarko offered to acquire New Kerr-McGee for $16.4 billion in cash and the assumption of $1.6 billion of New Kerr-McGee’s debt. The purchase price was a 40% premium above New Kerr-McGee’s current stock price. New Kerr-McGee shareholders approved the offer in August 2006, and New Kerr-McGee Corporation became a wholly owned subsidiary of Anadarko.
Tronox began to struggle almost immediately after the March 2006 spinoff. Tronox had anticipated that its financial position would be substantially bolstered by the sale of land in Henderson, Nevada. However, the property was extensively contaminated from ammonium perchlorate waste in ponds that potentially endangered the Las Vegas water supply. Because of cash flow issues, Tronox was unable to fund the Legacy Liabilities at the previous levels. Even with the reduced expenditures, the Legacy Liabilities amounted to 56% of Tronox’s 2006 EBITDA and 95% of its 2007 EBITDA.
Following a series of motions that reduced the scope of the claims, 34-day trial was held that involved 28 expert witnesses, over 6,100 exhibits and thousands of pages of deposition testimony of 40 witnesses. The court began its analysis by stating that litigation appeared to raise a novel of first impression-namely under what circumstances can an enterprise rid itself of its legacy environmental and tort liabilities by spinning off substantially all of its assets and leaving behind property incapable of supporting the liabilities. The court went on to say that the question was important because of the limited circumstances under which the owner or operator of property can avoid remediation obligations imposed by Federal and State environmental laws.
We limit our discussion on the court’s holdings to the claims for actual and constructive fraudulent conveyance claims.
Actual Fraudulent Conveyance Claim
Plaintiffs alleged that the transactions that culminated in the spinoff were made “with actual intent to hinder, delay, or defraud” creditors within the meaning of the federal Bankruptcy Code and the Oklahoma Uniform Fraudulent Conveyance Act. The court said that although there was no disclosure of the scheme in December 2002 and the disclosure in March 2003 was minimal and ineffective, the defendants made it clear in the S-1 Registration Statement that Tronox was being left with all of the Legacy Liabilities. Indeed, the court explained, this was also clear to the potential purchasers of Tronox who declined to submit bids because of their concerns about Legacy Liabilities. Moreover, the court said that the plan to impose the legacy liabilities on Tronox was what triggered the EPA demand letter in 2005.
What the defendants did not disclose, the court said, was that Tronox would not be able to support the legacy liabilities that were to be imposed on it by the restructuring plan. However, the court said that disclosure of a scheme is no defense and that liability may be imposed for an intentional fraudulent conveyance where the fact and purpose of a conveyance may have been known to creditors but the transferor intended to hinder or delay them.
The court rejected the defendant’s contention that plaintiffs had to prove that the defendants intended to damage a creditor by preventing them from collecting a debt. Instead, the court said the defendant’s interpretation of the phrase “actual intent to hinder, delay, or defraud” was too narrow. Relying on the definition of “intent” set forth in the Restatement (Second) of Torts and prior caselaw, the court explained that a transfer may be made with fraudulent intent even though the debtor did not intend to harm creditors but knew that by entering the transaction, creditors would inevitably be hindered, delayed or defrauded.
The court found that it was undisputed that New Kerr-McGee acted to free substantially all its assets from 85 years of environmental and tort liabilities. Without recourse to these assets and given the “minimal asset base” of Tronox, the court said the obvious consequence of this restructuring was to hinder and delay the legacy creditors. The court held that such a result was substantially certain to occur as a result of the restructuring.
The defendants argued in their brief that the every witness that testified on their behalf agreed that the Legacy Liabilities were not a driver behind the separation. However, the court said the record supported the finding that a principal goal of the separation of the E&P assets from the chemical business was to cleanse the E&P assets of every legacy liability resulting from the 85-year history of the company and to make the cleansed company more attractive as a target of an acquisition. Some of the evidence that the court relied on to support this conclusion was:
- Lehman’s files make clear the centrality of the liability issues to the transactions undertaken and that the effect on creditors was well understood;
- Lehman recognized that the environmental liabilities being left with Tronox were unique;
- Lehman’s principal witness testified that “other chemical companies didn’t have legacy liabilities of other businesses attached to an ongoing operation;
- A Lehman email stated that the deal to sell to Apollo appeared to have “cratered” because Kerr-McGee would not represent that it was not aware of any other material liabilities outside of the 27,000 documents in the data room;
- The testimony of CEO and CFO that the effect on creditors was never considered was contradicted by the record and by defendants’ efforts to cleanse the record. The court noted that senior management had instructed Lehman to delete slides form its presentation that discussed the complications of the Legacy Obligations;
- The credibility of the denials by the principal witnesses for the Defendants was further undermined by the destruction of documents in violation of an agreement with the Justice Department. For example, the court observed that the senior management directed their secretaries to destroy all files relating to the spinoff when they retired later in 2006, a few months after the tolling agreement was signed.
Badges of Fraud For Inferring Fraudulent Intent
Because of the difficulty of proving actual fraudulent intent, plaintiffs may rely on so-called “badges of fraud” which involve circumstances that are so commonly associated with fraudulent transfers that their presence gives rise to an inference of intent. The UFTA identifies eleven specific “badges of fraud”. Any one of these factors can create a presumption that the transaction was fraudulent which the defendant must then rebut. The court said that the presence of several badges of fraud constitute strong and clear evidence of fraudulent intent. The court found the following five factors supported the conclusion that the defendants acted with actual intent to hinder or delay creditors:
- The transfer or obligation was to an insider (i.e., substantially all of Kerr-McGee’s assets were transferred to a corporate affiliate in the 2002 transactions, and then transferred additional consideration to an affiliate in the IPO);
- Old Kerr-McGee retained possession and control of the assets after the 2002 transfers as well as after the November 2005 IPO;
- The transfer or obligation was disclosed or concealed-(The court previously concluded that the disclosure for the 2002 transfers was ineffective and insubstantial) ;
- Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit-(Kerr-McGee of course had been in litigation for years regarding its environmental and tort liabilities); and
- The transfer was of substantially all of the debtor’s assets-(the assets transferred represented more than 80% of the assets of the consolidated enterprise)
To overcome the presumption of fraud, the defendants had to show a legitimate supervening purpose for the conveyances. The defendants advanced three “legitimate supervening purposes” as defenses to Plaintiffs’ contention that they acted with “actual intent to hinder or delay creditors” that is actionable under the UFTA.
First Legitimate Supervening Purpose
First, they contended that the record showed that Kerr-McGee intended and believed at all times that Tronox was and would be solvent and able to pay its debts and a successful independent company. The court disagreed, noting that Tronox started life with a capital structure that included $550 million in debt, a mere $40 million in cash and environmental liabilities that had cost Kerr-McGee more than $1 billion in the years prior to the IPO. The court also noted that Tronox’s projected cash flow was inadequate to service its debt without significant land sales that were not assured, and its prospects were clouded by a down-turn in the business cycle of its one product. In any event, the court said that the question was not if Tronox was “doomed to fail,” nor if defendants wanted Tronox to be a “big success.” Instead, the court said the real question was if Defendants had a good faith belief that Tronox would be able to support the Legacy Liabilities that had been imposed on it. The court said one of the most compelling facts in the enormous record of the case was the absence of any contemporaneous analysis of Tronox’s ability to support the legacy liabilities being imposed on it.
The defendants argued they and their advisors spent substantial time and took multiple steps to ensure that Tronox would be a viable standalone and that creditors would not be adversely impacted by its separation. Defendants claimed the controller worked with the external accounting firm analyzing cash-flow models prepared by Tronox’s management in connection with Tronox’s S-1 Registration Statement that projected Tronox’s cash flow through 2011. However, the court said that the cash flow was not thorough, observing that even though the “Provision for Environmental Remediation” was broken out on a pro forma basis for Tronox prior to 2005, it was apparently included in “Other” expenses for 2010 and 2011 with an entry of zero. The court said there was no support in the record for the proposition that Tronox’s environmental expenses would diminish to zero in 2010. The court noted the cover memo from the external audit stated that he was informed that “Kerr-McGee management believe … Tronox should experience a much diminished level of environmental charges going forward, reducing the historical operating losses related to the discontinued operations as well as the related cash flow requirements.” The court found estimate was “anecdotal and not rooted in reality,” stating in a footnote that “it would have been more reasonable for Kerr-McGee to anticipate paying more for environmental expenditures in the future.” The court noted that from 2002 to 2005, Kerr-McGee added more to its environmental reserves than the amount spent in each of those years. The amount reserved for expected future expenses increased over 47% from 2001 to 2005. The auditor’s memo stated that “Kerr-McGee has agreed to support Tronox, related to these and other environmental matters with the 50% cost reimbursement provided over the next seven years.” As previously discussed, the court said this reimbursement support was largely illusory.
The second piece of evidence that Defendants relied for the proposition that they took numerous steps to ensure that Tronox would be viable and creditors would not be adversely affected was a solvency opinion that concluded after four pages of caveats and conditions that “the fair value and present fair saleable value of the Company’s assets would exceed the Company’s stated liabilities and identified contingent liabilities.” The court said the critical issue in this case was the amount of Tronox’s contingent liabilities but the solvency opinion simply used the reserve in Tronox’s financial statements as Tronox’s anticipated contingent liabilities. The court then went on to say that a reserve for contingent liabilities in a financial statement has no probative value in determining liabilities or solvency for fraudulent conveyance purposes. Furthermore, the court said there was no evidence that the author of solvency opinion was even aware of the importance of the legacy liabilities to Tronox’s solvency. The court noted that the firm that prepared the solvency opinion testified that its concern from a fraudulent conveyance perspective was that Tronox had incurred of debt in the IPO and was not going to retain the proceeds from the debt issuance but instead dividend the proceeds up to its parent, Old Kerr-McGee. The court went on to say that while the dividending of proceeds to a parent was the usual concern in a leveraged buy-out (“LBO”), the real issue in this case was the amount and effect of the legacy liabilities.
