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Enron vs Dynegy raises key questions

What did Dynegy Inc know and when did it know it?

That Watergate-like question is among several that US Bankruptcy Court Judge Arthur J Gonzalez will have to answer in deciding whether the Houston energy company should pay $9 billion or more to rival Enron Corp for backing out of its merger.

While legal experts generally give the winning odds to Dynegy, they say it is by no means an open-and-shut case. IBP Inc, for instance, recently won a long-shot legal battle to force Tyson Foods Inc to heed a merger contract in a similar case.

"Typically these things are not easy to win," said Thomas Lys, professor of mergers and acquisitions at Northwestern University's Kellogg School of Management. But he added that the IBP lawsuit proves it's not a complete long shot.

Enron, which filed both the damages suit and a Chapter 11 bankruptcy filing on Sunday in the Southern District of New York, claimed that Dynegy "wrongfully" breached an agreement to buy Enron in a $9 billion stock deal.

The dispute will explore two key questions. First, did Enron inform Dynegy of the depths of its financial problems during the merger talks? Also, can Dynegy show that there were sufficient grounds to invoke the "material adverse change" provision in walking away from the deal?

Legal experts say that the mounting lawsuits against Enron are already a big enough threat to be considered an "adverse change" since the deal was struck.

Enron faces major litigation on many fronts, including suits by shareholders, employees and others. In addition, it's facing federal and congressional investigations over its byzantine financial structure, off-balance sheet transactions, restated profits and allegations of insider dealings, providing still more fodder for multibillion-dollar class-action suits alone.

Enron may also have difficulty proving it adequately disclosed its financial condition, legal experts say, since it's unlikely to be given the benefit of the doubt, given a widespread perception that it was less-than-forthcoming about its problems. Many were caught unaware as its share price collapsed and it ultimately made its bankruptcy filing December 2.

"It's hard to know who is right, since we can't say what Enron told Dynegy or what they didn't," said one New York bankruptcy attorney not involved in the case who asked to remain anonymous. "However, there is a widespread perception that Enron was not forthright."

In exiting the merger agreement, Dynegy claimed that Enron failed to disclose its financial liabilities, notably a $691 million note payment that was accelerated to late last month due to a ratings downgrade. It also said Dynegy believed Enron had $3 billion in cash on its books, when it had only $1.2 billion, as it disclosed in a "10-Q" regulatory filing after the deal was signed.

The cash shortfall "destroyed any remaining confidence or credibility, and that is what killed the deal," a Dynegy official told investors on a conference call December 3.

For its part, Enron is claiming that Dynegy had another agenda all along. Martin Bienenstock, a Weil Gotshal & Manges attorney who is leading Enron's legal case, claimed that Dynegy used Enron's 10-Q disclosure as a ruse to effectively ruin a major rival and take possession of the Northern Natural Gas pipeline, the prized Enron asset that is also at the centre of the dispute.

As part of the contract, Dynegy obtained an option to buy the Northern Natural pipeline in return for a $1.5 billion cash infusion in preferred shares in the event the deal was "properly" terminated. Enron claims that since Dynegy "wrongfully" terminated the deal, it has no right to take over the pipeline.

"Anything that might have happened after the signing was all based on facts that Dynegy knew or should have known prior to the signing," said Bienenstock in an interview.

Outside legal experts said that even if Enron wins none of its claims, it may have good reason to file the lawsuit. By saddling Dynegy with the threat that it may lose the case and pay a whopping legal settlement, Enron may effectively be trying to force Dynegy to drop its claim to the pipeline.

Although Dynegy derides Enron's suit as "frivolous and disingenuous," the implications and uncertainties of a major legal battle can be worrisome for trading partners and creditors. And Dynegy's share fall in recent days is reflecting that.

While Enron's chances of winning its claim to "not less than $10 billion" from Dynegy appear slim, some experts say bankruptcy court judges tend to try to ensure the long-term survival of companies in such cases. And that could well mean that Enron needs to keep what is one of its key assets, the Northern Natural pipeline.

"This may be a tactical lawsuit to get the pipeline back, reasoning that Dynegy's creditors are going to get nervous," said Joel Greenberg, a partner in law firm Kay, Scholer, Fierman, Hayes, Handler LLP and chairman of the firm's corporate finance practice.

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