This excerpt taken from the DPL 10-K filed Feb 22, 2007.
Item 1b Unresolved Staff Comments
Information relating to our properties is contained in Item 1 CONSTRUCTION ADDITIONS, and ELECTRIC OPERATIONS AND FUEL SUPPLY, and Note 10 of Notes to Consolidated Financial Statements.
Substantially all property and plant of DP&L is subject to the lien of the mortgage securing DP&Ls First and Refunding Mortgage, dated as of October 1, 1935 with the Bank of New York, as Trustee (Mortgage).
In the normal course of business, we are subject to various lawsuits, actions, proceedings, claims and other matters asserted under laws and regulations. We believe the amounts provided in our consolidated financial statements, as prescribed by GAAP, for these matters are adequate in light of the probable and estimable contingencies. However, there can be no assurances that the actual amounts required to satisfy alleged liabilities from various legal proceedings, claims, and other matters discussed below, and to comply with applicable laws and regulations will not exceed the amounts reflected in our Consolidated Financial Statements. As such, costs, if any, that may be incurred in excess of those amounts provided as of December 31, 2006, cannot be reasonably determined.
Former Executive Litigation
On August 24, 2004, DPL, and its subsidiaries DP&L and MVE, filed a Complaint (and subsequently, amended complaints) against Mr. Forster, Ms. Muhlenkamp and Mr. Koziar (the Defendants) in the Court of Common Pleas of Montgomery County, Ohio asserting legal claims against them relating to the termination of the Valley Partners Agreements, challenging the validity of the purported amendments to the deferred compensation plans and to the employment and consulting agreements, including MVE incentives, with the Defendants, and the propriety of the distributions from the plans to the Defendants, and alleging that the Defendants breached their fiduciary duties and breached their consulting and employment contracts. DPL, DP&L and MVE seek, among
other things, damages in excess of $25,000, disgorgement of all amounts improperly withdrawn by the Defendants from the plans and a court order declaring that DPL, DP&L and MVE have no further obligations under the consulting and employment contracts due to those breaches.
The Defendants have filed their answers (and subsequently, amended answers) denying liability and filed counterclaims (and subsequently, amended counterclaims) against DPL, DP&L, MVE, various compensation plans (the Plans), and current and former employees and current and former members of our Board of Directors. These counterclaims, as amended, allege generally that DPL, DP&L, MVE, the Plans and the individual defendants breached the terms of the employment and consulting contracts of the Defendants and the terms of the Plans. They further allege theories of breach of fiduciary duty, breach of contract, promissory estoppel, tortious interference, conversion, replevin and violations of ERISA under which they seek distribution of deferred compensation balances, conversion of stock incentive units, exercise of options and payment of amounts allegedly owed under the contracts and the Plans. Defendants counterclaims also demand payment of attorneys fees.
On March 15, 2005, Mr. Forster and Ms. Muhlenkamp filed a lawsuit in New York state court against the purchasers of the private equity investments in the financial asset portfolio and against outside counsel to DPL and DP&L concerning purported entitlements in connection with the purchase of those investments. DPL, DP&L and MVE are not defendants in that case; however, DPL, DP&L and MVE are parties to an indemnification agreement with respect to the purchaser defendants. On August 18, 2005, the Ohio court issued a preliminary injunction against Mr. Forster and Ms. Muhlenkamp that precludes them from pursuing certain key issues raised by Mr. Forster and Ms. Muhlenkamp in their New York lawsuit that are identical to the issues raised in the pending Ohio lawsuit in the New York court or any other forum other than the Ohio litigation. In addition, the New York court has stayed the New York litigation pending the outcome of the Ohio litigation. Mr. Forster and Ms. Muhlenkamp have appealed the preliminary injunction and the appeal is pending at the Ohio Supreme Court.
The trial commencement date for this case is set for April 30, 2007.
Cumulatively through December 31, 2006, we have accrued for accounting purposes, obligations of approximately $56 million to reflect claims regarding deferred compensation, estimated MVE incentives and/or legal fees that Defendants assert are payable per contracts. We dispute Defendants entitlement to any of those sums and any other sums the Defendants assert are due to them and, as noted above, we are pursuing litigation against them contesting all such claims.
On or about June 24, 2004, the SEC commenced a formal investigation into the issues raised by the Memorandum (see Note 17 of the Notes to the Consolidated Financial Statements). Although the SEC has not taken any significant action in furtherance of their investigation during 2006, we stand ready to cooperate with their investigation.
On May 28, 2004, the U.S. Attorneys Office for the Southern District of Ohio, assisted by the Federal Bureau of Investigation, notified us that it has initiated an inquiry involving the subject matters covered by our internal investigation. Although the U.S. Attorneys office and the FBI have not taken any significant action in furtherance of their investigation during 2006, we stand ready to cooperate with their investigation.