Defendants’ final reason for their asserted belief in Tronox’s future was that the cash flow projections of the parties’ respective experts agreed that Tronox experience positive cash-flow for all projected years, except for 2006 when Tronox would be less than $1 million cash flow negative.” However, the court said that the problem with the expert reports were that they were performed after the transaction to support the litigation positions. Such post-transaction reports, the court said, could not serve as substitute for the absence of any internal contemporaneous analysis of the effect of the transfers on Kerr-McGee’s legacy creditors. Based on the record, the court concluded that neither the Board nor management ever reviewed a contemporaneous analysis of the effect of the transactions on the legacy liability creditors, and there is no evidence that one was ever prepared.
Second Legitimate Supervening Purpose-
The defendant’s second defense to badge of fraud inference was that the purpose of the restructuring was to unlock the inherent value of each of Kerr-McGee’s businesses by creating two successful standalone companies, and thereby maximize shareholder value. However, the court said that the defendants were not being sued because they made a business decision to spin off the chemical business from the E&P but because they to spin off “substantially all the assets” of the enterprise (the E&P assets) and imposed 85 years of the legacy liabilities on a fraction of the assets. The court said the defendant’s burden was not to prove if there were some legitimate business reasons for the challenged transactions but to prove a legitimate supervening purpose for the “manner in which the transfer was structured.” In concluding that the defendants failed to meet this burden, court noted the following facts:
- Defendant’s investment banker testified that every chemical business has some environmental liabilities but “not like this they don’t.”
- The liabilities imposed on Tronox included those associated with every discontinued business that Kerr-McGee had owned or operated;
- Senior management rejected an April 2001 presentation Lehman to allocate the legacy liabilities in a manner proportionate to the asset values of the two lines of business;
- Defendants never articulated a legitimate business reason for imposing all of the legacy liabilities on Tronox;
- Before the spinoff, Old Kerr-McGee was an unattractive merger candidate as evidenced by the fact that Anadarko had rejected a merger in 2004 because of future environmental liability for which there was “no end in sight for at least 30 more years.”After the divestiture, Anadarko acquired the E&P business at a 40% premium.
Third Legitimate Supervening Purpose
Defendant’s final argument to rebut the badge of fraud inference was that they merely attempted to limit the overall environmental liability of the group. The court said defendants were trying to equate the conveyances as simply a risk management strategy but that this was not a situation where a company’s management used lawful ways to reduce the adverse impact of contingent liabilities. Instead, the court said the restructuring placed substantially all of the assets of Kerr-McGee out of the reach of the legacy liability creditors. In addition the court found that the defendants:
- did not pay consideration for the December 2002 transfer of the stock of the E&P subsidiaries and did not pay fair consideration or reasonably equivalent value in connection with the spinoff;
- were acutely aware of the legacy liabilities, and if they did not have a precise amount, the reason is they assiduously avoided performing the analysis necessary to obtain one;
- Did not rely on fairness opinions. Indeed Lehman’s managing director believed that the legacy liabilities would choke the flower that was Tronox’s TiO2 business; and
- carefully preserved the attorney-client privilege as to the legal advice they received and therefore cannot rely on an advice-of-counsel defense
The court said that if defendants’ conduct were simply management of legacy liabilities, then all enterprises with substantial existing environmental liability would be encouraged to do exactly what Defendants did — manage the liabilities so as to leave them attached to a fraction of the assets unable to bear them. Thus, the court found that plaintiffs have proved by clear and convincing evidence that defendants acted with actual intent to hinder or delay creditors, and Defendants wholly failed to rebut the evidence
Constructive Fraudulent Conveyance
To prevail on constructive fraudulent conveyance claim, plaintiff had to prove that (i) there was a conveyance of an interest in property or the incurrence of an obligation; (ii) receipt of less than reasonably equivalent value; and (iii) that the transferor was or was rendered by the conveyance insolvent, inadequately capitalized, or unable to pay its debts as they came due
There was limited dispute on the first point and the court easily found that Plaintiffs satisfied their burden of proof that Tronox as a consolidated entity received less than reasonably equivalent value (REV) since at the conclusion of the IPO, $17 billion in assets had been spun off and only $2.6 billion had been transferred in.
The more hotly contested question was if Plaintiffs satisfied their burden of showing that Tronox was insolvent because of the transactions. The defendants relied on a “market” defense, asserting that Tronox was not insolvent at the time of the IPO because it was able to issue $450MM in senior secured debt and sell $350MM in bonds to “market participants” who performed independent due diligence that extended well beyond publicly available information.
The court said the $450 million in debt did not deserve any weight in the solvency analysis. The court explained that these “market participants” were not representative of “the market” because the debt was secured by all of the assets of all of the Tronox companies, and the sophisticated lenders who bought this debt well knew they would come first in any bankruptcy or liquidation of the enterprise. Moreover, the court said these “market participants” received millions of dollars in fees from Kerr-McGee or anticipated significant fees from financing the purchase of the assets. Further, the court noted, none of these entities independently valued Tronox’s environmental or tort liabilities. The court went on to say that the defendants never explained how the diligence performed by these “market participants” and the information they obtained gave them any independent insight into the legacy liabilities. Instead, the court found ample evidence in the record that Morgan, CSFB and Lehman all took account of the obvious fact that if Tronox failed regardless of the reason, their debt would be protected.
While the court agreed that Tronox’s ability to issue unsecured bond debt and stock was Defendants’ strongest indication of solvency, the court found that plaintiff’s expert testimony convincingly demonstrated that the projections on which the IPO was based were inflated, sell-side projections, and that key numbers were imposed at the direction of Kerr-McGee’s chief financial officer. The court said the record was also clear that the financial statements omitted certain critical contingencies and potential liabilities. As an example, the court pointed out that EPA sent Kerr-McGee a formal demand for reimbursement of $350MM in past response costs and interest for the Manville superfund site but Kerr-McGee included no disclosure of the potential liability for that site. The defendants justified this omission on the existence of auditors’ letters and comments from the partner in charge at Covington that Kerr-McGee had “substantial defenses” to liability but the court pointed to four legal memoranda from Kerr-McGee’s counsel concluding that it was likely that Kerr-McGee had liability as the successor to American Creosoting Corp.
Similarly, the court noted that Kerr-McGee omitted any disclosure in the IPO Registration Statement of contingencies related to the contract for the sale of land in Henderson, Nevada. At the time of the IPO, Centex Homes and the Landwell Company had an ostensible contract to purchase the Henderson site for a total of $515 million, $154 million of which would be payable to Tronox on account of its 30% interest in the property. The Henderson proceeds were included in Tronox’s projections and were essential elements of its future cash flow. However, there was no disclosure of the risks relating to the land sale contract. It was not disclosed that the land had previously been contaminated and that “no action letters” had to be obtained from the Nevada Division of Environmental Protection (NDEP) for each of the four parcels being sold. The court noted an August 2005 Lehman email warning that a leadership change within the NDEP would “definitely delay” and “possibly could kill” the deal. It was not disclosed that, by the time of the IPO, the first three of four closing dates for the contract had passed and been extended. Most important, it was not disclosed that the contract was merely the economic equivalent of an option, in that it gave the purchasers the right to walk away for $2 million in liquidated damages (less than 1% of the purchase price).
The defendants also argued that supplementing this general market evidence was two critical “bookends” that established Tronox’s solvency. The first so-called bookend relied upon by the defendants was an offer to purchase the Chemical Business by Apollo that was based on six months and millions of dollars in diligence. The other “bookend” that defendants propound as evidence of Tronox’s solvency was the confidence of its officers and directors in its future as well in the form of the contemporaneous statements and actions of Tronox’s own officers and managers, including, including statements subject to the securities laws.
The defendants argued that Apollo’s bid was unassailable evidence of Tronox’s solvency because the Apollo submitted its bid after performing exhaustive due diligence. The defendants contended that Apollo and its advisors accessed the virtual data room more than 24,000 times and were intimately familiar with the issues facing the Company, including the so-called “secret’ sites,” the Henderson Property contract, Tronox’s financial performance and projections, and the TiO2 industry’s anticipated future performance.” However, the court said defendants overstated the nature and significance of the Apollo bid, explaining that Apollo did not make a “final and binding” offer for Tronox of $1.3 billion. For support, the court cited the opinion expressed by JP Morgan, Kerr-McGee’s investment banker on the deal, that the Apollo bid contained open items and that critical parts of the contract remained to be negotiated such as additional disclosures that could trigger Apollo’s rights of termination. Significantly, Apollo’s bid contained indemnities or environmental and tort liability totaling $504 million. The court noted that Kerr-McGee had previously rejected all indemnities and other guarantees relating to the legacy liabilities since this would not result in the “clean break” that Kerr-McGee demanded.
Moreover, the court said the trial record was inadequate to give Apollo’s analysis of Tronox’s environmental and tort liabilities the weight that Defendants demand. The court said there was no dispute that Apollo performed “‘significant diligence assessing the nature of the environmental liabilities, including retaining environmental consultant and environmental counsel. However, the court pointed to a memo prepared by Apollo that suggested the firm did not perform a true risk analysis but simply determined it could manage the liabilities over the period of time it would own Tronox. For purpose of a UFTA, the court said this did not constitute the basis for a solvency analysis. As a result, the court concluded that the unaccepted Apollo bid did not provide “unassailable” or even probative evidence of Tronox’s solvency at the time of the IPO.
The other “bookend” that the defendant argued was evidence of Tronox’s solvency was the confidence of its officers and directors in its future. Defendants said all of the witnesses who were employed by Tronox testified that at the time of the spinoff they believed Tronox was “solvent” and not doomed to fail. The court said, however, that the optimism of some of Tronox’s management was not evidence of solvency under the UFTA and certainly no more proof of Tronox’s solvency than those who believed the Legacy Liabilities would be fatal.
More relevant to the court was that within six weeks of the spinoff, Tronox management was forced to adopt what were termed “draconian” cost-cutting measures by its CEO. While the court acknowledged that the Tronox’s need to cut costs was not proof of balance sheet insolvency, it was evidence that management’s good faith efforts to keep the enterprise going and their belief that this was possible do not constitute a “bookend” that proves or disproves Tronox’s solvency. The court said there was no question that Tronox’s cash-starved position made it increasingly difficult to pay any expenses relating to the Legacy Liabilities as well as prevented Tronox from accessing the indemnification provided by Kerr-McGee. In the end, the court conclude, there was no substitute for performing an analysis of the fair value of Tronox’s assets as at the date of the IPO and measuring them against the fair value of its liabilities.
