Mahonia Ltd. v JP Morgan Chase Bank

In this action the Claimant (“Mahonia”) claims on a letter of credit (the “L/C”) issued by the Defendant, WestLB AG (“West”) on 5^th October 2001, at the request and for the account of Enron Corporation (“Enron”) on behalf of its subsidiary, Enron North America Corp (“ENAC”). The amount payable under the L/C is $165 million. Demand was made under this L/C on 5^th December 2001 and it is common ground that a conforming document, namely an Event of Default Statement, was presented for payment there under. It is accepted that the burden is on West to establish a defence in relation to the circumstances in which the L/C came to be issued if judgment is not to be given against it. This matter came before Colman J on applications by Mahonia to strike out the defences or to grant summary judgment in its favour which he refused in a judgment given on 30^th July 2003.

West is a German bank with offices in London, New York, Houston and elsewhere. Mahonia is a special purpose vehicle (SPV) incorporated in Jersey. The other party to the action is JP Morgan Chase Bank (“Chase”), at whose instance Mahonia was incorporated and with whom Chase concluded transactions parallel to those concluded by Mahonia with ENAC. West also has a Part 20 claim against Mahonia and Chase, should its defences fail. In essence West maintains that the L/C was induced by fraud or conspiracy, that it is unenforceable because of the illegal purpose for which it was issued or alternatively that West can recover damages for the fraud or conspiracies in which Mahonia and Chase were involved.

At the time of the transaction Enron was a primary customer of both Chase and West and each bank was one of Enron’s primary (“Tier 1”) banks. Although much discredited since its sudden and dramatic collapse, precipitated by revelations of its involvement in plainly questionable off -balance sheet transactions, throughout the period with which this action is concerned Enron was considered one of the world’s most successful companies, employing innovative methods to raise what was referred to as “structured finance”. Enron’s auditor at the time was Arthur Andersen (“Andersens”). Andersens, like Enron itself, was held in high regard, as one of the major international auditing firms.

West issued the L/C under a committed bank instrument facility dated 10^th September 2001 (“the Facility Agreement”). Issues arise as to whether it was bound to do so and whether the L/C is unenforceable by reason of illegality. The L/C had been requested by Enron, pursuant to an Instrument Request (“the Instrument Request”) in order to support a Swap transaction entered into by ENAC with Mahonia (“the ENAC/Mahonia Swap”). The Instrument Request referred only to this single Swap. The beneficiary of the L/C was stated by Enron to be Mahonia.

Shortly after the L/C was issued on 5^th October 2001, Enron’s financial difficulties began to come to light. On 16^th October 2001, Enron published its third-quarter results which reported a non-recurring charge of $1.01billion. On 8^th November 2001, Enron filed a form 8K with the SEC in which it gave notice of its intention to restate its accounts going back to 31^st December 1997 and confirmed that its previous accounts could not be relied on. On 19^th November 2001, Enron made a 10Q filing with the US Securities Exchange Commission (the SEC) and on 2^nd December 2001, Enron went into Chapter 11 Bankruptcy. An event of default having thus occurred under the L/C, demand was made by Mahonia on 5^th December 2001.

It is common ground between the parties that there were two other Swaps which related to the ENAC/Mahonia Swap. The two other Swaps were the “Mahonia/Chase Swap” and “the ENAC/Chase Swap”. These Swaps provided for fixed and floating payments in opposite directions. The fixed payments in the ENAC/ Mahonia swap and the Mahonia/Chase swap, which were made on 28^th September 2001, amounted to $350 million (less an agreed arrangement fee of $1 million to Chase). Chase paid this sum to Mahonia under the Mahonia/Chase Swap and Mahonia paid it to ENAC under the ENAC/Mahonia Swap. Under the ENAC/Chase Swap, the fixed payment which ENAC agreed to pay Chase was $355,961,248.40, payable on 26^th March 2002. In each Swap contract, the floating payments under the Three Swaps were calculated by reference to the price of a notional quantity of gas, being 127, 923, 977 Mmbtu of Natural Gas, multiplied by the settlement price on 25^th March 2002 of the Nymex Henry Hub Gas Futures Contract for the April 2002 delivery month. The effect of these Three Swap transactions was that $350 million was paid by Chase to Mahonia and by Mahonia to Enron in September 2001 and Enron was obliged, approximately six months later, to pay a sum amounting to approximately $356 million to Chase. Because the floating payments were exactly the same in each of the Three Swap transactions, the ultimate effect, if all parties performed their obligations, was to provide Enron with $350 million (less $1 million arrangement fee) for a period of about six months, for which it was obliged to pay a figure which equated to repayment of a loan of $350 million with an effective annual interest rate of 3.44%. It is clear that the figure of $356 million was calculated specifically by reference to interest rates.

Issues arise between the parties as to the proper characterisation of these transactions and the appropriate method of accounting for them in Enron’s balance sheet and financial accounts. In simple terms, West maintains that these transactions constitute a loan, that they should have been the subject of accounting as a loan and that the existence of the 3 limbs of the composite transaction and its nature as a loan should have been disclosed prior to its issue of the L/C. In wrongly accounting for it, Enron acted in breach of US GAAP (Generally Accepted Accounting Principles) and thus in breach of the US Securities Exchange Act of 1934.

West contends that it is entitled not to pay the demand made under the L/C or is entitled to cross-claim against Mahonia and Chase because it has six defences or causes of action:

The ENAC/Mahonia Swap and the Mahonia/Chase Swap are referred to as “Prepay transactions”, “prepays” or “forward” transactions. These terms are used to refer to arrangements in which one party pays in advance for goods or services to be provided at a later date. There is plainly nothing objectionable about such transactions in themselves but West maintains that the Three Swaps transaction in issue here involved no prepayment for the future delivery of goods or services at all because of the effect of the other Swaps, that it was concluded for accounting purposes only and that it was a “disguised loan”. It is said that the “prepay” transactions involving Chase and Enron, of which this was one, were structured to achieve a particular accounting treatment pursuant to which Enron could account for their proceeds as “cash flow from operations” and could present its repayment obligations on its balance sheet, not as debt but as “price risk management liabilities”. West submits that the loan was disguised as “energy trading contracts” in circumstances where a genuine energy trading contract is made for the purpose of generating profits on or from exposure to shifts or changes in market prices. It is said that the deception at the heart of the Three Swaps transaction is that it involved a structure which was designed to make it appear that each of the Three Swaps involved a genuine energy trading contract when the reality was, when taken as a whole, that they were economically a loan transaction structured to achieve the elimination of any price risk or exposure to shifts and changes in the market prices of any commodity at all. Because the reality was one of loan, the proceeds of the prepay transaction should have been booked as “cash flow from financing” and the obligation to repay ought to have appeared as a “debt” in the balance sheet.

The Three Swaps Transaction was preceded by a history of earlier “prepay transactions” which, for convenience, have been labelled “Chase I – Chase XI”.

The first prepay transaction took place in December 1992. As with all the other prepay transactions, it was proposed by Enron to Chase. Enron sought a forward sale or swap, to be concluded by the year-end 1992 under which Chase would pay the purchase price to an Enron subsidiary, which would deliver physical oil over an extended period in the future. This would generate immediate financing for Enron, against an undertaking by Enron to supply oil at a later date. Chase personnel in London understood that there was a tax advantage to Enron in this proposed transaction, inasmuch as it could use up existing tax credits which could be set against the profits made on this forward sale. It is clear that this prepay transaction was the subject of advice to Enron by Andersens and that the transaction had to be a sale and not a loan for the purpose of making use of the tax credit.

At the time, Chase considered that it was, under applicable banking Regulations, prevented from taking delivery of physical oil and Mr Webster of Chase’s London Branch suggested the use of a “Special Purpose Vehicle” (SPV) namely a Jersey registered company which could take delivery of the physical product. The London Tax Efficient Finance team in London to which Mr Webster belonged, had for some years used Jersey SPV companies which were incorporated and run by the Jersey law firm, Mourant Du Feu & Jeune (“Mourant”) or companies associated with it. The SPV would be ultimately owned by a Charitable Trust and the directors were partners or employees of Mourant. Such SPV’s became commonly used in “structured finance” arrangements utilised by banks. For a small profit margin, the SPV would take part in the suggested transaction on condition that its liability was limited to the assets in the transaction itself. In this way the directors could properly, in the best interests of the SPV, conclude such transactions and thus render a service to the bank that had brought the transaction to it. The SPV would commonly have no offices or employees of its own and would therefore utilise, by way of agency agreement, either the bank or other dealers in the product or derivatives to protect its position, whilst a Security Agreement and an Agency Agreement would give the arranger complete control over the assets which were the subject of the transaction.

In the first prepay transaction, the English law contractual documents were drafted by London lawyers and covered the relationship between Chase and the Jersey SPV, which in this case was Stoneville Aegean Limited (“Stoneville”). In its final form the transaction involved Stoneville entering into a Forward Sale Agreement with the Enron subsidiary pursuant to which it made an upfront payment of $75 million, funded by Chase, in exchange for the right to receive title to oil on set dates during the following year. The market risks to Stoneville of changes in the prices of oil were hedged by Stoneville by selling the oil forward on the New York Merchantile Exchange (“NYMEX”) by way of Oil Futures Contracts matching the amounts, dates and specifications of the future oil flows from Enron. The actual trading in oil futures was handled on Stoneville’s behalf by Chase Futures Corporation as Stoneville’s agent. Stoneville later entered into a contract with an oil company or trader to sell the oil it received from Enron under exchange for physical (“EFP”) Oil Futures Contracts, which exactly matched Stoneville’s short position with NYMEX, thereby closing out that position. The first six months’ oil deliveries by the Enron subsidiary were sold to four different energy companies. In this way Stoneville’s position was entirely protected.

The Forward Sale Contract by which the Enron subsidiary sold the oil to Stoneville was subject to New York law and was provided by Enron’s Houston’s lawyers who prepared the Margin Agreement, Enron Guarantee and an opinion letter under United States law. This was the course adopted for all future prepays until at least June 2000, after which it appears that Enron’s in-house lawyers themselves took over the drafting.

It is apparent therefore that Enron’s auditors were advising on the underlying concept for this forward sale from the outset and that the involvement of an SPV occurred because of the perceived regulatory position of Chase. It seems that Enron also entered into a $100 million prepay transaction for the year end 1992 with another Bank, namely Bankers’ Trust, which may well have felt able to take delivery of the physical oil itself, without the need for an SPV. It was an intrinsic part of the first prepay transaction and it is accepted that the same applied to the later prepays, that the SPV would not incur any liability which it would not be able to meet out of the proceeds of the transaction and that Chase’s recourse against Stoneville was to be limited to the assets generated by that transaction. This “limited recourse” agreement was undoubtedly a feature which enabled the directors of the SPV to consider that the transaction could properly be concluded in the best interests of the SPV for the small profit involved. As “credit support” for the Enron subsidiary’s obligations to the SPV, Enron gave a Parent Guarantee.

West, for the purpose of its case, did not contend that this transaction or those in Chase II – IV, were in themselves necessarily objectionable, but, in argument, stated that they might well be.

The second prepay transaction closed in June 1993. Other Banks bid for the business in competition with Chase. At the request of Enron, Mahonia, a different SPV, was Enron’s subsidiary’s counterparty. Mahonia was incorporated as a “finance company” “to assist in transactions arranged by Chase Bank” according to the words used on filings made at the time of its incorporation. As Chase points out, it never had any direct or indirect ownership in Mahonia nor have Chase personnel ever held any of Mahonia’s constitutional offices which were all held by Mourant personnel. Under the terms of this second prepay transaction, once Mahonia received oil from the Enron subsidiary it sold the oil on to Stoneville which disposed of it on NYMEX in the same manner as in the first prepay transaction. The reason for the retention of Stoneville in the chain appears to have been the desire to use an entity already known to the counterparties with whom sales of the product or futures were concluded. Otherwise the transaction was structured in the same way as Chase I.

Credit support for this second prepay transaction was provided by way of a Parent Guarantee from Enron, and a syndicated performance letter of credit on which Mahonia could draw if the Enron subsidiary failed to deliver oil. The syndicated Banks accepted the risk of Enron’s insolvency rather than the risks of the structure as a whole because they guaranteed Enron’s performance.

The syndication had been arranged by Chase through its New York Syndications Department with Chase taking the joint largest share in the syndication. The executive summary given to the Syndicate Banks explained to them, as did similar documents in relation to later prepays, that Chase had funded the prepayments by Mahonia and that any proceeds of the Letter of Credit which would be payable on Enron’s default would therefore be paid to Chase. Chase was always the largest or joint largest participant in these performance Letters of Credit. Once again, lawyers were heavily involved in this in New York and Houston on the part of Chase and Enron, together with Enron’s legal department whilst Mourant dealt with the Jersey end of the transactions.

The third prepay transaction was concluded in December 1994 and adopted the same structure as the second prepay transaction. Mahonia’s price risk was hedged in the market and the documentation was once again provided and negotiated by lawyers for Enron and Chase. Chase appeared to have obtained this business in the face of competition from other Banks who were invited to bid for it.

The next prepay transaction was executed in September 1995, by which time Chase believed that Enron had already executed six prepay transactions, only three of which had been with itself. For the first time the commodity for this prepay transaction was gas, rather than oil, apparently because of the size of the gas inventory or the scale of sales of oil already concluded. Stoneville no longer featured as there were no goodwill contacts from its earlier dealings in oil which would assist for these dealings in gas. Mahonia’s dealings on NYMEX were conducted through Cargill Investor Services Inc because Chase Futures was winding down its operations. Mahonia purchased gas from the Enron subsidiary and disposed of it on NYMEX by the use of EFP Contracts. Credit support took the form of a Parent Guarantee from Enron and a syndicated performance Letter of Credit put together by Chase some time after the closing of the prepay transaction.

Chase draws attention to this particular performance Letter of Credit because West participated in it as part of the syndicate. West took a $20 million share amounting to 8.9% of the total, in the knowledge that any proceeds of the Letter of Credit which would be payable on Enron’s default would be paid to Chase, that Chase had financed the transaction and that Mahonia was an SPV. This is clear from the evidence of Mr Richard Newman, West’s Global Client Relationship Manager for Enron in New York and then in Houston, which took the form of a statement and deposition adduced under the Civil Evidence Acts. Although untested in cross examination, I had no difficulty in accepting the reliability of his evidence, which was that he was well aware that Chase did a number of prepay transactions with Enron over the years, that Mahonia was an SPV set up between Chase and Enron and that Chase had funded this particular 1995 transaction. When West’s Board in Dusseldorf sanctioned participation in this Letter of Credit, on the application of West’s New York branch which was involved in the transaction, it is likely to have seen the executive summary distributed by Chase which stated that Mahonia was a Special Purpose Corporation and made it clear that Chase had advanced an upfront payment of $225 million to Mahonia and that the proceeds of any drawing on the Letter of Credit, which operated in the event of Enron defaulting on the Guarantee of its subsidiaries’ obligations, would be paid to Chase. Although West in London may have had little knowledge of the details of this involvement, West in Dusseldorf may well have known considerably more.

On 31^st July 1996, following its merger with Chemical Bank, Chase became a New York State chartered bank and obtained approval from the State Banking Department to engage in prepay transactions involving the physical delivery of product, provided that such transactions were customer driven and were simultaneously matched at the time Chase entered into the transaction with its customer.

