In recent years, the U.S. coal industry has been struggling to compete with cheap natural gas and the rise of renewable energy, leading to a wave of bankruptcies. In the past four years, eleven American coal mining companies, representing half of the coal mined in the U.S., have filed for bankruptcy. As these companies struggle financially and file for bankruptcy, the increased attention to their financial practices has also drawn attention to the potential for financial fraud.
Whistleblowers with knowledge of financial fraud in the coal industry can receive protections and rewards through the Dodd-Frank SEC Whistleblower program, which allows whistleblowers to confidentially report securities and commodities fraud. Whistleblowers can also report companies who are fraudulently avoiding paying penalties owed to the federal government or certain state governments under the False Claims Act. Under the Dodd-Frank Act, whistleblowers who provide original information that leads to successful prosecution can receive between 10% and 30% of monetary sanctions. Under the False Claims Act, whistleblowers are eligible for 15% and 30% of the monetary sanctions.
Particular attention has been drawn to how coal companies have used bankruptcy proceedings to evade liabilities. Analysis of SEC filings related to four major coal bankruptcies found that “since 2012, four of the largest American coal producers have used Chapter 11 to discharge or otherwise avoid approximately $5.2 billion in regulatory debts: $3.2 billion in retiree benefits and $1.9 billion in environmental liabilities.”
Among the companies attempting to shed liabilities during bankruptcy is Murray Energy Corporation, the fourth largest U.S. coal producer and the last major contributor to the industry’s pension plan. Murray Energy’s bankruptcy drew attention when the company asked a federal judge to waive health care payments to retirees. In May 2020, a bankruptcy judge approved a settlement between Murray Energy and employees that will allow the company to transfer significant liabilities off its balance sheet. Claims from lenders have also raised new questions about the company’s financial statements.
Lenders Allege Manipulation of Financial Information
When Murray Energy filed for Chapter 11 bankruptcy protection in the Southern District of Ohio in October 2019, the company and certain subsidiaries entered into a restructuring support agreement in which the company would finance its operations throughout Chapter 11 with cash on hand and access to debtor in possession (DIP) financing through a DIP Facility that would provide $350 million in new money. Prior to filing for bankruptcy protection, GACP Finance Co. LLC (GACP) had provided Murray with approximately $90 million in loans. Under a new agreement, these loans were rolled up under the $440 million DIP facility.
Under the agreement with GACP, the value of Murray Energy’s coal assets could not fall below $160 million for any weekly period or below $175 million for more than three consecutive weeks, and Murray Energy was required to submit weekly current asset reports. In a motion filed on May 13th, GACP stated that the parties’ negotiation history and documentation established that current assets could only comprise coal receivables and inventory. According to the filing, in mid-April it was apparent that Murray Energy was heading toward default, and GACP encouraged Murray Energy to enter into good faith negotiations to create a potential solution to the impending default. Instead, on April 30, 2020, Murray Energy submitted a current assets report which improperly included non-coal “receivables.”
GACP stated that Murray Energy acted in bad faith when it submitted recent reports of its assets and engaged in “blatant and unequivocal breaches” of the financial covenant by including non-coal receivables in a “Current Assets Report.” GACP alleged that Murray Energy manipulated its financial information by including non-coal receivables because its coal receivable and inventory were “rapidly disappearing at an alarming rate,” and they had fallen far below the $160 million floor. Without including the non-coal receivables, they would have failed the Current Asset Test required by the agreement.
GACP also stated that the non-coal receivables included “questionable insider ‘management fees’” and that Murray Energy failed to provide any information about whether these “management fees” were current or stale. The parties had agreed that GACP was allowed to freeze Murray Energy’s bank accounts in the event of default without notice. GACP stated it was seeking a court order prohibiting Murray Energy or other parties from exercising that right to block or limit bank account withdrawals.
A committee of unsecured creditors has also claimed that, before the company filed for bankruptcy, Murray Energy founder Robert Murray and CEO, COO and CFO Robert Moore fraudulently used the struggling company as their own personal “piggy bank.” The creditors prepared a complaint alleging fraudulent transfers and breaches of fiduciary duty and sought permission from a U.S. bankruptcy court to sue Murray and Moore for debts owed by the company. The claims stemmed from an investigation into how Murray and his family spent company funds while the company struggled.
In the complaint, the creditors alleged that Murray and his family used corporate assets and funds for personal benefit while the company was allegedly insolvent, redirecting at least $9.8 million in cash to nonprofits the family was affiliated with and funded personal expenses including luxury aircraft. The creditors also alleged that the two executives were grossly overcompensated despite the company’s weak financial position, arguing that the compensation the two executives received was “more in line with compensation paid to the CEOs of Fortune 100 companies with revenues 15 to 250 times greater than the debtors’ revenues.” Murray Energy, the unsecured creditors, and the superiority lenders are negotiating the terms of a settlement in response to the complaint.
Financial pressure can increase the likelihood of financial fraud, and a significant portion of employees in the oil, gas, and mining industry say that they can rationalize fraud to help a company survive a downturn. As the coal industry faces pressure both from the long-term financial low natural gas prices and renewable energy and also from new challenges produced by the Covid-19 pandemic, the potential for financial fraud in the coal industry will likely remain high.
While the focus on a company’s financial practices immediately before and during a bankruptcy can raise important questions about potential fraud, the large number of companies entering bankruptcy suggests that, in order to identify where financial fraud has occurred, industry whistleblowers could play a crucial part in providing answers.