The court then proceeded with a solvency analysis. Plaintiff’s expert submitted reports totaling over 2,600 pages to attempt to value the environmental liabilities. Defendants called two expert witnesses and adduced over 8,000 pages of reports to dispute Plaintiffs’ expert. Separate experts and reports were relied on in connection with the tort liabilities. The defendants calculated the Legacy Liabilities at $278.1MM on a net present value basis while plaintiffs’ present value of the liabilities as of the IPO date was between $1.0 and $1.2 billion.
The court found the plaintiff’s estimation of the Legacy Liabilities more persuasive, characterizing plaintiff’s analysis as the only comprehensive valuation in the vast record of this case of Tronox’s environmental liabilities. The court noted that plaintiff’s expert spent more than 40,000 hours preparing a comprehensive report that was designed to calculate the cost of remediation at the 2,746 sites where Kerr-McGee had potential liability. In his 2,042-page report and 580-page rebuttal report, plaintiff’s expert assigned costs to only 372 of the 2,746 sites. 214 of the sites he chose were being remediated in 2005 or the subject of existing Kerr-McGee reserves, and therefore included on Schedule 2.5(a) of the MSA. He included 157 additional sites that they were similar to the “listed” sites in terms of contaminants and that would likely require remediation. He reduced his net costs by reimbursement from third parties such as the United States and certain States, and also apportioned costs among other liable parties but did not reduce the costs estimates for insurance, the indemnity under the MSA. He also did not adjust the amounts for the net tax impact since the tax benefits were treated as a contingent asset in the solvency analysis.
In contrast, the court said, Kerr-McGee never performed a comprehensive analysis of the Legacy Liabilities but simply relied on the accounting reserves for the environmental liabilities which the court said were applicable in a UFTA solvency analysis. The court said defendant’s expert report as well as his testimony was simply prepared as a rebuttal to plaintiff’s report. In a scathing footnote, the court reviewed criticisms of the defendant’s expert in other cases, noting that one court characterized his opinions as “naked guesses” or “far too speculative” and having “no firm grounding in science. Another judge rejected his responses in answer to the Court’s questions as “rank speculation,” concluding, “[t]here is simply no evidence to support [his] view,” and rejected his “suppositions … as unfounded and lacking all credibility.
In rejecting defendants position that the net present value of the remediation costs of Tronox as of November 2005 was $278.1MM, the court noted that Old Kerr-McGee’s environmental expenditures during the five years prior to the IPO had averaged $160MM per year, that it had spent $580MM just at the West Chicago Thorium site, that it had received a demand from the EPA for $179MM for the Manville superfund site and that Tronox had succeeded to virtually all of the Kerr-McGee sites. In other words, the court said that defendant’s expert concluded that Tronox’s future environmental liabilities should have been valued at approximately the amount that Kerr-McGee had paid over the preceding two-year period. This opinion, the court said, did not pass the “common sense test”.
Defendant’s expert evaluated plaintiff’s net present value of the remediation costs using a “conceptual probability” matrix. He assigned a 10% probability to response actions that he deemed “unlikely but possible,” a 30% probability to response actions that were “possible,” a 50% probability to response actions that were “equally likely,” a 70% probability to response actions that were “more likely than not”, and a 90% probability to response actions that were highly likely. The court said that while such a matrix provides an aura of scientific precision, the analysis was dependent on the judgment of those who use it– and found that defendant’s expert did not support his probability allocations fairly. To illustrate its point, the court noted that for the former Kerr-McGee wood-treating facility in Wilmington, North Carolina, defendant’s expert claimed his choice of a remedy, in situ solidification, was the most likely approach and assigned it a conceptual probability of 50%. He claimed at trial that his decision was based on project documents, site-specific information, and site-specific technical analysis, but Plaintiffs established that at deposition he had conceded that in situ solidification had never been used at any other Kerr-McGee wood-treating site, and such assumption materially understated the reasonably anticipated remediation cost. Likewise, at the Riley Pass uranium site, the court observed that defendant’s expert concluded the remedy would consist only of institutional controls such as fencing at a cost of $340K even though regulators had already rejected this approach in 2005 and instead proposed a $12MM remedy.
Application of ASTM E2137 To Solvency Analysis
The court said the defendants argued that the “preferred methodology” for estimating future environmental costs was the “expected value” probabilistic described in the ASTM “Standard Guide for Disclosure of Environmental Liabilities”. It appears the court intended to refer to ASTM E2137 “Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters.” Nevertheless, the court cited to section 5.2.2 stating that a probabilistic approach may not always provide the ‘best estimate for a given set of circumstances” and referred to section 5.2.3 providing that the approach used should be based on the “number of events and quality of information available or obtainable.” The court found that plaintiff’s expert adequately explained that he did not use an expected value approach because he concluded that sites were either sufficiently well-developed to conclude that one remedy was likely or information was insufficient to assign reliable probabilities to remedial outcomes. Accordingly, the court ruled that the plaintiff’s expert properly exercised his judgment when he used the “most likely value” approach recognized by E2137.
Defendants also contended that the use of the “most likely value” approach was also flawed because it failed to address future uncertainty. Instead, defendant’s expert opined that plaintiff’s expert should have applied a “gating” analysis to determine the likelihood that Tronox would incur costs at a site. However, the court said that the objective of a solvency analysis was to assign a “fair valuation” to all debts, which the court said was defined as a liability on a bankruptcy “claim.” The court explained that a solvency analysis is often used in bankruptcy filings where all debts are “accelerated” and debtors are obligated to send notices to every known potential environmental creditor. The court noted that defendant’s expert admitted that he had previously never used a probabilistic analysis to estimate environmental costs in a fraudulent transfer case and that his probabilistic analysis assumed that the environmental claims were mere contingent claims that should be subject to a discount for the probability they will never be pursued. In contrast, the environmental claims would have been accelerated by the bankruptcy filing because the creditors would have become aware that they would lose the claims if they did not file and pursue their claims. As a result, the court found that the decision by the plaintiff’s expert to assign remediation costs to only 372 of Tronox’s 2,746 sites amply accounted for the fact that some potential remediation would never be pursued notwithstanding the fact that an insolvency case would accelerate them.
Relevance of Financial statements
Plaintiffs attempted to overcome the evidence of Tronox’s issuance of unsecured debt and stock in connection with the IPO by demonstrating that the financial statements on which the market relied were false and misleading, and the court agreed there was much evidence in the record regarding the insufficiencies of the Tronox financial statements. However, the court said it was not necessary for Plaintiffs in this case to prove that the IPO financial statements were false and misleading because this case is about the Legacy Liabilities that Kerr-McGee imposed on Tronox and their impact on Tronox’s solvency. In this case, the court emphasized, there was no contention that Tronox’s financial statements issued in connection with the IPO would be useful in determining Tronox’s solvency. The court pointed out that no party or any expert in the case suggested that financial statements and the reserves taken for environmental and tort liabilities were useful in a determination of solvency under the UFTA
The court said the principal reason why financial statements are of little use in a solvency analysis is that generally accepted accounting principles (GAAP) require reserves only for claims that are “probable” and “reasonably estimable.” Nevertheless, the court said the record was replete with evidence that Kerr-McGee misapplied even this lenient standard and thereby understated its liabilities for GAAP purposes. The court pointed to testimony that Kerr-McGee only established reserves for those costs that it knew it was going to incur or almost certain it would incur. The court mentioned in a footnote that the personnel in Kerr-McGee’s S&EA Department prepared internal Sarbanes-Oxley certifications that covered only “known and reasonably estimable liabilities” and that its law department’s control documentation similarly misstated the standard, providing that reserves should be established “where a judgment or loss [was] considered probable and measurable.” The court said that New Kerr-McGee was aware of numerous sites where it had potential environmental liability but did not disclose or reserve for these potential liabilities. These undisclosed sites were referred to internally as the “secret sites.
The practical effect of this misapplication of GAAP, the court said, was that Kerr-McGee did not assess a potential environmental contingency at a site prior to receiving a demand or complaint from a third party. The court noted that Tronox’s new controller and chief accounting officer raised concerns about this practice carried over from Kerr-McGee of reserving for environmental liabilities only after a demand was received from a third party. However, as the court observed, the MSA required Tronox to continue to use Kerr-McGee’s reserve setting methodology after the spinoff. Indeed, after a review of the 2008 reserves for 11 sites, Tronox concluded that the 2008 reserves were understated by $68.5 million and the financials were withdrawn. In October 2011, Tronox issued revised financial statements for the years ended December 2008-2010, concluding that its $189MM environmental reserve was understated by $303.2MM.
The court also found that since Kerr-McGee’s public financial statements were reported on a consolidated basis, the restricting transactions were not meaningfully disclosed in the company’s public financials. There was no disclosure, the court explained, that the “reorganization” diverted substantially all of the assets of the parent to a new holding company that would eventually disclaim liability for the Legacy Liabilities. As a result, the court concluded, it was impossible to determine the effect of the distribution to “a newly formed intermediate holding company,” and there was no disclosure that Kerr-McGee had this “newly formed intermediate holding company” assume more than $2 billion in debt owed to the group’s largest creditors because those creditors had the protection of covenants in their loan agreements.
However, the court said that financial statement reserves for environmental liabilities had no probative value in a solvency analysis because generally accepted accounting principles (GAAP) require reserves only for claims that are “probable and reasonably estimable.”
The remaining issue for the court to determine is the measure of damages. The parties will brief the issue over the next 60 days. Regardless of the outcome, though, there is little doubt that this case will be appealed.
On April 3, 2014, EPA and the Department of Justice (DOJ) announced an agreement to resolve fraudulent conveyance claims against Kerr-McGee Anadarko . Under the settlement, Anadarko will pay $5.15 billion to the litigation trust so that the settlement proceeds can be distributed to the trust’s environmental and tort beneficiaries. Specifically, the trust’s environmental and tort beneficiaries will receive approximately $4.475 billion and $605 million, respectively. More information on the settlement is available from the EPA website by clicking here
Tuesday, June 4th, 2013
The brownfield reforms that swept the country in the 1990s created new tools for developers of contaminated sites to help minimize their liability. Some of the reforms like the CERCLA Bona Fide Prospective Purchaser (BFPP) liability protection are self-implementing while others such as prospective purchaser agreements, covenants not to sue or letters stating that the developer is not a responsible party must be requested by the property owner. The outcome might have been different in Route 21 Associates of Belleville v. MHC, Inc., 486 B.R. 75 (S.D.N.Y. 2012) if the property owner had entered into a prospective purchaser agreement (PPA) with the New Jersey Department of Environmental Protection (NJDEP).
