On April 3, 2014, the U.S. government announced it had reached a $5.15 billion settlement with Anadarko Petroleum Corp. (“Anadarko”), the largest settlement for environmental contamination in U.S. history. The settlement resolves 85 years of environmental liabilities by Kerr-McGee Corp. (“Kerr-McGee”), which Anadarko acquired in 2006.

While the settlement must be approved by a federal bankruptcy court, all parties have moved on from what has been a protracted legal dispute that ended with a finding that Kerr-McGee’s spinoff of its corporate environmental liabilities was a fraudulent conveyance. The U.S. Department of Justice’s Environment and Natural Resource Division, the U.S. Attorney’s Office for the Southern District of New York, and the U.S. Environmental Protection Agency all declared victory and issued press releases condemning the environmental and corporate conduct that led to the settlement. Meanwhile, Anadarko’s share price rose nearly 15% after the announcement and reached an all-time high, and analysts deemed the company to be a prime acquisition target for major oil companies.

This Bryan Cave bulletin discusses and identifies takeaways from this record government settlement, and concludes with a look at how the government may itself apply these lessons.

Background

In 2006, Texas-based Anadarko acquired Oklahoma-based Kerr-McGee for $18 billion. The acquisition came just three months after Kerr-McGee finalized a long-planned corporate spinoff of its chemical production business and its significant environmental liabilities. Kerr-McGee retained its valuable oil & gas exploration and production unit (which generated approximately $1.8 billion in profit in 2005). The spun-off company, Tronox, Inc. (“Tronox”), in contrast, took over the less lucrative titanium dioxide business (which generated $106 million in profit in 2005) and all Kerr-McGee environmental liabilities. These liabilities included responsibility for contamination of more than 2,700 sites in 47 states, which resulted from such activities as uranium mining, radioactive thorium production, and manufacturing of a component in rocket fuel.

From its inception Tronox’s structure lended itself to failure. In the spinoff, Tronox received (i) $550 million in debt, (ii) just $40 million in cash, and (iii) environmental liabilities that had cost Kerr-McGee an excess of $1 billion between 2000 and 2005. Whereas Kerr-McGee had spent an average of $160 million per year on environmental remediation, Tronox was only able to fund $90 million per year. The cost of Kerr-McGee’s legacy environmental liabilities amounted to 56% of Tronox’s EBITDA in 2006 and 95% in 2007. Tronox filed for bankruptcy in 2009.

In May 2009, the United States and co-plaintiff Anadarko Litigation Trust filed a complaint in the Tronox bankruptcy case alleging that Kerr-McGee’s corporate spinoff was a fraudulent transfer of its liabilities intended to shield Kerr-McGee from environmental liability. In December 2013, after a 34-day trial, the U.S. Bankruptcy Court for the Southern District of New York found that the separation of Kerr-McGee’s oil & gas assets from its legacy environmental liabilities was a fraudulent conveyance. In an issue of first impression involving the application of fraudulent conveyance laws to substantial environmental and tort liability, the bankruptcy court found that Kerr-McGee had acted with an intent to hinder and delay creditors through the corporate spinoff.

While the United States initially sought $25 billion for environmental cleanup, the bankruptcy court rejected this request, stating that Kerr-McGee “must respond in damages, but not at the level demanded by the Plaintiffs.” Based on expert testimony, the judge identified the range of damages from the fraudulent conveyance to be between $5.15 billion and $14.17 billion, plus attorneys fees.

The settlement for $5.15 billion is at the bottom of the bankruptcy court’s estimated damages. Of the settlement amount, 88% ($4.4 billion) will pay for environmental cleanup and to settle claims from Kerr- McGee’s legacy contamination. The remainder of the settlement will be used to satisfy tort claims alleging health effects from the contamination.

Lessons Learned

Based on Kerr-McGee’s conduct in spinning off its environmental liabilities, there are critical takeaways for companies considering corporate spinoffs and/or managing environmental liabilities.

  1. Analyze Ability to Support Liabilities. The bankruptcy judge was perplexed by Kerr-McGee’s lack of analysis of Tronox’s ability to manage legacy liabilities: “one of the most compelling facts [was] the absence of any contemporaneous analysis of Tronox’s ability to support the legacy liabilities being imposed on it.” Based on the record, it appears that neither Kerr-McGee’s Board nor management reviewed a contemporaneous analysis of the effect of the liability transfer on legacy liability creditors.
  2. Allocate Proportional Liabilities. In the spinoff, Tronox was saddled with a disproportionate and unexplainable amount of Kerr-McGee’s liabilities. For instance:
  • Legacy Environmental Liabilities. The bankruptcy court emphasized that Kerr-McGee “never articulated a legitimate business reason for imposing all of the legacy liabilities on Tronox.” In fact, Kerr-McGee transferred to Tronox “every legacy liability of every discontinued business that Kerr- McGee had engaged in over the prior 75 years” – even for those businesses that were closely associated with the oil & gas business, such as drilling, refining, and petroleum production manufacturing and marketing.
  • Other Liabilities. In addition, Kerr-McGee required that Tronox assume responsibility for $442 million in pension obligations and $186 million in other unfunded post-employment benefits. In fact, the only liabilities that Kerr-McGee’s oil & gas unit retained were liabilities associated with current xploration and production operations.
  1. Ensure a Realistic Financial Structure. The conditions imposed on Tronox led the company down a path towards eventual bankruptcy. For instance:
  • Environmental Remediation Requirements. Despite being left with only $40 million in cash, Tronox was prohibited for seven years from amending policies that Kerr-McGee had established for environmental remediation and administration.
  • “Illusory” Indemnification. The bankruptcy court assessed a $100 million, seven-year indemnity running from Kerr-McGee to Tronox as “illusory” because (i) the indemnity would cover only 50% of Tronox’s environmental remediation costs and (ii) only if Tronox spent $200,000 more than the existing environmental reserve at each individual contamination site. Because Tronox never had sufficient cash, it could never trigger Kerr-McGee’s reimbursement obligation.
  1. Do Not Withhold Critical Information From Directors. The bankruptcy court condemned Kerr-McGee for management’s failure to advise the company’s Board of the risk of a spinoff in a bankruptcy situation. After Kerr-McGee’s lawyers spent three months researching fraudulent conveyance litigation in failed spinoffs, the company’s investment bank concluded in a draft Board presentation that a spinoff would be a cleaner “separation from legacy liabilities” than a sale, but that it would be “[c]omplicated under [a] bankruptcy scenario.” In the final Board presentation, however, the bankruptcy complications were deleted and the Board was never advised of the very scenario that eventually played out with Tronox.
  2. Establish Precautions to Preserve Documents. Applicable in any case or investigation, it remains fundamental to preserve relevant documents. The bankruptcy court criticized Kerr-McGee for its “cavalier attitude” toward the destruction of documents in violation of an agreement with the Justice Department. In 2006, Kerr-McGee’s Chief Executive Officer retired and directed his secretary to destroy all of his files. That same year, the company’s Chief Financial Officer also retired and directed that (i) all of his documents related to the Tronox spinoff, other than formal agreements, be destroyed and (ii) all emails and electronic documents be deleted from his computer.

Conclusion

Though Kerr-McGee’s conspicuous conduct provided the government with its case for a fraudulent transfer claim, companies must nonetheless be vigilant to properly structure a spinoff and/or conveyance of legacy liabilities, particularly in highly-regulated industries. In the future, it is likely that the government will use the lessons from the Anadarko settlement as guideposts to determine whether to seek redress from an acquirer for the conduct of an acquired company.