Despite this permission which enabled Chase to take physical delivery of product, the fifth prepay transaction, which concluded in December 1996, adopted in part the same structure as the fourth. Both oil and gas were used as the commodity (which Mahonia sold on the spot market when received), but for the first time (although this was not clear on the documents), Mahonia did not hedge its position at the outset but at the end of January entered into a fixed for floating net settled swap with Chase, as Chase then did with Enron, as opposed to deals with other parties. West relies on this further element as an objectionable feature to the transaction, creating a circular movement of money in respect of the products themselves. Credit support again took the form of a Parent Guarantee from Enron and a syndicated performance Letter of Credit. Although it had pleaded the objectionability of Chase VI – IX, it appeared at trial that Chase V shared the same critical features.

West was invited to participate in this syndicated Letter of Credit with an executive summary which was in similar form to the 1995 summary but West declined to participate.

For the first time, Chase in New York, as opposed to its London branch co-ordinated the transactions. It seems that, in the light of the regulatory approval for Chase to take title to commodities, Chase may have envisaged undertaking this transaction which concerned gas, without involving Mahonia. However the transactions took the usual format with the involvement of an SPV as Enron wished to continue on the same basis. The previously employed structure with documentation approved by lawyers was utilised, tailored for this transaction, which was finalised in December 1997 with one real difference.

Because Chase could now take physical delivery of the product, this prepay for the first time involved a prepaid Forward Sale Contract between Chase and Mahonia in terms which closely mirrored the Natural Gas Forward Sale Agreement between Mahonia and the Enron subsidiary. Chase took delivery of the commodity for which prepayment had been made because of its changed regulatory position instead of merely advancing funds to the SPV. The effect of the contract between Chase and Mahonia was to put Mahonia in funds however so that it was able to provide funds to the Enron subsidiary by way of advanced payment.

Chase sold the gas it received to various energy companies as required by the State Banking Department approval conditions. Some of the commodity Chase received was sold on the market to Enron and Chase’s price risk was hedged by means of net settled swaps with Enron.

It is the circular feature of this transaction to which West draws attention and which, it maintains, demonstrates the unlawfulness of the transaction. The involvement of a third party in sales transactions when the underlying economic reality is a loan, is said to be one of the objectionable features which disguised the reality of the position. West maintains that Chase VI – Chase XI all gave rise to breaches of US GAAP and the provisions of the Securities Exchange Act of 1934.

These two transactions were concluded in June 1998 and December 1998. The only difference in the structure of Chase VII from the earlier transactions was that the credit support for Enron’s obligations was provided by Surety Bonds rather than a performance Letter of Credit. These Surety Bonds were issued by highly rated insurance companies and were understood to be the functional equivalent of Letters of Credit. Not only were Surety Bonds used in Chase VII and Chase VIII but at Enron’s request, existing performance Letters of Credit in relation to Chase V and Chase VI were replaced by Surety Bonds also.

In both Chase VII and Chase VIII, Enron purchased the commodity which Chase had acquired under the prepay transactions. This made life easier for Chase since it had to sell the commodity received, in order to meet regulatory requirements and Enron represented a significant share of the market. As Enron’s credit was acceptable to Chase, there was then no need to obtain separate credit risk approval from Chase’s Credit department in respect of new lines of credit for new purchasers on sales which customarily provided for payment by the end of the month following delivery. On Chase VII, Enron purchased half of the commodity Chase received whilst the other half was sold into the market generally. On Chase VIII the entirety of the commodity was sold back to Enron.

Chase IX was concluded in June 1999 with a structure which was substantially the same as Chase VIII.

These two transactions were concluded in June 2000 and December 2000 respectively. Chase X took the same form as Chase XI save that the credit support was split into two tranches with $400 million being supported by Surety Bonds and $250 million being supported by credit derivatives. Chase’s satisfaction with Surety Bonds as a form of security was diminishing however because of problems which had arisen on such Bonds in film financing transactions. Chase XI was syndicated inasmuch as Chase shared the funding with one other Bank, although the original intention had been to include a third Bank as well. Surety Bonds remained the credit support but with a diminished exposure for Chase as a result of the syndication. The essential structure of the transaction remained the same, modified to reflect the participation of the co-funder. Another SPV was incorporated and used in relation to the other Bank’s participation in the transaction.

It was thus some eight months later, in August 2001 that Chase XII was the subject of negotiation.

As with all the previous prepay transactions, contact was initiated by Enron, in this case by Mr Deffner to Mr Walker on Thursday, 30^th August 2001. During the following week, following the Labour Day holiday, which included the Monday, Messrs Dellapina, Traband, Walker and Serice of Chase (the deal team) discussed the possibility of obtaining credit approval from Chase’s Credit Department (“Credit”) which, by reason of the extensive levels of exposure of the Bank to Enron and the lesser evaluation of surety bonds as credit mitigation, they perceived as being reluctant to see any, or any significant, increase and might be looking for a reduction in exposure. This did not reflect any lack of confidence in the soundness of Enron’s financial state but simply the degree of exposure to one particular customer, however large and apparently creditworthy. There was discussion by the deal team of the “run-off” of the Enron prepay transactions, representing the amount of “amortisation” of these transactions up to then. The intention was to seek to persuade Credit to approve a new prepay transaction on the basis that any new exposure would only replace existing exposure which had previously been approved and had now been repaid. In practice Mr Ballentine in Credit had already taken the run-off into account when considering that the level of Chase’s exposure to Enron should not be increased, and perceived any new prepay transaction as additional exposure.

In addition there was a concern about risk mitigation and credit support because, by this time, Credit had come to consider that Surety Bonds represented an unsatisfactory form of risk mitigation in the light of the failure by Insurers to pay on Bonds issued in the context of the film financing transactions. Moreover as events turned out, the Surety Bond market effectively collapsed with the events of 11^th September 2001.

In the period immediately following the events of 11^th September 2001, Enron pressed Chase for progress as none had been achieved thus far. At this stage, the possibility of an initial short-term deal was discussed, requiring Chase to fund the entire deal initially and then, after closure, to syndicate out the risk on a more long-term basis. Enron wished to have this deal concluded by the end of the third quarter, an accounting date, as Chase well understood. This was in fact a common feature of all the earlier prepay transactions which were invariably concluded with an eye to the end of accounting periods.

The need for a short-term deal meant that there was no real prospect of a transaction involving physical delivery of the oil to Mahonia or Chase. Instead of a physically settled prepay the decision was made to structure a financially settled prepay which meant that, given the lack of confidence in Surety Bonds, the high price of credit derivatives and the impossibility of a performance Letter of Credit where no physical performance was involved, a financial Letter of Credit became the only potential available means of credit support. (It is common ground that a physical deal and a financially settled Swap would be accounted for in the same way.)

Although it was hoped by the Chase deal team that Credit would give its approval to Chase funding $150 million, because that was the run-off over the three month period to the end of the year, by which time it was hoped that syndication could take place, Credit gave its approval only for 10% of the sum sought of $350 million, namely $35 million. This was the standard “hold” that Credit liked to see on a deal such as this. Enron was keen not to produce the Letters of Credit by way of credit support until after the end of the third quarter and Chase was prepared to give it some latitude and ultimately agreed that this support should be provided by October 8^th 2001.

Thus it was agreed in principle by Credit at Chase that Enron should receive $350 million by way of financing from Chase, via Mahonia for a three-year period (less the arrangement fee of $1 million) on 28^th September 2001 but was required to post Letters of Credit as credit support to the tune of $315 million by October 8^th 2001. Syndication of funding could be worked out later, perhaps with those who had provided credit support for Enron. For reasons to do with liability for withholding tax payable by Enron, however, the latter decided that the length of the short-term deal should not exceed six months in the first place with the result that the final stages of the prepayment transactions were to take place on 26^th March 2002.

The September 2001 prepay transaction comprised three separate commodities swaps which were documented on Standard ISDA terms. The combined effect of these Swaps at inception was that Chase advanced the fixed amount of $350 million to Mahonia under the Mahonia/Chase Swap and Mahonia advanced the same amount to ENAC under the ENAC/Mahonia Swap. Six months later these swaps required floating payments to be made in accordance with the price of Natural Gas Futures by Mahonia and ENAC respectively, but an ENAC/Chase net settled Swap hedged Chase’s price risk at the same level against a payment for ENAC. If all parties performed their obligations, the combined effect of the Three Swaps would be that the floating payments due from ENAC to Mahonia, from Mahonia to Chase and from Chase to ENAC cancelled each other out and ENAC would pay Chase under the ENAC/Chase net settled Swap the fixed sum of $356 million approximately. With full performance the only sums actually paid would be the advance payment from Chase to Mahonia and Mahonia to ENAC of $350 million on 28^th September 2001 and the payment 6 months later from ENAC to Chase of some $355.961 million (leaving aside any question of putting up margin or collateral in the meantime).

It was a term of the ENAC/Mahonia Swap that ENAC provide a letter of credit for $315 million in respect of its obligations. The ISDA terms included provisions as to the terms of the letter of credit for which the form was set out in Schedule 2.

The Three Swaps were all subject to ISDA terms and conditions and in the case of the ENAC/Mahonia swap there was provision for additional collateral to be put up in respect of the floating payment which depended on the daily movement of market prices over the 6 month period. Under the terms of the ISDA Master Agreement between Chase and ENAC, Chase had to put up collateral when the market differential exceeded $50 million, whilst ENAC had to do so when it exceeded $10 million in respect of the totality of ISDA transactions between them, including Chase XII.

By 8^th October 2001, Enron provided the required credit support in the shape of two Letters of Credit. The first of these was a Letter of Credit for $150 million which was provided under the terms of a syndicated Facility Agreement concluded in May 2001, led by Chase itself. The second Letter of Credit for $165 million was provided under the terms of the Facility Agreement led by West, which was again syndicated to other Banks. The provenance of this Letter of Credit did not become known to Chase until 4^th October 2001, in circumstances which are the subject of some dispute between the parties. In none of the drafts of the ENAC/Mahonia Swap, nor in the final executed documentation dated 28^th September 2001, was the identity of the issuers of the Letters of Credit specified.

The Three Swaps are represented in a schematic diagram which forms Appendix 1 to this Judgment, which was page 6 of the Exhibit produced by Chase in its opening. There is no doubt that it was designed to be a structure that would not constitute a loan, with the benefit of professional advice as to how to achieve that object. In form it consisted of Three Swaps but the dispute centred on its substance and effect.

Mahonia was a “special purpose vehicle” (SPV). It was owned by a charitable trust called the Eastmoss Trust, of which the trustees were Mourant & Co. Trustees Ltd, a company which was associated with the Jersey lawyers Mourant Du Feu & Jeune (MDF). Mr. James, who gave evidence and whose evidence was entirely reliable, is currently senior partner of MDF and chairman of the Mourant group which is composed of MDF and a number of companies which provides specialist administration services, amongst which is Mourant & Co. Trustees Ltd. The Eastmoss Trust was constituted under an Instrument of Trust Deed dated 20^th May 1986 under which the property of the Trust and any income derived from it is held “for the benefit of such charities or charitable purposes as the trustees shall in their discretion determine”. The original property of the Trust was shares in an SPV called Eastmoss Ltd. Since then the shares of numerous SPV’s have come into the ownership of the Trust including Mahonia, which was formed at the request of Chase, “to assist in transactions arranged by Chase”. It is ironic “happenstance” that the off the Shelf company involved in these transactions has the name of a plant sometimes used as a hedge.

Mahonia was incorporated on the 16^th November 1992 with a nominal share capital of £10,000 of which only £10 has been issued. This share capital is held by the Eastmoss Trust through nominee share holding companies. There were two directors of Mahonia, both of whom were lawyers at Mourant, namely Mr. James and Mr. Jeune. The corporate secretary of Mahonia has at all times been Mourant Secretaries, a company in the Mourant group. Mahonia has no office premises of its own and no employees. It acts only through agents appointed under agency agreements by its directors. MDF act as lawyers for Mahonia in Jersey as necessary, in the persons of Mr. James, Mr. Essex-Cater and Ms. Carter.

Stoneville Aegean Ltd was another SPV owned by the Eastmoss Trust which operated in the same way as Mahonia and featured in Chase I, II and III. All SPV’s owned by the Eastmoss Trust operated in a similar manner, on the evidence of Mr. James. The whole point of an orphan SPV was that it should not be owned by nor legally controlled by the party which had requested its creation and which intended to enter into transactions with it. For various regulatory and tax purposes, it was essential that the SPV should be independently owned and independently controlled. This was true of both Stoneville and Mahonia.

Mahonia only ever entered into transactions at Chase’s invitation. Chase as arranger, would structure a transaction in which it wished Mahonia (or Stoneville) to participate and would then enquire of Mahonia’s directors whether they were willing to transact the business. There is no doubt at all that the directors were free to refuse to conclude the transaction or to seek amendments to it before agreeing to participate. The directors had, in accordance with the law of Jersey, to determine whether or not the conclusion of the transaction was in the best interest of the company. The best way of showing that it was in the best interest of the company was, as Mr James said, for the company to make a profit out of the transaction and for the expenses and risks to the company to be minimised by the structure of the transaction. As a consequence as a term of the deal, the arranger would pay the SPV’s costs of entering into the transaction, including its lawyers’ fees, brokerage fees and the like. The SPV would enter into an Agency Agreement, often with an associated company of the arranger, so that all the handling of the transaction, after the execution of the documents, was effected by such agents.

In the case of Mahonia, as was the universal practice of all Mourant SPV’s according to Mr James, the directors would insist on a Limited Recourse Agreement, under which the arranger agreed that the liability of the SPV to the arranger would be limited to the assets involved in the transaction in question. The other obligations undertaken by the SPV to any third party would be matched by comparable obligations owed by the arranger to it or by indemnity. In this way the SPV’s risks were minimised and the directors would be able, in the best interest of the SPV, to conclude transactions involving very substantial sums of money whilst the SPV received nominal fees for taking part in the business, normally of the order of $5,000-$10,000. Mourant, as lawyers, would have their fees paid in relation to their work on the transactions and the profit from the nominal fee paid to the SPV would ultimately be paid out by way of dividend and used for charitable purposes.

The arranger would wish to maintain control over the assets involved in the transactions and for this purpose Security Agreements would be concluded, together with the Agency Agreements which meant that the arranger would, following execution of the documents by Mahonia, effectively run the transaction from start to finish. Moreover, because of the arranger’s security interest, it would take upon itself the negotiation of the documents, not only for the transaction between itself and the SPV, but for the transaction between the SPV and any third party. Thus in Mahonia’s case, Mr. Levy of Chase would and did negotiate the form of the Swap transaction between ENAC and Mahonia and the form of the L/C in support before tendering the draft documents, which Chase had approved, to Mahonia’s directors for their comments, any amendments which they required and execution.

I accept the evidence of Mr. James and Mr. Levy that Mahonia was free at all times to seek amendments to the documents. It was also free to decide whether or not to conclude the transaction. Whilst the directors at Mourant would always wish to conclude transactions at the behest of the arranger, and as lawyers at Mourant they would wish to earn Mourant legal fees from proposed transactions, they would also, as lawyers be conscious of their duties as directors of Mahonia to act in the best interest of the SPV and therefore to ensure that the SPV’s risks were minimised, its expenses covered and a small profit was made. If there were elements of the transaction with which the directors were unhappy, I find that they would have sought amendment, as they did from time to time, or refused to agree to Mahonia’s participation.

