NewsMissoula County


City of Missoula loses ‘bad faith’ claims in water case, may be on the hook for millions

Costs to be determined, but mayor said pursuit worth the risk
Missoula Water
Posted at 11:44 AM, Dec 23, 2021
and last updated 2021-12-23 13:44:26-05

The City of Missoula has owned its own water utility for four years, and it’s made investments in infrastructure as Mayor John Engen promised it would when he took the Carlyle Group to court to force a sale of the water company, then Mountain Water Co.

Now, another bill is coming due for the city in the fight that has taken place since before the sale, and it’s likely to run in the millions of dollars, the Daily Montanan is reporting.

In 2015, a district court judge found the City of Missoula had the right to use its power of eminent domain to buy the utility, and three water commissioners set the price tag at $88.6 million for the system, now Missoula Water. All told, the city calculated it paid $99 million for the utility, lawyers and related development agreements in the condemnation case.

But the City of Missoula believed the Carlyle Group plotted a “deceitful scheme” by promising to sell the system but then declining offers prior to condemnation. In a separate lawsuit, the city alleged Carlyle Infrastructure Partners reneged on a deal to sell the utility to the city, and its representatives breached their “duty to deal fairly and in good faith with the city,” forcing the city to “incur significantly higher costs” in acquiring the water system. So Missoula asked the court to make Carlyle pay.

In a Nov. 30 “interim award,” a panel of arbitrators dismissed with prejudice all eight claims the city filed against investment fund Carlyle with a clinical analysis of interactions among key players in the deal. All three arbitrators signed the decision, and it noted the panelists received as evidence more than 600 exhibits, more than 580 pages of briefing, plus testimony and expert reports.

The panelists note they were designated to evaluate the allegations as part of an arbitration agreement among the City of Missoula, Carlyle, and the Clark Fork Coalition, a water watchdog based in Missoula. In 2011, the three parties had signed a letter of agreement related to the possible sale of Mountain Water by Carlyle to the City of Missoula, at the time the only municipality in Montana that didn’t own its own water system. The agreement noted disputes would be settled by three arbitrators, one selected by each party, and a third selected by the two.

In the unanimous decision, the panel found both the city and Carlyle had “experienced, sophisticated and specialized advisors,” and that Engen fulfilled his commitments and “exhausted every reasonable avenue at his disposal to maximize the opportunity for the City to acquire the system it had so long sought.”

However, the panel also determined the city never had an enforceable promise of a sale, as it had argued. Rather, the panel found the city had a right to make an offer, and that Carlyle considered the offers presented, but they weren’t high enough by a long shot.

“It was likely that the city could not afford to finance the acquisition of Mountain Water at anything approaching market value,” the panel wrote. “As a result of the City’s decision to pursue condemnation and its successful conclusion, it avoided those challenges.”

In an interview with the Daily Montanan, Engen said he is talking with lawyers about next steps, and he isn’t sure if the city will appeal any aspects of the case. But he said he does not regret pursuing it.

“If I thought for a minute that we were risking ownership of the utility, if I were putting taxpayers and ratepayers at significant risk, or the city in general at significant risk, we would not have pursued it,” Engen said.

The city’s lawyers took the current case on contingency. However, in a worst-case scenario for ratepayers, the city will be held liable for all of Carlyle’s lawyers’ fees and costs in addition to its own costs, such as for travel and arbitration. In the condemnation case, the city paid roughly $12 million in legal fees of its own and the the defendants’ litigation costs, according to a court document.

Engen anticipates a decision on how much the city will have to pay in summer 2022, and he said the total amount in the current case could also run in the millions and might mean temporarily deferring some projects. But he also said it will be manageable.

“It’s a big deal in terms of our disappointment in Carlyle not being held accountable for its business practices and for taking advantage of the City of Missoula, which I believe they did,” Engen said of the recent decision. “Financially, it could be significant, but not a direct hit to the pocketbooks of ratepayers or taxpayers. We can manage for the award within the water utility, and we believe we can do that without rate increases, but we don’t know today.”

In their decision, the arbitrators examined the offers the city made for the company versus how much the utility was worth on the market — and the commitment the city had wanted from Carlyle versus the one it secured.

Claims dismissed

The arbitration panel found that eight claims by the city were properly arbitrated, and it dismissed all with prejudice: fraud, fraudulent inducement, deceit, constructive fraud, negligent misrepresentation, breach of the duty of good faith and fair dealing in part, breach of oral contract or verbal agreement, and unjust enrichment in part. - Interim Award

A prickly history and the deal making

The decision outlines in detail the saga that took place in the city’s march toward public ownership since 2011.

“The City of Missoula had long wanted to own the water system that provides water to the City,” the decision said. “The City was the only one of 129 municipalities in Montana that did not own its own water system.”

But the owner, Henry “Sam” Wheeler and his family, didn’t want to sell to the City of Missoula because in the 1980s the city had tried, unsuccessfully, to condemn the asset. When he was ready to sell in 2010, Wheeler sought out Carlyle, which had expressed interest earlier, and an agreement between the parties set the price for the three utilities at $158.8 million, the decision said.

Wheeler’s lawyer said he could get a higher number if he went on the open market, and another official with the water utilities estimated the value at as much as $250 million, but Wheeler opted to proceed with the Carlyle Group in part because it could pay cash, the decision said.

Carlyle believed it needed the city’s support for the deal to close, and the city believed it had a better shot at buying the utility from Carlyle. So in September 2011, the city, Carlyle and the Clark Fork Coalition signed the letter of agreement “obligating (Carlyle) to consider in good faith an offer from the City to purchase Mountain Water.” It also said the City and Clark Fork Coalition would support the sale of the water utility to Carlyle before the Public Service Commission.

