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AEP Energy Services Gas Holding Co. v. Bank of America

August 28, 2007

AEP ENERGY SERVICES GAS HOLDING COMPANY, ET AL., PLAINTIFFS,
v.
BANK OF AMERICA, N.A., ET ANO., DEFENDANTS.



OPINION

In this action plaintiffs are AEP Energy Services Gas Holding Company ("AEPGH"), Houston Pipe Line Company LP, and HPL Resources Company LP (together "HPL"). All plaintiffs will usually be referred to in this opinion as "AEP." Defendants are Bank of America, N.A., ("BofA") and The Bank of New York ("BONY"). BONY is trustee of an entity known as Bammel Gas Trust ("BGT"). BGT is a special-purpose entity owned in equal shares by BofA and Enron Finance Corp., a subsidiary of Enron Corp. In one of the two transactions at the heart of this case, BGT borrowed money from BofA to buy gas from HPL, which it then, effectively leased back to HPL.

AEP's claims arise out of a 2001 transaction wherein AEPGH purchased HPL from Enron. AEP's claims can be divided into two sets, (1) declaratory claims, whereby AEP seeks declarations that BofA has no security interest in natural gas stored in HPL's facilities, and (2) contract and tort claims for damages in which AEP claims that BofA fraudulently induced AEP to enter into the 2001 transaction.

The following is a description of the motions that have been made with respect to various counts in the complaint and various counterclaims in the answer. There are ten counts in the complaint and seven counterclaims asserted by defendants. A description of the allegations in the various counts and counterclaims will be deferred until later in the opinion, after a summary of the facts.

The Motions and Prior Rulings

Seven motions have been made: (1) AEP's motion for partial summary judgment seeking to prevail on Counts II and VI of the complaint and seeking dismissal of all of defendants' counterclaims; (2) BofA's cross-motion for partial summary judgment dismissing Count VI of the complaint; (3) BofA's motion to refer AEP's motion for partial summary judgment to the Enron bankruptcy court; (4) BofA's motion for summary judgment seeking dismissal of all of AEP's claims and seeking relief on BofA's counterclaims II-IV; (5) AEP's motion to file a third amended complaint; (6) AEP's motion to correct the summary judgment record; and (7) AEP's motion to defer BofA's main motion for summary judgment pending additional discovery.

Prior Rulings

On January 31 and February 1, 2007, and later on March 12, the court heard argument on the summary judgment motions. On February 1, the court made several findings on the record. The court held that BofA has a valid, presently-enforceable security interest in 55 billion cubic feet of gas that was not subordinated in the 2001 transaction in any way. The court also held that the Enron bankruptcy was a default under the relevant agreements. The court further held that the settlement agreement between Enron and BofA that resolved BofA's claims in the bankruptcy court does not affect BofA's ability to enforce its security. Finally, the court rejected AEP's theory that the 1997 transaction was a sham. Under that theory, AEP argued that BofA has no security interest in the gas because BGT is not the true owner of the gas.

On February 22, after submissions from counsel, the court sent a memorandum to counsel applying its findings to specific counts and counterclaims in the summary judgment motions. The court denied AEP's motion as to Counts II and VI, and granted BofA's motion with respect to Counts II through VI, dismissing these counts. With respect to the counterclaims, the court denied AEP's motion as to the counterclaims, and granted BofA's motion as to Counterclaims II through IV. The court also denied BofA's motion to refer AEP's partial motion for summary judgment to the bankruptcy court. Those rulings are hereby confirmed.

Also in the February 22 memorandum, the court reserved decision on BofA's motion regarding Counts I and VII through X of the complaint. As to the counterclaims, there were no motions remaining. There was further argument on Counts VII through X on March 12 after which the court again reserved decision.

The present opinion deals with Counts I and VII through X of AEP's complaint. Count I seeks a declaration that BofA's security interest in gas owned by BGT is limited to an interest in personal property storage gas. Counts VII through X allege causes of action for false contractual representation, common law fraud, fraud in a stock transaction (Texas statute), and negligent misrepresentation. For the reasons stated below, the court grants BofA's motion on Counts I and VII through X, and the counts are dismissed. Thus, the entire complaint is now dismissed.

The court denies the other three motions filed by AEP-motions for leave to file a third amended complaint, to correct the summary judgment record, and to defer summary judgment proceedings under Rule 56(f).

Facts

On December 30, 1997, Enron entered into a complex special-purpose-entity ("SPE") transaction that was structured to qualify for "off-balance-sheet" accounting treatment. The transaction is documented in a number of agreements collectively referred to as the "Operative Documents." The Operative Documents include, inter alia, a Participation Agreement, a Security Agreement, a Pressurization Agreement, a Marketing Agreement, a Performance Guaranty, a Declaration of Trust, an Option Agreement, a Storage Gas Sale Agreement, and a Commodity Swap Agreement between BGT and BofA. Another relevant agreement, which is not part of the Operative Documents, is a Commodity Swap Agreement between BofA and Enron Capital and Trade Resources Corp. ("ECT"), an Enron subsidiary. The relevant details of the transaction are as follows.