In this case, RT21 Associates of Belleville (RT21) purchased property in Belleville, New Jersey (the “Site”) from the Walter Kidde Division of Kidde, Inc (Kidde) in March 1983. Kidde represented in the purchase agreement that RT21 “would not be responsible by reason of the violation of any law, rule or regulation regarding toxic volatile organic or environmental hazardous substances.”
In 1991, RT21 discovered a previously unknown leaking underground storage tank. After further investigation uncovered other areas of contamination, RT21 entered into a memorandum of agreement (MOA) with the NJDEP n 1993 to remediate the site. RT21 then filed a lawsuit against Kidde under the New Jersey Spill Compensation and Control Act (Spill Act) which the parties eventually settlement in 1996. Under the 1996 settlement agreement Kidde agreed to remediate all areas of concern and obtain a “no further action” letter from NJDEP. Kidde also agreed to indemnify RT21 for any clean-up liability for the pre-existing contamination.
Kidde’s cleanup progressed slowly over the next decade and proposed sales to K-K-Mart and Home Depot fell through because of concerns over the contamination. To facilitate a sale to Lowe’s, RT21 entered into a Brownfield Redevelopment Agreement (Brownfield Agreement) with NJDEP in 2006. The Brownfield Agreement provided that RT21 would be the primary party responsible for remediating the site and would be eligible for reimbursement of 75% of its eligible remediation costs.
In December 2007, RT21 entered into an addendum to the 1996 Agreement (2007 Addendum) with MHC, Inc which had acquired Kidde. MHC was a subsidiary of Millennium Chemicals Inc. (“Millennium Chemicals”) which, in turn, was an affiliate of Lyondell Chemical Company (Lyondell).
The 2007 Addendum provided that RT21 would complete the remedial investigation for the groundwater and soil, obtain an NFA letter for the soils, obtain approval of a RAW for the onsite groundwater. MHC, on the other hand, agreed to reimburse RT21 for the 25% of costs that were not covered by the Brownfield Agreement, maintain the groundwater and vapor recover systems and obtain a NFA letter for both onsite and offsite groundwater.
RT21 obtained an NFA letter for soils in early 2009 at a cost of approximately $2.4MM. RT21 also submitted to NJDEP a remedial action workplan (RAWP) for the onsite groundwater at a cost of approximately $1.049MM. NJDEP approved the RAWP in 2010, which completed RT21’s obligations under the 1996 Agreement. However, Lyondell and its affiliates filed a voluntary chapter 11 bankruptcy petition in January 2009.
RT21 filed a proof of claim seeking $1,049MM as an administrative expense. In the rider to its claim, RT21 estimated the groundwater remedy could cost $6.6 million based on a fixed price remediation contract. MHC filed an objection seeking to disallow RT21’s claim under 502(e) of the Bankruptcy Code as contingent, unliquidated claims asserting that .
The bankruptcy court approved a reorganization plan in April 2010. The plan provided for creation of the Millennium Custodial Trust (MCT) which became the parent of certain former debtor affiliates of Lyondell, including MHC. MCT was tasked with liquidating the assets of these debtors. Pursuant to the plan, MHC rejected many of its executory contracts including the agreements with RT21.
RT21 filed a motion seeking an order requiring MCT to comply with the Addendum, arguing that the contract was not executory because it had completed all of its obligations under the Addendum. RT21 also to have its cleanup costs afforded administrative expense priority. The bankruptcy court denied RT21’s specific performance claim, found that the 1996 Agreement and Addendum were executory contracts that had been properly rejected and that RT21’s claim was not entitled to administrative priority because the agreements were pre-petition transactions that did not provide a direct benefit to the post-petition estate. The court ruled that RT21 would have general unsecured claim for costs already incurred in cleaning up the Site in the amount of $1,019,358.40. However, the court disallowed RT21 claims for future, holding these were contingent claims for reimbursement that RT21 was co-liable with the debtor.
On appeal, the district court upheld the rejection of the specific performance claim breach of contract claims are usually converted into monetary damages and RT21 had not established that damages were not a “viable alternative” to performance of the agreements. In addition, the costs could be monetized in the form of invoices like those that RT21 had submitted in connection with its proof of claim. Moreover, unlike other cases relied upon by RT21, the court said RT21 was not trying to seek enforcement of an injunctive order issued under RCRA 7002.
The district court also agreed that RT21’s cleanup costs were not entitled to administrative priority treatment since section 503 of the Bankruptcy Code only authorized such treatment for costs incurred to cleanup property in which an estate has an interest in or owns and the debtor did not own or operate the property during the bankruptcy proceeding.
On the disallowance of the future costs under section 502(e), RT21 argued that its claim was in the nature of restitution or indemnity and not a claim for reimbursement or contribution. Moreover, RT21 argued it could not be co-liable with the debtor because it was an innocent purchaser. RT21 asserted that NJDEP had declared RT21 as an innocent party in the Brownfield Agreement. However, the court found Brownfield Agreement simply provided that RT21 had certified that it was not a person deemed liable for the contamination at the Site and had performed an environmental due diligence investigation. In other words, the court said, NJDEP had not made a determination that RT21 was an innocent party but simply that RT21 had assured NJDEP that it qualified for the state innocent purchaser defense.
The court also pointed out that RT21 had taken contradictory positions in the proceedings. The court noted that RT21 had argued to the bankruptcy court that it could face “untold liability” if specific performance was not awarded while its counsel told the district court that RT21 could walk away from the brownfield agreement, and keep any cash distribution without having to complete the cleanup in support of its contention that its claim for future costs should be allowed.
Finally, the court conceded that its ruling would produce a harsh result for RT21 that had incurred significant costs to remediate contamination it had not caused and as a general unsecured creditor might only receive a distribution from the bankruptcy estate of 1% of its costs. However, the court that the reality of chapter 11 bankruptcy proceedings are that they are not really controversies between creditors and a debtor but instead a battle group of creditors to allocate limited resources of the debtor to satisfy losses that many creditors will suffer. The court said that stripped to their essence, RT21’s arguments were an attempts to skip the line of creditors and get paid in whole dollars—whether by obtaining specific performance or by receiving administrative priority. While granting such relief to RT21 would make little difference to the liquidating debtor, the practical effect of such a ruling would be to further injure the debtor’s other creditors such as tort victims, vendors, and employees who have their own sympathetic circumstances.
Developers in New Jersey frequently enter into PPAs with NJDEP when developing residential properties or mixed use projects since the PPAs contain a covenant not so sue from the NJDEP that runs with the land. Though less common used for purely commercial properties, a PPA could have served as evidence that the NJDEP determined RT21 was an innocent party. This would have allowed RT21 to establish that it was not “co-liable with the debtor” and that it was not seeking a contribution claim for reimbursement but actually indemnity. These facts could have allowed the court to rule that the future costs were allowable claims. Granted, RT21’s claim would still be a general unsecured claim but this still would have resulted in a greater cash distribution.
If a PPA is not available, a property owner can try to add language to a voluntary cleanup agreement that it is not a responsible party. State cleanup agreements can also help with CERCLA contribution or cost recovery actions. For example, parties filing CERCLA contribution actions must show that their costs were incurred consistent with the National Contingency Plan (NCP). Some state regulatory programs provide that parties remediating a site under a state oversight document are presumed to be in compliance with the NCP. In addition, some state programs provide that a party remediating a site is presumed to have exercised “appropriate care”, thereby allowing the property owner to satisfy the post-acquisition continuing obligations of the BFPP liability protection.
Sunday, May 5th, 2013
A federal bankruptcy court authorized the owner of the upscale Marble Cliffs Crossing Apartments complex in Columbus, Ohio to install a methane gas remediation plan over the objections of the purchaser of the mortgage note, holding that the plan was necessary to protect the safety of tenants and was critical for preserving the value of the property. The order allowed the owner/debtor-in-possession (DIP) to use cash collateral in the form of rent proceeds to pay for the installation and monitoring of the methane remediation system. In re Marble Cliffs Crossing, LLC, 2012 Bankr. LEXIS 5099 (Bankr.S.D.Ohio 10/21/12)
In many ways, the events surrounding the Marble Cliff Commons Apartments are a microcosm of the national economy over the past decade. The project involved lack underwriting, overly-optimistic financial projections, inadequate environmental due diligence, a failed restructuring attempt, a loan default, debt purchase at an auction sale and a pre-emptive bankruptcy filing by the property owner to facilitate debt restructuring.
The 30-acre complex consists of includes 276 rental units located in nine ranch style buildings and twenty-four two story buildings, a 3/4-acre pond, a community building and a mail center. A 7,000 square foot community center includes the leasing offices, three social rooms, a business center, a fitness center, a billiard parlor, a movie theater and an outdoor heated swimming pool, and a dog park. The complex was constructed in 2003 on the site of a former limestone quarry was used for the disposal of construction/demolition debris, yard waste, and other biodegradable materials between the 1970s until approximately 1985. Prior to construction, soil fill material was placed over the fill and a compacted clay “cap” was installed. Some of the buildings were constructed on the solid rock portion of the quarry and some of the buildings were constructed on the clay “cap” where the construction fill was located.
The development was originally financed with a $30MM loan originated by Armstrong Mortgage Company (Armstrong) in 2002 and guaranteed by the Department of Housing and Urban Development (“HUD”). Marble Cliffs Crossing, LLC (Marble or Debtor-in-possession) also granted a liens on all rents and profits generated by the complex. Apparently, Armstrong was owned by the former owner of the property. The project encountered unanticipated delays in infrastructure construction and a market shift to home ownership that prevented the complex from reaching its projected occupancy rate. By 2005, the complex was encountering financial difficulties and had to restructure the HUD-guaranteed loan.
Also in 2005, tenants began complaining of odors. The Debtor retained a consultant to perform an indoor air quality investigation which detected elevated levels of organic compounds in certain areas. As a result, a passive methane system was installed in certain areas around the complex and odor complaints decreased significantly.
