May 30th 2008

John Driscoll
The Times-Standard
May 30, 2008

A Fresno Superior Court judge recently denied the state's request to throw out a lawsuit lodged by the Pacific Lumber Co. that alleges California breached its obligations under the 1999 Headwaters deal.

Judge Alan Simpson kept three of the company's claims in place, and dismissed two others but gave it leave to refile them. Simpson wrote in his May 20 ruling that he could not rule at this stage in the litigation on whether the state violated its contract with Palco, since that would depend on a review of the facts.

The lawsuit was filed in 2006, claiming that restrictions above and beyond those imposed by the Headwaters agreement were imposed on the company and threatened its viability.

The state and federal governments paid Palco $480 million for the 7,400-acre Headwaters Forest and two smaller groves, and put in place special regulations for the company. With additional regulations through the North Coast Regional Water Quality Board -- which did not sign onto the agreement -- the company was not able to log what it expected.

In January 2007, Palco went bankrupt. A major ruling on which of two reorganization plans will be approved by the U.S. Bankruptcy Court in Corpus Christi, Texas, is expected soon. Judge Richard Schmidt said in a hearing Thursday that he intends to rule on the matter by the end of next week, said Palco Vice President and General Counsel Frank Bacik.

But the Headwaters suit factored into the bankruptcy proceedings, with various parties arguing over the potential value of Palco's claims against the state. How it may proceed and what value it may have to the company will depend on who controls Palco after it emerges from bankruptcy.

The Mendocino Redwood Co. and Palco creditor Marathon Structured Finance Fund have indicated they would want to settle the litigation. The other plan proponents, the noteholders with a lien on Palco's 210,000 acres, have said they would weigh whether or not to move forward with the suit. Both propose to establish a trust to manage the suit, with benefits being forwarded to creditors.

Bacik said the Fresno court's ruling doesn't alter the litigation, but changes could come depending on who ends up with it. He said the court's upholding of three of five claims means the suit has merit.

"The lawsuit is a breach of contract action three times over instead of five times over," Bacik said.

The ruling has been somewhat overshadowed by the larger bankruptcy process.

California Resources Agency Sandy Cooney said, "While no one is every happy about a denial of motion of judgment, we have great respect for the legal process and faith in that process as it moves forward."