BGT, the SPE in this transaction, was created by the Declaration of Trust, and BONY was made trustee. BGT is owned in equal shares by BofA and Enron Finance Corp. As part of the transaction, BGT bought 80 Bcf (billion cubic feet) of natural gas from HPL, which was then an Enron subsidiary. The agreements refer to this gas as Storage Gas. BGT paid $232 million for the gas.

HPL operates the Bammel Storage Facility (or Storage Reservoir), an underground storage reservoir for natural gas, and a gas pipeline associated with it. The Storage Gas bought by BGT was a mix of 55 Bcf of "cushion gas" and 25 Bcf of "working gas" that was contained in the Bammel Storage Facility. Cushion gas is gas that is needed to pressurize the facility and that allows the facility to function. Cushion gas cannot be withdrawn without destroying the facility. Working gas is non-cushion gas that is stored in the Bammel Facility.

BGT obtained the money to purchase the gas from (1) a $218 million loan from Nations Bank, N.A., the predecessor-in-interest to BofA;*fn1 and (2) equity investments in BGT by BofA and Enron Finance Corp., each in the amount of $6.96 million. Under the Security Agreement, BGT granted BofA a security interest in the purchased gas, as collateral for the loan.

Although BGT purchased the gas from HPL, BGT agreed to allow HPL to continue to use the gas according to the terms of the Pressurization Agreement. In return, HPL agreed to pay BGT "pressurization fees." BGT used the pressurization fees received from HPL to pay the interest on the loan to BofA. Also under the Pressurization Agreement, beginning in February 2004, HPL was obligated to withdraw the gas and make it available to BGT according to the following schedule:

Month Volume (in Bcf)

February 2004 6.925374

March 2004 7.402986

April 2004 7.164180

May 2004 7.402986

June 2004 7.164180

July 2004 7.402986

August 2004 7.402986

September 2004 7.164180

October 2004 7.402986

November 2004 7.164180

December 2004 7.402986

Under the Marketing Agreement, ECT agreed to sell the gas that HPL made available throughout 2004 on behalf of BGT. The proceeds from this sale would be used by BGT to pay back the principal of the loan to BofA. Since the majority of the gas owned by BGT was cushion gas, which cannot be withdrawn without destroying the facility, HPL was authorized to make available, and ECT was authorized to sell, amounts of gas equivalent to the cushion gas, called "exchange gas."

HPL also received an option to purchase the gas, pursuant to the Option Agreement.

As part of the transaction, BGT entered into a commodity swap with BofA in order to hedge against the variable price of natural gas, its only asset. As the gas was to be sold off in 2004, BGT was to pay BofA the then-current (2004) price of gas and BofA was to pay to BGT the 1997 price. BofA then entered into a parallel commodity swap with ECT in order to hedge against BofA's risk. Under this swap, BofA was to pay ECT the 2004 price, and ECT was to pay BofA the 1997 price. AEP refers to this set of swaps as the back-to-back commodity swap. The agreement evidencing this latter commodity swap is the agreement that is not part of the Operative Documents.

Finally, Enron executed a Performance Guaranty in favor of BofA and BGT. Enron guaranteed the performance of all of HPL's and ECT's obligations under the Operative Documents.

The purpose of this 1997 transaction was to "monetize" the gas-Enron essentially converted the gas, a commodity, into cash-while keeping the liability for the loan off of Enron's consolidated balance sheet. That is, if this transaction qualified as an SPE transaction and qualified for off-balance-sheet treatment under the applicable accounting rules-a question which is part of the dispute in this case-then Enron could properly recognize the proceeds of the sale of the gas to BGT without having to report the debt to BofA on its financial statements.

Sometime in 2000, Enron decided to sell HPL. For its own accounting advantage, Enron desired to leave the 1997 transaction in place and to provide a long-term lease of the Bammel pipeline and the Bammel Storage Facility, which HPL operates, to the eventual purchaser. As it turned out, AEP was the purchaser in a complex transaction that closed at the end of May 2001. The following is a description of what led to this transaction.

In July 2000, AEP expressed interest in purchasing HPL. Dwayne Hart, AEP's Vice President for Business Development, had previously worked at Enron, was familiar with HPL, and knew that the storage gas was monetized. AEP desired to purchase HPL, the Storage Facility, the pipeline and the gas owned by BGT, but Enron refused.

