The Mega-C Trust and the Road Forward

Over the last couple of years, there have been many questions about the integrity of the Second Amended Trust for the Benefit of the Shareholders of Mega-C Power Corporation and whether the Trust would have any real value for individuals who invested in Mega-C, a company that turned out to be a complete scam. Since I drafted the original agreements and much of the structural work survived with modest changes in the bankruptcy court, I thought it might be useful to offer an author's perspective. I have not had any contact with the shareholders trust or its trustee since late 2006, so my discussion will be general in nature and involve some speculation. But I don't think the following discussion is too far off the mark. 

This post does not constitute legal advice to any creditor or shareholder of Mega-C Power Corporation and I encourage each interested party to consult with his own lawyers about his specific circumstances. This post has not been reviewed, authorized or endorsed by the U.S. Bankruptcy Court, Mega-C's Chapter 11 Trustee, the Liquidation Trust, the Shareholders Trust, Axion Power International, Inc. or their respective management and attorneys. The commentary, opinions, interpretations, evaluations and estimates set forth herein are mine alone and others may strenuously disagree. I have no obligation to update this post for subsequent events. My only goal is to provide an analytical framework that interested parties can use to evaluate the range of possible outcomes. 

Subject to all of the foregoing, my key observations and thoughts are: 

• Mega-C's promoters filed the bulk of the creditor claims in its bankruptcy case and all of those claims have been eliminated. While Axion and its founders originally had $1.3 million in creditor claims, those claims were reduced to $100 in the 2006 settlement agreement. There is one large unresolved creditor claim, but I do not believe the claim has substantial merit. If that claim is resolved on favorable terms, the surviving creditor claims should be less than $1 million. While it's too early to predict timing with any certainty, I think the liquidation trust is close to resolving all creditor claims and its trustee should be in a position to finalize his cash requirements and stock sale plans within 3 to 6 months. 

• After giving effect to the settlement agreement with Axion that paved the way for confirmation of the Chapter 11 plan, the shareholders trust held 5.7 million Axion shares. Under the terms of the plan, 1,000,000 of those shares were set-aside in a separate liquidation trust for the purpose of paying creditor claims and the administrative costs. The balance remained in the shareholders trust; provided that if the liquidation trust needs more resources, it can request additional shares from the shareholders trust. When the bankruptcy case is closed, any shares that remain in the shareholders trust will be available for distribution among the individuals who personally filed valid shareholder claims in the bankruptcy case. 

• Of the 1,000,000 shares that originally went to the liquidation trust, 685,000 shares were pledged as collateral for $2,055,000 in loans that were used to pay pre-confirmation administrative costs. The remaining 315,000 shares will eventually be sold to pay creditor claims and additional administrative costs. In their joint report for the quarter ended June 30, 2008, the trustees of the liquidation and shareholders trust (a) reported that 750,000 additional shares were being transferred to the liquidation trust from the shareholders trust, and (b) stated that the trustees believed the anticipated proceeds from the sale of the 1,065,000 shares would be sufficient to pay creditor claims and administrative costs and permit closing of the bankruptcy case. 

• When the trustees filed their joint report, Axion's stock price was approximately $1.75, which leads me to conclude that the liquidation trust anticipated a budget of roughly $2 million for creditor claims and administrative costs. Since Axion's stock price subsequently declined into the $1.30 range, I think there is a fair chance that the liquidation trust will need up to 500,000 additional shares to make up the shortfall resulting from a lower stock price. 

• The shareholders trust currently holds 3,950,000 Axion shares. If I assume the liquidation trust will need 500,000 additional shares to generate $2 million in proceeds, then the shareholders trust will be left with 3,450,000 shares to pay its own administrative costs and make distributions to shareholders. Depending on the cost and complexity of shareholders trust administration, I think it would be reasonable to assume that roughly 3 million Axion shares will ultimately be distributed to Mega-C's shareholders. 

