Tuesday, January 21, 2014

WV Chemical Spill: Can you over do entity formation? (Hint: Yes.)

Freedom Industries -- the company apparently responsible for contaminating the Elk River (and, along with it, 300,000 West Virginia residents’ drinking water) – has filed for Chapter 11 bankruptcy.  The company wasted little time filing for reorganization, and the process already has some people on edge. 

From a public relations perspective, this kind of cases does not serve the concepts of Business Organizations especially well.  The use of limited liability vehicles is sanctioned by law, and such use has been credited with creating all kinds of opportunities for growth through pooled resources that would not otherwise occur without the grant of limited liability.  I happen to think that’s true.  (See, e.g., Corporate Moral Agency and the Role of the Corporation in Society, p. 176, By David Ronnegard) 

Still, one of the issues is that figuring out who owned Freedom Industries took some sleuthing (reporter's findings here).  It appears the structure is as follows: 

Freedom Industries’ Chapter 11 documents list its sole owner as Chemstream Holdings, which is owned by J. Clifford Forrest.  Forrest also owned the Pennsylvania company, Rosebud Mining, which is located at the same address Chemstream Holdings lists for its headquarters.  The

Reports note that the chapter 11 filing also states that two entities have offered to lend up to $5 million to fund Freedom Industries’ reorganization.  The two entities are VF Funding and Mountaineer Funding, the latter of which is a West Virginia LLC formed by its sole owner: J. Clifford Forrest.

The idea that the owner of the company that owns the company that owned the chemicals that harmed the water in West Virginia is now seeking to create a new company to loan money to the company that owned the chemicals is note sitting very well with many of those harmed by the chemical leak. 

Some of those harmed by the chemical spill are objecting to the proposed reorganization structure. As reported here, West Virginia American Water (WVAW), the utility providing the tainted water (and the subject of it own lawsuits because of it), claims the water company will be “the largest creditor by far in this bankruptcy case.” As such, WVAW has asked (PDF here) the bankruptcy judge to slow down the reorganization so that the utility and other creditors an opportunity get a better sense of the ownership structure and how the creditors (and possible creditors) will be treated. 

This case probably looks even worse because it keeps coming back to a single person, and not a group of investors. Again, one company – Chemstream Holdings, Inc. is owned by one person -- J. Clifford Forrest, who then is the sole owner of a company seeking to loan money to the embattled company. 

Keeping with that theme, after a little sleuthing of my own, I found that although the initial reports were of VF Funding and Mounatineer Funding LLC offering to loan $5 million to Freedom Industries, it seems to have gotten even more convoluted.  There is yet another company in the mix – WV Funding LLC (pdf), which was formed on January 17, 2014, and on the same date the entity filed to be the Debtor in Possession of Freedom Industries (pdf). WV Funding LLC was organized by same Wheeling attorney who formed Mountaineer Funding LLC for Forrest.  The sole listed member of WV Funding LLC? Mountaineer Funding LLC (pdf). Related documents here.

All of this, at least at this point, seems permissible. Still, at some point, it really does start to look like someone is trying to pull a fast one.  And even a staunch defender of the corporation and uncorporation has a hard time arguing otherwise.  At a minimum, and even though there are good counterarguments (like Steve Bainbridge makes here in a different context), such behavior starts to make an expansive view of enterprise liability a lot more attractive. 

http://lawprofessors.typepad.com/business_law/2014/01/wv-chemical-spill-can-you-over-do-entity-formation-hint-yes.html

Business Associations, Corporations, Entrepreneurship, Ethics, Joshua P. Fershee, LLCs, Unincorporated Entities | Permalink

Comments

It sounds as if the problem here isn't limited liability; it's Chapter 11. Or, rather, the *potential* problem. I don't see how all this reorganization is going to help the owner unless the judge makes a bad decision. The idea of Chapter 11 is that it's supposed to help the creditors by preventing liquidation of the debtor. If the creditors are clearly hurt by wiping the slate clean, then the judge should move the company to liquidation instead, right?

Posted by: Eric Rasmusen | Jan 30, 2014 11:56:16 PM

Eric, I agree that limited liability is not the inherent problem from a legal standpoint, but it is a potential problem from a public perception standpoint, which can lead to poor outcomes, with the bankruptcy judge or on the legislative/regulatory side. My post here sheds a little more light on views on this front. My expectation is that this will move to liquidation unless something major comes to light that shifts liability (or much of it) away from Freedom Industries, which I consider unlikely.

Posted by: Joshua Fershee | Jan 31, 2014 7:28:27 AM

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