In August 2000-after reviewing a memorandum from Enron's investment bankers-AEP submitted a non-binding bid for HPL. In September, Enron created a data room for AEP to conduct due diligence. AEP sent twenty-five people to the data room, including outside counsel and investment advisors. By late November or early December, AEP was provided with the Operative Documents (see supra). During the diligence, AEP requested to review audit work papers of Arthur Andersen relating to Enron. Enron refused. The parties dispute whether AEP received the Commodity Swap Agreement between BofA and ECT.

After months of negotiating, AEP and Enron settled on a transaction with the following structure. AEP bought HPL. HPL bought 25 Bcf of working gas back from BGT for $94 million (BofA later agreed to release its security interest in that amount of gas (see infra)). That left BGT with title to 55 Bcf of cushion gas only. HPL assigned its rights and obligations under the 1997 transaction to BAM Lease Co. ("LeaseCo"), an Enron subsidiary. LeaseCo then leased the Bammel Storage Reservoir and its associated pipelines and facilities to HPL for thirty years (with an optional renewal term of twenty years). AEP prepaid the rent for the entire thirty-year lease in the amount of $274 million. Additionally, under a Right to Use Agreement, LeaseCo granted HPL "quiet enjoyment" of the cushion gas. Quiet enjoyment is defined in the Right to Use Agreement as possession and use of the cushion gas free of adverse claims of third parties (§ 1.01).

Thus, LeaseCo was used as a vehicle for granting HPL (and AEP who was buying HPL) all of the rights that HPL had had under the 1997 transaction, while Enron continued to retain all of the obligations of HPL under that transaction (via LeaseCo). That is, HPL continued to use and operate the Bammel Facilities and the cushion gas, but LeaseCo was now obligated to make the pressurization payments to BGT. That way, the 1997 structure was kept in place and AEP received the Bammel Facilities in a transaction which was as close to a sale as was possible. All told, AEP paid over $741 million.

All of the above was negotiated by December 27, 2000, when Enron and AEP signed a Purchase and Sale Agreement. However, BofA, whose security would be affected, had not yet been brought in. BofA was finally approached in early 2001 and it eventually consented to the new arrangement. In May 2001, the parties, including BofA, executed a number of agreements. Several of the agreements were amended and restated versions of the 1997 transaction documents. For example, the Security Agreement between BofA and BONY, the Performance Guaranty by Enron, and the Pressurization Agreement were all amended to substitute LeaseCo for HPL and to account for the reduction of BofA's security interest from 80 Bcf to 55 Bcf. BofA agreed to release 25 Bcf from its security. The increase in natural gas prices since 1997 ensured that with only 55 Bcf in 2001, BofA still had enough value in the security to cover the loan. Though the Right to Use Agreement, mentioned above, was negotiated by the end of 2000, it was also only executed in May 2001.

Finally, BONY, HPL, Enron, and BofA executed a Consent and Acknowledgement (the "Cushion Gas Consent"). The central provision in the Cushion Gas Consent was that BofA consented to HPL's use of the cushion gas as provided in the Right to Use Agreement. The Cushion Gas Consent also explicitly preserved BofA's security interest in the gas. Cushion Gas Consent § 10 ("For avoidance of doubt, nothing herein shall impair the lien and security interest of BofA under the Security Agreement . . ."). It was AEP and Enron who drafted the Consent, and they presented it, fully drafted, to BofA for signing. BofA changed a single word before signing it-it added the word "actual" before "knowledge" in section 2(e).

Section 2(e) is the centerpiece of AEP's misrepresentation and fraud claims ("section 2(e) claims"), dealt with in this opinion. It provides that,

Each of BofA and the Trustee agrees and acknowledges that each Operative Agreement is in full force and effect and that, to its actual knowledge, no defaults by . . . [Enron] exist and no events or conditions exist which after the passage of time or the giving of notice or both would constitute a default or Event of Default by . . . [Enron] thereunder.

The parties have agreed on how to construe the phrase - "to its actual knowledge, no defaults by Enron exist" - as follows. The parties agree that what is meant here is that, at the time of the closing of the 2001 transaction, BofA did not possess any actual knowledge of Enron defaults.

Under section 5.01 of the Amended and Restated Performance Guaranty, one of the Operative Documents, there exists a default if any representation made by Enron under the Guaranty is incorrect in any material respect. One of the representations made by Enron under the Guaranty is that,

The audited consolidated balance sheet of Enron and its Subsidiaries as of December 31, 2000, and the related audited consolidated statements of income, cash flows, and changes in stockholders' equity accounts for the fiscal year then ended and the unaudited consolidated balance sheet of Enron and its Subsidiaries as of March 31, 2001, and the related audited consolidated statements of income, cash flows, and changes in stockholders' equity accounts for the fiscal quarter then ended . . . fairly ...


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