On June 24, 2004, the Internal Revenue Service (IRS) began an audit of tax years 1998 through 2003 and issued a series of data requests to us including issues raised in the Memorandum. The staff of the IRS requested that we provide certain documents, including but not limited to, matters concerning executive/director deferred compensation plans, management stock incentive plans and MVE financial statements. On September 1, 2005, the IRS issued an audit report for tax years 1998 through 2003 that showed proposed changes to our federal income tax liability for each of those years. The proposed changes resulted in a total tax deficiency, penalties and interest of approximately $23.9 million as of December 31, 2005. On November 4, 2005, we filed a written protest to one of the proposed changes. On April 3, 2006, the IRS conceded the proposed changes that we filed a written protest to and issued a revised audit report for tax years 1998 through 2003. The revised audit report resulted in a total tax deficiency, penalties and interest of approximately $1.2 million. We had previously made a deposit with the IRS of approximately $1.3 million that we requested on April 14, 2006 be applied to offset the $1.2 million tax deficiency, penalties and interest for tax years 1998 through 2003. The Joint Committee on Taxation completed its review of the revised audit report for tax years 1998 through 2003 and sent us a letter dated June 16, 2006 stating that it took no exception to the revised audit report.
Insurance Recovery Claim
On January 13, 2006, we filed a claim against one of our insurers, Associated Electric & Gas Insurance Services (AEGIS), under a fiduciary liability policy to recoup legal fees associated with our litigation against three former executives. An arbitration of this matter was held on August 4, 2006. The arbitration panel ruled on or about September 12, 2006 that the AEGIS policy does not require an advance of defense expenses to us. Rather, the arbitration panel stated that we are required to file a written undertaking as a condition precedent to repay expenses finally established not to be insured. We have filed a written undertaking with AEGIS and will continue to pursue resolution of the claim through mediation and arbitration in 2007.
State Income Tax Audit
On February 13, 2006, we received correspondence from the Ohio Department of Taxation (ODT) notifying us that ODT has completed their examination and review of our Ohio Corporation Franchise Tax Returns for tax years 2002 through 2004 and that the final proposed audit adjustments result in a balance due of $90.8 million before interest and penalties. We have reviewed the proposed audit adjustments and are vigorously contesting the ODT findings and notice of assessment through all administrative and judicial means available. On March 29, 2006, we filed petitions for reassessment with the ODT to protest each assessment as well as request corrected assessments for each tax year. On October 12, 2006, we signed a Memorandum of Understanding with the ODT that stated if the ODTs positions are ultimately sustained in judicial proceedings, the total additional tax liability that we would be subject to for tax years 2002 through 2004 would be no more than $50.7 million before interest as opposed to the $90.8 million stated in the ODTs correspondence of February 13, 2006. We believe we have recorded adequate tax reserves related to the proposed adjustments; however, we cannot predict the outcome, which could be material to our results of operations and cash flows.
We are also under audit review by various state agencies for tax years 2002 through 2004. We have also filed an appeal to the Ohio Board of Tax Appeals for tax years 1998 through 2001. Depending upon the outcome of these audits and the appeal, we may be required to increase our tax provision if actual amounts ultimately determined exceed recorded reserves. We believe we have adequate reserves in each tax jurisdiction but cannot predict the outcome of these audits.
Labor Relations Unasserted Claim
In September 2006, we became aware of an unasserted claim under the Fair Labor Standards Act concerning the calculation of overtime rates for our unionized workforce. By agreement of Local #175 and DP&L, we jointly submitted the claim to a neutral third party who ruled in favor of DP&Ls position. As a result of this decision, Local #175 has decided not to pursue any claim against DP&L.
Pending before the U.S. Supreme Court is a proceeding, Environmental Defense v. Duke Energy (Duke Energy) that does not involve DP&L as a party but may have a significant effect on the outcome of litigation described below that involves allegations of violations of the CAA. A key issue in that litigation that may be dispositive with respect to other pending cases is what test to apply for measuring whether modifications to electric generating units should trigger application of New Source Review (NSR) standards under the CAA. In general terms, the dispute is whether to measure pre- and post-modification emissions based on the rate of emissions per hour of operation or based on total emissions over time. The latter test, if applied, could trigger NSR requirements for equipment replacements that result in a plant running more often because it is more economical or dependable, even if the emissions rate per hour of operation does not change. A ruling is expected in the first or second quarter of 2007. DP&L cannot predict the outcome of the Duke Energy case. Moreover, in each of the cases identified below, there may be case-specific facts and allegations that may cause a judge to find that the U.S. Supreme Courts ruling is based on different facts and allegations and is therefore not controlling in the case before the judge.
In September 2004, the Sierra Club filed a lawsuit against DP&L and the other owners of the Stuart Generating Station in the United States District Court for the Southern District of Ohio for alleged violations of the CAA, including issues that may be decided by the Supreme Court in the Duke Energy case and other issues relating to alleged violations of opacity limitations. DP&L, on behalf of all co-owners, is leading the defense of this matter. A sizable amount of discovery has taken place and expert reports are scheduled to be filed at various times from May through September, 2007. Dispositive motions are to be filed in January 2008. No trial date has been set yet.
Additional information relating to legal proceedings involving DPL and DP&L is contained in Item 1 ENVIRONMENTAL CONSIDERATIONS, Item 1 COMPETITION AND REGULATION, and Item 8 Note 15 of Notes to Consolidated Financial Statements.