Financial conditions further deteriorated in late 2008 and the HUD-guaranteed loan went into default. In 2010, Armstrong assigned the mortgage to HUD who sold the loan at auction for $23.25MM to MTGLQ Investors, L.P. (MTGLQ). Marble subsequently entered into a forbearance agreement with MTGLQ to allow Marble to explore refinancing options. A prospective purchaser who was acceptable to both the note holder and the property owner performed additional environmental due diligence. The investigation revealed the presence of elevated levels methane and hydrogen sulfide gases in the subsurface below the complex at levels, and recommended additional investigation.
When the purchaser declined to proceed with the transaction, MTGLQ commenced foreclosure proceedings on November 1, 2011. Marble responded by filing a chapter 11 bankruptcy proceeding in November 2011 approximately two weeks later, staying the foreclosure action. Marble then obtained approval by the court to use cash collateral to retain an environmental consultant to further evaluate the environmental issues at the complex.
In early 2012, Marble’s environmental consultant conducted two rounds of indoor air monitoring in eleven apartments that revealed only minor concentrations of methane and no hydrogen sulfide. The consultant also performed a desktop review of historical reports and aerial photographs to better understand the location and type of fill material. Based on this information, the consultant drilled seven additional soil bores and installed twelve gas probes. The results of the additional subsurface gas testing were consistent with the earlier data. As a precautionary measure, Marble authorized the installation of methane detectors in the common areas of all buildings and in each of the ranch apartments.
The consultant also recommended installing a subsurface remediation system to control the lateral and vertical migration of methane gas. Marble obtained approval for the consultant to evaluate alternatives for the remediation system and prepare detailed engineering plans and technical specifications for the remediation system at a cost of approximately $71K.
Marble sought input from the Ohio Environmental Protection Agency (OEPA), Ohio Department of Health, the Columbus Public Health Department, the federal Environmental Protection Agency and the Agency for Toxic Substances and Disease Registry. The agencies requested that Marble perform supplemental sampling in additional locations, and then approved the design of a remedial system. Marble also worked with the agencies to prepare a letter to the tenants describing the environmental issues and the proposed remediation System.
Because of the additional work and interaction with the government agencies, Marble had to file a motion with the court to increase the authorized budget by approximately $42K. Initially, MTGLQ objected to the request for additional funds but the court ultimately approved the request.
Marble then sought court authority to implement the remedial system approved by the government agencies that was estimated to cost approximately $754K. The proposed remedial system consisted of a series of seventeen wells at the probable locations of fill materials that would collect the methane gas and direct it through underground pipes to a central area for safe ventilation. The remediation system would operate for several years until the methane gas concentrations dropped to acceptable level.
MTGLQ retained an expert to review the proposed remediation plan and filed an objection. At a hearing, MTGLO’s expert testified that the system might not be effective in removing methane gas because the radius of influence around each of the seventeen wells may be insufficient to extract methane gas, especially for the wells located directly under the buildings. MTGLQ’s expert said the remediation costs could increase significantly if the remedial system was improperly designed. Instead, he testified that additional testing should be conducted, which could cost as much as $50K to $100K. Marble objected to any delays because the approaching cold season could increase the costs of the existing proposed system.
The court found that both experts agree that the radius of influence would not be in perfect circles, and that Marble’s expert acknowledged described the radius of influence would be “amoeba-like” in shape, and that there was a possibility for some overlap and some gaps because the nature of the soil and the heterogeneity of the fill material. However, the court noted, Marble’s expert testified that further testing was not necessary because the system could be re-balanced after installation without having.
The court noted that MTGLQ’s expert had not visited the property to conduct testing, did not review OEPA documents or even talk to OEPA personnel. Moreover, the court observed that MTGLQ’s had never designed a gas extraction system and did not have any data indicating that the proposed remediation system would be ineffective. Furthermore, the court observed that OEPA would review the Debtor’s periodic reports to determine the efficacy of the post construction balancing. Finally, the court observed that OEPA has not requested any additional pre- construction testing.
As a result, the Court concluded that the Debtor had presented a reasonable plan and that it was imperative to implement the remediation as soon as possible to protect the interests of all creditors and the safety of the tenants. The court said the gas remediation plan was a capital and/or maintenance expense contemplated by the Agreed Order, and constituted an ordinary and necessary business expense as contemplated by Section 363(c)(1) of the United States Bankruptcy Code. Finally, the court found that MTGLQ had adequate protection because the property value exceeded the amount of the secured claim. Since the Creditor was over secured, there was no need for any type of adequate protection payment or additional liens to commence and complete the remediation program, as proposed by the Debtor.
In March, the Debtor filed a progress report and presented testimony confirming that the remediation plan had been installed and was properly operating. The bankruptcy proceeding was subsequently dismissed after the parties informed the court that they had settled their dispute.
Monday, August 20th, 2012
The 2009 bankruptcy filing of Tronox, Inc. has spawned some interesting litigation. A trial commenced in May in the bankruptcy court for the Southern District of New York where a Litigation Trust formed as part of the Tronox reorganization plan is seeking $25B in damages from Kerr-McGee, a subsidiary of Anadarko Petroleum. Tronox, a manufacturer of titanium dioxide, a white pigment used in a variety of products, filed for bankruptcy largely because of staggering environmental liabilities it inherited when it was spun-off from Kerr-McGee in 2005.
While the trial has received much attention, a significant settlement was recently announced in a consolidated class action filed by Tronox shareholders who purchased common shares of Tronox between November 28, 2005 and January 12, 2009. The Stipulation and Agreement of Settlement may have implications for environmental disclosure as well as D&O insurance. In Re Tronox Inc., Securities Litigation, No. 09-CV-0662 (S.D.N.Y).
The complaint named as defendants certain former directors and officers of Tronox, Kerr-McGee Corporation and Anadarko Petroleum Corporation. The Complaint alleged that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) and 78t(a), and Rule 10b-5 by failing to disclose material adverse facts about the Company’s true financial condition, business and prospects. Specifically, the Complaint alleged that the defendants orchestrated a scheme to transfer massive environmental liabilities of Kerr-McGee to Tronox in the filings for the Tronox IPO.
The plaintiffs alleged that while company has reserved approximately $200MM for environmental remediation reserves, it actually had liabilities approaching $900MM legacy liabilities, most of which came from the historic operations of Kerr-McGee. The plaintiffs also pointed to filings made in 2009 where Tronox admitted that its prior filings “should no longer be relied on because the Company failed to establish adequate reserves as required by applicable accounting pronouncements” and noted that the Company had not yet completed a review of “all known sites where the company may have environmental remediation and other related liabilities” and that the adjustments would likely be material. The complaint further alleged that as a result of these fraudulent acts the individual Kerr-McGee directors and officers reaped a windfall in personal profits.
The defendants filed separate motions to dismiss the Section 20(a) claims. In January 2011, the district court issued an opinion preserving most of the claims but dismissed the successor liability claims against Anadarko. In re Tronox Securities Litigation, 769 F. Supp. 2d 202 (S.D.N.Y. 2011). On August 7th, the parties announced a $37MM settlement. All but $2MM of the settlement will come from D&O insurance. Tronox’s auditor, Ernst & Young, agreed to pay $2MM.
This case is interesting because it is one of the first cases where the failure to publicly disclose environmental liabilities has resulted in a substantial settlement. The settlement also reflects the growing risk public companies face for improper disclosure of environmental liabilities. It also illustrates the importance of ensuring that the standard pollution exclusion contained in D&O policies had a carve-out for securities claims and derivative claims based on environmental disclosures.
Following is a detailed discussion of the transactions that are the heart of the $25B Litigation Trust lawsuit. The allegations are taken from the adversary complaint as reported by the bankruptcy court in Tronox Inc. v. Anadarko Petroleum Corp. (In re Tronox Inc.), 429 B.R. 73 (Bankr. S.D.N.Y. 2010).
Over the course of 70 years, Kerr-McGee had accumulated massive environmental liabilities associated with various lines of businesses including petroleum terminals, offshore drilling operations, gasoline stations, wood-treatment sites and agrochemical operations (“Legacy Obligations”). By 200, Kerr-McGee had terminated most of these historic operations and was left with two core businesses: a large and thriving oil and gas exploration and production operation and a much smaller chemical business. Several potential suitors had considered purchasing Kerr-McGee because of what viewed as undervalued oil and gas operations but had been scared away by size of the potential environmental liabilities.
In 2001, Kerr-McGee embarked on a two-step strategy coined “Operation Focus” to make itself more attractive for acquisition by segregating the Legacy Obligations from the oil and gas business. The firm formed a new “clean” parent company (“New Kerr-McGee”) along with a new “clean” subsidiary, Kerr-McGee Oil and Gas Corporation (“Oil and Gas Business”). Old Kerr-McGee, which was now a subsidiary of New Kerr-McGee then began to transfer billions of dollars of oil and gas assets to Oil and Gas Business.
As a result of this restructuring, Legacy Obligations were only partially segregated since New Kerr-McGee still exercised control (and hence responsibility) over the legacy liabilities sitting in Old Kerr-McGee. The next step was to sever the Chemical Business and the Legacy Obligations from New Kerr-McGee through either a sale or a spin-off. However, Kerr-McGee concluded the Chemical Business was too small to credibility take on the Legacy Obligations. As a result, the firm went on an acquisition binge to inflate the balance sheet of the Chemical Business. Old Kerr-McGee acquired the titanium dioxide (TO2) business of Kemira Pigments Oy (“Kemira”) without performing any meaningful due diligence. According to the adversary complaint, had Kerr-McGee conducted due diligence it would have learned of significant environmental issues associated with Kemira. By carrying the Kemira assets at an inflated acquisition cost, Old Kerr-McGee allegedly was able to cover the Legacy Obligations.
Initially the chemical business operation struggled because of economic conditions. When business conditions improved, New Kerr-McGee replaced senior management of the Chemical Business with executives who did not understand the magnitude of the legacy liability. In 2005, the New Kerr-McGee board authorized the company to divest the Chemical Business through sale or spinoff.