In practice problems rarely arose because Chase had a clear idea of what was likely to be acceptable or unacceptable to the directors of Mahonia because of Mahonia’s need to reduce risk to a minimum in order for its directors to consider it justified to conclude the transaction for the small fee which would be payable. The SPV’s position had to be as protected as far as possible from liabilities it could not pay. In negotiating the documents therefore Chase not only looked after its own interests, to ensure it had proper security in respect of the transactions concluded by Mahonia but also after Mahonia’s interests. Over the course of Chase I – XII, the form of documents evolved, requiring limited alterations to fit the particular transaction in mind. As the Chase witnesses expressed it, a “template” emerged which required adaptation from case to case, but which gave Mahonia the degree of protection from exposure which its directors found acceptable.

On a number of occasions Chase required documentation from Mahonia acknowledging that Mahonia did not enter into transactions in reliance upon any advice or representation from Chase and confirming that it made its own decisions. Mr. James was happy to give such acknowledgement because he and Mr. Jeune did evaluate each transaction to ensure that it was in the best interest of Mahonia to conclude it. The limited recourse agreement, which was in most cases written, applied even where it was not formally documented. I find that it was this which was largely instrumental in enabling Mahonia’s directors to conclude that it was in the SPV’s interest to enter into the transactions in question. It was, as Mr James said, absolutely standard for orphan SPV’s (meaning SPV’s where the shareholders were independent of the arranger) to give the arranger’s agents control over the transactions and all the assets involved in them whilst retaining total freedom in respect of the decision whether or not to conclude the transaction itself.

The point is clearly explained in a passage in Mr. James’s evidence which runs as follows: -

Q: The existence of not only a charge over all your assets in favour of Chase, not only an agency agreement with Chase, but also a limited recourse agreement with Chase, would add up to a pretty powerful mix of factors, which would indicate that you were controlled by Chase, would it not?”

A: No. This is invariably the case in all SPV’s, orphan SPVs in which I deal with. It is the case that arrangers do not like to allow the directors of the SPVs freedom to access the bank accounts and to use the money in their own ways. They want to make certain that the transaction is controlled exactly the way in which it has been set up to perform and if we start doing things differently to that, that would damage the transaction.

And so the way of ensuring that that is the case is that you build in security arrangements and a lot of control in relation to the particular transaction, which is very different to control of the entity itself.

…

Our control was the fact that we could decide whether or not to do a transaction. Once we decided to do a transaction, the terms of that transaction were then established and in the same way as in all orphan SPV transactions the arranger and the counterparties would make absolutely certain that the control of the transaction itself was very firmly in the hands of those who had the economic risk of that transaction.”

Both parties relied on the limited recourse agreement in support of their case as to the independence or non-independence of Mahonia. I find as a fact, on the basis of Mr. James’s evidence, that although no written document exists in respect of Chase XI and Chase XII, there was a limited recourse agreement effective for each of the transactions known as Chase I – Chase XII. The formal document in the last two Chase transactions was omitted by oversight but applied just the same. In my judgment it supports the independence of Mahonia rather than anything else because it was a requirement of Mahonia that it had such protection, amongst other forms of protection, before it was prepared to conclude any of the transactions in question. Although it was suggested by West that there was a point at which it was decided that limited recourse agreements should be abandoned and that Chase and Mahonia were thereafter not prepared to have that kind of document evidenced in writing, I find that this was not the case and, following the point where it was suggested that this decision was made, there are a series of further limited recourse agreements in relation to the succeeding Chase transactions. There seems to have been a suggestion that there could not be a limited recourse agreement in a transaction other than Chase I – XII for peculiar reasons limited to that transaction.

Mahonia would never initiate any transaction. The request would always come from Chase to participate, with a given structure and drafted transactional documents. There was a need for Mahonia to understand the overall purpose of the transaction in order to assess whether or not it was in the interest of the company to take part, to assess the degree of risk and to avoid any illegality. If the directors were satisfied that Mahonia could make profits, that its costs were paid and that these criteria were satisfied, it would be minded to enter into any transaction that was brought to it by Chase. Mr. James would look to ensure that the arrangement did not leave a liability in Mahonia which it could not meet. That involved matching contracts and removal of price risk so far as possible, leaving default risk about which the SPV could normally be confident because of the substantial nature of the arranger and the limited recourse agreement should the third party default.

I find that Mahonia was independent of Chase. Mahonia was not owned by nor controlled by Chase. It decided whether or not to conclude the transactions that Chase brought to it, under which it surrendered control of its assets in the transaction to Chase or others connected to or nominated by Chase. Once it had independently decided to conclude the transaction which had been almost entirely structured by Chase and the third party in the manner outlined above, by agreement it gave control over the transaction and the transactional assets to others. Mahonia was therefore never controlled by Chase, even though, by agreement, it entrusted Chase or Chase related parties or nominees to control the transactions which it had independently concluded.

It is clear that initially Mahonia was utilised by Chase for forward purchases from ENAC, because Chase considered that there was a regulatory problem for it, as a Federal Bank, to take physical delivery of gas or oil products, whereas Mahonia could do so. This difficulty disappeared in 1996.

Mr. James’s evidence was that, so far as he was concerned, he understood tax treatment to be an important issue for Enron in entering into Chase I- Chase -IV. He did not recall any discussions of the purpose underlying the transactions after that. There had been discussion between him and Mr. Webster of Chase London at the outset about the avoidance of characterisation of the transaction as a “loan”. He understood that the purpose of the early transactions was to take advantage of tax credits available to Enron against net operating losses and that Enron’s auditors had to be satisfied that the transactions were sales and not loans in order to get that tax benefit.

All the evidence from Chase and Enron personnel was at one in saying that Enron’s purpose was understood to be the raising of finance- “getting cash in the door”. Prepays were one method of doing this, which had accounting consequences which I find that Enron considered advantageous. They did not involve off Balance Sheet accounting as total liabilities on the transactions were shown on it but they did give rise to entries on the Balance Sheet as Price Risk Management liabilities rather than debt. Some of Enron’s personnel appeared to think that the presence of Mahonia affected the accounting treatment to be given to the transactions, but on the expert evidence before me, it was common ground that it did not. There was a view however that a three party set of transactions involving an independent third party such as Mahonia, with no cross default or cross collateralisation provisions between them avoided a problem which might arise in a two party situation.

There could be no question of consolidating Mahonia in Enron’s accounts, nor of questioning its independence from Enron, who played no part in its formation or the running of its activities. Enron’s lawyers drafted representation letters for Chase III - VIII which were signed by Mahonia and Enron stating that the hedging strategies and hedging transactions entering into by each of them were independent of those of the other. Mahonia’s hedging transactions in Chase III and IV were concluded by agents on its behalf, but there was no liaison with Enron over either these hedging transactions so there was no difficulty in making these representations. Under Chase VI – XI Mahonia on-sold to Chase.

In reality Mahonia had virtually nothing to do with Enron or ENAC throughout the course of Chase I – Chase XII since Chase dealt with ENAC both in negotiation of the transaction before presentation to Mahonia for acceptance and in ensuring performance of the transactions following the execution of the transactional documents, the Security Agreement and the Agency Agreement.

When representations were sought from Mahonia, Mr James would examine them to see whether or not they could be given, as he did in relation to the representations sought by Andersens’ through Enron in relation to Chase XII. These representations were as follows: -

Mr. James understood that Andersens were seeking these representations from Mahonia in order to check upon its independence and substance and in particular to check upon its independence from Enron. The first three representations were given in the form sought by Andersens’ and each clearly relates to the question of independence from Enron rather than Chase. The fourth representation was not given in the form originally requested. The original request made by Andersens through Enron was for Mahonia to confirm that Chase did not own Mahonia or consolidate the company under general acceptable accounting principles. Mr. James took the view that this was not a representation which Mahonia could give since it had no knowledge of Chase’s accounting. The representation that he was prepared to give simply related to ownership and Andersens were satisfied with this.

It is not suggested that any of these representations were untrue. Mahonia had earned small profits on other transactions than those with Enron as a result of other Chase instigated transactions. This amounted to part of the $70,000 cash which also represented Mahonia’s unencumbered assets. Although, by virtue of various security agreements Mahonia’s assets were generally charged to Chase, cash in a bank account with Royal Bank of Scotland was not caught by the fixed and floating charges because under the law of Jersey a formal assignment of the bank account was required before any security could be effective.

West contends that, although each representation was accurate, the overall effect was misleading in giving the impression of a company of substance. West also challenged representations made in the Swap agreements whereby Mahonia represented that it was “engaged in the business of reselling the natural gas delivered” under the agreements and was purchasing for resale to third parties and that it had entered into the transactions for commercial purposes related to “its business as a producer processor or merchandiser of natural gas or natural gas liquids”. Those representations were true, notwithstanding that Mahonia was an SPV because it was indeed buying and selling for its own account and was therefore a merchandiser. Additionally West questioned whether Mahonia was a “eligible contract participant” and a “eligible commercial entity” for the purposes of the Commodity Exchange Act of the United States which Mahonia was, because, although an SPV, the requirements for eligibility were based upon gross assets or turnover. The position is that Mahonia could accurately describe itself in the way that it did in the Swap transactions and could give these representations as requested. It was not under any duty to do anything further, nor to specify what other assets it had, what other unencumbered assets it had what net assets it had. Nor was it asked to state, nor did it represent that it conducted business on a wider scale than transactions introduced to it by Chase. If Andersens were happy with the representations requested and given Mahonia cannot be criticised for giving them.

So far as Mr. James was concerned the transactions were always presented to him with well-known lawyers and accountants involved for Chase and Enron. In many transactions there was a degree of circularity and he understood all the transactions involved structured finance for Enron. It was never suggested to him that he had any knowledge of any improper accounting by ENAC or any intention to indulge in any such accounting. Nor did he know about US GAAP and how Chase or Enron did its accounting.

Chase draws attention to an Andersens file note dated 24^th June 1993 which discusses Chase I and the basis for recording that the cash proceeds would not be recorded as debt but would be included with activities from price risk management in Enron’s consolidated financial statements. The background was summarised in the following words: -

“In June 1993 Enron Hydrocarbons Marketing Corp. (EHMC), an indirectly wholly-owned subsidiary of Enron Corp. (Enron) entered into a crude oil sales agreement with Mahonia Limited (Mahonia). Mahonia is a special purpose entity incorporated under the laws of New Jersey. Financing to Mahonia is provided by Chase Manhattan Bank (Chase) in the form of a prepaid Swap that mirrors the physical transaction between EHMC and Mahonia. Under the terms of the agreement EHMC received $230 million in cash in return for their commitment to deliver 12.1 million barrels of crude oil from January 1994 to November 1994 (see summary of transaction at Exhibit I).”

It thus appears that Andersens’ were well aware of Mahonia’s status as a SPV, long before the four representations were sought from it in September 2001.

I have described in outline the three interrelated swaps transactions that constitute the arrangements made in September 2001. Expert evidence was adduced by Chase and Mahonia from Professor Tufano, a financial economist and Professor of Financial Management at Harvard Business School whilst West adduced evidence from Mr. Stanton who was the head of Structured Finance and Chief Operating Officer of Global Capital Markets at Robert Fleming & Co. until April 2001. These experts sought respectively to define the transactions in Chase XII as “structured finance” or as a “loan”. Professor Tufano took the view that, whether the ENAC/Mahonia Swap and the ENAC/Chase Swap were each seen in isolation, or viewed together with one another, with or without reference to the Mahonia/Chase Swap, there were characteristics of these transactions which meant that they could not properly be characterised as a loan. They were, he said, a typical example of what is commonly referred to as “structured finance” since, on any definition of those words, a transaction involving the use of a SPV, credit support arrangements (posting of margin and external third party credit support) and ancillary transactions which modify the price risk of the underlying asset, would qualify. Mr. Stanton’s view however was that, although there were characteristics of these transactions which were dissimilar to the conventional loan, the term “structured finance” was not a meaningful one, since it was so loosely used in banking and financial circles, and none of those characteristics to which Professor Tufano referred were such as to affect the substance of the matter, which on his analysis was that of a loan.

In my judgment, the question of nomenclature of the transactions is of little importance. The issue between the parties is the proper way to account for these transactions, which is a matter of accounting principle and practice, not one of usage of words in the jargon of banks, financial markets or economists. The reports of the experts did nonetheless draw attention to the features of the transactions which could affect their accounting treatment and Chase’s view of it as bankers, and it is to those that I now turn.

The ENAC/Mahonia Swap is a forward prepay under which Mahonia was required to pay to ENAC the sum of $350 million on September 28^th 2001 (the “initial fixed payment amount”) and $0 on March 26^th 2002 (“the second fixed payment amount”) in exchange for the payment by ENAC to Mahonia of a floating payment on March 26^th 2002 representing a notional quantity of natural gas at a market index price on March 25^th 2002 for the April 2002 delivery month.

Mahonia had additional protection in the shape of a parent company guarantee from Enron Corp. in respect of ENAC’s obligation, which was also supported by standby letters of credit from West and Chase, each of which was syndicated. The total of these amounted to $315 million, thereby leaving $35 million uncovered. Under the terms of the ISDA agreement operating between them, ENAC was obliged, in the event of an increase in the market price of gas which would have the effect of increasing its liability in respect of the floating payment, to provide collateral/ margin on a daily basis, in the shape of cash and/or US Securities or “other eligible support”. If the market price of gas then dropped, the collateral required would equally be reduced so that there remained $35 million uncovered at all times in respect of ENAC’s obligation to pay Mahonia for the market price for the gas. No collateral was required from Mahonia in the ENAC/Mahonia transaction, as Mahonia had no further payment obligations.

Under the Chase/Mahonia Swap, Chase was required to make a fixed payment to Mahonia and Mahonia was required to make a floating payment to Chase, in identical terms to the respective obligations of Mahonia and ENAC under the ENAC/Mahonia Swap. No collateral was required from Mahonia in respect of movements in the market price but the agreement between Mahonia and Chase gave Chase a security interest in the assets which Mahonia would receive under the ENAC/Mahonia Swap. Moreover Mahonia appointed Chase as its agent in relation to the ENAC/Mahonia Swap and there was a limited recourse agreement between them, albeit not written.

Under the ENAC/Chase Swap, ENAC was required to pay Chase the fixed sum of $355,961.258 on March 26^th 2002 in exchange for the floating payment by Chase on the same date in respect of the same notional quantity of natural gas and at the same price as that to which the other two swap agreements referred. ENAC and Chase had entered into an ISDA Master Agreement on 5^th April 1994 under which either party could be required to put up collateral in respect of market movements of the gas price. The amount of collateral to be posted depended upon the current market value of the gas involved in the transaction less a threshold amount which was dependent on the parties’ S & P ratings. (The threshold applied to the totality of dealings between ENAC and Chase under ISDA terms, which included a large number of transactions apart from Chase XII.) Enron’s rating at September 28^th was BBB+, which meant that the threshold amount for it was $10 million whilst, as Chase’s rating stood at AA - or higher, its applicable threshold was $50 million. If the market movements resulted in net sums which exceeded the relevant threshold for the party in question, collateral was required. Additionally ENAC’s parent company Enron Corp. guaranteed ENAC’s obligations to Chase up to an aggregate of $50 million.

