Opinion ID: 163762
Heading Depth: 3
Heading Rank: 1

Heading: The Bushton Plant

Text: Kinder-Morgan purchased the Bushton Plant from Enron in March 1997. The plaintiffs allege that, despite Kinder-Morgan’s statements to the contrary, the Bushton Plant was unprofitable during the third quarter of 1997 and was a significant cash drain on the Company. The Bushton Plant was initially unprofitable because Kinder-Morgan was obligated to make lease payments on the plant of $23 million per year. Immediately prior to the acquisition of the Bushton Plant, Rose Robeson, the Assistant Treasurer of Kinder-Morgan at the time, told defendant Clyde McKenzie and John DiNardo, a Kinder-Morgan vice president, that their positive financial projections for the plant were incorrect and that, because of the $23 million lease payment, the Bushton Plant would not be profitable. During the third quarter of 1997, McKenzie and DiNardo frequently went to Robeson’s office to complain to her about how the Bushton Plant was losing money and to ask her how they could get out of the lease. -6- Another reason it was alleged that the Bushton Plant was unprofitable was the “keep whole” contracts to which the Plant was a party. Under such contracts, the Bushton Plant processed natural gas for third parties to remove natural gas liquids (“NGLs”), which Bushton sold separately from natural gas. In exchange for being able to keep the NGLs to sell itself, Bushton was obligated to “keep whole” the third parties for the reduction in the energy content of their natural gas stream associated with the removal of NGLs. That is, Bushton had to replace the NGLs with processed natural gas containing an equivalent amount of energy. As long as the market value of the processed gas that Bushton had to provide to keep the third parties whole was less than the value of the NGLs it sold for itself, it could turn a profit under the contracts. The risk under “keep whole” contracts, however, was the possibility of a price inversion. A price inversion is a market condition in which the value of the processed gas Bushton had to contribute under the contracts exceeded the value of the NGLs it extracted. In this situation, the contracts would be unprofitable. The complaint alleges that the Bushton Plant suffered from a price inversion affecting the profitability of its “keep whole” contracts. In the Spring of 1998, DiNardo held a meeting with employees to discuss the problems at the Bushton Plant, and at that meeting he reported that Bushton was generating losses of as much as $700,000 per month. -7- The complaint states that to hide the operational problems at the Bushton Plant, Kinder-Morgan accelerated, in violation of Generally Accepted Accounting Principles (“GAAP”) and the Company’s own revenue recognition policy, the recording of income from three contracts associated with the Bushton Plant. 2 Specifically, the plaintiffs point to contracts with three energy companies: Louis Dreyfus Natural Gas Corp., KMEP (an entity in which defendant Richard Kinder was chairman and CEO), and Koch Industries, Inc. By recording the income from these contracts before it had actually been earned and received, the plaintiffs allege that Kinder-Morgan inflated the Company’s financial results for the 1997 third quarter and fiscal year. The Dreyfus and KMEP contracts obligated Kinder-Morgan to store natural gas liquids over five-year periods in exchange for total payments of approximately $3.5 million. The Koch contract required Kinder-Morgan to refrain from operating a “butane liquid isomerization unit” at Bushton for a tenyear period, in exchange for payments totaling $18 million over the life of the 2 The plaintiffs allege that GAAP includes the principle that revenue, and the income earned from that revenue, must be earned before it is recognized on a company’s books. For example, when a company has a contract to provide services for a fixed price, the company should not record the receipt of the price for its services until they are actually delivered. Kinder-Morgan appeared to embrace this principle in its own stated polices. The Company’s 1997 Annual Report of Form 10-K stated: “(D) Revenue Recognition Policies. In general, the Company recognizes revenues as services are rendered or goods are delivered.” -8- contract. The complaint alleges how Kinder-Morgan allegedly accelerated recognition of the income due under the contracts: In order to record inflated earnings, [Kinder-Morgan] reduced the Louis Dreyfus, KMEP and Koch contracts to their present value as of the third quarter of fiscal year 1997 and recorded the present value of the contract as income. The present value of the three contracts is approximately $14,300,000. Recording transactions in this manner violated GAAP because [Kinder-Morgan]’s performance obligations were not complete. The Company was still obligated to provide storage services and refrain from operating the isomerization unit well into the future. Under these circumstances, income should have been recorded ratably over the life of the contract. As a result of accelerating the revenue recognition, third quarter and fiscal year 1997 net income was overstated by approximately $14,300,000. Second Am. Compl. at 23, ¶ 87. Without the accelerated income recognition, the Bushton facility would have recorded a loss of approximately $10 million in the third quarter of 1997 instead of the $5.1 million of operating income recorded by the company in the Form 10-Q it filed for that quarter. Despite the fact Bushton actually was losing money and had profits only because of the allegedly improper income recognition, Kinder-Morgan stated in reporting its financial results for the third quarter of 1997 that the Bushton plant “positively impacted [KinderMorgan’s] earnings.”