Judgement Delayed 4/15/04

by Ted S. McGregor Jr.


On Tuesday morning, federal Judge Edward Shea postponed the River Park Square parking garage trial that had been set to begin on Monday. The night before, the Spokane City Council had agreed to issue new debt to buy out all holders of bonds related to the RPS garage -- including those bondholders they were scheduled to face in court on Monday. Shea told lawyers in a conference call that he would reschedule the trial for either June or September -- if indeed a trial were still required.


Monday still represents a deadline, however, as Shea wants motions by that day from defendants that have settlement agreements pending with the city. Also announced on Monday night was a settlement agreement with Walker Parking Consultants, one of the key firms in the garage deal gone bad. With the judge's deadline, it looks as if more negotiations will occur this week. Defendants that do not get their name in front of Shea now will either have to ask for him to consider their cases later or simply go to trial as defendants, with the city assuming the role of plaintiff. Shea, who endorsed the city's new approach without deciding on all the details of it, will hear arguments on May 11 about how the case will proceed. The bondholders, meanwhile, agreed to accept less than they were seeking at trial to transfer their claims to the city.


While the events represent progress for the city's new strategy, risks remain. Although the city may pick off some of the low-hanging fruit -- defendants eager to get out of the case or those with limited resources, or both -- the big defendants with deep pockets may still take their chances at trial. That means the city will have issued millions in new debt while still being stuck with chasing down the money. On the plus side, however, the city's move allows it to control its own destiny and bring closure to a matter that could have gone on for many more years. Also, in becoming the plaintiff, the city assumes a more natural fit as the aggrieved party seeking justice.


How likely the various parties are to settle before trial is strictly a function of how strong they regard their defenses to be -- and of how much they fear the plaintiffs' case. The wild card is that a jury would decide the entire matter. Most of the lawyers involved in the case are litigators -- meaning that they specialize in dealing with juries. If a trial comes, the arcana of securities law will likely take a back seat to simply telling a story. Sure, the various reports, memos and expert witnesses will make their appearances, but there's an important distinction between burying a jury with too much evidence and simply telling a story that makes sense.


For some quick background, let's review: Back in 1997, the city decided to lend its credit to the garage project -- helping "save" downtown by making a real estate deal more lucrative for the Cowles family. The garage, however, would be owned by the Spokane Downtown Foundation, not the city. The city planned to take over the garage after the debt was retired in 20 years, although it would never own the land under it. Questions about the deal nagged the project, then erupted into full public revolt when new leaders sought to lessen the city's involvement on the basis that the deal was a kind of corporate welfare. Meanwhile, the garage failed to meet expectations, leaving its bills unpaid. The involved parties -- the city and the Cowles group -- could not agree on a way to fix the problem. This led to a default on the garage's debt payments, which acted like lighting a match on kindling. Angry investors filed a lawsuit in federal court, and the result has been a legal meltdown with an estimated $10 million-plus in legal fees having been spent.


Since attorneys have taken over and digested the facts, several competing theories have emerged in relation to the federal case. Here's a quick look at the theories that would be presented at trial. Judge for yourself which ones make sense and which ones don't.





THEORY NO. 1: NOTHING BAD HAPPENED


Under this theory, the former plaintiffs -- some of the nation's most sophisticated bond buyers -- were viewed as angry when their investment didn't pan out. So they did what Americans do when they get mad: They went to court. Now they will be paid off, leaving the city to argue that the deal went sideways because bond buyers were misled. The bond sellers, the city can now argue, failed to disclose information about the deal. The defendants that subscribe to the "Nothing Bad Happened" theory, however, believe there was adequate disclosure and that the deal went bad for other reasons.


It was clear, this theory goes, that Walker was doing nothing more than guessing about the future earnings of a new and different facility. And in the end, the bond rating says it all. The BBB- rating is the lowest investment grade rating, just a step above junk-bond status. If the bondholders weren't sure about what they were getting into, the rating should have offered a clue.