These three transactions were entered into contemporaneously and in contemplation of one another. They were however legally distinct in that there was no cross referencing between them. There were no cross default provisions and no cross collateralisation provisions. A default by a party in one transaction would therefore not impact upon the rights and obligations of the parties in the other transactions. There were three distinct parties to the transactions as a matter of law and the contracts between them imposed distinct rights and obligations upon each of them.

It is accepted by Chase that the ENAC/Mahonia Swap transaction, as a prepay, inevitably involved financing, in as much as Mahonia gave six months credit to ENAC. It is also accepted that when the three transactions are looked at in the round, there was a financing to ENAC, achieved by the three transactions. Whilst on the ENAC/Mahonia transaction alone, there was a clear market risk for both ENAC and Mahonia, the effect of the other two transactions would be to eliminate this price risk for all parties at 26^th March 2002, provided that all performed their obligations in accordance with the terms of the contracts between them.

On this footing West maintained that the economic substance of the transactions constituted a loan because the only payments which would ultimately be made, in the event of full performance, were the initial payments of $350 million from Chase to Mahonia and from Mahonia to ENAC followed by the payment by ENAC to Chase of almost $356 million six months later, the difference being a figure which reflected a calculation of current interest rates which amounted to about 3.4 per cent pa.

Mr Stanton seemed slightly reluctant to admit that there were forms of finance that were not loans, but it is obvious that, as a matter of law this is so and he said he had been involved in such transactions. Sale and leaseback arrangements, sales and repurchases (“repos”), aircraft leasing, bonds, gold swaps and various forms of commodity finance exist as pointed out by Prof Tufano. The way they are viewed by a banker or by accountants or the taxman may differ, but the characteristics of a transaction which provides financing are not always such as to make the instrument a loan and customers of banks have reasons for wanting financing that does not take the form of a loan. Mr Stanton agreed that there would be nothing unusual about a customer structuring financing transactions for the tax or accounting treatment they would receive and that it would not be surprising to hear of a bank that participated in (and marketed to other banks) a financing which was designed by the customer to be accounted for as “non debt” financing.

The fact is that the Chase XII transactions involved not two parties but three and that the form of each transaction was that of a swap transaction involving fixed and floating payments and other financial obligations which were directly linked to the movement in the market price of natural gas.

Thus Chase and Mahonia point out that: -

This last point was exemplified in evidence and argument by a series of different illustrations as to what would occur in the event of default of one party with the market price of the gas moving over the 6 month period.

Thus if collateral had not been posted then, assuming a gas price of $3.50, in the event of ENAC’s default, Chase/Mahonia, even if taken together would receive $223.23 million net whilst, if Chase defaulted, Chase/Mahonia, if taken together would receive $447.73 million net.

With rising prices, if ENAC defaults and is unable to pay, Chase’s loss exceeds the sum originally “advanced” and, if the price rises to over $5.25 Chase/Mahonia actually have to pay a net sum to ENAC, as shown on Prof Tufano’s modified Figure 8 and Figure 9. If Chase defaults and is unable to pay, ENAC has to pay more than the fixed payment sum originally envisaged under the Chase/ENAC Swap. The effect of the independence of the three transactions is that the defaulting party gains at the expense of the innocent parties because of the substantive obligations owed as between Chase, Mahonia and ENAC. It is clear that there is credit exposure of each party which is related to price movement.

The position is of course affected and mitigated by the collateral obligations for which the ENAC/ Mahonia and the Chase/ENAC swap agreements provide, if fulfilled, whether the price goes up or down.

Whilst the position with regard to the upward movement is illustrated in the preceding paragraphs, that of downward movement is simpler. If the market price was to go down, there would be adequate collateral on the ENAC/Mahonia Swap (subject to the $35 million hold) and collateral on the ENAC/Chase Swap (subject to the $10 million ENAC threshold). West are therefore right in saying that the net loss for Chase and Mahonia together should never exceed $45 million if collateral is provided as it should be up to the last possible moment before 26^th March.

In practice however, if there was default on that date, it is likely that there would be a shortfall in relation to collateral due prior to that, since it is highly likely that a party going into liquidation will fail to put up margin in the period preceding its declaration of insolvency. If its credit rating slips in the period prior to insolvency, which is also a real possibility, there will be requirement for increased margin, but whether or not that would be met must be doubtful.

In general however, if the collateral obligations are met, it is only when the transactions are looked at individually, rather than as a whole, that the independent obligations are seen to give rise to substantial variable losses for individual parties.

Examples can be multiplied by reference to different gas prices which reveal nonetheless that the nature of the obligations undertaken by the parties differ significantly from those which would be undertaken in a conventional loan situation. The substance of the three transactions, when taken compositely, is affected by the fact that there are three independent transactions between three parties with fixed and floating payments in each which are not in any way dependent upon one another as a matter of law. Moreover the requirement for the provision of margin, which not only operates asymmetrically as between Chase, Mahonia and ENAC, but operates by reference to the price of gas, differs from any conventional provisions for security, where additional security is required when the collateral provided drops in value. Here where the price of gas goes up, additional margin is required both from ENAC to Mahonia and from Chase to ENAC, because that is what swap contracts subject to ISDA require.

Whether or not a bank would assess the overall structure as it would a loan, the effect of default in the Chase XII transaction is different, as appears from the preceding paragraphs. Whilst the economic effect of full performance is the same as a conventional loan in the final outcome, there are differences in the obligations and economic effect on the way, because of the asymmetrical margin provisions, which depend on price movement and their effect on liquidity.

Price risk is eliminated on the floating payments due on March 26^th 2002, if all are made but price risk remains in relation to the provision of margin in the interim period. In the event of default losses are clearly price risk related.

Mr Stanton was content to accept that, viewed individually, the parties to the swaps in Chase XII were taking trading positions, but when taken together, their effect was, he said, a loan and none of the characteristics referred to, nor the consequences which occurred in the scenarios posited by Chase (which he considered for the most part unrealistic and unlikely) affected that view. To Prof Tufano these elements were critical in analysing the nature of the three instruments in Chase XII and their individual and collective impact.

These therefore are the matters which fall to be considered and taken into account in assessing the proper accounting treatment to be given to Chase XII, Enron’s actual accounting for it and any involvement of Chase itself in any such accounting. In my judgment, the characterisation of the Three Swaps in Chase XII as a matter of law, business economics or banking only serves as the background to the critical question of proper accounting treatment.

The $165 million Letter of Credit was provided by West under the terms of a Facility Agreement dated 10^th September 2001. The heading to this agreement read as follows:

“Trade Finance and Reimbursement Agreement

(for the primary purpose of supporting the general corporate business of the European subsidiaries of Enron Corp)”.

This was a committed facility in the sense that West, as the Issuing Bank, agreed that it would, following its receipt of an Instrument Request (as defined in the Facility Agreement) issue Instruments in accordance with its terms. Issues arise with regard to the construction of the terms of the agreement and in connection with an ancillary agreement allegedly reached in August or September 2001 by the terms of which, West contends, it was agreed that Instruments should not be provided to secure financing from other Banks. Whether the point is framed as a collateral agreement or as a form of estoppel, in order to make this point good, West has to establish that there was such an agreement or mutual assumption as a result of communications between it and Enron.

The Facility Agreement was made between Enron Corp (the Enron parent company and defined in the Facility Agreement as “the company”), West as Issuing Bank and the other syndicate banks. It contained the following provisions:

“WHEREAS

(A)

The Company requires from time to time the issue of letters of credit, bid bonds, performance bonds, guarantees and other instruments, primarily (but not exclusively) in support of the European business and operations of itself and its Subsidiaries and Related Entities including Enron Europe Limited and Enron Metals Limited.

(B)

The issuing Bank shall issue such letters of credit, bid bonds, performance bonds, guarantees and other instruments on the terms and subject to the conditions set out in this Agreement. …………

“Instrument” means a letter of credit, guarantee indemnity, performance bond or bid bond or such other form of instrument as the Company and issuing Bank may from time to time agree, each such Instrument to be substantially in a form agreed by the Company and the Issuing Bank on or prior to the date of this Agreement or in such other form as the Issuing Bank may from time to time approve, such approval not to be unreasonably withheld or delayed.

………….

“Related Entity” means, in relation to the Company, any person in which the Company holds, directly or indirectly, any shares, voting rights or other ownership interests.

………….

“Subsidiary” of any Person means any corporation, partnership, joint venture, or other entity of which more than 50% of the outstanding capital stock or other equity interests having ordinary voting power (irrespective of whether or not at the time capital stock or other equity interest of any other class or classes occurrence of any contingency) is at the time owned directly or indirectly by such Person; provided, however, that no such corporation, partnership, joint venture or other entity shall (a) constitute a Subsidiary of the Company, unless such entity of a Consolidated Subsidiary of the Company, or (b) constitute a Subsidiary of any other Person, unless such entity would appear as a consolidated subsidiary of such person on a consolidated balance sheet of such Person prepared in accordance with GAAP. Unless otherwise provided or the context otherwise requires, the term “Subsidiary” when used herein shall refer to a Subsidiary of the Company.

…………

2.

INSTRUMENTS

2.1

Instrument Request

Subject to the terms and conditions set forth herein, the Company may request (a) the issuance of an Instrument by delivering an “Instrument Issuance Request” substantially in the form attached as Exhibit A-1 properly completed, or (b) the amendment of an outstanding Instrument (including an amendment that extends the term of an Instrument), by delivering an “Instrument Amendment Request” substantially in the form attached as Exhibit A-2 properly completed (each of the Instrument Issuance Request and the Instrument Amendment Request, an “Instrument Request”) to the Issuing Bank at any time and from time to time from the date of this Agreement until the Final Instrument Issuance Date (subject to the provision of Clause 2.2(c) below) by facsimile transmission. Each Instrument Request shall, when issued, be irrevocable. The Issuing Bank shall not be required to issue or amend any Instrument where, if issued or amended, there would be outstanding more than ten (10) Instruments, each with a principal amount of less than $200,000 (or its equivalent).

2.2

Instruments

(a)

Subject to the terms and conditions set forth herein, and provided that no Default or Event of Default has occurred and is continuing, the Issuing Bank agrees that it will, following its receipt of an Instrument Request prepared in accordance with the terms and conditions of this Agreement, issue one or more Instruments:

(i)

on the day specified for each issue in any Instrument Request received by the Issuing Bank in accordance with Clause 2.1 not later than 12.00 (noon) (or such later time as the Company and the Issuing Bank m ay agree from time to time) on the date specified in such Instrument Request for the issue of such Instrument; or

(ii)

on the next following Business Day where such Instrument Request is received by the Issuing Bank after 12.00 (noon) (or such later time as the Company and the Issuing Bank may agree from time to time) on the date specified in such Instrument Request as the date for the issue of such Instrument.

(b)

Each Instrument will be denominated in Dollars, Sterling, euros or, with the consent of the Banks and the Issuing Bank which shall not be unreasonably withheld or delayed, any other currency which is freely convertible into Dollars, and will be extended for the general corporate purposes of the Company (including such purposes of Enron Europe Limited, Enron Metals Limited and/or any other Related Entity of the Company). Without in any way affecting the obligations of the Company under this Agreement, neither the Issuing Bank nor any Bank shall be obliged to monitor or verify the purpose of any Instrument.

(c)

The Issuing Bank shall not be required to issue or amend any Instrument under this Agreement where:

(i)

following the issue of such Instrument, the Total Instrument Disbursement Exposure would exceed the Total Commitments (and upon issuance of amendment of each Instrument, the Company shall be deemed to represent and warrant to that effect.

(ii)

in the case of an Instrument Amendment Request, the Issuing Bank, acting reasonably and in accordance with good international banking practice, is not reasonably satisfied that such amendment will be acceptable to, or has been accepted by, the beneficiary of the Instrument to which such Instrument Amendment Request relates; or

(iii)

such Instrument would, if issued in accordance with the Instrument Request, expire at its counters at any time after the close of business on the Final Instrument Expiry Date.

The Issuing Bank will notify the Banks promptly following the issuance by the Issuing Bank of an Instrument and may, at its sole discretion, notify the Banks of any material amendment of an Instrument.

(d)

The Issuing Bank shall not be required to issue any Instrument to the extent that it is aware that the issue of such Instrument would be contrary to any law, regulation, regulatory requirement or directive which is legally binding on or applicable to any Bank in its place of incorporation or in the jurisdiction in which its Funding Office is located at the date of this Agreement or which would be contrary to any official directive, guideline or code of practice, issued by any governmental or regulatory body, applicable to any Bank in any such jurisdiction which, although not having the force of law, is of a type with which institutions of a similar nature to such Bank generally are accustomed to comply, until such Bank is replaced in accordance with Clause 2.14 or until the issue of such Instrument otherwise ceases to be so contrary; provided that the Issuing Bank shall promptly notify the Company of its intention not to issue such Insurance pursuant to this Clause 2.2(d).

(e)

Subject to Clause 2.2(f), each Instrument will be governed by the laws of England and Wales and, in the case of letters of credit, to the extent not inconsistent with such laws, will incorporate the terms of the UCP 500.

…………

2.6

Fees

The Company agrees to pay to the Issuing Bank such fees as are set forth in a separate fee agreement between the Company and the Issuing Bank. In addition, the Company agrees to pay the fees listed in this Clause 2.6 (collectively, “the Fees”). ……………..

(a)

Commitment Fee. The Company shall pay to the Issuing Bank (for the account of each Bank) a fee in Dollars calculated at the rate of zero decimal four per cent (0.4%) per annum on the undrawn, unutilized and uncancelled amount of such Bank’s Commitment and which shall accrue on a daily basis ……………..

(b)

Instrument Fees

(i)

The Company shall pay to the Issuing Bank (for the account of each Bank) a risk weighting fee (the “Instrument Fee”) in respect of each Instrument issued ……….

…………..

3.2

Additional Conditions Precedent to issuance of Each Instrument

The obligation of the Issuing Bank to issue or amend any Instrument shall be subject to the additional conditions precedent that on the date of such issuance or amendment, as the case may be, (a) the following statements shall be true (and the giving of the applicable Instrument Request shall constitute a representation and warranty by the Company that on the date of such issuance or amendment, as the case may be such statements are true):

(a)

The representations and warranties contained in Clause 4.1 of this Agreement are correct on and as if the date of issuance of amendment as the case may be, of such Instrument (other than those set out in Clause 4.1(d) and (e) and other than those representations and warranties that expressly relate solely to a specific earlier date, which shall remain correct as of such earlier date), before and after giving effect to the issuance or amendment as the case may be, of such Instrument and to the application of the proceeds therefrom, as though made on and as of such date, and

(b)

No event has occurred and is continuing, or would result from such issuance or amendment, as the case may be, of such Instrument which constitutes a Default, an Event of Default or both.

…………….

4.

REPRESENTATIONS AND WARRANTIES

4.1

Representations and Warranties of the Company

The Company represents and warrants on the date hereof and (other than in relation to those representations and warranties contained in Clause 4.1(d) and (e) on the dates falling at three-monthly intervals thereafter, as follows:

………….