While the firm and its investment banker, Lehman Brothers were promoting the sale of the Chemical Business, EPA demanded that New Kerr-McGee reimburse the agency for approximately $179MM in response costs incurred at the Manville,New Jerseysuperfund site. In response, New Kerr-McGee required the Chemical Business to enter into an Assignment, Assumption and Indemnity Agreement in May 2005. The Chemical Business did not receive any consideration in exchange for assuming these liabilities or agreeing to indemnify the Oil and Gas Business. Indeed, to eliminate the risk that the Chemical Business could potentially seek contribution from New Kerr-McGee for the Legacy Obligations following a sale or spin-off, New Kerr-McGee backdated the Assignment, Assumption and Indemnity Agreement so that it was purportedly made effective as of December 31, 2002.
Several potential purchasers were scared away by the potential environmental liabilities. The firm did receive one bid for the Chemical Business in the amount of $1.6B but was conditioned that all liabilities related to wood treatment facilities, including the Manville site, would be retained by the seller. New Kerr-McGee initially offered to provide the purchaser with a $400 million indemnity if it assumed the Legacy Obligations. However, New Kerr-McGee ultimately decided it needed a “cleaner” separation from the Legacy Obligations and opted to pursue a spin-off. New Kerr-McGee proceeded with the spin-off even after being advised by Lehman Brothers that the proposed sale would yield more than $500MM in additional after-tax cash proceeds than the spin-off. However, a spin-off meant that New Kerr-McGee could dictate the terms of the deal, avoid any third-party due diligence and eliminate any standard representations and warranties regarding its environmental liabilities.
In the fall of 2005, New Kerr McGee incorporated Tronox, Inc as the holding company for the Chemical Business and the Legacy Obligations. A Master Separation Agreement was drafted. While New Kerr-McGee retained an attorney to represent the interests of the Chemical Business, New Kerr-McGee limited the attorney’s participation, disregarding his substantive comments and excluding him from meetings after he raised concerns on behalf of his client.
The master separation agreement provided that Tronox would assume $550 million in debt in connection with the spin-off. New Kerr-McGee also received approximately $26 million in cash, which represented all of Tronox’s cash in excess of $40 million. Tronox also provide a broad indemnification to New Kerr-McGee for the Legacy Obligations. New Kerr-McGee did agree to provide Tronox with a limited indemnity expiring in 2012 of up to $100 million, covering 50% of certain environmental costs actually paid above the amounts reserved for specified sites for a seven-year period. The Complaint alleged that the indemnity was illusory since New Kerr-McGee knew that the Tronox would not have sufficient cash flow to spend the reserved amounts and thus trigger the indemnification.
Upon execution of the master separation agreement, New Kerr-McGee received 100% of the Tronox stock. In November 2005, New Kerr-McGee sold 17.5 million shares of Tronox Class A shares in an initial public offering (the “IPO”) which generated $225MM in proceeds. After the IPO, Kerr-McGee continued to hold 56.7% of Tronox’s outstanding common stock. In March 2006, Kerr-McGee distributed the balance of the shares that it owned as Class B shares to its shareholders as a dividend.
According to the complaint, New Kerr-McGee materially understated the Legacy Obligations. When the SEC regulation S-K, issuers of stock are required to disclose contingent liabilities that “probable” and “reasonably estimable”. However, New Kerr-McGee only set reserves for those costs that it knew it was going to incur or almost certain it would incur. The company also avoided estimating ranges of possible costs and estimated costs based on low-probability “best-case scenarios”. The company even failed to disclose to its accountants that it had potential environmental liabilities at certain sites. The result was that although New Kerr-McGee was aware of numerous sites where it had potential environmental liability, it did not disclose or reserve for these potential liabilities. According to Kerr-McGee documents, these undisclosed sites were referred to internally as the “secret sites.
Less than three months after the completion of the Tronox spin-off, Anadarko offered to acquire New Kerr-McGee for $16.4 billion in cash and the assumption of $1.6 billion of New Kerr-McGee’s debt. The purchase price was a 40% premium above New Kerr-McGee’s current stock price. New Kerr-McGee shareholders approved the offer on August 10, 2006, and New Kerr-McGee Corporation became a wholly owned subsidiary of Anadarko.
Saturday, April 7th, 2012
The most recent decision in Flake v. Schrader-Bridgeport Int’l, Inc., 2011 U.S. Dist. LEXIS 30372 (M.D. Tenn., Mar. 23, 2011) is just another chapter in this long-running environmental saga involving a successor liability, bankruptcy, toxic tort and environmental justice issues along with a piece of American automotive history. This well-traveled case began in a Tennessee county court in 1994, moved to the federal bankruptcy court and federal district court in New York, went back to Tennessee for rulings by a federal district court, and is now on appeal to the Court of Appeals for the Sixth Circuit.
The story begins simply enough in the 1920s when Scovill, Inc acquired the A. Schrader Co, a manufacturer of the Schrader pneumatic tire valve (a/k/a the American valve). From 1964 to 1985, the Schrader Automotive division of Scovill, Inc. operated a plant located in Dickson, Tennessee. The plant was leased from the Dickson County Industrial Development Authority (IDA). The plant used TCE as a degreaser.
In 1985, Scovill was acquired by First City Industries (First City) who began to divest the firm of its non-core assets. As part of this strategy, the Dickson plant was closed. Around this time, the state started to become concern about potential groundwater contamination from a local landfill that had received wastes from the Dickson plant and other manufacturers in the areas.
Scovill decided to spin-off its Schrader Automotive division into a newly formed subsidiary, Schrader Automotive, Inc. (SAI). Pursuant to an October 1985 transfer agreement, SAI acquired all of the assets and liabilities of the Schrader Automotive division. SAI agreed to indemnify Scovill from all known and unknown liabilities relating to the Schrader Automotive Division’s business.
In March 1986, ArvinMeritor, Inc. (Arvin) agreed to purchase SAI. The purchase Agreement attempted to disclaim any liability on the part of Arvin relating to Dickson County by expressly affirming that SAI was not the owner of the Dickson Plant and that Arvin would not be assuming any liabilities relating to the operation of the Dickson Plant. To facilitate the transaction, SAI and Scovill entered amended the 1985 Transfer Agreement to unwind or rescind the SAI’s obligation to indemnify Scovill for claims arising from the Dickson Plant. Scovill released SAI and also agreed to indemnify SAI as well as Arvin for any breach of any representation or warranty by Scovill under the 1986 Agreement. Scovill’s indemnification obligation was guaranteed by First City.
In 1988, Scovill exercised its option to purchase the Dickson Plant from the IDA and then sold the Plant to Tennsco Corporation (“Tennsco”). In the mid-1990s Arvin sold SAI which was merged with Bridge Products, Inc. SAI was the surviving entity and changed its corporate name to Schrader-Bridgeport International, Inc (SBI).
Between 1985 and 1988, Saltire worked with the state to obtain closure of the facility’s hazardous waste management units. However, the closure did not include groundwater analysis and EPA launched its own RCRA Facility Assessment in 1987 that resulted in the identification of 15 solid waste management units. Scovill entered into a RCRA 3008(h) order to implement corrective actions.
First City filed for bankruptcy protection and as part of pre-packaged chapter 11 plan of reorganization, Alper Holdings (Alper) began the controlling shareholder of First City and assumed the obligations of First City under the Arvin Guaranty. By this time, Scovill changed its name to Saltire Industries, Inc. (Saltire). Alper and Saltire entered into a management agreement in where Alper agreed to manage Saltire’s various environmental matters. Nicholas Bauer was appointed as Saltire’s Vice President of Environmental Affairs but he was paid by Alper and sometimes represented himself as an Alper official. He also worked out of an office in Virginia where Alper was authorized to do business.
In December 2003, a number of plaintiffs filed suit against Saltire and Alper Holdings, alleging property damage and personal injuries from TCE in the groundwater. Partly to manage the environmental liabilities related to the Dickson plant, Saltire filed a chapter 11 petition in 2004. Arvin filed a claim against Saltire pursuant to the Indemnity that was disallowed after Saltire filed an objection and Arvin decided not to oppose the motion. Arvin reasoned it had a full guarantee from Alper that would provide greater protection than an unsecured claim in the bankruptcy proceeding. SBI did not file a proof of claim, though. A liquidating plan of reorganization was confirmed in 2006. As part of the plan, Alper negotiated a settlement on behalf of Saltire with the creditors committee where Alper agreed to forego its claims against Saltire and to pay $1 million to Saltire.
In 2004 and 2005, residents filed claims against Saltire, Alper, Schrader and ArvinMeritor alleging personal injury and property damage claims arising out of the contamination of a spring flowing through their property by the Dickson manufacturing plant. The Flake plaintiffs wanted to bottle and sell water from the spring and asserted their plans were upended when they learned that the wells on their property were contaminated. Other plaintiffs asserted property damage and personal injury claims.
In 2007, Scovill reached a $15MM settlement with its insurer that resolved the plaintiffs’ claims arising out of remediation of the Dickson Plant as well as liabilities associated with other facilities. The bankruptcy court issued a Stipulation and Order Approving Settlement that allowed plaintiffs’ claims for personal injury and property damage in the aggregate amount of $1.5 million, and expressly released Scovill/Saltire from any and all other claims.
Schrader notified Alper of a claim under the Guarantee in 2006 and then filed a complaint against Alper in 2007. This action prompted Alper to file its own chapter 11. The plaintiffs filed claims in the Alper bankruptcy case. Schrader also filed claims for past and future defense costs relating to the toxic tort litigation as well as indemnification. In a series of opinions in 2008, the bankruptcy court ruled that Alper could not be held liable for claims arising out of the Dickson plant and disallowed the claims. In re Alper Holdings USA, 2008 Bankr. LEXIS 86, (Bankr. S.D.N.Y. Jan. 15, 2008); In Re Alper, 2008 Bankr. LEXIS 522 (Bank. S.D.N.Y. 2/25/08), In re Alper Holdings USA, Inc., 386 B.R. 441 (Bankr. S.D.N.Y. 2008). The rulings said that Alper could not be directly liable for causing the contamination because Alper had no connection or relationship to Saltire or Dickson County until seven years after the Dickson Plant closed in 1985. The court also concluded that Alper’s “indirect, incidental” ownership interest in Saltire through First City did not retroactively make Alper liable for what went on in the Dickson Plant prior to its closure. The court also said that the plaintiffs had failed to plead sufficient facts to show that Alper had direct liability for negligent remediation when it effectively loaned Bauer, its employee, to Saltire to supervise the remediation. Finally, the court found that Alper had no indirect liability to the on either an alter ego or veil piercing theory, holding that neither the existence of a management agreement nor the common employee between the parent and subsidiary justified the extraordinary remedy of piercing the corporate veil. The plaintiffs appealed but the bankruptcy court rulings were affirmed. In re Alper Holdings USA, 398 B.R. 736 (S.D.N.Y. 2008).