At the end of the year, Carlyle bought Mountain Water as part of the package deal for Park Water, the group of three utilities.

In early 2012, at Engen’s invitation, he, Robert Dove, a managing director at Carlyle at the time, and other players had a dinner in Washington, D.C., where they discussed a future deal, the decision said. Descriptions of the dinner conversation differ.

The mayor testified that Dove put his arm around him after the meal and asked if he was “ready to own a water company,” the decision said. It said Dove testified he “might well have said” “are you ready to buy a water company,” but that a government relations advisor for Carlyle recalled Dove saying he was “going to let the City have an opportunity to buy the company.”

The city’s subsequent attempts to purchase Mountain Water from Carlyle didn’t gain traction.

Paying for Mountain Water Co.

In 2013, an investment banker working on behalf of the City of Missoula sent a draft letter to Dove naming a purchase price of $65 million, “subject to described adjustments,” according to the panel’s decision.

But the decision notes the investment banker, Roger Wood of Moelis & Co., had concluded the value of Mountain Water was higher, somewhere from $80 million to $110 million. And the decision said he knew the city’s financial limitations. In an interview, Engen said the calculations by Wood showed the value could range anywhere from $40 million to roughly $100 million.

“Wood also calculated that the City could raise between $60 million and $75 million to finance a purchase transaction,” the decision said.

One problem for the city was that Carlyle owned Mountain as part of a trio of water utilities, with the two others in California. And peeling one utility away from the group to sell it as a separate entity cost a fair amount of money, at least $23.5 million in a calculation Bryan Lin of Carlyle made after receiving the purchase proposal from the city, the decision said.

Citing Lin, the decision said the city would have had to offer $88.5 million just to cover a write-down.

In a letter to Wood, Dove of Carlyle rejected the city’s proposal and said he believed the issues in play were “insurmountable,” the decision said. They included Carlyle’s “inability to shelter a significant taxable gain” because of a double taxation issue and overhead dollars the Missoula utility paid that would be lost if Carlyle sold, the decision said.

“Sometime in September or October 2013 (likely September 8), (Carlyle) told the City that to be competitive the City would need to propose a purchase price of $85 million, net of taxes,” the decision said.

The decision said the record does not reflect that Carlyle discussed those other factors before, but that the issues were legitimate ones. It also said “the substantial weight of the evidence” shows Carlyle was open to selling to the city if it made a competitive offer.

But in October 2013, the city again offered $65 million, the same price Carlyle already had rejected, and the city did not address other factors, such as double taxation and stranded overhead in its offer, the decision said.

“Indeed, the city did not even mention those issues,” the decision said. “Mayor Engen admitted that the City offered the same purchase price because it had the hammer of condemnation over Dove’s head.”

In late December 2013, the mayor received a price of $120 million, and the following month, the city offered $50 million. Carlyle declined the offer. The city filed its condemnation case three months later in April 2014.

In 2016, Carlyle sold the trio of companies to Liberty Utilities, subsidiary of Algonquin Power and Utilities Corp, and it received a purchase price of $327 million, the decision said.

“The purchase price suggested an implied value of Mountain Water of roughly $109 million,” the decision said. “The sale price of Park Water to Liberty provides useful information about Mountain Water because it resulted from an auction process with many potential buyers.”

The final condemnation judgment was issued in June 2017.

Fighting hard without a contract

Engen said he continues to believe Carlyle made the acquisition as difficult as possible for Missoula and reneged on its promise to sell. But he said he didn’t have the pledge in writing because he was told that putting it in writing would negate a deal.

“Mayor Engen, through tenacity and the leveraging of his position on behalf of his constituents, was tireless in his efforts to exact the greatest benefit to them,” the decision said. “The evidence is virtually undisputed that the support of Mayor Engen was necessary to obtain PSC (regulatory) approval for the sale of Park Water to (Carlyle), which eventually allowed the city to acquire Mountain Water through its successful condemnation action.”

But the decision said despite those “vigorous efforts,” “there is little evidence that (Engen) or anyone else acting for the city reached an enforceable verbal agreement with Dove or anyone else acting for (Carlyle) regarding the acquisition by the City of Mountain Water, and substantial evidence that no such agreement was reached.”

In the decision, the panel said it previously granted Carlyle summary judgment in its claim the city breached the arbitration clause of the letter of agreement by going to court instead, and it would enter an award confirming that decision. The final costs to the City of Missoula aren’t known yet.

However, under public ownership, the city has been able to use water rates to pay the mortgage on the system, pay to operate it, and pay to improve it without raising rates until last week, Engen said. He said if the bill for the current case is high enough, the city might have to defer projects, but he also said the city proposed the recent rate increase, which the Missoula City Council approved, independent of the outcome in this case. He noted rates are still lower than they were in 2011.

“As both a taxpayer and a ratepayer, you are continuing to get what I think is a far better value than you ever would have gotten under Liberty’s ownership,” Engen said. “Those guys were talking about a 5 percent rate increase year after year. They were not investing in repairing the system, which we’ve done to the tune of $6 million to $8 million a year. And we’re planning on continuing that.”

The city’s finance office noted that in the condemnation case, Carlyle was awarded $1.1 million and Mountain Water was awarded $2.8 million in attorneys’ fees and costs. The city noted its costs for arbitration and other expenses in the current case are $1.19 million to date; the amount doesn’t include any attorneys’ fees for the city given those were taken on contingency.

“I keep reminding myself that the fact that we own this system will have enormous benefits for generations,” Engen said. “And whatever the award here, it will be a drop in the bucket compared to the savings and improvements to the system over time.”