(d)

The audited consolidated balance sheet of the Company and its Subsidiaries as of December 31, 2000 and the related audited consolidated statements of income, cash flows and changes in stockholders’ equity accounts for the fiscal year then ended and the unaudited consolidated balance sheet of the Company and it Subsidiaries as of March 21, 2001 and the related unaudited consolidated statements of income, cash flows and changes in stockholders’ equity accounts for the three months then ended, certified by the chief financial or accounting officer of the Company, copies of which have been delivered to each of the Banks, fairly present, in conformity with GAAP except as otherwise expressly noted therein, the consolidated financial position of the Company and its Subsidiaries as of such dates and their consolidated results of operations and changes in financial position for such fiscal periods, subject (in the case of the unaudited balance sheet and statements) to changes resulting from audit and normal year end adjustments.

(e)

Since December 31, 2000 through the date hereof, there has been no material adverse change in the business, consolidated financial position or consolidated results of operations of the company and its Subsidiaries considered as a whole.

…………

5.1

Affirmative Covenants

The Company covenants agree that so long as any Instrument shall remain outstanding, any Instrument Obligation shall remain unpaid or any Bank shall have any Commitment hereunder, the Company will, unless the Majority Banks shall otherwise consent in writing:

………….

(b)

Compliance with Laws, Etc

Comply, and cause each of its Subsidiaries to comply with all applicable laws, rules, regulations and orders to the extent non-compliance therewith would have a material adverse effect on the Company and its Subsidiaries taken as a whole, such compliance to include, without limitation, compliance with environmental laws and the paying before the same become delinquent of all taxes, assessments and governmental charges imposed upon it or upon its property except to the extent contests in good faith.

(c)

Use of proceeds:

Request the issuance of an instrument only of general corporate purposes of the company (including such purposes of any Related Entity of the Company) not in violation of Clause 5.2 (f).

…………..

5.2

Negative Covenants

So long as any Instrument shall remain outstanding, any Instrument Obligation shall remain unpaid or any Bank shall have any Commitment hereunder, the Company will not at any time, without the written consent of the Majority Banks:

…………..

(f)

Use of Proceeds

Use any Instrument or the proceeds of any Instrument for any purpose other than for general corporate purposes of the Company (including such payment of any Related Entity of the Company), or use any Instrument or such proceed (i) in a manner which violates or results in a violation of any law or regulation, (ii) to purchase or carry any margin stock (as defined in Regulation 11 issued by the Federal Reserve Board) or to extend credit to others for that purpose or (iii) to make nay investment in any person if such investment is opposed by the board of directors, general partner or other governing body of such Person.

6.

EVENTS OF DEFAULT

6.1

Events of Default

If any of the following events (“Events of Default”) shall occur and be continuing:

………………

(b)

Any representation or warranty made by the Company (or any of its officers) (including representations and warranties deemed made pursuant to Clause 3.2), under or in connection with any Facility Document shall prove to have been incorrect in any material respect when made or deemed made and such materiality is continuing; or

(c)

The Company shall fail to perform or observe any terms, covenant or agreement contained in Clause 5.2 or shall fail to perform or observe any other term, covenant or agreement contained in any Facility Document on its part to be performed or observed if, in the case of such other term, covenant or agreement, such failure shall remain unremedied for 30 days after written notice thereof shall have been given to the Company by the Issuing Bank at the request of any Bank; or

……………..

then, and in any event, the Issuing Bank (i) shall at the request, or may with the consent, of the Majority Bank, by notice to the Company declare the obligation of the Issuing Bank to issue further Instruments, or amend Instruments already issued to be terminated, whereupon such obligation and all of the Commitments shall forthwith terminate, except for obligations to the Issuing Bank in respect of then outstanding Instrument and Instrument Obligations, …………..

8.7

Governing Law: Service: Entire Agreement

(a)

This Agreement shall be governed by, and construed in accordance with, the laws of England and Wales.

(b)

Each of the Company, the Issuing Bank and the Banks irrevocable submits to the non-exclusive jurisdiction of the courts of England in respect of any claim or matter arising out of or in connection with this Agreement.

………..

(d)

This Agreement and the other Facility Documents accepted by the Company constitute the entire understanding among the parties hereto with respect to the subject matter hereof and supersede any prior agreements, written or oral, with respect thereto.”

The form of Instrument Request to which the Facility Agreement referred constituted Exhibit A-1 to that Agreement. It provided boxes for completion in which details of the Instrument sought were to be set out but it contained no scope for setting out the purpose for which the Instrument was required. Enron was required to certify that no Event had occurred and was continuing, or would result from the issue or amendment of the Instrument sought, which constituted a default or an event of default within the meaning of the Facility Agreement.

Recital (B) and clause 2.2 of the Facility Agreement make it plain that this was a committed facility. West was, by the terms of clause 2.2(a), obliged to issue Instruments (as defined) following its receipt of an Instrument Request prepared in accordance with the terms and conditions of the agreement. Under clause 2.2(b) the obligation extended to instruments which were required for the “general corporate purposes” of Enron Corp. (including such purposes of Enron Europe Limited, Enron Metals Limited and/or any other Related Entity of the Company), whilst the title referred to the primary purpose as support of the European subsidiaries. This is reinforced by clauses 5.1(c) and 5.2(f).

Clause 2.6 sets out the fees payable by Enron for the Facility. Clause 2.6(b) sets out the fees payable in respect of each Instrument issued whilst clause 2.6(a) sets out a “Commitment Fee” which is payable by Enron at a specified rate on the undrawn and unutilised and uncancelled amount of the commitment made under the facility at a specified annual rate accruing on a daily basis. West was paid for maintaining a facility which was available for use by Enron on the submission of Instrument Requests prepared in accordance with the terms and conditions of the Facility Agreement.

“Instrument” was defined to include a letter of credit, guarantee, indemnity, performance bond or bid bond or such other form of Instrument as Enron and West might from time-to-time agree, each such Instrument to be substantially in a form agreed by Enron and West on or prior to the date of the Facility Agreement, “or in such other form as the issuing bank may from time-to-time approve, such approval not to be unreasonably withheld or delayed”. Notwithstanding the comments of various witnesses on this clause, its construction is clear. It does not entitle West to refuse to issue a letter of credit or guarantee if the Instrument in question is substantially in a form agreed between Enron and West. Equally West cannot refuse to issue such an Instrument in a different form unless that form is unreasonable. It is the question of the form of the Instrument, not the purpose or objective which underlies it, to which this clause of the Facility Agreement refers. There has been no suggestion that there was anything untoward about the form of words of the letter of credit which was the subject of discussion between Mr. Goodwin of West and Ms. Mata of Enron and Mr. Levy of Chase.

Clause 2.2(c) specifically sets out the circumstances in which West is not required to issue or amend any Instrument under the Facility Agreement. This is the clause which deals with substantive reasons for not issuing an Instrument as opposed to the definitional clause which goes only to questions of forms of words.

Clause 2.2(d) provides a further exception to West’s obligation to issue an Instrument, namely where it is aware that the issue of such an Instrument would be contrary to any applicable law which is binding on any of the syndicated banks. That is said to give rise to the argument of illegality under the US Securities Exchange Act and the accounting principles of GAAP, which is the subject of dispute between the parties.

The only other basis upon which there could be any refusal by West to issue an instrument is set out in the conditions precedent to the issuance of each Instrument in clause 3.2. None of these conditions precedent give rise to any right on the part of West to refuse to issue a L/C on the basis of the underlying purpose for such an Instrument. No evidence was produced to show that any of the representations or warranties in clause 4.1 (other than clause 4.1(d) and (e) which related to the accuracy of Enron’s accounts at 31^st December 2000 and 31^st March 2001) were incorrect. And whilst these breaches constituted events of default, there was no knowledge of this prior to 5^th October 2001 when the L/C was issued.

There remains the issue of illegality under clause 5.2(f). This arises by virtue of clause 6.1(c) which provides that a failure to perform or observe any term covenant or agreement contained in clause 5.2 is to constitute an event of default which, by the terms of clause 3.2(b) amounts to non-compliance with the condition precedent provision. Clause 5.2(f) provides that Enron will not use any Instrument or the proceeds for any purpose other than the general corporate purposes of the company nor in a manner which violates or results in a violation of any law or regulation. If the true purpose of the L/C had been made known to it, West maintains that it would have been entitled to refuse to issue the L/C because of the breach of US GAAP in Enron’s accounting practices.

Since the Facility Agreement provides that L/C’s are to be issued if they are for general corporate purposes (clause 2.2(b)), clause 5.1(c) and clause 5.2(f)), West is dependent upon its arguments about fraud or illegality, as entitling it to refuse to issue the L/C, placing reliance upon the last paragraph of clause 6 which entitled it to refuse to issue further Instruments if there had been an event of default, which by clause 6.1(c) is linked to clause 5.2(f) and to clause 3.2(b). Thus ultimately West was not in a position, as a matter of construction of the Facility Agreement to refuse to issue the L/C in favour of Mahonia, transferable to Chase, in the absence of some point of fraud or illegality which might justify such a course.

Additionally, when the commercial realities of the position are considered, having heard a number of bankers’ evidence on the point, I find that, with a letter of credit obligation, the issuer looks only to the applicant’s credit-worthiness in respect of its own exposure. It matters not one whit to the issuing bank what the purpose of the L/C is, nor what the nature of the underlying transaction is, if it is satisfied with the credit risk of the applicant to whom it looks for recourse in the event of being called on to pay under the L/C. In many cases banks will take security in respect of this recourse but in the present case the Facility Agreement provided for no such security save in circumstances where an event of default had occurred. I shall revert to this point later in the judgment in the context of reliance by West upon any representation made about the underlying transaction and the likelihood of any refusal by West to issue the L/C, if it had known the matters of which it now complains and of which it maintains it was ignorant at the time.

West alleges in its Statement of Case that at meetings during the period between May and July 2001, Mr Frohmaier of West made clear to Mr Crowe of Enron that the Facility was not to be used as a back-up facility to secure loans from other Banks. A conversation on similar lines is alleged between Mr Crowe and Mr Taylor of West. It is also alleged that an agreement was reached between Enron and West that the Facility would not be used in this way and that such agreement was concluded, either in a telephone conference call on 15^th August 2001 or in a separate conversation between Mr Frohmaier, Mr Bourke and Mr Crowe.

Because the Syndications Department to which Mr Frohmaier belonged was situated on the same floor as the traders at West, telephone conversations on the telephones in use on this floor, including those of Messrs Frohmaier and Bourke were taped. Apart from the telephone conversations of 14^th and 15^th August referred to below, no tapes of telephone conversations have been produced or relied on by West in support of this allegation. I heard the evidence of a number of witnesses on this point (including Messrs Frohmaier, Bourke, Sai Louie, Saint, Edey and Goodwin of West) and listened to or examined the transcripts of the conversations which were taped, upon which reliance was placed. In reality and unsurprisingly, the witnesses’ evidence of the taped conversations added little to the transcripts of the tapes of those conversations.

Mr Frohmaier who was West’s most senior person involved in negotiation of the Facility Agreement with Enron gave evidence which was inconsistent with West’s Statement of Case and Further Information supplied in support of it. His oral evidence was also inconsistent with his own witness statement in which he said that the issue had not arisen before July 31^st. He was on holiday between 3^rd and 20^th August and therefore played no direct part in the telephone conversations of 14^th and 15^th August, although whilst on holiday he did converse with Mr Bourke on 15^th August with regard to the issue of a sample Guarantee that had arisen, which was the subject of the telephone discussions with Enron personnel on those two dates.

Mr Bourke’s evidence was that a problem first surfaced on 24^th July 2001 when Miss Martin, Enron’s in house lawyer submitted a sample form of guarantee for approval, as anticipated in the definition of “Instrument” in the Facility Agreement. This was intended to be a sample of a guarantee which could form the basis of that to be used for intra- group loans. According to Mr Frohmaier’s witness statement, the point at which this issue first arose for him was 31^st July 2001 when he was told of the submission of a draft Guarantee, which was capable of use to support Enron’s borrowings from another Bank. It was agreed between various West personnel that he would be responsible for calling Mr Crowe to say that this was unacceptable. Under cross-examination he agreed that he did not do this before he went on holiday. His witness statement referred to only one telephone conversation which he had with Mr Crowe on the subject on his return from holiday which, in oral evidence, he said, took place after 4^th September 2001. When asked under cross-examination about West’s case that there had been conversations between May and July 2001, he maintained that the subject had been one element of one conversation before he went on holiday but that it had not been an “issue” in the sense in which he used that term in his witness statement. He could give no details as to when this earlier conversation occurred nor of what exactly was said. It was not supported by Mr Bourke nor by the taped transcripts of calls, nor does it make any sense in the light of the emergence of the issue which led to the telephone conference call of 15^th August 2001.

Mr Taylor’s evidence was that he had a brief aside with Mr Crowe in a large meeting in Enron House at the early stages of the drafting of the Facility Agreement, after the mandating of West. His evidence was that, in this aside, he said that the facility was not to be used as a “back stop” for financing by other banks and Mr Crowe agreed to this. This was not said across the table so others did not hear it.

If there was any such conversation between Mr Taylor and Mr Crowe, expressly on the subject of use of the Facility for securing other Bank borrowings, it was not something of which Mr Bourke was aware. In a transcript of a telephone conversation between Mr Taylor and Mr Bourke, the latter is recorded as telling Mr Taylor on 8^th August 2001 of the problem that had arisen over the sample guarantee. In this conversation, Mr Taylor refers to the purpose of the loan by reference to the need for inter-company guarantees, but never suggests that he had a prior conversation with Mr Crowe on the subject of use for securing other financing. I am driven to the conclusion that no such conversation took place prior to 14^th August 2001, since it is otherwise inconceivable that Mr Taylor would not have mentioned it to Mr Bourke when the guarantee issue arose and became the subject of discussion. Moreover, if any conversation had taken place on the subject, the only reason for Mr Taylor failing to mention it to Mr Bourke would be that he regarded it as having no significance in the context of the negotiations, nor as any kind of agreement in principle by Mr Crowe to a restriction on the use of the facility. If Mr. Taylor had thought that there was agreement already, he would have insisted that this should be put to Enron at a time when it seemed to him that they might be taking a directly contrary stance. I reject therefore Mr. Taylor’s evidence of such a conversation with Mr. Crowe.

Mr Frohmaier and Mr Bourke expressed their conviction that they had both participated in a telephone conversation with Mr Crowe. In their oral evidence they said this must have taken place after 4^th September 2001, and that in it Mr Crowe had agreed that the Facility Agreement was not to be used for Instruments supporting other Bank borrowings. This was after the conference telephone call of 15^th August 2001.

There is no doubt that the question of the usage of the Facility Agreement was raised in the conference call telephone conversation of 15^th August 2001, as the transcript of that conversation shows, to which I refer hereafter. This call involved a large number of participants, whose contributions were not always audible nor responsive. All agreed that the issue was resolved on that occasion, but the basis of that agreement was in issue.

The evidence of Messrs Bourke and Frohmaier was that Mr Bourke updated Mr Frohmaier on the position after the call, on the latter’s return from holiday, and told him that the matter had been resolved. Both Mr Frohmaier and Mr Bourke agreed that, as a result, there was no need for the matter to be raised thereafter with Enron, but Mr Bourke thought that Mr Frohmaier wanted to hear with his own ears from Mr Crowe what had been said on the telephone call. If the matter was of significance and justified a further call between Mr Frohmaier and Mr Crowe however, it is hard to see how the matter could have been left by Mr Frohmaier, following his return from holiday on 20^th August, until some time after 4^th September 2001, which Mr Frohmaier and Mr Burke agreed had to be the case, because of the terms of a taped telephone call of that date.

