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October 25, 2005.

ARBAY LLC, Plaintiff,
DUQUESNE LIGHT HOLDINGS, INC., et al., Defendants.

The opinion of the court was delivered by: THOMAS HARDIMAN, District Judge


I. Introduction

This case arises out of the purchase and sale of landfill gas interests. Plaintiff Arbay LLC (Arbay) is an Isle of Man company that was created to acquire the gas interests at issue and transfer them to Defendants, which sought to take advantage of substantial tax benefits pursuant to § 351 of the Internal Revenue Code. The tax benefits were denied by the Internal Revenue Service and the landfill gas sites are inoperative.

  Arbay was a nominal party to the transaction and remains so in this case, having assigned its rights to Diversified Group, Inc. (Diversified). The Defendants — Duquesne Light Holdings, Inc., formerly known as DQE, Inc. (DLH), Duquesne Light Company (DLC), and Envirogas Holdings, Inc., formerly known as Envirogas Recovery, Inc. (Envirogas) — are related companies.

  A two day bench trial was held on August 1-2, 2005. The gravamen of Arbay's claim is that Defendants DLH and DLC breached their promises to redeem $1,000,000 in Envirogas preferred stock and to pay Arbay 6% dividends thereon for 20 years. II. Facts

  A. The Arbay-Envirogas Transaction

  The transaction that precipitated this case (Transaction) was conceived by Edward Wallace of Florin Financial (Florin). Wallace and Florin had experience with tax-driven corporate deals and had facilitated five § 351 transactions with DLH subsidiaries other than Envirogas. Diversified and its principal, James Haber, had experience with similar transactions. Arbay facilitated the acquisition of the landfill gas interests by borrowing 500,000,000 Dutch guilders (worth approximately $250,000,000) from Rabobank (Loan).

  The Loan was secured by a collateral account which held the majority of the proceeds of the Loan and the landfill gas interests. Thereafter, Arbay contributed all of its holdings in the landfill gas interests to Envirogas in exchange for: (1) $20,000,000 in cash; (2) Envirogas' assumption of Arbay's outstanding payment obligations to the developer of the landfill gas sites; (3) $1,000,000 of Envirogas preferred stock (Preferred Stock); and (4) an assumption agreement in which Envirogas became co-obligor on the Loan. Arbay's actual compensation for the Transaction was only $750,000 because the $20,000,000 in cash and $1,000,000 in Preferred Stock were paid to Diversified and Florin. As part of the Transaction, Monongahela Light & Power (ML&P) was required to guarantee the obligations of its subsidiary Envirogas and to agree further to retain sole ownership of another DQE subsidiary, Diemen Flevo, which would continue to hold DLH bonds worth $60,000,000.

  On November 3, 1997, Arbay, Envirogas and ML&P entered into a Subscription and Contribution Agreement (Subscription Agreement). The Subscription Agreement is an integrated contract that served as the operative document for the Transaction. All parties hoped that the Transaction would satisfy the requirements of § 351 of the Internal Revenue Code, which involves an asset for stock exchange and is intended to defer the recognition of gain or loss on the transferred property by importing the transferor's basis in the property to the transferee, requiring gain or loss to be recognized only when the property is sold. Thus, Defendants sought to acquire a "stepped-up basis" in the transferred assets that included the amount of the Loan. In addition, certain tax credits were available under § 29 of the Internal Revenue Code for gas produced from landfills, although they were worth substantially less than the tax benefits to be derived from the stepped-up basis. In order to qualify the Transaction under § 351, it was necessary to issue preferred stock that met certain criteria.

  Schedule A to the Subscription Agreement sets forth the terms of the Preferred Stock that was issued to Arbay, which provides that dividends are to be paid ". . . when and if declared by the Board of Directors. . . ." In addition, Envirogas may redeem the stock after the twenty-first anniversary of its issuance.

  B. The Parties and Their Discussions Regarding the Transaction

  Although Arbay is the named Plaintiff in the case, Diversified is the real party in interest Diversified is a trust for the benefit of the children of its President, James Haber, who, along with Arbay's counsel, Robert Unger, had substantial involvement in the Transaction. By agreement, Diversified contracted to act on Arbay's behalf on all United States matters and was assigned all of Arbay's interests in the Transaction. Accordingly, any recovery in this lawsuit belongs to Diversified.

  Defendants DLH and DLC are Pennsylvania corporations, while Defendant Envirogas is a Delaware corporation. Envirogas is a subsidiary of DQE Financial, formerly known as Montauk, Inc., and is the successor in interest to Envirogas Recovery, Inc. Christine Hovan Flynn (Flynn), who was an employee of DLC and President of Envirogas from the time of its formation in 1997, managed the execution process of various transactions for DLC. She interacted with personnel of the companies with whom DLC contracted and ensured that all of the necessary approvals were obtained. Flynn had neither the authority nor the responsibility for negotiating the terms of the Arbay Transaction. Instead, she prepared presentations to explain and present the Transaction to senior management for approval. Flynn interacted with Diversified and Haber to gain an understanding of the structure of the Transaction so she could communicate effectively with senior management. She also interacted with Robert Unger, who was counsel to Arbay and viewed Flynn as a "high-up executive" with DLC, but he had no details regarding Flynn's role or authority.

  In early 1997, based on its experience with Florin, DLH decided to pursue the § 351 Transaction utilizing assets which were also eligible for tax credits under § 29 of the Internal Revenue Code. The purpose of the Transaction was to help DLH and DLC meet their tax planning objectives, and to provide a creative financing mechanism to enable DLC to meet its earnings objectives and support its stranded cost ...

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