Mirant Corp. and the Official Committee of Unsecured Creditors of the generator in its bankruptcy proceeding announced late Thursday that they have filed a lawsuit against Mirant's former parent company, Southern Co., seeking recovery of at least $2 billion in connection with transfers made to Southern prior to Southern's spin-off of Mirant in April 2001.
The lawsuit was filed in the U.S. Bankruptcy Court for the Northern District of Texas, in Ft. Worth, where Mirant's Chapter 11 reorganization case is being heard by Judge D. Michael Lynn. Mirant and the Mirant Committee of Unsecured Creditors are plaintiffs in the lawsuit.
Mirant is represented in the lawsuit by the law firm of White & Case LLP, reporting directly to a Special Committee of the Board of Directors that is composed of board members who were not on the Mirant board prior to Mirant's spin-off from Southern on April 2, 2001. The Mirant Committee of Unsecured Creditors is represented by the Texas-based law firm Andrews Kurth LLP.
"As detailed in the complaint, Southern Company 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," said Thomas E. Lauria, lead attorney for White & Case in Mirant's Chapter 11 case.
"The Special Committee's investigation 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 Southern caused Mirant to flow upstream, only to then spin-off the debt-burdened subsidiary before its latent problems could come home to roost," Lauria said.
Mirant said that the lawsuit asks the bankruptcy court to issue orders that would:
The lawsuit states that Southern made cash advances to Mirant to fund early investments in power generation projects, and that any differences between project financings and the purchase price were characterized in Southern's financial statements through the end of 1996 as equity contributions to Mirant.
However, Southern later re-characterized all subsequent equity contributions to Mirant as cash advances or loans in order to strip Mirant of much-needed cash prior to the IPO and spin-off of Mirant, and required Mirant not only to repay the principal amount of the advances (totaling more than $926 million) but also required Mirant to pay interest on those advances totaling approximately $108 million, the lawsuit charges.
The lawsuit further alleges that during 1997, 1998, and 1999, Southern caused Mirant to make or commit to make acquisitions totaling more than $6 billion, for which Mirant was unable to obtain significant project financing because it grossly overpaid for most of the acquisitions in that time frame.
The lawsuit states that Mirant's own energy trading and marketing group consistently warned management that it did not expect to be able to sell the output of those power plants at the high energy prices that were used to justify the purchase price for many of those power plant acquisitions.
However, Southern nevertheless caused Mirant to proceed with the acquisitions, the lawsuit says. Because it paid more than fair-market value for those acquisitions, Mirant's balance sheet showed a total increase in "goodwill" in 1997 of approximately $1.6 billion.
The lawsuit additionally describes how an analysis in 1997 of Mirant's business prospects by independent consultants hired by Southern concluded that Mirant was undercapitalized by $893 million, and recommended that Southern consider an IPO of 19.9% of Mirant's stock to raise potentially $500 million, to be followed by a complete spin-off of Mirant to Southern's shareholders. However, the lawsuit alleges, Southern kept the IPO and spin-off plan secret from Mirant's senior management until late December 1999.
The lawsuit also asserts that Southern caused Mirant to borrow $700 million in July 1999, of which $192.5 million was used to reduce advances and $97 million was used to pay interest on the advances, which, again, Southern had previously characterized to investors as equity contributions that would not require interest payments.
Further, in October 1999 Southern caused a Mirant subsidiary to borrow $1.45 billion, which was used in part to repay an additional $734.5 million of advances and an additional $10.3 million of interest, Mirant said. In total, advances and interest payments returned by Mirant to Southern in the last half of 1999 totaled $1.03 billion, the lawsuit states.
Between December 1999 and May 2000, Southern caused Mirant to pay dividends to Southern totaling over $668 million, even though Mirant had to borrow all the funds needed to pay those dividends, the lawsuit states.
Then, in preparation for the planned spin-off, Southern caused Mirant to acquire certain generating businesses from Potomac Electric Power Co. (PEPCO) at grossly excessive prices, resulting in Mirant booking over $1.5 billion in "goodwill" related to the transaction and assuming out-of-market power sales contracts with a long term liability in excess of $2.3 billion, the lawsuit states.
The acquisition was necessary from Southern's viewpoint in order for the Mirant spin-off to pass the so-called active trade or business test, which was necessary to obtain a favorable tax treatment ruling, the lawsuit says.
Southern also caused Mirant to issue one share of Series B Preferred Stock to Southern, valued at $234.5 million, which Southern later caused Mirant to redeem in exchange for Mirant's interest in a subsidiary jointly owned by the two companies, according to Mirant. Mirant's interest in the subsidiary was valued for book purposes at approximately $247.9 million at the time of redemption of the Series B preferred share.
Once Mirant was spun off by Southern, the company immediately began to experience cash flow and liquidity problems, which caused the company to liquidate some of its most valuable assets and terminate expensive contractual obligations incurred while Southern was in control. Despite their efforts, Mirant's debt was downgraded to below investment grade by Moody's Investor Service in December 2001, just seven months after the spin-off. Upon advice of its new auditors, Mirant restated its financial statements for 2000 and 2001 with significant reductions in earnings and equity positions.
These developments forced Mirant's energy trading business to begin posting 100% collateral on all energy transactions, further constricting liquidity and leading to Mirant having to file for protection under Chapter 11 of the U.S. Bankruptcy Code in July 2003, when the company could not repay over a billion dollars of then maturing debt, the lawsuit says.
Southern was aware that the $2 billion of "upstream" payments it caused Mirant to make before the spin-off would jeopardize Mirant's liquidity and its ability to generate much-needed cash flow from its energy trading business, the lawsuit asserts.
In early 2004, Mirant's board of directors formed a special committee to investigate potential claims and causes of action arising from transfers to Southern in connection with Mirant's initial public offering and spin-off.
The members of the special committee are Stuart Eizenstat, chairman, Robert McCullough and Ray Robinson. None of these directors have ever had any affiliation with Southern, and they all joined the board after Mirant became an independent company in April 2001. The special committee directed the law firm White & Case to conduct an investigation into the transfers and report its findings to the committee.
In turn, the committee made a recommendation to the Mirant board with respect to the actions to be taken in connection with the subject matter of the investigation. Subsequently, the board authorized the litigation against Southern.
S. Marce Fuller, Mirant's President and CEO, and A.W. Dahlberg, chairman of the Mirant board, recused themselves from all board discussions and decisions relating to the legal action against Southern because they had been Southern officers before the formation and ultimate spin-off of Mirant from Southern.
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