A Break in The Action

By Janice Castro

The case won immediate fame as the biggest bankruptcy in U.S. history. Last week it threatened to become one of the most bewildering and perhaps most bitterly contested business crises in modern memory. The $10 billion legal battle royal between Texaco and Pennzoil clearly entered a new and murky phase after the country's third-ranking oil company (1986 sales: $32.6 billion) made its bombshell decision on Sunday, April 12, to file for Chapter 11 protection. Whichever side was right in the dispute, the horrendous legal tangle surrounding the two firms vastly increased -- along with the business uncertainty.

Nonetheless, as New York Bankruptcy Judge Howard Schwartzberg assumed his overseeing duties with Texaco, it seemed to many analysts that the company had suddenly gained the upper hand in the high-stakes brawl it had appeared to be losing. Said Sanford Margoshes, an oil analyst at the Shearson Lehman Bros. investment firm: "Texaco has bought time. Its prospects are not as bleak." Wall Street seemed to agree. When the New York Stock Exchange opened trading after Texaco's bankruptcy filing, the company's stock dropped from 31 7/8 to 28 1/2 a share. Then the holdings rebounded, closing last week at 31 1/4. Pennzoil shares, which had surged from 79 3/4 to 92 1/4 during the previous week, plunged by more than 15 points the day after the Chapter 11 action and closed the week at 78.

The Big Board seemed to judge that Pennzoil's combative chairman, J. Hugh Liedtke, 65, had overreached himself in the dispute. It has dragged on since November 1985, when a Texas jury issued a $10.5 billion judgment against Texaco for inducing Getty Oil to break a merger agreement with Liedtke's Houston-based firm. Shortly before the bankruptcy, Texaco filed an affidavit in a Texas appeals court claiming that any settlement over $500 million would trigger defaults. Liedtke, on the other hand, said he turned down a Texaco offer of $2 billion two weeks ago. Liedtke wanted more like $4 billion to $5 billion and felt confident he could get it after a 9-to-0 Supreme Court decision that week referred the legal war back into Texas courts. Many analysts currently believe Pennzoil will be lucky to get $1 billion years from now. Liedtke insists that "Texaco can't frighten anyone into settling by declaring bankruptcy. We will win ultimately."

Lawyers for both sides showed up last week at a Houston appeals-court hearing, which had been mandated by the Supreme Court decision, on whether Texaco should be required to put up a bond for some $10 billion while continuing to appeal the 1985 Texas judgment. Protecting itself from such an appeals decision had been a vital factor in Texaco's decision to flee into bankruptcy. The Houston hearing was stayed after Texaco lawyers argued that the Chapter 11 filing triggered an automatic halt to other legal proceedings. Pennzoil officials said they might challenge the bankruptcy petition, but at week's end they had not done so.

Meanwhile, the U.S. was faced with the spectacle of a healthy corporation sheltering under laws ostensibly intended for the weak and ailing. As Anthony Ludovici, an oil analyst for the Tucker, Anthony & R.L. Day investment firm, put it, "While Texaco will be in bankruptcy, Texaco won't be a bankrupt company."

Quite the contrary. Taking advantage of liberalized bankruptcy laws enacted in 1978, which no longer require corporations to demonstrate that they are insolvent, the oil giant is immune, for the moment, from far more than the debilitating bond judgment. Pennzoil can no longer slap liens, as it was reportedly preparing to do, on up to $8 billion in Texaco assets. With $3 billion already in reserve, Texaco no longer has to pay $630 million worth of annual interest on $7 billion in normal business debts. Nor is it required to pay dividends on 242.3 million outstanding common shares, an estimated saving this year of nearly $727 million.

Texaco's future financial position may be even better. Only Texaco's principal holding company and two financial subsidiaries are huddling within Chapter 11. Dozens of operating subsidiaries around the world are carrying on business as usual. They will help keep Texaco's annual cash flow close to $3.6 billion and its anticipated profit this year higher than $650 million -- all outside Pennzoil's direct grasp. That wrinkle took Chairman Liedtke by surprise. As he told TIME, "I thought that when we were suing Texaco, we were suing all of Texaco." Liedtke has claimed that Texaco illegally transferred assets, including its sprawling refinery in Port Arthur, Texas, to the operating companies during the litigation to prevent their seizure.

