In a case stemming from a partnership struck during the telecom boom, last week a judge awarded a $244 million judgment for bankrupt WinStar Communications against Lucent Technologies Inc. Allowing for interest and other costs, Lucent plans to take a $300 million charge for the quarter ended December 31.
The decision, say attorneys for WinStar, may establish new case law concerning vendor-financing relationships, especially regarding what constitutes an “insider” for purposes of bankruptcy preference law. Insiders — a term generally considered to apply only to related entities, officers and directors, and their relatives — may be compelled to disgorge payments made by a company as much as 12 months before the company files for bankruptcy; non-insiders, only 3 months.
In October 1998, in the first of two related agreements, Lucent became the primary secured lender to WinStar, providing the much smaller broadband provider with a $2 billion line of credit to build a wireless communications network. In the second, Lucent consented to provide “best of breed” equipment to WinStar and, in cases where Lucent couldn’t provide it, to finance WinStar’s purchase of that equipment from other companies.
WinStar trustee Christine Shubert sued Lucent in April 2001 on the grounds that it forced WinStar to file for bankruptcy protection by breaking a contract between the two companies, according to Reuters. (Later that year, noted the wire service, WinStar’s assets were purchased by telecom IDT Corp.) The trial was completed in June.
In his ruling, U.S. Bankruptcy Court Judge Joel B. Rosenthal cited substantial wrongdoing by both companies. When Lucent was feeling pressure in the third and fourth quarter of 2000 to report higher sales, “extracted what it needed to prop up its own revenue from WinStar in the purchases of unneeded equipment,” the judge wrote. The larger company also manipulated the timing of a refinancing notice that would have revealed WinStar’s shaky financial status until Lucent could extract more revenue, he added.
For its part, “WinStar repeatedly and knowingly helped Lucent by making massive, last minute, allegedly unneeded purchases that were arranged by Lucent as the ends of quarters approached,” he ruled. As a result of those deals, Lucent could report more revenue than it really made. Indeed, the judge wrote, “the dollar amount of WinStar’s purchases of Lucent equipment in end of quarter sales was on average eight times as high as the dollar amount of WinStar purchases of Lucent equipment in months in which a quarter did not end.”
“It’s one of the first times that a vendor has been determined to be an insider of its customer by virtue of its strategic partnership with that customer,” says Stephen M. Rathkopf, a partner with the law firm Herrick, Feinstein, which represented WinStar. The lesson, adds Rathkopf, is that “if you compel a customer to engage in transactions, the benefit of which is to create revenue for you at the expense of your customer, that could create a situation where you become an insider of that company.”
“We have made strong arguments supporting our view that this suit was without merit. We are examining the judge’s ruling very carefully and will vigorously appeal the decision,” said Bill Carapezzi, Lucent’s general counsel, in a published statement. A spokesman for Lucent declined to comment further.