• I don't have a precise tally of the claims that were filed with the Bankruptcy Court, but the Chapter 11 trustee counted approximately 24.5 million voting shares for purposes of the plan the confirmation hearing. Of that total, 900,000 shares were canceled in a settlement with C&T's scientists, 3 million shares were canceled in a settlement with Taylor and another 200,000 shares were canceled in a settlement with Usling. In addition, Pardo has previously stated his intent to abandon his claims for 14.5 million shares. In total, the cancellations and claim abandonments should reduce the number of outstanding Mega-C shares from 24.5 million to roughly 6 million. 

• Two shareholder groups own the remaining Mega-C shares. The first group is people who actually bought Mega-C shares from that company or one of its promoters. The second group is people who received shares from a Mega-C promoter because of some pre-existing relationship. As near as I can tell, the two groups are evenly balanced and each is group owns roughly 3 million Mega-C shares. I think the most difficult issue facing the shareholders trustee will be resolving the competing interests of these two groups. 

• If the shareholders trust decides that distributions should be limited to people who invested in Mega-C, the share distribution ratio will approach 1 for 1. If it decides to leave all remaining shareholder claims intact, the share distribution ratio will be closer to 1 for 2. While the legal issues facing the shareholder's trust are complex, I think its trustee should be in a position to finalize his distribution plan within 6 to 9 months. 

Despite the vigorous propaganda and disinformation campaigns that Mega-C's promoters have waged for the last five years, the simple fact is that Mega-C was broke and its promoters were the subjects of an OSC investigation before Axion's founders met each other for the first time. The iceberg had already breached the Titanic's hull and the stern was slipping beneath the waves. Instead of simply abandoning ship, Axion's founders built a new lifeboat for all of the stranded passengers and paid for it with their own funds.

Over the years, I've seen a lot of small companies fail. Sometimes the failures were due to bad behavior and sometimes they were due to bad luck. This is the first time I've ever seen a group of stockholders salvage the wreckage of a failed business, start over again from scratch, provide all the necessary capital and preserve a substantial interest in the new company for the equity investors in the failed company. 

Overall, the administrative costs of the Mega-C bankruptcy will probably be in the $4 million to $6 million range and the bulk of those costs will be directly attributable to litigation instituted, inspired or supported by Mega-C's promoters who cynically used the litigation to build support among the people they had cheated. I think it tragic that the individuals who were responsible for Mega-C's failure have increased the cost of bankruptcy administration by millions of dollars and decreased the ultimate distribution from the shareholders trust by millions of shares. While my opinion really doesn't matter in the overall scheme of things, I'm saddened that more Mega-C shareholders have not actively supported Axion and its founders who went to extraordinary lengths to leave no investor behind. 

I would have preferred a speedier resolution. I would have preferred a resolution that did not waste millions of dollars in administrative costs on frivolous litigation with Mega-C's promoters who never won a substantive hearing based on evidence. But I derive a great deal of satisfaction and comfort from knowing that Axion's founders insisted on protecting the innocent Mega-C shareholders and the trust structure we jointly established in December 2003 will ultimately serve the purpose it was designed to serve. 

I will do my best to respond to reasonable and factually accurate comments and questions. But I have no intention of letting my blog be used as a forum for disinformation.

Stockholm Syndrome and Stock Promoters

Stockholm Syndrome is a psychological disorder where a kidnap victim develops intense feelings of loyalty to his kidnapper. A similar pathology is common in domestic abuse cases where a battered wife or child will staunchly defend an abusive husband or father. A lesser-known pathology is one that I like to refer to as Battered Investor Syndrome, or BIS, a disorder where defrauded investors continue toxic relationships with stock promoters who repeatedly lie to them while stealing or wasting their hard-earned money. I can't claim to understand the root causes of BIS, but I know that until BIS victims acknowledge and accept the facts and decide "I'm mad as hell and I'm not going to take it any more" the cycle will continue and the promoters will keep going back to the same victims for more money and more forgiveness.