This theory also explains away the allegedly pumped-up purchase price by justifying it as fair. And discovery seems to prove this theory, as, they would argue, no smoking guns were uncovered.


This theory also holds that the main reason the bonds were purchased was not because of Walker's numbers but because of the security added to the deal in the form of paying debt service, first from garage revenues and in the form of the city's parking meter pledge in the event of shortfalls. Later, both securities were compromised; the city reneged on its pledge -- claiming that loans which cannot be repaid are gifts -- while the trustee decided to divert garage revenues to legal fees, hastening the default. In short, if a deal had remained a deal, the bondholders would still be getting paid.





THEORY NO. 2: THE BOND BUYERS WERE TRICKED


Of course, the bond buyers don't agree with theory No. 1. They argued that there were important facts that were not disclosed to them before they invested in the garage -- for instance, the fact that one bond-rating agency, Moody's, declined to give the bonds an investment rating. Or that claiming the garage's validation program was "revenue-neutral" was not an accurate description, as it wound up representing a $2 million-a-year shortfall. Or that the purchase price was really determined by the Walker report, which was created with oddly optimistic numbers, including a 100 percent hike in the hourly rate and an unheard-of boost in the average length of stay for shoppers.


The plaintiffs were prepared to counter the claim that the BBB- rating was warning enough by saying BBB- bonds are investment-grade bonds and must play by the rules. As for whether there was enough disclosure in the Official Statement, the legal document used to sell the bonds, the former plaintiffs may have asked the jury to think of it as walking down a path. If you tell people simply that there may be danger ahead on the path, when in fact you know that the path drops into an abyss 10 feet down the road, you are liable when people fall over the cliff. Now the city is free to argue that the people who put the deal together knew, or should have known, that the project would not work.


From the bond buyers' point of view, the issue of who tricked them wasn't all that important -- they were tricked, and a jury or judge would decide who was to blame. That's why they named just about everyone with fingerprints anywhere on the deal. For the city, however, the stronger case may be against the professionals -- that group of defendants made up of consultants, underwriters, lawyers and others who could take the deal to market. That leads to the next theory.





THEORY NO. 3: THE PROFESSIONALS SCREWED UP


Once Spokane and the developer of the mall project, Spokane's Cowles family, had the outlines of a deal, they brought in professionals who could finalize it. The primary defendant on this front is Prudential Securities, which underwrote the bond issue. Under this theory, Spokane took the deal as far as it had the expertise to do, then it hired leading national firms to help protect them from their own mistakes. Now if the deal was rotten, this theory goes, those professionals should have discovered the problems, and perhaps the deal would have been killed at the underwriting stage -- as many deals are.





THEORY NO. 4: THE CITY WAS TRICKED


This theory takes a more sinister view of the theory that the professionals screwed up. It goes further by arguing that the city was actually taken advantage of by a partner bent on maximizing the public contribution and a bunch of financial advisers more interested in their fees than the fallout of a bad deal. For a long time now, that's the story Spokane has told itself about the parking garage mess. For years, this belief has driven public policy, journalism, voters' decisions and the city's standing in the national financial community. There's evidence to support this theory, but from Judge Shea's point of view -- and he's the authority at the moment -- it might as well be a fairy tale. In fact, the city had hoped to be able to blame the developer, specifically, in federal court for, among other things, pumping up the numbers and generally rigging the system to bilk the city.


Trouble is, the city council of 1997 has been determined, legally at least, to have entered into the partnership with its eyes fully open to the risks. Much of the city's complaint, debunkers of this theory say, is Monday morning quarterbacking. In hindsight, perhaps someone should have raised concerns about the parentage of the Spokane Downtown Foundation -- but no one ever did. With 20/20 hindsight, city officials and outside counsel perhaps should have fought political leaders more on the purchase price for the garage -- but they didn't.


In fact, many of the city council members from 1997 have continued to stand by their vote, pointing to a downtown many think has rebounded since the mall opened. How could they have been tricked if they got what they wanted?