It is clear that, prior to 14^th/15^th August 2001, there had been extensive prior discussion of some of the potential uses of the Facility and in particular the use of it for furnishing London Clearing House (LCH) guarantees for Enron’s newly acquired subsidiary in Europe, MG, and its satellite companies, and for furnishing guarantees in respect of MG Group inter company loans. Self evidently the Facility was not to be limited to these functions but emphasis was placed on these and the European tenor of the business when Enron was seeking to obtain a facility from West and the latter was trying to interest the predominantly European Banks which were intended to make up the Syndicate. I find that these two purposes were always understood to be part of the reason for the Facility and that attention was focussed on them because of the desire to stress the European connection.

By 26 June 2001 a Summary of Key Terms had been produced by Enron’s lawyers as the basis of negotiation of the Facility Agreement itself. This showed the applicant as Enron Corporation and the purpose of the facility as the issuance of listed Instruments primarily for the purpose of supporting the general corporate business of the European subsidiaries of Enron, including Letters of Credit, LCH Guarantees, other Guarantees whether in favour of affiliates of the borrower or any other third parties, Contract Bonds and Performance Related Guarantees, Standby Letters of Credit and any other financial Instrument agreed between the borrower and the Issuing Bank. In the first draft of this Summary of Key terms put forward by West’s lawyers, the purposes for which Guarantees could be issued under the facility had been restricted to LCH Guarantees and inter-company loan Guarantees. Enron however insisted that this was to be a wide general facility for general corporate purposes, to be operated by Enron out of Houston so that the restriction was removed, albeit that the European connection was a selling point to West and the potential syndication Banks. Enron would not accept any restriction beyond that contained in its US facility agreements, including in particular the Facility Agreement reached in May 2001 with Chase.

The West Facility Agreement refers to this European connection in Recital A and clause 2.2(b) but the terms of the Agreement itself made it clear that there was to be no restriction on the use to which the Facility was to be put as long as the Instruments were required for the “general corporate purposes” of the parent company Enron and its “related entities”. Many of the West witnesses agreed that they knew Enron would never agree to any Facility Agreement which did not give the same width and flexibility as the US facility negotiated in May 2001 and that Enron’s standard form of wording which appeared in the Facility Agreement was non negotiable. Mr Bourke who took the lead in later negotiations said that any Bank which wanted to do this Facility with Enron would have known that it was required to use standard Enron documentation out of Houston and that any attempt to depart there from would be bound to fail.

In my judgment it is plain that whilst these two specific matters relating to LCH guarantees and guarantees of inter company loans were discussed as part of the rationale for the Facility Agreement and that West’s expectation may have been that the majority of use would be for these purposes, there was never any suggestion, save in exchanges leading directly to the conversations of 14^th and 15^th August and the exchanges themselves (discussed later in this judgment) that there would be any binding limitation in the purposes for which the facility could be used, beyond those which ultimately appeared in the Facility Agreement itself. Indeed when the subject matter arose in discussion on 14^th and 15^th August the idea of any use to support other borrowing appears to have been a new one to Miss Martin of Enron. The point could not therefore have been raised between lawyers nor raised with lawyers on either side in the context of a legal restriction prior to that point.

When sample documents were sent by Enron to West with a view to approval for the purposes of the definition of “Instrument” under the Facility Agreement, there is no doubt that West sought to obtain agreement to a restriction on the use of the Instruments to be issued. In this context, Mr Sai Louie, the lawyer employed by West, sought to restrict the Facility to use for “trade finance related” activities only. In a conversation between Mr Crowe, Miss Martin and Mr Bourke and Mr Sai Louie on 14^th August, the transcript of which was available to the Court because the conversation had been taped, this question was raised. Mr Crowe would not agree to any such wording because it would restrict Enron in employing a wide facility that could be used for any type of “Instrument” to which the Enron standard wording referred. In particular, as was common ground between the parties, this would cut across the use of the facility for intra-Enron/MG group Guarantees which would otherwise fall plainly within the ambit of the “general corporate purposes” of Enron, its Subsidiaries and Related Entities. In this conversation, the West representatives referred to the pricing benefit which Enron could obtain if it used the West L/C as collateral for other borrowing since West competitors could be prepared to lend at a lower rate with the benefit of West’s AAA rating on the default Letters of Credit supporting the borrowing. Moreover West’s representatives made the point that they had been telling their potential syndicated Banks that two major components of the purpose of the Facility were Enron’s requirement for security for LCH obligations and inter-company Guarantees. Miss Martin said that it had never been the intention, when forwarding the sample guarantee in respect of intra- group loans to give the impression that it was to be used for the purpose suggested by Mr Bourke and in evidence she said that she was astonished that anyone could have inferred that from a standard form guarantee. Her statement of intent in that conversation was limited to the intent behind the sending of that sample guarantee, which had not yet been tailored for use as an inter company guarantee. She and Mr Crowe went on to say that other guarantees might be required under the Facility, including, by way of example a financial guarantee to the Bank of England, when a form of guarantee of a similar kind would be used.

Mr Crowe and Miss Martin also made it clear that the purpose of the facility was always meant to be for general corporate purposes and that a “trade finance” restriction was unacceptable. It was agreed that the matter would be further discussed in the presence of operations personnel on the following day but Mr Sai Louie understood the point being made by Miss Martin that the use of wording for a restriction on use, such as “trade finance related” was uncertain in itself and would give rise to endless argument as to compliance.

At about half past twelve UK time on 15^th August Mr Bourke discussed the matter with Mr Frohmaier who was on holiday in the South of France. Mr Frohmaier suggested the possibility of a side letter from Enron, saying that it would not use the facility to issue guarantees in favour of other Banks from whom it had borrowed money. The other possibility raised was the inclusion of an express limitation in the Facility Agreement but the perceived problem with that from West’s viewpoint was that syndicate Banks might be constantly enquiring whether or not the Instrument issued was in compliance.

Against that background the conference call took place on 15^th August with a large number of participants and some degree of inaudibility, over-speaking and lack of correspondence or responsiveness between individual contributions. On Enron’s side Mr Crowe, Miss Martin and Miss Kerr took part, whilst Messrs Sai Louie, Bourke, Saint, Edey and Goodwin represented West. The primary speakers were Mr Sai Louie, Mr Bourke, Mr Crowe and Miss Martin, with some contributions from Mr Saint upon which West relies, although his contribution remained unidentified until the trial and did not feature in his witness statement.

Mr Bourke opened the business part of the conversation by offering to delete the “trade finance related” wording previously put forward by Mr Sai Louie, if the wording of the sample Guarantee could be tightened to which Miss Martin and Mr Crowe did not demur. They regarded this as an “easy win” since the purpose of the Facility Agreement, as expressed in it, was “general corporate purposes”, whilst tightening the words of a sample guarantee for a specific purpose (intra- group loans), which did not touch the Facility Agreement itself, was not a problem for them. They could consider other forms for other functions in the future. Miss Martin said that the purpose of sending that particular sample Guarantee had been to provide a basic draft on which to base inter-company loan guarantees.

According to the transcript, the following exchange took place in the ensuing conversation:

“NICOLA KERR: Yes, I understood that it would be different types of indemnities (inaudible) bonds, bid bonds, guarantees, standby LCs or –

JERRY EDEY: The instruments are alright, the instruments are fine.

RICHARD SAINT: It’s purely that it’s not collateralising other bilateral facilities.

JERRY EDEY: Bank Loans –

TIM SAI LOUIE: Correct

ROBERT BOURKE: Or something like that

SOPHIE MARTIN: Oh, right, Okay, yeah, well it’s not the intention

SIMON CROWE: That’s not the intention

RICHARD SAINT: That was all our point

(overspeaking)

SOPHIE MARTIN: Well, we – hey, that’s a good idea though!

Overspeaking

ROBERT BOURKE: (overspeaking) margin (ovespeaking) 50 basis points on WestLB risk. Okay, Tim will draft up (inaudible) tighten that clause.

TIM SAI LOUIE: So, basically we’re agreed commercially that it’s basically trade related and inter-company and other things are excluded?

SIMON CROWE: Trade related in the page 1 is going.”

Mr Sai Louie agreed, when giving evidence, that when he used the expression “we’re agreed commercially” that was to indicate agreement on a commercial issue, not a legal issue. His comment that “inter company and other things are excluded” was completely at odds with what had gone before and the Enron witnesses said in evidence that they did not pick up on it, perhaps even did not hear it. Despite the efforts of various West witnesses to identify the point at which there was acceptance of a legally binding obligation not to use the facility for securing financing for other Banks, the only statements made by Miss Martin and Mr Crowe involved expressions of intention and nothing more and there was no agreement to the last contribution of Mr Sai Louie set out in the above quotation. Mr Crowe’s comment was not a response to it, and indeed he was making the point that there was to be no “trade finance” restriction. All knew that the width of the terms of the Facility Agreement were non negotiable from Enron’s viewpoint since Enron wanted to maintain maximum flexibility in its use of the facility and that whatever was said here could not affect that, whatever agreement was reached on the wording of the sample guarantee. Miss Martin said in evidence that both her expression of intention and her comment that it was a good idea were directed to the idea of getting cheaper borrowing from other banks on the strength of West’s credit rating, but the idea that the suggested restriction to “trade related” financing could be removed from the wording of Facility Agreement itself and that some other lesser restriction could be agreed with binding legal effect in an exchange of this type, without any agreed wording of any kind, let alone wording which found its way into the terms of the Facility Agreement (which was the subject of detailed negotiation and drafting involving eminent firms of lawyers) does have an element of unreality about it.

The outcome of the conversation was that it was agreed that Mr Sai Louie would redraft the form of intra- group Guarantee and send it to Miss Martin to see if agreement could be reached on its terms, whilst the proposed restriction to “trade related” activities would be deleted. The lawyers would liaise to “tighten” the sample Guarantee for inter company loans which occurred when Mr Sai Louie provided an alternative draft for Miss Martin to review, in a short form (as opposed to the long form of guarantee previously produced) and on 10^th September 2001 Miss Martin e-mailed a slightly fuller form of Guarantee including some further standard provisions which Mr Sai Louie, in a telephone conversation of 12^th September, accepted as being “generally OK”. The words “trade finance related” were also excised as a restriction in the Facility Agreement.

On this basis it cannot be said in my judgment that there was any binding agreement by Enron in this conference call not to use the facility for the purpose of securing other borrowings. There was never any intention on the part of either side to override the non-negotiable terms of the Facility Agreement, nor any common assumption as to any restricted meaning or effect to be given to its terms. No suggestion of any amendment was made to its proposed terms nor was any side letter proposed, let alone agreed. No unequivocal representation was made as to the actual use to which the Facility would or would not be put.

It is significant that no information was ever given by West to any of the Syndicate Banks of any restriction beyond that set out in the Facility Agreement itself. West accepted that the “trade related” wording was unworkable and was satisfied with the expressions of intention given by Mr Crowe and Miss Martin, which did not give rise to any binding commitment which affected the terms of the Facility Agreement. The form of sample guarantee for inter company loans was agreed between Enron and West in a form which did not indicate to West that it was to be used to secure borrowing from other Banks, but no agreement was reached nor representation made by Enron that the Facility would never be used for purposes which would otherwise fall within the ambit of the Facility Agreement.

It is against this background that the suggestion that there was a telephone call some time after 4^th September between Messrs Frohmaier, Bourke and Crowe falls to be considered. This suggested dating of the call first emerged in the witness box because of the terms of the transcript of the taped call of that date. Since agreement had been reached on the deletion of any restriction to “trade finance related” activities and on the way to achieve a solution to the problem of the sample guarantee, in the shape of liaison between Mr Sai Louie and Miss Martin to agree the form of that guarantee (which duly occurred), I cannot conceive of circumstances in which Mr Crowe would give Messrs Frohmaier and Bourke any commitment which would go any further than what was said on 15^th August in relation to any restriction on Enron in its use of the Facility. The conversation of 4^th September, which appears to be the first conversation between Mr Frohmaier and Mr Crowe after the former’s return from holiday, was taped and there is no mention of the subject in it at all. It would be odd if the subject was not raised then but was raised later, in circumstances where Mr Frohmaier wanted to hear with his own ears what had been said in the conference call in his absence on holiday. I do not accept that any such call took place. Moreover, in my judgment, if any such conversation had taken place at all between 4^th and 10^th September, it could not have been anything more than a general expression of intention of the same kind as was made in the telephone conference call, without any legal effect on the terms of the Facility Agreement itself which, as Enron had insisted, was non negotiable on this point.

Mr Crowe had no recollection of any telephone conversation with Messrs Frohmaier and Bourke to the effect alleged by West, just as he had no recollection of the alleged conversation with Mr Taylor at a meeting. He accepted in an interview with West’s solicitors on 30^th July 2002 and in cross examination that it was not the intention to use the facility to issue guarantees to backstop Enron’s loans to other banks and that had he been asked to confirm this, he would have done so or probably would have done so. This lends credence to the very unspecific evidence of the West witnesses, but in the absence of any taped recording of any such call, despite the confident evidence of Mr Bourke that the call took place from West’ Syndications Department where all calls were taped and Mr Frohmaier’s conviction that such a call did occur, it is hard to conclude that such a call really did take place. If any other statement was made by Mr Crowe, outside the conference call, it could only have been in a meeting. Yet there is no record of a meeting between the 4th and 10^th September. Moreover any statement could only have been in the same terms as given in that call because of Enron’s need for the wording of the Facility Agreement to remain wide and flexible, because he knew that the Facility would be operated out of Houston and not by himself in London and because of his own and Enron’s legal department’s insistence on maintaining the “general corporate purposes” wording and not accepting any “trade related” restriction. Accordingly, even if Mr Frohmaier and Mr Bourke are not confused in their recollection of this call (which they may have muddled with the conference call of 15^th August 2001 or an internal account of this call), anything that was said was of such a general nature that the occasion cannot be identified and it is not capable of giving rise to any agreement or representation which could have any legal effect. The same holds true for any conversation that might have taken place with Mr Taylor on the same subject.

On 10^th September the Facility Agreement was executed. Clause 8.7(d) provided that the Agreement and the Facility documents (as defined in it) accepted by the company (which did not include any “Instrument”) were to constitute the entire understanding between the parties with respect to the subject matter of the Agreement and that the Facility Agreement itself would supersede any prior agreements, written or oral with respect thereto. That clause was designed specifically to avoid disputes of the kind which have arisen here. Whilst I find, as a matter of fact, that there was no agreement or understanding reached on 15^th August 2001 or at any other time which restricted the use of the Facility Agreement by Enron in the manner suggested by West, any such agreement made during the course of negotiation would fall foul of clause 8.7(d) which was specifically designed to obviate any dispute of this kind.