Alper also objected to the Schrader claim, asserting they should be disallowed under section 502(e)(1)(B) of the Bankruptcy Code because they were contingent claims for reimbursement or contribution from an entity that is co-liable with the debtor. The bankruptcy court found that Alper was obligated under the Guaranty to indemnify Schrader for its past legal fees and expenses and that these were not contingent liabilities since these costs had already been incurred. Thus, the court overruled the objection. However, the court said the claims for future costs and indemnification were clearly claims for contribution or reimbursement, and contingent since the amount of the ultimate liability was unknown. Schrader argued that it could not be co-liable with Alper under 502(e)(1)(B) because Tennessee law no longer recognizes the common law doctrine of joint and several liability. However, the court said that the toxic tort plaintiffs had alleged that Alper and Schrader were liable as the corporate successors to Saltire for the negligent actions of Saltire. These allegations were in stark contrast to those asserted against ArvinMeritor which had been sued based upon its own subsequent and independent negligent and grossly negligent conduct. Accordingly, the court disallowed the Schrader claims for future costs and indemnity. In re Alper Holdings USA, 2008 Bankr. LEXIS 2634 (Bank. S.D.N.Y 9/18/08).
Plaintiffs then turned their attention to Schrader-Bridgeport International, Inc (SBI), its parent, Tomkins plc, and Arvin. First, the district court disposed with the claims against Tomkins, ruling in 2010 that general involvement with the subsidiary corporation’s performance, finance and budget decisions, and general policies and procedures was insufficient basis to assert personal jurisdiction over the parent much less pierce the corporate veil. Flake v. Schrader-Bridgeport Int’l, Inc, 2010 U.S. Dist. LEXIS 23951 (M.D.Tenn. 3/15/10).
Turning to the claims against SBI and Arvin, the court also rejected plaintiff’s motion for partial summary judgment that the defendants were the successor in interest to Scovill, and Schrader Automotive. The court agreed with SBI that none of the exceptions to the general rule of non-liability for purchasers of corporate assets applied. The court said that Scovill retained responsibility for the Dickson Plant under the 1986 agreement. Likewise, Arvin did not acquire the plant in the 1995 agreement. Indeed, the court observed that Scovill continued to list the plant on its insurance policy after the 1986 transaction. Thus, the court held, so there was no assumption of liability.
The plaintiffs also asserted that SBI and Arvin were liable under the mere continuation theory. The facts that plaintiffs relied on were that Schrader Automotive Group employees became SAI employees and performed the same work after the transfer to SAI, Plaintiffs also pointed to the fact that Arvin and Schrader Automotive Group had the same general manager. The court ruled there was no successor liability under a mere continuation theory because there was no common identity of stock, shareholders and directors among SBI and Scovill or Arvin.
Plaintiffs had also pointed to an affidavit that SAI removed waste materials from the Dickson Plant. However, the court said the public records reflected that Scovill was the cleanup lead for the property. Moreover, the court said the contamination described in the affidavit related to metal sludge materials deposited offsite from the Dickson Plant and was unrelated to plaintiffs’ claims about TCE-contaminated groundwater.
Finally, the court said that even if SBI or Arvin could be considered to be successors to SBI’s, their liability would be limited to the extent of Scovill’s liability. However, the court explained, plaintiff’s settlement with Scovill settled SBI’s liability. As a result, the settlement also extinguished SBI’s and ArvinMeritor’s liability for those claims.
Tuesday, March 27th, 2012
In Shelton Property Rural Acreage, LLC v Placid Oil Co., 2011 U.S. App. LEXIS 16681 (5th Cir. 8/10/11), Placid Oil operated oil wells on leased property from 1942 to 1956. In 1986, Placid filed a chapter 11 bankruptcy proceeding. The bankruptcy court issued a confirmation order in 1988 that contained a discharge of all claims except those created or assumed by the reorganization plan. The order also included a discharge for any future claims for damages that occurred prior to the discharge.
In 2002, Shelton Property Rural Acreage, LLC (Shelton) purchased the property that had been leased by Placid. After discovering contamination associated with the prior drilling operations,Shelton commenced a lawsuit against Placid in state court. Placid filed an adversary proceeding with the bankruptcy court, arguing that since the property owner at the time of the bankruptcy proceedings had not filed a proof of claim for any alleged environmental damage to the property, Shelton’s claim had been discharged by the bankruptcy court’s 1988 order.
In response,Shelton argued the discharge should not apply to its claim because the prior landowner had not receive adequate notice of Placid’s bankruptcy proceeding. Shelton asserted that the prior owner should have been considered a known creditor because a water study published in 1958 had showed that water wells on the property were contaminated due to oil and gas activities. Moreover,Shelton said an article in a June 1964 issue of Oil and Gas Journal discussed that the Little River bordering Shelton’s property was being polluted due to unlined oil and gas pits.
The bankruptcy court upheld the discharge and the Fifth Circuit affirmed. The appeals court said there was no specific information in the record to suggest that Placid knew of any claims related to property it leased from Shelton’s predecessor. The court said no environmental complaints had been made between 1956 and 1986. The court rejected Shelton’s assertion that the environmental damage was easily identifiable since it had taken Shelton six years to notice the damage. Finally, the court noted that Placid had tens of thousands of former leaseholds and it would have been unreasonable to require Placid to give each lessor actual notice of the bankruptcy. In light of this evidence, the appeals court agreed that Shelton’s predecessor was an unknown creditor who was only entitled to notice by publication. This requirement was satisfied when Placid published notice of its bankruptcy on three separate occasions in the Wall Street Journal.
It is unclear of Shelton performed any environmental due diligence prior to acquiring the property. However, a good historical search would have revealed the prior oil leasing activities, could have identified the responsible party and revealed the bankruptcy proceeding. If Shelton had been armed with this information prior to taking title, it could have explored various risk management strategies instead of becoming forced to bear the full brunt of the cleanup.
Sunday, March 4th, 2012
The second our series of recent cases involving the due care element of the CERCLA third party defense is State of New York v Adamowicz, 2011 U.S. Dist. LEXIS 102988 (E.D.N.Y. 9/13/11) where a property owner was unable to establish that it exercised due care despite spending over $1MM addressing environmental concerns at its site. The problem was that it waited too long to respond to the environmental concerns caused by its tenant.
In this case, National Heatset Printing (NHP) entered into a five-year lease in 1983 for a building located in East Farmingdale, New York. NHP used the premises for lithographic tri-color printing and generated a variety of hazardous wastes including wastes solvents and used inks. A the time of the lease, the property was owned by the Michael Adams Co., Inc with partial ownership interests held by Michael Adamowicz individually and as trustee of the Michael Adamowicz IV trust, and Mary Adamowicz, as trustee for the Bonnie Anne Fraser and Mary Margaret Fraser trusts. The One Adams Blvd. Realty Co (OABR) partnership managed the property.
Soon after the lease, the Suffolk County Department of Health Services (“SCDHS”) notified NHP that its discharge of wastewater into the on-site leaching pools was a violation of state and county environmental laws. The SCDHS advised NHP that it either had to connect the discharge to the municipal sewer system or cease all industrial discharge. Two years later, the SCDHS observed waste drums stored outside without secondary containment and soil stained from inks and oils. MHP entered into an Order on Consent with SCDHS that required NHP to clean out the leaching pools and bring its facility into compliance. The property was eventually connected to the municipal sewer system in January 1987 but the liquids and sludges in the leaching pools were not removed despite a series of notices in 1988 from the SCDHS to both NHP and the property owner. In November 1988, SCDHS issued a complaint against Adamowicz.
Meanwhile, NHP filed a chapter 11 bankruptcy petition in November 1987 that was converted to a Chapter 7 case in 1988. The bankruptcy court ruled that the NHP lease was terminated as of June 17, 1988 and that OABR could take possession of the property by that date. The court issued the final decree for the Chapter 7 bankruptcy in December 1992.
In 1988, OABR began implementing response actions at the site. These actions included retaining consultants to remove the contents of the leaching pool, investigating the pool’s connection to an overflow pool, removing drums and containers abandoned by NHP, implementing a remedial investigation and a treatment system for the PCE.
In 1990, the OABR partnership acquired title to the site. Also that year, Elizabeth Fraser succeeded Mary Adamowicz as trustee. In 1996, the OABR partnership conveyed the Site to OABR Corp.
In February 1994, the New York State Department of Environmental Conservation (“NYDEC”) notified Adamowicz that the agency was considering placing the site on the state superfund list but offered OABR the opportunity to voluntary undertake cleanup. When OABR Corp declined to remediate the site, the NYSDEC implemented response actions. During the investigation, the NYSDEC identified contaminated groundwater migrating toward a residential area that was served by private wells. In response, the Suffolk County Water Authority connected six residences and three businesses served by these wells to the public water supply at a cost of $24MM. By the 2009, the NYSDEC incurred $4MM in response costs and sought cost recovery under CERCLA.
The State of New York filed a motion for summary judgment against OABR Corp as the current owner and the trust beneficiaries. In an unpublished order dated March 31, 2011 (doc. 222), the court granted but denied the motion against the trust beneficiaries. The court denied a motion for reconsideration that is cited above.
The court found that OABR was liable both as a current owner and as a successor to the OABR partnership who had owned the property at the time of the releases identified by SCDHS. OABR asserted the third party defense, claiming it had not been in a contractual relationship with NHA when SCHDS had confirmed contamination in early 1988 because the November 1987 bankruptcy filing had the effect of terminating the lease. However, the court said the lease did not terminate until the lease was deemed rejected by the court in June 1988.
