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ARE INVESTORS LIABLE FOR LBOs GONE BUST?
Tom Rabone first laid eyes on Kaiser Steel Corp.'s huge mill back in 1946 after his dad found work there. By 1950, he was making steel at the Fontana (Calif.) plant, too. The work was often brutal, but pay and benefits were good: By the time Rabone retired in 1983, he and his wife had raised four kids, sending one to Stanford University. They looked forward to a generous pension and full medical coverage as long as they lived. "People felt there was some security that was assured," he recalls.
Then came Irwin L. Jacobs. Pressed by the Minneapolis raider, Kaiser went private in a 1984 leveraged buyout. Jacobs pocketed more than $60 million for selling his stake in Kaiser, including $14 million in greenmail. But under the new owners and the heavy LBO debt, Kaiser ran aground, unable even to pay health insurance premiums. By 1987, it had filed for bankruptcy, leaving Rabone and more than 7,000 other retirees with slashed pensions and no medical insurance. "People were asking: `Do I pay my bills and buy groceries, or do I buy my prescriptions?' " says Rabone.
Now, Rabone is hoping that a group of Kaiser retirees will be able to recapture some of the $160 million in cash that the LBO paid to stockholders. Kaiser, on behalf of retirees and other creditors, is suing Jacobs and a slew of Wall Street firms, including Goldman Sachs, Bear Stearns, and Smith Barney. At issue: Can public investors, and even their brokers, be held liable for money they made on an LBO if it later goes sour? The defendants, of course, say no.
The case, awaiting arguments set for Sept. 19 before a U. S. Circuit Court of Appeals, promises to plant a signpost in an expanding area of the law known as "fraudulent conveyance." This legal concept isn't new: The first fraudulent-conveyance statute dates back to Elizabethan England. The term has less to do with fraud in the usual sense than it does with the transfer of assets out of an insolvent company--or an asset transfer that leaves a company without enough capital to operate.
STICKY WICKET. Now, creditors are aggressively exploring ways to expand fraudulent conveyance to failed LBOs (table). With the likes of Revco DS Inc. and Campeau Corp. in bankruptcy, fraudulent conveyance "is a hot topic right now," says Marty Harper, a lawyer for Kaiser creditors.
The legal principle behind this new wave of fraudulent-conveyance cases is familiar, notes University of Chicago law professor Douglas G. Baird: If a business was insolvent at the time of its sale, then its creditors--not those who sold the business--are entitled to any proceeds. "If I'm a debtor and you're a creditor," Baird explains, "one of the things I can't do is transfer my assets to escape paying you back."
Particulars of the current cases differ. But in each, creditors of the bankrupt company are trying to get back from selling shareholders--and, in some cases lenders, accountants, and financial intermediaries--proceeds and fees from a buyout that sometimes was completed years ago. The Kaiser suit looms especially large because, among the pending fraudulent-conveyance cases, it's at the highest judicial level--just below the U. S. Supreme Court. "It will certainly color arguments in other cases," says Barry L. Zaretsky, a Brooklyn Law School professor and the court's examiner in the Revco case.
In trying to recover money from stockholders and their brokers, the Kaiser plaintiffs have their work cut out. The lower court agreed with defendants that Congress in 1982 protected them from such suits. To maintain liquidity in the securities markets, the law shields payments made in the chain ef transactions that compose the clearing and settlement process-- where, say, cash goes from a buyer to his broker, from the broker to a clearinghouse, from the clearinghouse to the seller's broker, and then to the seller. Last year, the appeals court upheld dismissal of the suit against mere "conduits," such as clearinghouses, but agreed to decide if brokers and investors may be sued.
It's an excruciatingly technical point, to be sure. But it's also one that, given the last decade's craze for going private, could have a sweeping impact if the appeals court agrees. Consider: If investors could be held liable when they buy stock in a pending takeover that years later is deemed to be a fraudulent conveyance, they'll surely think twice, damaging liquidity. Citing the potential instability such a ruling could bring to the securities-settlement system, the Securities & Exchange Commission has filed court papers siding with the defense.
Even if the appeals court rules against Kaiser, Jacobs and his investment partners won't be finished with the whole affair. The lower court specifically excluded the Jacobs group from its dismissal of the suit against the others. Plaintiffs allege that Jacobs knew that Kaiser's huge unfunded liabilities, especially those for the retirees' medical benefits, made it insolvent before the buyout but that he went ahead and helped to strip the company anyway.
At that, Jacobs scoffs. Kaiser, he says, "was definitely a going concern." Kaiser's accountants, Touche Ross, came to the same conclusion, notes Jacobs' lawyer, Jerome B. Simon, who says that to challenge the audit "is Alice in Wonderland." Jacobs adds that Kaiser "just sued everybody they could find."
Rabone blames just about everybody, too, including Kaiser's former management and board, which Kaiser also sued. Kaiser in June settled that case for $17 million. And, through a court-ordered trust, the Rabones now have health insurance. But coverage is less generous, and it costs them $235 a month. Folks in Fontana are "hopeful we may be able to increase those benefits" through the suits, Rabone says. Yet the bitterness over the failed Kaiser LBO remains.
BIG FRAUDULENT-CONVEYANCE CASES
Kaiser no longer makes steel, but for retired steelworkers and other creditors it's still seeking over $200 million from investors and advisers who worked on the 1984 buyout
Creditors are suing investor Reginald Lewis and lender Bankers Trust over the 1987 buyout. In a key July ruling, the court said financiers could be forced at trial to forfeit their fees
Donald Trump paid $16 million to settle fraudulent-conveyance claims by Resorts bondholders after his 1988 sale of Resorts International to Merv Griffin
The drug store chain, now in bankruptcy, has dropped its fraudulent-conveyance suit against small shareholders and advisers involved in its 1986 buyout. It's still pursuing big investors and lenders
DATA: BWRobert Barker in Fontana, Calif., with David Greising in Chicago