Enron Corp is mounting a counter challenge in a lawsuit brought against it by Westdeutsche Landesbank Girozentrale (WestLB) in a New York court. The bank is seeking the turnover of the US$19.9 million it paid under a standby letter of credit (L/C) to a customer of two related subsidiaries of the collapsed US energy giant.

A central issue in the case is that money paid by the customer, TPS McAdams LLC to the Enron subsidiaries, National Energy Production Corp (NEPCO) and NEPCO Power Procurement Company (NEPCO Power), for engineering work at a Mississippi power project was not used to pay for costs associated with that project. Rather, Enron 'swept' the funds paid to its subsidiary into its own coffers.

Outline claims

West LB claims the NEPCO subsidiaries - which are not bankrupt - should have retained all funds paid for the construction work in the power project. Enron claims the bank's efforts to recover its US$19.9 million are an attempt to circumvent subordination principles under bankruptcy law.

Enron has moved to dismiss the adversary proceeding brought by WestLB in the US Bankruptcy Court for the Southern District of New York on 8 January 2002. The bank contends it should be able to recover the US$19.9 million because it is not a part of Enron's bankruptcy estate.

WestLB's argument

The bank's complaint states that Enron's two NEPCO subsidiaries entered into a series of contracts worth around US$240 million with TPS McAdams in the construction of the 599MW McAdams Power Station in Mississippi.

TPS McAdams, part of TECO Power Services Corp., made stage payments of around US$186 million as work on the power station progressed according to the complaint. WestLB maintains these payments should have covered amounts due to subcontractors and suppliers on the project, as well as amounts due to the Enron subsidiaries.

Funds witheld

According to WestLB, TPS McAdams withheld 10 per cent of the stage payments in order to secure the satisfactory completion of work under the contracts and by August 2001 had withheld some US$20 million of funds which the NEPCO subsidiaries could obtain a form of security such as L/C were posted.

In the same month and Enron asked WestLB to arrange a US$23.9 million L/C on behalf of NEPCO and in favour of TPS McAdams. This would be arranged under a master L/C and reimbursement agreement already agreed between the bank and Enron. WestLB says it issued on 14 August 2001 an irrevocable, standby L/C naming TPS McAdams as a beneficiary, and Enron as an applicant on behalf of NEPCO and NEPCO Power.

Default

The L/C essentially allowed for TPS McAdams to draw funds upon presentation to the bank of a sight draft and a certification that either NEPCO or NEPCO Power failed to fulfil conditions of the construction contracts. TPS McAdams asked for payment of US$19.9 million under the L/C on 3 December 2001, the day after Enron filed for bankruptcy. WestLB paid TPS McAdams on 14 December 2001.

WestLB maintains that only after it had made payment did it discover that stage payments made in the project were not used to meet the project's costs. Rather, they were turned over by the NEPCO subsidiaries' parent company. The bank argues that Enron's capture of the project funds caused the subsidiaries to default under the terms of the construction contracts and that Enron and its two subsidiaries requested the L/C in order to obtain the cash being withheld by TPS McAdams.

Enron should pay

The bank argues it would not have issued the L/C had it known that the two NEPCO companies were funnelling project funds over to Enron and that neither subcontractors and suppliers nor the subsidiaries' own costs in the project were being paid.

WestLB also claims that NEPCO and NEPCO Power were in or on the verge of default under the construction contracts when the L/C was issued and a draw under it was inevitable. The bank further claims that Enron, NEPCO and NEPCO Power were insolvent and there was no possibility of reimbursement of the draw.

An essential strand in WestLB's argument is that Enron holds the McAdams project funds in trust for the subcontractors, suppliers and NEPCO and NEPCO Power. Therefore the bank argues the money is not a part of the Enron bankruptcy estate. The collapsed energy firm should therefore be ordered to give the US$19.9 million to WestLB, according to the bank.

Enron's move to dismiss

The essence of Enron's move to dismiss the complaint lies in the argument that the bank is trying to get round the law of subordination in bankruptcy and that WestLB is a general unsecured creditor seeking to create a right of subrogation. Subrogation means that a new creditor takes the place of the original creditor.

Enron argues that UCP 500, which is applied to the master L/C agreement, does not provide for rights of subrogation. Lawyers for Enron are also arguing that under the US Uniform Commercial Code, the bank is not subrogated to the rights of NEPCO, NEPCO Power or the subcontractors. The lawyers also maintain that WestLB's argument that Enron effectively holds funds in trust for the two subsidiaries and subcontractors conflicts with the principle that a debtor's creditors should be treated equally.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.