Moe relevant to our discussion, the court said that even if the lease had been severed by the bankruptcy filing in 1987 and that release occurred after that date, the OAB Defendants had failed to demonstrate that they satisfied the “due care” and “precautions” elements of the third party defense. In supporting its due care argument, the OABR defendants contend that they had spent over $1MM to address concerns of the state and country regulators since early 1988. The State responded that the February 1988 SCDHS letter had directed NHP and the owner to immediately remove all liquids and sludge from the leaching pools, that OABR Corp knew that NHP operated a photo-plate making and printing business, that the building was not connected to the public sewer system until 1987, and that NHP used leeching pools at the Site.
The Court agreed with the NYSDEC that OABR Corp had not established the due care and precautionary elements. First, the court said the defendant owners knew the nature of NHP’s business from the lease and periodic inspections by Adamowicz or his father. Second, the court noted the lease expressly gave the landlord the right to enter the premises if it was abandoned or the tenant had defaulted on its rent payments, and that this right of re-entry had been triggered by that time the state inspectors had observed staining and improperly stored drums. Despite knowing the site contained numerous leeching pools, that discharges to cesspool system where prohibited and the environmental conditions at the site, the court said the OABR defendants failed to take any action for five years. The court also observed that these events took place prior to NHP’s filing for bankruptcy and prior to the February 1988 SCDHS letter. Moreover, the noted that unlike other “due care” cases, OABR Corp was not a new owner confronting the scope of its duty to investigate a new property acquisition but instead it or its predecessor had been in possession of the site since at least 1980 and charged with the knowledge of the environmental conditions at the site. Accordingly, the court ruled that OABR Corp has not shown it is entitled to the protection of an affirmative defense under CERCLA.
The portion of the decision ruling that the trust beneficiaries of a distributed trust was also interesting and will be the subject of later post.
Sunday, December 25th, 2011
It seems like there were a lot of cases in 2011 involving commercial properties impacted by methane gas from former landfills. A recent case involved a novel question if the owner of a hotel damaged by methane gas migrating from a landfill could seek administrative claim status in a chapter 7 bankruptcy case.
In the case of In Re Resource Technology Corp, 2011 U.S. App. LEXIS 22022 (7th Cir. 10/31/11), Congress Development Company (Congress) owned and operated a landfill in Hillside, Illinois. From 1992 to 1996, Congress used a flare system to control landfill gases. In 1996, Congress contracted with Resource Technology Corporation (RTC) to construct and operate a gas collection and control system (GCCS) that would replace the flare system. RTC, in turn, would convert the gas to electricity and then sell the electricity to power companies. In 1999, RTC filed a chapter 11 bankruptcy petition and continued to operate the GCCS as a debtor in possession (DIP) until 2003 when the bankruptcy court appointed a Chapter 11 trustee.
In October 2002, Markwell Hillside LLC (Markwell) purchased a Holiday Inn hotel located next to the landfill. As it turns out, Markwell’s purchase was ill-timed as conditions at the landfill significantly deteriorated in 2002. According to an expert in the bankruptcy case, RTC did not properly operate or maintain the GCCS during its time in bankruptcy. The problems included a history of high-pressure gas readings, broken fittings, broken valves, broken wellheads, and broken sampling ports.
In September 2005, the bankruptcy court converted the RTC case to a Chapter 7 liquidation proceeding. A chapter 7 trustee was appointed and given operational control over RTC’s was its business operations were wound down. Four days after the chapter 7 trustee assumed control, the GCCS failed. Landfill gases migrated into the hotel through electrical outlets and floor cracks. The odors sickened guests and employees, resulting in a disastrous fall off in the hotel’s business for a period. Markwell subsequently filed its own chapter 11 proceeding.
The Illinois Environmental Protection Agency (IEPA) issued notices of violation to Congress and RTC after receiving odor complaints. The Chapter 7 trustee responded that the estate lacked the financial resources to fix the GCCS and estimated even if it had the funds, it would take a year to bring the GCCS into compliance. In January 2006, the bankruptcy court lifted the automatic stay and allowed Congress to take control of the GCCS. Congress then terminated its contract with RTC and began to rebuild the GCCS.
Landfill gas continued to enter the hotel. Markwell discovered explosive levels of methane gas at the hotel in February and March of 2006. This was apparently the final nail for Maxwell reorganization hopes. In September 2006, Markwell’s trustee sold the Holiday Inn for 20% of the value had there not been a methane problem.
In May 2006, Markwell’s trustee filed an administrative claim against RTC’s Chapter 7 estate seeking compensation for damages. Markwell alleged that RTC’s negligent maintenance of the GCCS had created a nuisance that damaged Markwell’s property and caused economic loss. The Markwell estate assigned its claim to Samuel Roti, Markwell’s sole member. Roti then amended the Chapter 7 claim, requesting compensation for out-of-pocket costs, loss of hotel revenue, damage to the land, and diminution in the hotel’s market value.
Creditors in a chapter 11 bankruptcy may seek administrative claim status for post-petition environmental claims on the basis that the chapter 11 DIP or trustee has an obligation to comply with environmental laws under 28 U.S.C. 959. However, Markwell never filed a claim against the chapter 11 estate. Instead, Roti sought what it characterized as a post-petition administrative claim against the chapter 7 trustee on the basis that it “operated” the GCCS for nearly four months.
The United States District Court for the Northern District of Illinois rejected the request for administrative priority status and the Court of Appeals for the Seventh Circuit affirmed. The appeals court noted that the trustee had been operating RTC’s system for only four days when the failure occurred. The court said the failure resulted from years of RTC’s neglect, there was no evidence that the chapter 7 trustee was aware of that neglect, did not exacerbate the problem, could not have done anything to prevent the failure within the few days that it had nominal control of the system, and could not have done anything to mitigate the damage afterward. The court is was possible that the Chapter 11 trustee may have had some responsibility for the neglect of the GCCS but there was no longer a Chapter 11 estate from which Roti could seek relief.
The appeals court acknowledged that the nuisance matured into a claim when the Chapter 7 trustee had possession of the GCCS and therefore could be viewed as occurring post-petition. However, since the acts causing the nuisance occurred prior to the time the chapter 7 trustee assumed control, the court said the trustee was “no more personally responsible for it than the owner of an apartment house is responsible for the murder of one of his tenants by another tenant.”
After concluding that the Chapter 7 estate and not the trustee was the proper tortfeasor, the court examined if the claim should be afforded administrative expense priority. The court said that while the chapter 7 trustee was given operational control, it was not the kind of operational control seen in chapter 11 cases where a trustee is managing an ongoing business to preserve and enhance the value of the bankruptcy estate. Instead, the court said, the trustee had neither the mandate nor resources to do anything but liquidate the estate.
Roti argued that estate had generated from revenue from the sale of energy and was therefore continuing the operation of the business. However, the appeals court said the trustee did not operate the GCCS in any meaningful way during the brief period it was in charge. While there was some revenue generated from energy sales, the court said the proceeds were less than 10% of its normal revenue and insufficient to cover the GCCS operating costs. The court concluded that the continued operation of the GCCS in its diminished state should be more properly viewed as simply the exercise of the estate’s obligation to prevent further contamination. Thus, while Roti as assignee of Markwell, was simply a general creditor.
Commentary: When companies encounter financial difficulties, spending on environmental compliance is often one of the first expense items to be slashed. Even during a chapter 11 bankruptcy when the estate has obligations to comply with environmental laws, debtors will often spend the absolute minimum on environmental compliance to preserve estate cash. As a result, parties considering purchasing corporate assets in a bankruptcy proceeding should carefully assess review environmental compliance prior to acquiring the assets. Lenders also need to scrutinize environmental compliance before exercising rights that could provide them with control over a defunct borrower’s facility. There have been many cases where lenders have become saddled with the costs of disposing of hazardous wastes. We have several archived posts that discuss the potential risks facing lenders during bankruptcy proceedings
Tuesday, October 25th, 2011
New Mexico had issued an order under its Water Quality Act to abate groundwater contamination eminating from septic field and lagoon on debtor’s property. The debtor argued that since the state was essentially requiring it to pay for the cleanup, the order should be considered a claim that could be discharged under the Bankruptcy Code. The state argued that the order was exempt as a regulatory action.
Relying on the Second Circuit’s LTV decision (In Re Chatageauy) and the Seventh Circuit’s Apex Opinion in In , United States Bankruptcy Court for the Southern District of New York ruled that the order was not a claim because NM had no right of payment under the state statute.
On appeal, debtor argued that NM had the ability to obtain payment under CERCLA and other laws, and therefore should be barred from enforcing the order. However, the District Court for the Southern District of New York said the analysis should be limited to the statute under which the state chose to issue the order, not other hypothetical remedies that might be available.
In re Mark IV Industries, 2011 U.S.Dist. LEXIS 110595 (S.D.N.Y. 9/28/11)
Tuesday, October 25th, 2011
A Chapter 13 debtor had previously owned a gas station. After the New York State Department of Environmental Conservation (NYSDEC) issued a notice of violation involving failing to comply with underground storage tanks (USTs) regulations, the debtor filed its chapter 13 petition. In its Statement of Financial Affairs, the debtor disclaimed knowledge of environmental issues despite having received the notice of violation. As a result, the NYSDEC was not included in list of creditors or any schedules of liabilities.. Because the agency was not aware of the bankruptcy proceeding, it did not file a claim or otherwise appear in the bankruptcy case.
A Chapter 13 plan was then approved by the court. The plan provided that the debtors would agree to make monthly payments to the chapter 13 trustee and that the debtor would surrender its property to the county for unpaid taxes. One year after the chapter 13 plan had been confirmed, NYSDEC filed motion to compel compliance under 28 under U.S.C. 959(b) which imposes obligations on trustee to comply with laws.
Because of the potential environmental liability associated with the property, the county did not take title to property. Because the plan had no provision for trustee to retain property, title revested to debtor by operation of law. The Court said the debtor fell within the scope of the parties subject to 959(b). Thus, the court ordered that any future surrender of the property would be conditioned on the debtor ensuring that steps are taken to comply with the NYSDEC Notice of Violation.
On NYSDEC’s motion to compel compliance, the court held that 959(b) did not create a remedy for failure to comply with environmental laws. Therefore, the court said it could not grant the relief sought by the NYSDEC. However, the court said that if debtor failed to comply with environmental laws, NYSDEC was free to either commence enforcement proceedings or move to dismiss the bankruptcy proceeding.
In re Wade Gollnitz, 2011 Bankr. LEXIS 3728 (W.D.N.Y. 9/28/11)