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Tronox Witness Says Kerr-McGee Misstated Liabilities

A Tronox Inc. accounting expert took the stand Thursday in a trial pitting the company against ex-parent Kerr-McGee Corp. over legacy environmental liabilities the pigment maker was allegedly saddled with, testifying that flawed reserve practices caused understatements in Tronox's environmental and tort liabilities.

AlixPartners LLP managing director Robert J. Rock, testifying in the monthslong trial before U.S. Bankruptcy Judge Allan L. Gropper in Manhattan, said Kerr-McGee employed flawed practices for setting reserves for possible environmental and litigation liabilities ahead of its November 2005 initial public offering of shares in Tronox, causing Tronox's contingent liabilities to be materially understated and not in accordance with generally accepted accounting principles.

"Kerr-McGee's recognition and disclosure of environmental liabilities was not in accordance with GAAP," Rock said. "Kerr-McGee did not evaluate potential liabilities until it received a demand, complaint or a notice from an agency advising that a site required mediation."

The trial, which began May 15 and is expected to last all summer, features the Anadarko Litigation Trust — Tronox's successor in the case — and the U.S. Department of Justice, which stepped into the case during Tronox's bankruptcy on behalf of the U.S. Environmental Protection Agency as the debtor's largest creditor, suing Kerr-McGee, which is now wholly owned by Anadarko Petroleum Corp.

The suit focuses on the 2005 and 2006 move that saw Kerr-McGee put its valuable oil and gas exploration and production assets into an entity known as New Kerr-McGee, leaving behind its pigment business laden with decades worth of environmental liabilities from Kerr-McGee's chemical operations.

The company has been calling witnesses in the case in its effort to paint Kerr-McGee and Anadarko as purposely isolating good assets from the toxic liabilities and creating Tronox as a company that was doomed to fail.

Rock's testimony was intended to describe the accounting situation leading up to the 2005 IPO, which the litigation trust is attempting to prove wrongly led Tronox to suffer greater environmental liabilities than it should have.

While GAAP have a standards of accruing reserves for "probably and reasonably estimable" costs, Kerr-McGee only set reserves for those costs it knew or almost certain it would incur, Rock said. Furthermore, it failed to reserve for project life cycle costs, avoided estimating ranges of possible costs, estimated costs based on low-probability "best-case scenarios" and set reserves using a top-down approach "motivated by budget and spending goals rather than costs that were reasonably estimable."

The company also failed to investigate and disclose environmental liabilities at certain sites, even to its own accountants, and didn't evaluate liabilities until it was required by an agency or complaint to do so.

"Thus, even though Kerr-McGee was aware of myriad sites at which it had potential environmental exposure, it ignored those potential liabilities for purposes of setting reserves and making disclosures required by GAAP," Rock said.

As a result of all this, he said, the legacy liabilities allotted to Tronox at the time of its spinoff were materially understated.

After filing for bankruptcy protection in 2009, Tronox filed the suit in an attempt to recover $15 billion it said Kerr-McGee and Anadarko owed it as a result of the fraudulent transfer. That figure has since grown to $25 billion with interest.

Judge Gropper ruled the week before the trial began that Anadarko is not a proper defendant in the suit because it maintained Kerr-McGee as an isolated business unit. Now the debtor and the government are only going after Kerr-McGee and related entities, which are nonetheless owned by Anadarko, for recovery in connection with the spinoff and liabilities.

The Anadarko Litigation Trust is represented by David J. Zott, Andrew A. Kassof, David H. DeCelles and Jeffrey J. Zeiger of Kirkland & Ellis LLP.

The defendants are represented by Lydia Protopapas, Richard A. Rothman, Melanie Gray, Jason W. Billeck and Bruce S. Meyer of Weil Gotshal & Manges LLP, James J. Dragna, Thomas R. Lotterman and Duke K. McCall III of Bingham McCutchen LLP and Kenneth N. Klee and David M. Stern of Klee Tuchin Bogdanoff & Stern LLP.

The case is Tronox Inc. v. Anadarko Petroleum Corp. et al., case number 1:09-ap-01198, in the U.S. Bankruptcy Court for the Southern District of New York.