 

Over the last five years, I've had a once in a lifetime opportunity to watch the life cycle of a major stock fraud and study BIS in detail. The events I've witnessed still amaze me and they would make for a fascinating business or law school case study. But I'm far too tired to even try my hand at writing a detailed summary of the convoluted history.

 

The basic story is simple. A group of promoters agreed to join forces to create a new company that would finance R&D work on a new technology. Their business structure was doomed from the start but the details didn't matter because the inevitable failure could always be blamed on bad R&D results. Besides, these promoters were not ones to let the facts get in the way of a good story. Over a period of 18 months, the promoters sold stock to about 1,400 unwary investors in transactions that were never registered under applicable law. As one might expect, none of the investors received anything that remotely resembled a disclosure document. Overall, the promoters raised between $10 and $15 million. Some of the money went to R&D but the bulk the cash simply disappeared. The house of cards collapsed when securities regulators started asking questions about illegal stock sales.

 

Unlike most scams that abruptly end when the securities investigation begins, this company was different because the last round of investors included a handful of businessmen who were unwilling to accept a complete loss. So the investors banded together as allies, forged a new relationship with the owners of the patents, formed and financed a new company and then put a mechanism in place to protect the innocent investors who were defrauded by the scam. By the time the investor group was finished with its work, the new company owned the patents outright, a majority of the stock had been set aside in trust for the scam victims and the new company was adequately financed and fully compliant with applicable securities laws.

 

It didn't take long before the promoters of the original scam saw substantial value in the new company and decided that they wanted a big interest in the new company as compensation for their valuable contribution in causing the original train wreck. Predictably, the organizers of the new company didn't want anything to do with the promoters who had already skimmed millions of dollars from their original scam. So what started as a silly greenmail demand from the promoters quickly degenerated into an outright war.

 

Over the next four years, the promoters engaged in a non-stop campaign of historical revisionism, disinformation, Orwellian double-speak and scorched-earth litigation. Their arguments distorted the history of the old company and misconstrued the goals of the new company and its organizers. But as I noted earlier, the promoters were not ones to let facts stand in the way of a good story. In 20/20 hindsight, I don't believe the promoters ever believed they could win their lawsuits. Nevertheless, I'm convinced they believed they could make the litigation so expensive and time consuming that the new company would be forced to capitulate and offer a huge settlement. Thankfully, the new company was able to rise to the challenge, continue in operation and defend its position honorably and honestly.

 

While the promoters won the occasional procedural victory, they never won a court hearing based on facts and evidence. Even so, they were able to create enough fear that the BIS victims reportedly financed the bulk of their litigation costs. The litigation has finally been resolved. The promoters have no claims against or interests in the new company and all the money and time spent on litigation has been wasted.

 

Overall, the BIS costs have been staggering. The BIS victims lost between $10 and $15 million when they invested in the original scam. The frivolous litigation against the new company impeded its financing activities, reduced the price it could have gotten for its stock and forced the new company to divert substantial money and energy from technology development to litigation. The net effect of the litigation was to reduce the ultimate benefit to the BIS victims by more than 50% and disqualify a large number of BIS victims from participating in the payout at all. As the final insult, rumor has it that the promoters were able to shift the burden of financing their frivolous litigation to the shoulders of BIS victims and new pigeons who never got adequate disclosure. By the time the dust settled, BIS was responsible for at least three levels of economic loss and intense fear among the BIS victims who have never understood the simple truth that the promoters are pathological liars who will happily squander vast amounts of investor money if it advances their personal interests.

 

The promoters' hearing before the securities regulators is scheduled to begin soon and I have no doubt that they will be severely sanctioned because there is no defense against the alleged securities law violations. I remain hopeful that this final nail in the promoters' coffins will be enough to instill a little confidence that the new company has always been a steadfast defender of the BIS victims. I also hope that BIS victims' interest in the new company will be enough to offset some substantial part of the injuries they suffered at the hands of the promoters.

 

I'm an eternal optimist and believe that sooner or later the BIS victims will realize who their enemies were and who their friends are. The BIS victims and the new company both deserve a break. I suppose time will tell.