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Enron Mail |
I expect that if Mel didn't examine these witnesses in their depositions,
that they will certainly be called at trial. Also, their testimony is consistent with Michael Goldstein's comments to me that I didn't understand the implications of the ruling on these facilities. Personally, I think that Platte's testimony that he didn't officially certify the capacity of the machines in 1998 and, therefore, their capacity is unknown, is sort of contrived and made-up sounding in light of the Rev Proc.and the miracle of hindsight. The Sempra representations to the IRS that the proposed changes would significantly increase production probably didn't mean increase it from 105 to 115 tons per hour. Also, Coston is going to have to explain what he meant when he made his representations to the IRS and I don't think he's going to lie under oath (maybe I'm naive). Regardless of the preceding comments, it sounds like we probably need to talk to Tim W. about these issues and also probably need to talk to the K-M folks (through their lawyer) about this before the next round of depos. On a related note, I spoke with Michael Goldstein on Tuesday about several issues. First, I told him that if they were interested, we were interested in sitting down and talking about resolving things going forward. I questioned whether they would have an open mind toward issues like moving the equipment. He said that this would be up to Mr. Holmes but that he strongly doubted that "repricing the deal" or "dramatically changing the economics" of the deal would be acceptable. I also asked whether he thought a mediation would be acceptable. In response, he indicated that although he wouldn't rule it out, he thought it was premature. Finally, I mentioned that there had been some talk of deposing him. He said that his only involvement in the negotiation phase of the project would be in connection with advice to Sempra and, therefore, these communications would be privileged. He said he only met the Enron folks once before the documents were signed in August and this was supposedly a pretty casual meeting since he was allegedly busy doing other things. He also said that he had no involvement with the IRS PLR's. Let me know your thoughts about deposing him in light of this. Finally, George is still out of town but as soon as he returns, I'll get with him to get out the letter I know that Greg is anxious that we send out. Thanks. -----Original Message----- From: "Johnson, Christopher P." <CPJohnson@brobeck.com<@ENRON [mailto:IMCEANOTES-+22Johnson+2C+20Christopher+20P+2E+22+20+3CCPJohnson+40brob eck+2Ecom+3E+40ENRON@ENRON.com] Sent: Wednesday, May 23, 2001 6:14 PM To: Markel, Gregory A.; Brownfeld, Gail Cc: Setton, Ronit; Leit, David ; Zeisler, Aaron M.; Farache, Olivier N. Subject: R.W. Beck Depos Greg and Gail: I've just completed the depositions of R.W. Beck, Sempra's independent engineers on the Blue Grass/Somerset facilities. Specifically, I deposed Keith Platte all day Tuesday and deposed Lance Hardesty Wednesday morning. The testimony was generally unfavorable to us. In particular, I think they require us to rethink our theory that the recent IRS Rev. Proc.'s places limits on Sempra's "lost tax credit" damage claim. As you know, IRS Rev. Proc. 2001-30 stated that "a facility ... may be relocated without affecting the availability of the credit if all essential components of the facility are retained and the production capacity of the relocated facility is not significantly increased at the new location." It also stated that one of the conditions for obtaining a o 29 ruling is that "[t]he treated feedstock is subjected to elevated temperature and pressure that results in briquettes, pellets, or an extruded fuel product, or the taxpayer represents that the omission of this procedure will not significantly increase the production output of the facility over the remainder of the period during which the o 29 credit is allowable." This recent ruling from the IRS, of course, was inconsistent with Sempra's May 2000 PLR request, in which Richard Coston stated that "[a]nother consequence of the use of our emulsion binder is that less pressure is required in the briquetting phase to produce a synthetic fuel with a significant chemical change .... Applying less pressure[s] causes two changes to occur in the production process. First a smaller percentage of the synthetic fuel will be in the form of a briquette. Second, output capacity can be significantly increased." We know from the Enron agreements that Sempra sought to increase the capacity of the Blue Grass/Somerset facilities combined to 2,000,000 tons/year. If one assumes 24 hour/day operation for 360 days/year, each machine would need to have a 115 ton/hour capacity to reach this level. Keith Martin told us that the "increase in capacity" under Rev. Proc. 2001-30 should be measured against the capacity of the facility when it was "placed in service" prior to July 1, 1998. As I told you a couple of weeks ago, the Sempra Offering Memo contains a certificate from R.W. Beck that the Blue Grass and Somerset facilities were "placed in service" on June 30, 1998. In those certificates, Beck "certified" a capacity for each machine of 50 tons/hour, which, for the 2 machines, means a max of 876,000 tons/year. I concluded from this that, because Sempra's proposal to increase Blue Grass/Somerset capacity by reducing the "briquetting" of the output had been rejected by Rev. Proc. 2001-30, Sempra would not be able to claim tax credits above those that could be produced at 50 tons/hour, and that its damage claim would, at the very least, be capped at that level. Keith Platte (pronounced "Platty"), the lead engineer for Beck, and the guy who signed the certification, poked a big hole in this conclusion. Platte is very personable (particularly for an engineer), appears to know his field very well and, in my estimation, would make an excellent witness for Sempra, should he be called. (Mel did not question Platte.) Regarding capacity, Platte did not have a view as to the maximum capacity of the Blue Grass or Enron facilities. According to him, the Engineering, Procurement and Construction ("EPC") contracts pursuant to which the facilities were constructed said that the facilities were designed to operate at 50 tons/hour. Platte said that R.W. Beck's job was simply to certify that the facilities had indeed been constructed by 6/30/98 