It seems to me to be self evident that, if the parties had intended to conclude a binding agreement as to the purposes for which the Facility Agreement could or could not be used, that provision or restriction would be found in the Facility Agreement itself and would be made known to all the Syndicated Banks, since West’s witnesses maintained that the basis upon which syndication of the facility had proceeded was an element in the need for the restriction, although Mr. Bourke’s evidence contradicted this inasmuch as the documents showed, as he accepted, that he had spoken to potential syndicate members about Enron’s need for total flexibility in the use of the facility, world wide, for any purpose. As a matter of common sense, if there was an issue of importance to the parties, it is inconceivable that it would not find its way in to the Facility Agreement or, if it was of interest to West only, at the very least into a side letter. As West personnel knew that the Facility would be joining a pool of other stand-by letter of credit facilities administered out of Houston, an “understanding” with Enron London would be of no value, since Enron Houston would be unaware of it unless it was formally recorded as an agreement. Yet West personnel knew that Enron Houston would never accept such a limitation on its standard wording or any limitation on the flexibility it required.

Clause 8.7(d) of the Facility Agreement not only emphasises the point by requiring such matters to be included in the Facility Agreement if they are to be binding on the parties but creates an insuperable barrier to West’s arguments in respect of a collateral agreement or understanding made prior to execution of the formal contract. The executed Facility Agreement which included clause 8.7(d) was the subject of detailed discussion between experienced commercial lawyers for both parties in an arms length negotiation which left no room for additional oral agreements or understanding not encapsulated within it. West accepted that there was little room for negotiation on Enron’s standard terms which the latter required to give it the same flexibility in the use of L/Cs under the Facility Agreement as under its other facility agreements and the terms of the executed Facility Agreement reflected that.

Whilst there is no doubt that there was an expression of intention by Mr Crowe and Miss Martin on 15^th August 2001, it is equally plain that, throughout the whole course of negotiation, Mr Frohmaier and Mr Bourke of West and Mr Crowe and Miss Martin of Enron were fully aware of Enron’s requirement for a flexible Facility Agreement, which reflected the terms of the Facility Agreement recently concluded in May 2001 in the USA and which did not limit the purposes for which Enron could use it. The very terms of the Facility Agreement emphasise this, whilst drawing attention to the primary purposes for which it was intended, in order to sell the business to the European Syndicated Banks. The provisions of Recital A and clause 2.2(b) make it quite clear that the Instruments were to be used in support of the general corporate purposes of the company which included Enron’s European business and the business of its European Subsidiaries or Related Entities. The only restrictions upon the Instruments to be issued appear in clauses 2.2 (c) and (d), none of which are alleged to apply in the present case. Any further restriction which was intended to have any legal effect would have to appear in that part of the Facility Agreement or elsewhere in it, if West were not to be obliged to issue an Instrument which otherwise fell within the ambit of the definition of Instrument provided in the Agreement itself.

There is a revealing transcript of a telephone conversation between Mr. Frohmaier and Mr. Edey on 28^th November 2001 at a time when West was looking to give notice that it did not wish to extend the L/C beyond the date of March 29^th 2002. Having carried out a Companies House search on Mahonia, they were well aware that it was an SPV in Jersey connected with Mourant “which structures tax sort of driven transactions”. The conversation went on as follows: -

“JERRY EDEY: The question is – I mean, we’ll be saying to Enron that, you know, this isn’t you know – we wanted it to be trade related, okay, it’s general corporate purposes. But we don’t feel it’s in the spirit of the thing if this LC – but general corporate purposes, I mean –

STUART FROHMAIER: It can cover a multitude of sins.

JERRY EDEY: Mm. Well, that’s why, you know, I was sort of asking. I mean, this is more sort of like, as Jeff said, a structured corporate purpose. You know, general –

STUART FROHMAIER: For general corporate purposes if they’re in the business – you know, if they’re in the business of needing to issue LC’s because of the underlying transactions they’re doing, then you don’t have – I mean, you’re under no obligation to investigate, you know, the definition of general corporate purposes, are you?

JERRY EDEY: No, that’s right. But we’re looking for good reasons to get out of this because, you know, we’ve got the option of cancelling it within the next month.

STUART FROHMAIER: Yeah.

JERRY EDEY: That’s what we’d like to do. If we get this one off the books it’s be great. But, of course, that could precipitate a call as well.”

It is clear that neither thought that there was any restriction on Enron’s use of the Facility Agreement, that general corporate purposes covered structured financing and that although they had wanted letters of credit to be “trade related” they had not obtained that restriction. The most they could say was that they did not feel that Enron’s use of the L/C was “in the spirit of the thing”.

In my judgment therefore there is no basis upon which West can succeed in establishing that a Letter of Credit used to secure structured financing involving another Bank ran counter to any representation made by Enron or fell foul of any binding agreement, representation or common understanding between the parties or that there was any commitment of Enron’s which restricted it or precluded it from such use. It matters not whether the case is put as a collateral agreement or an estoppel by convention. The necessary ingredients cannot be established for either case. Moreover, in my judgment West’s personnel have always known this. It is a defence which has been put up by reference to the transcript of the 15^th August telephone conversation and the coffee shop interview with Mr. Crowe, conducted by West’s solicitors, which he refused to confirm when he had thought further and examined the documents more carefully.

In consequence, West was bound under the terms of the Facility Agreement to issue the L/C in favour of Mahonia and is therefore dependent on establishing that the L/C was procured by fraud or vitiated by illegality if it is not to be liable on it.

West’s case is that, in a telephone conversation on 4^th October 2001 Mr. Levy who was an in-house lawyer at Chase “expressly or impliedly” represented that the “underlying transaction” for the L/C was a swap between ENAC and Mahonia, that the purpose behind the request for the L/C was to provide Mahonia with security in respect of the ENAC/ Mahonia Swap and that the “real obligation” that the L/C would secure was ENAC’s obligation to Mahonia. This telephone conversation appears to be the one and only occasion when West had any direct contact with Chase before Enron’s insolvency. The conversation was taped and the tape was played to the Court and the transcript was examined. I heard evidence from Mr. Goodwin of West and Mr. Levy of Chase. Mr. Goodwin had telephoned Ms. Mata of Enron with a view to discussing the form of the letter of credit which Enron had requested West to issue. As the telephone rang, Ms. Mata was in the course of a telephone conversation with Mr. Levy of Chase. She told Mr. Goodwin that she was “talking to the people on the other line regarding the format” and then “patched him in” so that a conference call could take place. Mr. Goodwin was in London, Ms. Mata was in Houston and Mr. Levy was in New York. The call occurred at about 9:40 pm London time.

Prior to this call, during the course of the day of 4^th October, Mr. Harrison of Enron in London had called Mr. Goodwin to let him know that he should expect to receive a request from Ms. Mata to issue a letter of credit for $165 million. A transcript of the tape of that call was also available. Mr. Harrison said that Ms. Mata would send the wording over and was a bit jumpy “because it’s part of a 310 financing thing that they’ve just been doing or something”.

This was followed by an e-mail from Mr. Harrison to Mr. Goodwin with an attached request for the L/C for $165 million which Ms. Mata wanted to be issued the following day and to be effective from 9^th October 2001, in case Mr. Goodwin had not received the fax request direct from Ms. Mata. In fact he had received it and telephoned Mr. Harrison to tell him so and to say that there were only a few minor problems with the proposed wording. Mr. Goodwin asked Mr. Harrison what the L/C was for and Mr. Harrison said that there was a deal going on … “this is part of a $375 million deal but I don’t know the ins and outs of it… but I think it’s a financing deal… I don’t know if we’re actually buying something or we’re – it probably means we’re selling it – no or are we buying? We’re actually – and it looks like there may be a power plant of some sort… I can’t tell you anymore because I don’t know.”

From this conversation it was plain that Mr. Harrison had no real idea what the purpose of the letter of credit was and Mr. Goodwin replied that he was “not too fussed about that”. He raised some points about the last paragraph of the letter of credit which provided that it was transferable only to Chase or its successor and by which West gave its consent there and then to any such transfer, without the need for any further request of any kind. Mr. Goodwin wanted a provision for a request for transfer to be incorporated and had one or two other points on the wording.

Mr. Goodwin then made some proposed amendments to the draft wording of the L/C, probably having discussed the matter with Mr. Bryant at West. He forwarded this to Ms. Mata and left her a voicemail message for her to call him back to discuss it. When he heard nothing, he telephoned her in the circumstances I have described.

The conference call began with Mr. Levy introducing himself by name and Ms. Mata introducing Mr Goodwin as a representative of West. Mr. Goodwin’s evidence was that he assumed that Mr. Levy was from Mahonia, the proposed beneficiary or its lawyers. In his statement, Mr. Goodwin says that he “explained the issues on the transfer provisions and checked with Mr. Levy that the agreement for which the Mahonia L/C was required was the agreement between ENAC and Mahonia as indicated in the draft wording. Mr. Levy confirmed that this was the underlying agreement before we discussed and agreed the transfer wording”.

In cross-examination Mr. Goodwin confirmed that the conversation was a technical conversation of a mundane nature and he did not actually ask who the underlying agreement was with. Mr. Levy had a drafting concern to ensure that the draw statement for the L/C accurately set out the names of the parties to the swap. It was a Swap between ENAC and Mahonia so that the L/C did not need to refer to “Enron Corp.… on behalf of ENAC” as the account party. That was agreed with Mr. Levy saying: -

“Yeah, that accurately reflects who the underlying agreement is with”

There was then a discussion about the form of indemnity wording in respect of a transfer of the letter of credit and whether or not the name of the account party would be changed in the event of such a transfer, as commonly occurs when a letter of credit is transferred to a fresh beneficiary under a chain of sale and purchase transactions, where the intermediate seller wishes to conceal the identity of his own supplier, a point which was of no concern here.

In evidence, Mr. Goodwin accepted that he was not too interested in the purpose of the L/C at the time. He did not think that Mr. Levy had lied at the time. The conversation was technical and mundane and Mr. Levy confirmed that the underlying transaction to which the L/C referred was between ENAC and Mahonia. Mr Goodwin understood from the transfer provisions in the L/C wording, which provided for a transfer solely to Chase, that there was a relationship between ENAC and Mahonia and between Mahonia and Chase. He said he did not get the impression of a financing arrangement between Chase and Mahonia (which might be thought the likely conclusion to draw) but he had no interest in that. He had already been told by Mr. Harrison, amongst other things that it was or might be a financing deal, but this did not concern him. The whole object of the conversation was however to make the L/C draw statement and the transfer wording tie in with the swap transaction in question. The gist of the conversation concerned the identity of the parties to that transaction but he had no concerns about the underlying transactions. He did not now consider that Mr. Levy had lied to him.

Mr. Levy’s evidence was straightforward. He said he did not refer to any other transaction than the ENAC/ Mahonia swap during the course of the telephone conversation because it was a telephone call about the drafting of the letter of credit which was to support that transaction. He did not deliberately keep anything back from Mr. Goodwin about the existence of the other two Swaps or seek to mislead him since the concern was only with the drafting of the letter of credit in support of the ENAC/Mahonia Swap.

This allegation of deceit is one which should never have been made. It is formulated on the basis of the extraction of one sentence from the transcript of a taped telephone call, taken out of context. Mr. Goodwin did not and does not think that he was in any way deceived by Mr. Levy. Mr. Levy at no point misrepresented anything to Mr. Goodwin nor had any intention of deceiving him. They both knew the limited ambit of their conversation, namely the drafting points on the letter of credit which related to the ENAC/Mahonia Swap and that alone. That was the “underlying transaction.” The purpose behind the request for the L/C was to provide Mahonia with security in respect of the ENAC/Mahonia swap. That Swap gave rise to a “real obligation” on the part of ENAC which the L/C was to secure. There was no express representation or implied representation which was in anyway false. It is noteworthy that Mr. Edey of West’s trade finance department considered that the L/C should be honoured. Mr. Goodwin had never told him that he had been deceived by Mr. Levy.

Mr. Levy had no positive duty to explain to West what other transactions existed apart from the ENAC/Mahonia transaction. What he said was accurate and he honestly believed it to be accurate. He did not mislead Mr Goodwin at all.

The tape of this telephone conversation was played by Chase as part of their opening presentation to the Court. Following the conclusion of Mr. Goodwin’s evidence, Chase invited West to withdraw the allegation of deceit against Mr. Levy, rightly making the point that it appeared unsustainable from the tape and the transcript of that tape and that an allegation of this kind should not be made against a professional man. West, despite being given time to consider the point, did not avail itself of this opportunity. I consider that this allegation is one that should never have been made and should have been withdrawn long before the trial began, let alone after opening presentations or the conclusion of Mr. Goodwin’s or Mr. Levy’s evidence. It was a manufactured point arising from the scouring of transcripts of telephone conversations in the hope of finding some point upon which an allegation of fraud could be made against Chase, recognising that this was the only occasion upon which there was any direct contact between representatives of Chase and West. Although West relied on this exchange in the context of their wider allegation that Chase conspired with Enron to mislead it by holding back information on the Three Swaps and their purpose, that does not justify the making of an allegation in deceit against Mr. Levy on the basis of this telephone call. The making of this allegation and the persistence of West in pursuing it does not reflect well upon West and, regardless of any other issues in this action, I regard it as appropriate that West should pay indemnity costs in respect of this particular issue.

West contends that Enron’s and ENAC’s accounting for the swaps to which it was party was not in accordance with US Generally Accepted Accounting Principles (GAAP) and was therefore unlawful. West maintains that it was improper for Enron to classify the ENAC/ Mahonia Swap and the ENAC/ Chase Swap in Chase XII as trading instruments which took their place in the “Price Risk Management Activities” line of its balance sheet and to classify the cash inflows at inception and subsequent outflows on those Swaps as “operating” cash flow. West, in accordance with the views of their expert Mr. Turner, the former chief accountant of the SEC, maintains that the substance of the three Swap transactions, when taken together, constitutes a loan from Chase via Mahonia to Enron and that the sum of $350 million should be represented on Enron’s balance sheet as “debt”, whilst the cash inflows and outflows from the transactions should be represented as “financing” cash flow.

Unlike other areas of its business where Enron failed to make entries in its balance sheet for transactions (off balance sheet transactions), which have been the subject of considerable criticism elsewhere, Enron always accounted for the prepaid transactions on its balance sheet. The issue is whether it should have done so as “debt” or as “price risk management activities”. Because the transactions took the form of prepaid forward sales or swaps, they featured in the same way as trading contracts which were not concluded for financing purposes. It is common ground between the parties that the Three Swaps (Chase XII) and Chase I – XI were all concluded as a form of financing, as a way of Enron raising cash.

Whilst the expert reports from Mr. Turner (West’s expert) on the one hand and Professor Ryan (Chase’s expert) on the other were extensive, the issues were ultimately limited in scope. The key issue is the manner in which the ENAC/Mahonia Swap falls to be accounted, since, in his second report, Mr. Turner accepted that the ENAC/ Chase Swap should be treated as a derivative on the balance sheet, as Professor Ryan had stated in his first report. Further, once the form of the balance sheet entry in respect of the ENAC/ Mahonia swap is resolved, then the form of the entry in the cash flow statement automatically follows. If the ENAC/ Mahonia Swap is to be treated as an “energy trading contract” as Professor Ryan opined and as part of Enron’s “price risk management activities”, then it is accepted that the cash flow entries would form part of “operating” cash flows, whereas if it is to be treated as a loan or debt in the Balance Sheet, whether in part or in whole, then the cash flows would require at least an element to appear as “financing” cash flows. If Enron was entitled to classify the prepays as price risk management activities then a fair presentation was made in its financial statements.

