The Severstal Court Papers Disclosed

Renco and its subsidiary RG Steel, the defendants in Severstal’s New York court claim, have a month to file their reply, and for the time being they are saying nothing. Bette Kovach, spokesman for RG Steel, and Andrew Shea, spokesman for Renco, say they “will not comment on matters in litigation.” Nor will they answer whether it is Renco’s position that the March 2011 takeover terms for the three US steelmills did not obligate Renco and RG Steel to make a cash payment of $125 million to Severstal without agreement on subsequent accounting and valuation adjustments, and post-deal due diligence.

The full 28-page statement of claim by the Severstal group can be read here. It can readily be seen that Severstal acknowledges that by the end of March, days after the deal announcement, it had agreed to a reduction of RG Steel’s purchase obligation from $125 million to $89.4 million “based on the difference between certain financial metrics” โ€“ that is to say, between Severstal’s and RG Steel’s accounting.

The focus of this accounting is spelled out in the claim papers as the debts of the steelmills being transferred, the value of accounts payable by the mills, accounts receivable by the mills, and inventories of sellable steel and raw materials. Severstal told the court it had agreed with RG Steel that, after calculating that the net indebtedness of the mills for sale amounted to $299.8 million, and that their net working capital was $398.6 million โ€“ making a net value increment to RG Steel’s benefit of $98.8 million โ€“ the sum of RG Steel’s payment to Severstal should be reduced by $40.1 million.

In retrospect, it is now seems that Severstal either didn’t tell this to its auditors KPMG; or else agreed with KPMG to keep the shareholders on hold, and not informed until after the entire transaction closing process was done and dusted.

Further adjustments were proposed by RG Steel in May, and negotiations continued between lawyers and valuers for the two sides into June. RG Steel’s position, as reported now in the court documents, was that the net debt of the mills was bigger than Severstal had disclosed, and the net working capital smaller, so that the cash price for the assets should be reduced accordingly. According to RG Steel, debt came to $306.6 million, and working capital to $322.5 million. The difference had dwindled to just $15.9 million. Accordingly, RG Steel insisted it should reduce its payment obligation by $83 million, owing Severstal a balance of just $1.9 million.

Severstal reports objecting to “most, but not all of RG Steel’s proposed adjustments.” Two additional sums were then agreed at a meeting in August, the court has been told. But the two sides failed to agree on accounting for $9 million worth of debt and $89.6 million of working capital.

These numbers appear to turn into $44.4 million worth of adjustments cutting RG Steel’s cash obligation to Severstal, and that’s where the two sides have stopped. Severstal claims this money cannot be subtracted because the accounting method and principles on which it is based are inconsistent with those previously agreed for the deal. Severstal admits RG Steel might have a case for a compensating indemnity for part of this money, but not for an adjustment and deduction of it all.

By revealing to the court that Severstal decided it would not agree to $44.4 million of the adjustments, the court papers imply that Mordashov has accepted a reduction of RG Steel’s obligation to $45 million. The lawsuit is thus not really about $125 million, as the Russian press has been told, but about one-third of that amount.

Severstal also appears to have agreed to the appointment of PriceWaterhouseCoopers as an arbitrator of the remaining claims, but is asking the court to rule on what can be submitted to the arbitrator to decide, and what cannot.

In the itemization of accountable costs, charges and obligations which RG Steel has challenged, the court papers mention money owed by Severstal to pay steelworker health and pension benefits; equipment repairs; iron pellet supplies; rail transportation bills; lawyers’ fees; a $2.6 million bill owed to Siemens; and sales and other taxes.

Mordashov’s ghost makes a brief appearance in the lawsuit. This is in a reference to a Cyprus company, Baracom Ltd., as one of the owners of Severstal US Holdings of Delaware, one of the plaintiffs in the case. Baracom had been a vehicle through which Mordashov acquired shares in at least one US steel asset, the SeverCorr steelmill in Columbus, Mississippi. According to Severstal’s financial report for the first quarter of 2008, “in January 2008, the Group completed the acquisition of a 100% stake in Baracom Limited for a total consideration of US$ 84.4 million. Baracom Limited owns 79.9% of the voting stock of the holding structure which controls 74.2% of SeverCorr . SeverCorr is mini-mill which produces high quality steel for motor-car, construction, pipe and engineering industries.” There is no reference in that report to how Severstal valued Baracom or its de facto 59% stake in SeverCorr, to warrant paying Mordashov $84.4 million.

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