Shea killed the city's claims against the developer, but now that the city is seeking to take over the bondholders' claims, it can revive some of those arguments. While the "City Was Tricked" theory appeared to be kind of dead in the water last week, the city's new strategy has revived it. Of course the city would have to accept some responsibility to make such arguments against its one-time partner believable. In many ways, however, the former partners are inextricably linked, which leads to the next theory.





THEORY NO. 5 : THE PARTNERS SCREWED UP


Under this theory, the developer and the city got so carried away by their wishful thinking that they wound up (allegedly) defrauding investors. To be fair, it wasn't all wishful thinking; the project suffered from plenty of bad luck, too. It was going to be a different kind of project -- or so the story went -- but in the end, the mall and its vicinity suffered a net loss of stores and shoppers during the redevelopment phase. The surgery was a success, but recovery would take a while.


Plans to double the number of stores in River Park Square gave way to a quality-over-quantity concept that relied on fewer higher-end shops. Miscalculations on the rate structure led to angry parkers, and political upheavals continued to generate bad publicity for the mall. A year after the mall opened, a recession hit, then 9/11, forcing retailers to hold steady. Looking back, it was a kind of perfect storm, perhaps the worst time in recent decades to open a mall and garage.


The fact that the garage was a failure even before it opened appears to bolster this theory. Last-minute renegotiations with the theater tenant and the difficulty in creating a validation system that would fund the garage -- problems the partners were well aware of -- added up to certain bankruptcy.


Under this theory, all of these things were easy to predict or, at least, should have been taken into consideration. But early on, the partners would not listen to any advice that contradicted their rosy view of the matter. Independent auditors Coopers and Lybrand, who raised serious questions, were misrepresented on the eve of the city vote as supporting the deal. As a result, this theory goes, the partners shepherded a bad deal, then guaranteed it to underwriters, who acted in good faith on the numbers presented.


In fact, the plaintiffs were set to parade a series of experts and their reports before a jury, pointing out how just about everyone who came into contact with the deal expressed some kind of misgiving about it. It's unlikely the city would employ the same strategy, but the point the bondholders were trying to make could be redirected.


Some deals are peppered with red flags, the bondholders may have argued, but this one was full of red lights. Whether a jury believes the partners should have stopped at the red lights or if the professionals should have appears to be the key to determining whether this theory will resonate.





So if the city does wind up in court, it will tell the jury that it has suffered damages because it was unfairly caught up in the commission of a securities fraud. If the jury believes the city was mostly a victim, it would assign damages to the remaining defendants -- money the city could then use to lower the cost of its garage-settlement bond issue. On the other hand, if the jury believes it's nothing more than an investment gone bad -- like, say, investing in a Web site famous for a sock puppet -- the city will be left with (most likely) the garage and lots of new debt. (Of course in buying out the plaintiffs, at least the parking meter pledge would go away.)


But the result is more likely somewhere in the middle, with some defendants being saddled with more blame than others. Where it all winds up is anyone's guess, and that's precisely why defendants fear juries. There's one prediction that is safe to make, however. If indeed there is a trial and the city prevails, defendants will take turns on the courthouse steps to announce their plans to appeal. Upon review, the Ninth Circuit Court of Appeals could let the verdict stand, or it could send the case back to federal court to be retried, or it could agree to hear it. Then, of course, the appeals of that Ninth Circuit verdict could be sent to Washington, D.C., for the Supreme Court to consider. The time frame on all that? In all likelihood, at least five years.


Of all the theories out there, the one that peels away all the arguments to reveal a cycle of never-ending litigation appears to be the one that has Mayor Jim West's attention. After all, when he first announced his plan for the city to take the lead in finding a settlement, his opening comment was that he wanted to keep the case out of court. For now, at least, West has gotten his way.





To learn more, check out our archive of River Park Square parking garage stories. Click on the "River Park Square" button on the right of the screen.





Publication date: 04/15/04