Arch Coal (NYSE: ACI) has agreed to continue to provide surety bonds and letters of credit for obligations, primarily reclamation, of Magnum Coal, a unit of bankrupt Patriot Coal, related to the properties that Arch sold to Magnum in December 2005.
Patriot Coal acquired Magnum in July 2008. The surety bonding amounts are mandated by the state and are not directly related to the estimated cost to reclaim the properties. As of June 30, Arch had $35.3m of surety bonds remaining related to properties sold to Magnum, however Patriot Coal has posted letters of credit of $16.m in Arch’s favor, said Arch in its Aug. 9 Form 10-Q filing.
Patriot, a major coal producer in western Kentucky and West Virginia, sought Chapter 11 protection on July 9 at the U.S. Bankruptcy Court for the Southern District of New York. Arch is not the only major producer with exposure in the Patriot case. Peabody Energy (NYSE: BTU) spun off Patriot in 2007 in an IPO before Patriot acquired Magnum and is involved with Patriot primarily related to black lung obligations.
Magnum would have acquired a contract to supply coal through 2017 to a customer that had not consented to the contract’s assignment from Arch to Magnum, said the Arch Form 10-Q. Arch has committed to purchase coal from Magnum to supply to the customer at the same price the customer is charged for the sale. Under the coal supply contract, as amended, Magnum has the ability to buy out of its monthly contract obligations at prices that are predetermined for the remainder of the agreement. Also, a predecessor of Arch entered into a guarantee for the delivery of coal under a contract assigned to Magnum. If Magnum is unable to supply the coal for these coal sales contracts or pay the buy-out amount, if elected, and if the guarantee is enforceable, then Arch said it may be required to fulfill Magnum’s delivery or payment obligations. The maximum financial impact to Arch if required to fulfill Magnum’s obligations over the term of these contracts would be about $70m as of June 30.
“On July 9, 2012 Patriot Coal filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code, in order to undertake a comprehensive financial restructuring,” Arch noted. “Patriot has the expectation of continuing to serve customers, after receiving a commitment of debtor-in-possession financing. At this time, the Company does not believe that it is probable that it would have to purchase replacement coal, and, accordingly, no losses have been recorded in the consolidated financial statements as of June 30, 2012.”
Legal dispute with FirstEnergy nears an appeals court decision
In another legal matter, Arch is awaiting a court decision in an appeal of a coal contract dispute between International Coal Group, which Arch acquired in June 2011, and FirstEnergy (NYSE: FE), which acquired this lawsuit in a buy of Allegheny Energy.
Allegheny Energy Supply, the sole customer of coal produced at Arch subsidiary Wolf Run Mining’s Sycamore No. 2 mine on Harrison County, W.Va., filed a lawsuit against Wolf Run, Hunter Ridge Holdings and ICG in state court in Allegheny County, Pa., in December 2006, and amended its complaint in April 2007. Allegheny claimed that Wolf Run breached a coal supply contract when it declared force majeure under the contract upon idling the Sycamore No. 2 mine in the third quarter of 2006, and that Wolf Run continued to breach the contract by failing to ship in contracted volumes to the nearby Harrison power plant.
The Sycamore No. 2 mine was idled after encountering adverse geologic conditions and abandoned gas wells that were previously unidentified and unmapped. After extensive searching for gas wells and rehabilitation of the mine, it was re-opened in 2007, but with notice to Allegheny that it would neeed to operate at reduced volumes in order to safely and effectively avoid the gas wells. The amended complaint also alleged that the production stoppages constitute a breach of the guarantee agreement by Hunter Ridge and breach of certain representations made upon entering into the contract in early 2005. Allegheny voluntarily dropped the breach of representation claims, Arch noted. Allegheny claimed that it would incur costs in excess of $100m to purchase replacement coal over the life of the contract.
In November 2008, ICG, Wolf Run and Hunter Ridge filed an amended answer and counterclaim against the plaintiffs seeking to void the coal supply agreement due to, among other things, fraudulent inducement and conspiracy. In September 2009, Allegheny filed a second amended complaint alleging several alternative theories of liability in its effort to extend contractual liability to ICG, which was not a party to the original contract and did not exist at the time Wolf Run and Allegheny entered into the contract. No new substantive claims were asserted, Arch said. ICG answered the second amended complaint in October 2009, denying all of the new claims. ICG’s counterclaim was dismissed in May 2010 on motion for summary judgment. Allegheny’s claims against ICG were also dismissed by summary judgment, but the claims against Wolf Run and Hunter Ridge were not.
The court conducted a non-jury trial of this matter beginning in January and February 2011. At the trial, Allegheny presented its evidence for breach of contract and claimed that it is entitled to past and future damages in the aggregate of between $228m and $377m. Wolf Run and Hunter Ridge presented their defense of the claims, including evidence about the force majeure conditions. Wolf Run and Hunter Ridge presented evidence that Allegheny’s damages calculations were inflated because it did not seek to determine damages as of the time of the breach and in some instances artificially assumed future non-delivery or did not take into account the apparent requirement to supply coal in the future.
In May 2011, the trial court ruled that Wolf Run had breached the contract and that the performance shortfall was not excused by force majeure. ICG and Allegheny filed post-verdict motions in the trial court and in August 2011, the court denied the parties’ motions. The court entered a final judgment in August 2011 in the amount of $104.1m, which included pre-judgment interest. The parties appealed the lower court’s decision to the Superior Court of Pennsylvania. Wolf Run and Hunter Ridge have filed an appeal bond in the amount of $124.9m. Briefing is complete and oral argument was held on May 16. The matter is pending a decision by the court.
As of June 30, 2012, and December 31, 2011, Arch had accrued $111.4m and $108.3m, respectively, for this lawsuit, including interest. The ultimate resolution of this matter could result in an outcome which may be materially different than what the company has accrued.
Also in the Form 10-Q, Arch noted that the longwall in its Skyline mine will recommence operations in October and that the Dugout Canyon mine in Utah will begin mining its final longwall panel of the current seam in August. “Future production decisions will be based on market conditions,” said the Form 10-Q about these operations, which have been on the margin lately due to geology problems and weak coal markets. A move into a new seam, like that needed at Dugout Canyon, is usually a fairly expensive proposition. Arch expects an extended longwall outage at Skyline during the third quarter of 2012 as the operation transitions to a new district in its current seam. Given current weak demand trends, the company anticipates delaying the restart of the longwall until October.