Posted on 01/11/2002 1:12:22 PM PST by Magician
New York—Enron's desperate search for off-balance-sheet funding for its frenetic growth in the late 1990s has now led to a bitter legal fight between some of the biggest US banks and insurance companies in the wake of Enron's spectacular bankruptcy.
Whatever the outcome, the fight will mean yet more scrutiny for over-the-counter energy deals, market sources say. And big financial players in those markets may find it tougher to buy the amounts of counter-party risk insurance needed to avoid having to allocate their own scarce capital to such OTC deals.
The dispute was sparked soon after Enron's Dec 2 bankruptcy filing when big Enron lender JP Morgan Chase went to Manhattan US District Court to force almost a dozen major insurers to make good on nearly $2-bil of surety bonds they wrote between 1997 and 2000.
The bonds aimed to eliminate the risk Enron might default on any of six huge five-year forward sales of crude or natural gas to what was then Chase Manhattan Bank and two of its Channel Islands energy trading arms: Mahonia and Mahonia Natural Gas.
But the surety companies say they were lied to by Enron and Chase, claiming the would-be commodity deals were really a sham to obscure $2-bil of unsecured loans. If they had known that, the insurers claim in court filings, they would never have written the bonds, on which about $1-bil of obligations were still out when Enron went bust.
As seeming proof of the sham nature of the deals, insurers claim, no molecules have ever actually been exchanged between Enron and Chase under the sales. No transportation capacity has ever been booked and no contracts have been signed to either buy gas from suppliers or to sell it to end users. All the monthly settlements were apparently done in cash, or other non-physical terms, akin to a fixed loan payment schedule.
Nonsense, claims Chase. It insists the forward sales, for what appears to be the equivalent of nearly 1 Bcfe/d, were standard industry commodity deals, with standard cash settlement features. The insurers, Chase argues, are just trying to dodge paying a valid claim.
"Even if the [insurance companies] had not waived all defenses to payment under the surety bonds, the defenses [they] have asserted in resisting payment are meritless," declares Chase.
The fight pits Chase and Enron against Liberty Mutual, St. Paul Fire and Marine, CNA, Fireman's Fund, Safeco, Federal, Hartford Fire and Lumbermen's Mutual. The only insurer not fighting the claim is Travelers, an arm of yet another big Enron bank lender and commodities counter-party: Citicorp. How much revenue and profit such insurers may make annually from bonding OTC commodity deals is not known. But market sources say such surety bonding is commonly sought by risk-averse banks and other financial players in energy markets. It is a critical requirement to avoid having to allocate some of a bank's own capital to such deals under the sliding-scale risk-backing rules of US banking law.
Court filings indicate the insurer group got annual fees of 1.6% of the outstanding Enron bond amounts, which would work out to about $80-mil over the declining five-year life of the bonds. But they face potential losses of about $1-bil, and therefore have leveled unusually strong counter-claims against Chase and Enron.
Liberty Mutual, for instance, claims Chase's Mahonia knew in advance Enron had no intention of actually delivering oil and gas under the agreement, and had no intention of forcing Enron to perform. "Mahonia knew such facts were material to Liberty's decision to issue the surety bonds," Liberty alleges. St. Paul, obligated for 20% on four of the bonds, argues Chase has "unclean hands" in the dispute. "The contracts were not intended to be fulfilled as actual supply contracts," St. Paul claims. "But instead [they] were intended to provide a mechanism to obtain surety bonds...in the guise of forward supply contracts."
The detailed volume and delivery terms of the contracts, St. Paul argues, "created a misimpression they were intended to create an obligation for actual deliveries." And it raises the specter of "collusion between Mahonia and Enron" to conceal the real nature of the arrangement. To substantiate their arguments, the insurer group has sought permission to depose Enron officers and subpoena documents as part of the Enron bankruptcy case, which Chase and Enron are fighting intensely with a hearing set for Jan .
Among the Enron officers who signed the bond agreements was Jeffrey McMahon, now Enron's CFO.
If the insurer counterclaims prove valid, they raise a host of other questions about Enron's already-tarnished accounting methods, and the reporting and compliance activities of one of the country's most prestigious banks.—James Norman
Platt's Oilgram, Vol 80, No 2, Jan. 3, 2002
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