in accordance with the EPC contracts, meaning that, as of that date, the facilities had at least that capacity. Did they have a capacity of 75 tons/hour on 6/30/98? He cannot say, because he was not asked to and did not test that proposition. I spent some time with Platte establishing that the capacity of a facility cannot exceed the capacity limit of a particular component piece of equipment in that facility. He generally agreed with this fact, and that a "slow" piece of equipment could act as a "bottleneck." I then tried to establish the capacity limits for different pieces of equipment, particularly the briquetter. I got nowhere. He fell back on the proposition that, if he did not test it, he does not know the capacity limits. He said that, if I wanted to know the capacity limit of the briquetter, I needed to talk to the briquetter manufacturer. At the conclusion of the deposition, I decided that that is what I would do. I may still do that, but, after deposing Lance Hardesty today, I am less confident that that would be a fruitful course of action. Hardesty is not nearly as good a witness as Platte; he has a kind of wimpy, limp-handshake, dufus quality to him -- the kind of guy who was off in a corner playing with a slide-rule when God was handing out personality. Hardesty is, however, a very knowledgeable engineer. To cut to the chase, Hardesty 3 weeks ago "re-certified" the Blue Grass facility as it had been reconstructed back at Somerset, using the original Somerset design (e.g., no screen before the crusher, as it was designed at Norfolk). Hardesty certified that the Blue Grass facility had a capacity today of at least 105 tons/hour. Most significantly, I asked Hardesty -- who participated in the 6/30/98 certification -- to walk through an engineering plan of the facility from June 1998 and to identify all the changes in facility components between then and now. There were not many, and he believes (Holmes will have to confirm) that the significant components in the synfuel process -- the mixer, the blender and the briquetter -- are all the same, albeit with some modifications. Thus, Sempra's argument will be that, if those components were capable of producing 105 tons/hour in May 2001, they must have been capable of doing so in June 1998, the date the facility was "placed in service." What about the modifications? I asked Hardesty to identify all of them. Holmes and Frank Ikerd told him that the paddles and the internal workings of the mixer were changed somewhat. The blender also had replaced some internal pieces that wore out due to normal use. (These things do not sound significant to me, but an engineer or Keith Martin could convince me otherwise.) The briquetter is a different story. Hardesty had earlier admitted to me that the spacing between the briquetters is one of the things that can affect the percentage of output that results in a briquette (think of a piece of charcoal). Because of significant operational problems in the summer of 1998 (they kept breaking), the briquetters had to be reconfigured at the direction of the manufacturer (Komar Industries). Upon the completion of these modifications, the briquetter rolls could be adjusted to achieve spacing between the rolls of anywhere from 0.5" to 1". (Believe it or not, I know what this means.) Hardesty said that, during his visit to Somerset earlier this month, the briquetter was set at 0.5" spacing and the facility demonstrated a capacity of 90 tons/hour. He then ran a capacity test at 0.75" spacing, and the facility demonstrated a capacity of 105 tons/hour. I asked him how the capacities over what had been seen in June 1998 were achieved, and he said "Certain improvements were made to the chute feeding the briquetter and various transition points throughout the process so that the material would flow better, in avoiding plugging. But in June of '98, we never attempted any sort of a maximum test; we merely tested for the minimum EPC requirements of the EPC contract to install the facility." We then walked through each of the "improvements." In short, other than the changes to the briquetter, none of them struck me as the kind of thing that would offend the IRS. Focusing on the briquetter, I asked him why it had been set at 0.5". He said that he was told by Holmes and Ikerd that that was the setting the briquetter had after the modifications were completed in 1998. (We'll need to confirm this.) I asked him whether he ran a test at the full 1" spacing. He did not. According to Hardesty, "[w]e discussed it with Richard Holmes, Frank Ikerd and Richard Coston. And for conservatism with regards to maintaining the IRS placed-in-service ruling, three-quarter inch was selected as a nominal setting for still making briquettes of a similar ... size as we made on June 30 of 1998," and in roughly the same proportion of briquettes to non-briquetted fines. In other words, Sempra will argue to the IRS that, while it has been able to increase capacity over the capacity in 6/98, it has done so without omitting the briquetting requirement of Rev. Proc. 2001-30. Thus, Sempra's most recent PLR request will likely RETRACT Coston's May 2000 statement that the increase in capacity comes at the expense of briquetting. Obviously, there is still some factual work to be done to see if Sempra's new argument holds water. For example, how do they prove what the percent of briquettes to non-briquetted fines was in June 1998? Also, we should inspect the new facility at Somerset with our own engineer (we need to retain one) so we can draw our own conclusions. Finally, we will need to grill Holmes on much of the foregoing, because he continues to be the person with all the relevant knowledge. In sum, while the Beck depositions did not generate good testimony, they at least give us the tools to re-work our analysis on the possibility of using Rev. Proc. 2001-30 to limit Sempra's lost tax credit damages. Please let me know if you have any questions. Thanks, CPJ (from La Guardia, where I just landed) Christopher P. Johnson Brobeck, Phleger & Harrison, LLP 1633 Broadway New York, New York 10019 (212) 237-2558 (212) 586-7878 cpjohnson@brobeck.com ======================================================= This email message is for the sole use of the intended recipient(s) and may contain confidential and privileged information. Any unauthorized review, use, disclosure or distribution is prohibited. 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