Ultimately, though, Texaco may pay a heavier price for its bold gambit. For one thing, all of Texaco's regular creditors have been bludgeoned by the Chapter 11 device; their goodwill is important to the oil firm's longer-range survival. Among others, Texaco owes Chase Manhattan Bank $2.95 billion and Manhattan's Bankers Trust and Manufacturer's Hanover Trust an additional $1.5 billion. Outwardly, many of Texaco's creditors and lenders are serene about the situation. But at one major Manhattan bank with several hundred million dollars' worth of Texaco corporate notes on deposit, a senior executive admits to "angst and anxiety" over the bankruptcy filing. Venezuela's state-owned oil company has hinted that it may shut off shipments of crude to Texaco; the Venezuelans have been discussing the matter with Texaco Chief Executive James Kinnear.

Texaco stockholders are likely to feel anxious soon. Some of them "could be wiped out" by the bankruptcy, according to one legal expert. Many of the large institutional investors that hold Texaco stock are forbidden by various rules and regulations to own securities that fail to pay dividends. But even those that are not so constrained are unhappy. Harold Ofstie, for example, is portfolio manager of Philadelphia-based Delaware Management, which owns 3.7 million Texaco shares. The bankruptcy filing means a projected loss of $11.1 million in annual dividend income for Delaware. Says Ofstie: "We understand the reasons why Texaco went into Chapter 11. But we're an income-oriented investment company, and Texaco doesn't have a yield anymore. That's a problem we can't ignore." As time passes, Wall Street analysts expect that big investors will steadily dump millions of Texaco shares onto the market.

Under Chapter 11, Texaco's top management will operate much as it usually does. One of the attractions of the relaxed 1978 bankruptcy laws is that day- to-day management of an affected firm remains in the hands of its executives rather than those of a court-appointed trustee. Bankruptcy judges like Texaco's Schwartzberg oversee broader matters, such as the sale and acquisition of major assets, in consultation with committees of creditors.

But bankruptcy may feel downright unpleasant for Texaco's management if Pennzoil has its way on those committees. Rather than fight the bankruptcy frontally, the Houston company has apparently embarked on a more subtle strategy, based on its role as one of Texaco's major creditors. Says Pennzoil Attorney Irvin Terrell: "Texaco has got a lot of other partners now -- banks, trade partners and us. Their affairs will be under the view of the bankruptcy court, and the creditors will have a say. We hope Pennzoil will have the largest say."

Pennzoil's bankruptcy counsel, Michael Crames, insists that Texaco will not be able to borrow, offer collateral, sign leases or enter new lines of business without court permission. Says Crames: "Texaco is going to have to live in a goldfish bowl." As a member of Texaco's soon-to-be-formed unsecured-creditor committee, Pennzoil will have access to some of Texaco's sensitive documents and will be in a position to demand many more. Says Chairman Liedtke: "We want to make sure their money is spent wisely. We want to know everything." Texaco executives have said they will refuse to accede to paper chases outside the requirements of bankruptcy law. Ripostes Texaco Bankruptcy Counsel Harvey Miller: "Creditor committees don't run businesses."

Unquestionably, the hygienic solution for both sides would be to reach a settlement that will allow Texaco to emerge from its Chapter 11 cocoon. Executives at the oil giant have suggested such a possibility, maybe an indication that Texaco is using its bankruptcy as bargaining leverage against its smaller opponent. Manhattan Attorney Richard Lieb detects a more nuanced strategy in Texaco's Chapter 11 filing. By keeping most of its operating companies out of bankruptcy, he says, Texaco has issued an "open invitation to continued bargaining." Since bankruptcy does not involve the entire company, he argues, "it may be Texaco's way of saying, 'You see, we haven't completely closed the door to negotiations. Here's an incentive to keep talking.' "

But there is a substantial disincentive to keep the two sides from coming to terms too easily: the possibility of shareholder lawsuits if a prospective settlement is deemed too generous to either side. In conversations with TIME, Pennzoil's Liedtke said fear of just such litigation played a role in his rejection of Texaco settlement offers that he thought were inadequate. Joked Liedtke: "If we took what they offered, I would have sued myself." On the other side, major Texaco shareholders have indicated that they would be unhappy with any settlement payout that exceeded $1 billion.

Now that the elaborate bankruptcy mechanism has been engaged in the Texaco-Pennzoil case, it will grind on, perhaps for years. Pennzoil has so far spent at least $20 million in its legal bouts with Texaco, which in turn has spent several times that amount. Pennzoil, ominously enough, has built up a $300 million legal kitty to carry on the fray. Says the pugnacious Liedtke: "If they want to play burnout, it will be a while."

With reporting by B. Russell Leavitt/Atlanta and Thomas McCarroll/New York