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