"Limitations on corporation's ability to free itself from legacy liabilities"

Great Debates
1

Limitations on corporation’s ability to free itself from legacy liabilities

Also, corporate spin-off avoided as fraudulent transfer

The above give more details, but the short version is an energy and chemical company, Kerr McGee, created a new holding company to receive all the good assets. All the toxic assets, including upwards of $5 billion in environmental liabilities, remained with the legacy company that was then renamed Tronox. Shortly after all the transactions were completed (that is, within just a few months) the new Kerr McGee was acquired by another corp, Anadarko. The legacy corp and others, including the US Government (via the EPA), formed a trust which sued Anadarko (and new Kerr McGee) alleging fraudulent transfer among other issues in the Bankruptcy Court of the Southern District of New York.

After a trial and a ruling in favor of the plaintiffs last December, the bankruptcy court in May “issued a report and recommendation that the district court approve a settlement reached between the trust and the defendants that settled the parties’ dispute: that settlement amount was $5.15 billion. The district court will rule on that settlement in the coming months.” Also,here is a synopsis by the Justice Department on the case and how the proceeds will used.

The questions for debate are 1) there any chance the district court would not approve the settlement?

  1. The more important issue, will this put a damper on this practice of dumping liabilities on a spin-off that then declares bankruptcy?

I have seen this trick for several years now, and this is the first time I recall that someone did not succeed in using it. Just bad luck for Kerr McGee?

2

Would this be an apt analogy? A corporate person claims that it has a split personality(that it deliberately created), and that it should not be held responsible for what that bad personality has done?

3

I would consider that a fair description.

Another case close to home here in Saint Louis, Peabody Energy spun off Patriot Coal in 2007. Arch Coal threw in some pieces also. Patriot then declared bankruptcy in 2012 because of all the pension costs the 5 year old company had. It essentially converted most of its pension obligations and other debts into common stock to the creditors. After the restructuring it also went private, so no more pesky SEC reporting.

The fun bit there is also that Patriot created shell companies in New York so that they could specifically file in the Southern District also, which I guess had been fairly favorable to corporations before the above case, since I see no other reason for them to take the trouble.

Peabody and Arch did have to throw some more money into the pot also ($310M for Peabody, and $5M for Arch). Other details here.

The more I think about this, the more I keep seeing interesting ways to buy real estate. Buy a house and start a business. Transfer the mortgage to the business, and when it goes bankrupt - free house! Since I never transferred the deed, just the mortgage, I still own the house. I’m sure there are some legal hurdles along with tax and accounting issues, but if it works for Wall Street, surely it can work for Main Street.

Something tells me if this did become standard practice on Main Street, Congress would be drafting legislation to stop it the next week. They seem pretty cool with the status quo though. Props to Judge Gropper for ruling against it. The gentleman has a pretty good resume too.

4

You probably couldn’t do it with a house, since the mortgage contract presumably has strict rules on transfer of ownership of the house, but you could take out a number of credit cards, extract your entire credit limit in the form of cash advances, which you put in your bank account, and then let the collectors go after Pagan II who has no assets to seize, no income to garish, and no credit rating to harm.

5

Do you have a cite for where it worked in a legal sense? What you describe is a textbook fraudulent transfer/alter ego/corporate veil piercing. Our financial system would collapse if such a thing was allowed.

6

Even a legitimate medium sized business can have a hard time obtaining a credit card without a personal guarantee from an individual with good personal credit.

For some sort of a mortgage or line of credit you’ll have an underwriter reviewing the application, but a credit card doesn’t get that much attention. If you’re not personally guaranteeing your debt, there won’t be any “business” credit card.

7

I don’t have any data on the success rate, but it has been a common strategy for at least a decade. Here is an article about media companies doing it, focusing on the Tribune Co and Time, Inc. News Corp also. Verizon did it also, spinning off their directory business, but that deal is tied up in litigation alleging fraudulent transfer.

A Fortune article from 2005 talks about it a bit while discussing good spinoffs.

“The rub is that the parent will frequently set a business free for the most obvious reason: It’s a troubled, unprofitable sideshow the parent can’t wait to dump. To make matters worse, the parent frequently loads down the spinoff with baggage ranging from heavy debt to rusting plants.”

“Investors should profit if they apply five criteria. First, as discussed, pass up most carve-outs in favor of pure spinoffs. **Second, look at the level of debt. Big debt isn’t a killer if the new company has the earnings to carry it. But many spinoffs don’t. **Third, look for a growth story. If the old management was holding back expansion and the new team has a clear strategy for building businesses that were starved for capital, you can bet that the market will reward the risk. Four, search for hidden assets not reflected in book value, such as land holdings or lucrative brands.” Bolding mine.

I suppose a better analogy than a free house would be that I bought a money pit, and now I want to dump it without declaring personal bankruptcy, so I set up a shell company to absorb the loss.

I can see situation where this is a good strategy. Half the business is doomed to bankruptcy for whatever market reasons, so spin it off so the successful half can thrive. The issue I see is that the parent dumps a significant portion of debt that was used to build the successful half. Creditors loaned funds believing that the good half would pay it back, but instead see their notes being dumped into essentially the junk bond market.

The other downside, particularly for companies like Kerr McGee with environmental liabilities, is that the toxic sites sit vacant or abandoned factories rust away while the courts figure out who has to pay what to whom. Might pay off for the investors, but rarely does it pay off for the communities that have to clean up the mess.

8

I’m reasonably familiar with this case. I’ll note two things.

The Tronox spin-off was first bandied about by corporate raider Carl Icahn. Icahn acquired a large position in Kerr McGee and pushed for a couple of different things, including the spin-off of the chemical business. If anyone is familiar with Carl Icahn, they will know that this type of move is very common for him. It was the basic story of the sum of the parts being worth more than the whole. The spin-off of Tronox was Kerr McGee caving in to Icahn. By the way, around the same time Icahn acquired an interest in Temple Inland and pushed for its breakup. It was a paper company that also owned big timber interests and a bank. Shortly after the breakup, the bank failed. Of course a lot of banks failed at that point in time and this bank in particular was structured as an S&L with a large California home mortgage and mortgage backed securities portfolio. I don’t think Icahn foresaw either of these breakups as leading to failed spinoffs, and he in fact lost a decent amount of money with the bank.

From Anadarko’s perspective, they had a pretty strong and totally innocent reason for not wanting to acquire the Tronox portion of Kerr McGee: they aren’t a chemical company. Anadarko is an oil and gas company.

Do I think their is a chance that certain Kerr McGee execs felt they were ridding themselves of liability by spinning off Tronox? Yes, sure. I highly doubt they thought it would implode like it did. I think they thought it was a viable standalone company. I think they thought being a focused oil and gas company would create more value than being a diversified company.

Do I think Anadarko did anything wrong here? No, that’s crazy talk. Anadarko didn’t orchestrate this transaction. They are an oil and gas company that was interested in acquiring the oil and gas interests of Kerr McGee. It wouldn’t have made any sense for them to acquire a chemical company.