Mirant Lawsuit Could Make Southern Co. Liable For Debts

Mirant Corp. and its creditors committee have filed a lawsuit against its former parent, Southern Co., asserting, in effect, that the Atlanta-based holding company played a role in Mirant’s bankruptcy due to the way it structured the spin-off of Mirant in April 2001.

The plaintiffs are seeking to recover at least $2 billion in connection with transfers made to Southern before the spin-off was completed.

Lauria

Southern "caused Mirant to incur a mountain of debt and then stripped out approximately $2 billion in payments and transfers in anticipation of Mirant's April 2001 spin-off, even though Southern knew or should have known that Mirant had been left with inadequate resources to meet the obligations that its former parent had caused it to incur," says Thomas Lauria, the lead attorney for White & Case in Mirant's Chapter 11 case, in a statement.

He asserts that a special committee, set up by Mirant's board, revealed that “Southern had been advised as early as 1997 that its fledgling merchant-energy subsidiary was undercapitalized and was creating potential regulatory issues for the utility giant.”

Without informing Mirant's management, Southern developed a strategy to capitalize on the then-white-hot merchant-energy sector to raise billions of dollars of financing, "much of which flowed upstream to Southern prior to the spin-off of the debt-burdened subsidiary," says Lauria, “and before its latent problems could come home to roost."

The lawsuit also charges that during 1997, 1998, and 1999, Southern caused Mirant to make more than $6 billion in acquisitions, for which Mirant was unable to obtain significant project financing because it grossly overpaid for most of them.

The lawsuit was filed in the U.S. Bankruptcy Court for the Northern District of Texas, in Fort Worth, where Mirant's Chapter 11 reorganization case is being heard.

Southern spokesman Todd Terrell says the company will not comment, except to say, “We don’t believe there is any meritorious basis for the claim against Southern Co. and we intend to defend ourselves vigorously.”

He added that the company will file an official response within the required deadline, which is 30 days. “We will provide more details in that response,” he assured.

The lawsuit asks the bankruptcy court to issue orders that would void fraudulent payments, dividends, and other transfers that Southern forced Mirant to make from 1999 to 2001, which totaled more than $1.9 billion; reverse Southern's conversion of nearly $1 billion of equity investments it made in Mirant into debt; and declare Southern liable for all of Mirant's obligations to creditors.

In November 2002, Mirant said it would restate earnings by $41 million from January 1, 1999, through June 30, 2002, as a result of accounting errors. In July 2002, Mirant said it would restate several balance-sheet items from its 2001 financial statements.

Maximizing Assets In Bankruptcy

Peterson

Lowell Peterson, bankruptcy and labor partner of New York City-based Meyer, Suozzi, English & Klein explains that this is essentially a derivative action to maximize the assets available to Mirant's creditors in the bankruptcy proceedings. “In terms of a run-of-the-mill bankruptcy, this is unusual, but not unprecedented,” he adds.

Sure, there have been disputes in the past between parents and the companies they've spun off, such as Ford-Visteon and General Motors-Delphi. But Peterson says this one is more fundamental because of the profound allegations of fraud. The plaintiffs are alleging, in effect, that the parent looted the company in the spin-off.

Even so, he says it is never easy for the creditors of a bankrupt subsidiary to reach through to the parent corporation, so the “alter ego” claims in Mirant's lawsuit face an uphill battle.

As for the allegations that Southern, in effect, treated itself better than other arms-length creditors, Peterson says, “My sense is that some of these claims will be upheld and others will not; the court will engage in a detailed analysis with respect to each particular transaction.”

“One of the more interesting allegations is that Southern improperly converted a large part of its equity interest in Mirant into debt,” Peterson adds. This is very significant in bankruptcy court because in a Chapter 11 case like this one equity interests are wiped out, while entities that hold debt, such as bondholders, often obtain some kind of recovery, even if it is less than 100 cents on the dollar, he adds.

“Southern claims that Mirant owes it a lot of money and Mirant says it does not,” Peterson notes. Mirant also says that, even if Southern has legitimate claims, those claims should be equitably subordinated because of Southern's wrongdoing against Mirant and Mirant's creditors.

“These are classic moves in bankruptcy court,” asserts Peterson. “Ultimately the bankruptcy judge will decide the value of Southern's claims and will determine whether those claims should be equitably subordinated. The court will decide which of the payments Mirant made to Southern pre-bankruptcy can be voided—that is, Southern would be required to pay the money back. This all gives Mirant a significant bargaining chip against Southern.”

Suit Suggests Collusion

There is an additional dimension here, Peterson points out. This action is being brought by Mirant and the Official Committee of Unsecured Creditors, but the lawyers report to a Special Committee of Mirant directors who were not at the company before Mirant's spin-off from Southern.

“In other words, there is a very strong suggestion of collusion between Southern and the directors of Mirant at the time,” he adds. “This, plus the presence of a court-appointed Examiner suggests that Mirant's creditors have been able to convince the bankruptcy judge that the claims of collusion and fraud have enough merit to proceed.”

Other legal experts, however, don’t think this case is very unusual.

Monaghan

John Monaghan, a member of Holland and Knight's litigation department, says the allegations are not all that unusual. He asserts the issues of fraudulent transfers and breach of fiduciary duties were raised during the leveraged buyout boom during the 1980s.

“They are not stating any new propositions of law,” he adds.

But, he does note there were a number of successful fraudulent transaction actions back then, which he insists clearly had an impact on the LBO market and how they are documented. “It [Mirant’s lawsuit] may have an impact here if it’s successful,” Monaghan adds.

What are the potential future implications of this suit? How will future spin offs be impacted?

Peterson says if Mirant is successful, “it will send a signal to corporate parents that they have to go easy on overloading debt on the spin-off company and creatively siphoning off assets from the spin off company.”

However, Monaghan asserts: “I would be surprised if those already doing spin offs don’t take these theories into account.”