Equally, issues between the parties about Enron’s disclosure in its Accounts and accompanying statements add little to the question of classification of the transactions in the balance sheet since, if they were properly classified, there is no need for any further disclosure and, if they were not properly and lawfully classified, West does not need to point to any inadequacy of disclosure in addition to the unlawful accounting. Mr. Turner, West’s expert, accepted that disclosure issues followed from the decision whether the prepaid Swaps were to be treated as trading instruments or as a loan. Although West sought, in its closing submissions to raise a freestanding case in respect of inadequate disclosure in Enron’s Financial Statements and public disclosure documents, apart from the issue of the balance sheet, both Mr Turner and Leading Counsel had previously accepted that the point was determined by the issue of proper treatment on the balance sheet. In the notes to Enron’s form 10K for 2000, Enron referred to its “price risk management activities” in notes one and three. It stated that: -

“The cash flow impact of financial instruments is reflected as cash flows from operating activities in the Consolidated Statement of Cash Flows.”

“Enron engages in price risk management activities for both trading and non-trading purposes. Instruments utilised in connection with trading activities are accounted for using the mark to market method. Under the mark to market method of accounting, forwards, Swaps, options, energy transportation contracts utilised for activities and other instruments with third parties are reflected at fair value and are shown as “Assets and Liabilities from Price Risk Management Activities in the Consolidated Balance Sheet”.”

If the transactions at issue could properly be accounted for as “price risk management activities”, then this reveals that there were non-trading elements involved, which to the trained eye might indicate financing whilst the cash flow note speaks for itself. If Enron was not entitled to account for the prepays as price risk management activities, then the absence of specific disclosure of the transactions as financing transactions adds nothing. Notwithstanding West’s attempts to suggest that this was not the effect of Mr. Turner’s evidence, it is in my judgment clear that he did concede this at the outset of his cross-examination. The effect of his concession and of Professor Ryan’s evidence was that if proper accounting allowed these transactions to be represented as liabilities on the balance sheet, in the shape of price risk management activities, no further breakdown of the component parts of those liabilities was required in the accounts or in any separate form of disclosure and there was no unfair presentation.

The disclosures required are at the aggregate level, not at the individual transaction level, where liquidity is concerned. Thus, when Enron’s overall liquidity was in doubt, appropriate disclosure should have been made but this was not disclosure which related to the prepay transactions as such.

West’s freestanding case on disclosure was based on rule 240.12B-20 under the Securities Exchange Act which requires that “in addition to the information expressly required to be included in a statement or report, there shall be added such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading”. It is said that even if the accounting was correct and in accordance with GAAP there should have been specific disclosure of the Mahonia prepaid transactions (including Chase XII), revealing the economic substance of them. Such disclosure should have taken place in the financial statements and/or in the Management Discussion and Analysis of Financial Condition and Results of Operations. If however the substance of the transactions was properly accounted for, how can additional disclosure be required? Enron made numerous statements in its financial reports and its other public disclosures about its policy of monetising assets whenever possible to generate financing for its growth. Thus page 23 of Enron’s annual report for the year 2000 indicated that the segment which included Enron’s energy trading business monetised its price risk management assets: -

“Wholesale Services (the relevant segment) manages its portfolio of contracts and assets in order to maximise value, minimise the associated risks and provide overall liquidity. In doing so, Wholesale Services uses portfolio and risk management disciplines, including off setting or hedging transactions to manage exposures to market price movements… Wholesale Services manages its liquidity and exposure to third party credit risk through monetization of its contract portfolio.”

Further, in note 1 on its annual report for 2000, Enron stated that financial instruments were represented in the cash flow statement as arising from operating activities, as opposed to financing activities.

Quite apart therefore from the question whether an educated reader of accounts would evaluate not just the debt line in the balance sheet but the overall liabilities (which might well be expected) the real issue is the correctness of the classification in the balance sheet. The prepay liabilities were shown in the balance sheet and were therefore disclosed in a manner to which the notes referred. A reader could see this and therefore the issue is ultimately one of classification under GAAP for balance sheet purposes.

West’s case involves criticism not only of the Three Swaps in September 2001 but Enron’s accounting for the six previous prepaid transactions from Chase VI to Chase XI, which were effected from 1997 onwards (and possibly Chase I – V also). West maintains that the flaw in the accounting was the same in relation to the ENAC/Mahonia transaction in each prepay. West needs to make this point good in order to establish that Chase knew in September and October 2001 that Enron would wrongly account for the Three Swaps because it knew that Enron had wrongly accounted for the six previous prepaid transactions.

In this connection it is necessary to note that there were changes in GAAP, during the relevant period, to which the experts referred. The effect and significance of the new standards and guidance appears later in this judgment. FAS 133 and DIG K1 both took effect in respect of Enron for its 2001 reporting year and did not apply to any earlier years. EITF 98-10 and 98-15 were effective for fiscal years beginning after 1998. The experts differed as to the meaning, effect or relevance of these standards in the context of the dispute.

Despite suggestions to the contrary, it is clear from Mr. Turner’s first report that he initially took the view that the Three Swap transactions had to be viewed as a composite transaction and should be accounted for together as a loan. No details appeared in his first report as to the actual journal entries to be made but, in accordance with his evidence to the PSI, which he endorsed in his oral evidence to this court, his view as expressed there and in his first report was that the three transactions should be “collapsed” and represented as a unity, namely a loan from Chase to Enron, ignoring the presence of Mahonia. The inevitable conclusion to be reached from his first report was that Chase and Mahonia’s accounts should be consolidated and that the accounting entries to be made in Enron’s accounts were to reflect a direct loan from Chase to Enron. This is borne out by his expressed view that there was no applicable GAAP and the absence of reference in that report to FAS 133 upon which he later relied in his second report as the basis for accounting for the ENAC/ Mahonia swap in Chase XII. He opined that “no specific comprehensive accounting guidance for prepay forward transactions exists whether the three legs are viewed individually or (as they should be) as a composite transaction”.

By the time the matter came before the court, it was common ground that:

So far as the ENAC/Mahonia Swap is concerned, Mr. Turner, having initially denied that there was any GAAP specifically on point, in his second report accepted that EITF 98-10 was relevant when making the primary decision as to whether or not this transaction was to be treated as an “energy trading contract” or, as he put it in his second report, a “host loan with an embedded derivative” which fell to be accounted for under FAS133. The essence of his position at the trial was that, regardless of the apparent applicability of any standard set out in GAAP, there was an overarching question which had to be considered first, namely what was the economic substance of the Three Swaps, when considered together? If the economic substance of these Three Swaps differed from their legal form, then the GAAP standards applicable to each swap had to yield to that substance and once the true nature of the combined transaction had been identified, accounting entries could then be formulated for each leg of it.

Mr. Turner’s view was that not only did proper accounting require regard to be had to the economic substance of the transactions, but also that regard should be had to the subjective “intent” of ENAC in entering into them. In his view not only was there a principle of GAAP accounting inherent in the DNA of GAAP which could conveniently be expressed as “substance over form”, but the subjective intent of ENAC in concluding the transactions was relevant (which he tended to equate with “substance over form”). In addition he referred to the specific terms of EITF 98-10 which required the accountant to have regard to the intention which underlay any contract before it could be classified as an energy trading transaction.

The form that the swaps took was considered by Prof Ryan to be of significance and their economic substance fell to be assessed by reference to the obligations and risks involved. They were legally entirely independent of one another. There were no cross-default provisions between any of the Three Swaps nor any provision for off setting liabilities under one transaction against liabilities under another. Thus if there was a failure by ENAC to pay Mahonia on 26^th March 2002, Mahonia was still obliged to pay Chase and if the price of gas had increased between 28^th September 2001 and 26^th March 2002, Chase would still be obliged to pay ENAC, under their net settled swap, the difference between that value and the fixed figure due from ENAC. Thus each swap settled entirely independently one of the other and gave rise to entirely independent rights and obligations. In Professor Ryan’s view this feature of the transactions was one which had to be reflected in the accounting treatment of them, quite apart from the fact that they were Swap contracts with all the obligations that such transactions entail.

The accounting treatment utilised by Enron for these transactions meant that at any time Enron’s accounting for the Three Swaps would show liabilities of at least $350 million in its balance sheet for Chase XII. More could be shown, depending on the price movement of gas which affected the floating sum due from ENAC to Mahonia, although this would be balanced by an asset of equal size reflecting the floating sum payable to it by Chase on 26^th March 2002. Under loan accounting, there would never be a liability greater than $350 million (plus entries reflecting a sum representing “interest”) because there would be no mark to market valuation in respect of a floating payment due at a later date as occurred for the Swaps. Loan accounting would reflect the cash obligation alone. Professor Ryan took the view that this would represent an inadequate representation of the three transactions, both as a matter of form and substance.

Before embarking on the questions of form and substance and the relevant accounting principles, it is necessary to record briefly the hierarchy of GAAP. The SEC was created by the Securities Exchange Act of 1934 as a Governmental agency designated to regulate public securities markets and the companies that participate in them. The SEC is authorised to specify the form and content of public financial reports that must be issued by companies with traded securities. Throughout its history, the SEC has relied upon a series of private sector accounting standards setting bodies, currently the Financial Accounting Standards Board (FASB), to develop GAAP. The SEC staff periodically issue staff accounting bulletins that interpret GAAP. It is also involved in the FASB’s processes, including participation in meetings of the Emerging Issues Task Force (EITF).

The FASB issues GAAP in two main forms, namely Statements of Financial Accounting Standards (FAS’s) which typically provide accounting rules for specified classes of transactions and FASB Interpretations (FIN’s) that seek to clarify the position. There are in existence some 150 FAS’s and some 46 FIN’s. In addition the FASB periodically issues Concepts Statements (CON’s) which are not intended to function as accounting rules but as a guide for the FASB in its standard setting decisions.

In 1984 the FASB established the EITF so that it could provide timely guidance on emerging financial reporting issues. If consensus is reached by the EITF on an issue, the FASB will usually take no action and those consensus positions form part of authorised GAAP. FAS 133, Accounting for derivative instruments and hedging activities was issued in June 1998 and effective for fiscal years beginning after June 15^th 2000. This constituted a major change in accounting for a complex class of transactions and, anticipating a number of difficult issues in implementing it, the FASB established the Derivatives Implementation Group (DIG) as a temporary task force to help resolve those issues. The DIG functioned much like the EITF, meeting publicly but not exposing its documents for public comments. The FASB staff wrote up DIG issues based on their understanding of DIG’s discussion so that the DIG provided support for FASB staff rather than being an accounting standard setting body in its own right. DIG issues which are ratified by the FASB are authorised GAAP.

GAAS (Generally Accepted Auditing Standards) is the body of requirements for audits of financial statements and associated notes. GAAS was, until recently, set by the Auditing Standards Board and its primary auditing rules were issued in the form of Statements of Auditing Standards (SAS’s). Following the Sarbanes-Oxley Act 2002, the responsibility for developing GAAS moved to the Public Companies Accounting Oversight Board but in April 2002 that board ruled that the previously established GAAS could be relied upon on an interim basis. Whilst GAAS applies to auditing, I find that its principles must also be applicable to the preparation of financial statements.

Applying GAAP or GAAS requires significant professional judgement on the part of those preparing financial reports and on the part of the auditors. For many transactions GAAP provides a single acceptable way to account but it does not and cannot realistically provide unambiguous answers in respect of all transactions. Where it does not provide a single acceptable way to account for a transaction, preparers and auditors have to study and understand the GAAP rules that might apply and exercise professional judgement in seeking to apply those rules to the transaction in question. The judgment involves both the selection of accounting principles and the evaluation of any parameters necessary to apply those principles. As a consequence, for many transactions, various possible accounting treatments could be considered to conform to GAAP, it being solely a matter of professional judgement as to the appropriateness of the accounting adopted.

The hierarchy of GAAP is set out in a GAAS standard, SAS69 as follows: -

SAS69 treats the highest level GAAP with more reverence than any other level and in looking for appropriate accounting treatment, SAS 69 requires auditors to start at the top of the hierarchy in looking for guidance. The highest level of GAAP is the most general, the conceptually strongest, the most publicly debated and the most widely and best understood. The rules become progressively narrower, conceptually weaker, less publicly debated and less well understood through the descent in the hierarchy.

It is common ground between the experts that the main circumstances where judgment has to be applied in the selection of accounting principles is where there is no accounting rule directly in point. In such cases the characteristics of the transaction have to be identified and accounting has to be determined by analogy to other rules, in an attempt to identify the most relevant and reliable accounting treatment.

The principle of “substance over form” is not one which is enshrined in any authorised GAAP rule nor is it to be found in any leading Accounting or auditing text book. The purpose of FASB guidance in the shape of FAS and lower hierarchy GAAP is to set out the accounting treatment to be given to particular types of transactions. In a SEC Study pursuant to Section 108(d) of the Sarbanes-Oxley Act 2002 on the adoption by the US Financial Reporting System of a Principles-based Accounting System, the following appears in relation to the idea that a necessary component of principles-based standards is the inclusion of the “true and fair override”: -

“We do not believe that a “true and fair override” is a necessary component of a principles-based or objectives-oriented standard setting system. In fact, we would expect that an objectives-oriented standard setting regime should reduce legitimate concerns about the established standards not providing appropriate guidance, as the standards should be based on objectives that would almost certainly not be met by a presentation that was not “true and fair”. While this view might seem, on the surface, to be inflexible, it is, in fact, grounded in the objectives-orientated standard setting model. There are various ways that the economics of an arrangement can be viewed and evaluated. Reasonable people can reasonably disagree on the economics of an arrangement. It is, however, precisely the role of the standard setter to define the class of transactions included within the economic arrangement and to then establish the appropriate accounting for that class of transactions. While not everyone will agree with the standard setter’s conclusions, making the determination of the underlying economics of an arrangement and the appropriate accounting for that arrangement are integral to the standard setter’s role. Thus, we believe that when the standard setter establishes standards under an objectives-orientated regime, the accounting should, in virtually all cases, be consistent with the standard setter’s view of the nature of the economic arrangement”.

This excerpt from the study reflects the overall approach of the FASB. The whole point of accounting standards is to ensure uniformity in accounting so that comparable transactions are treated in the same way in accordance with the standard setter’s view of the economic arrangement.

SAS 69, which is an auditing standard includes the following at paragraph 6: -

“Generally accepted accounting principles recognise the importance of reporting transactions and events in accordance with their substance. The auditor should consider whether the substance of transactions or events differs materially from their form.”

It also includes at paragraph 9: -

“Because of developments such as new legislation or the evolution of a new type of business transaction, there sometimes are no established accounting principles for reporting a specific transaction or event. In those instances it might be possible to report the event or transaction on the basis of its substance by selecting an accounting principle that appears appropriate when applied in a manner similar to the application of an established principle to an analogous transaction or event.”

SAS 82 considers fraud in a financial statement audit and refers to risk factors relating to mis-statements arising from fraudulent financial reporting. An example of a risk factor relating to operating characteristics and financial stability is given as “significant, unusual or highly complex transactions, especially those close to year-end, that pose difficult “substance over form” questions”.

Paragraph 5(a) of SAS 69 states this: -

“Rule 203 implies that application of official established accounting principles almost always results in the fair presentation of financial position, results of operation and cash flows, in conformity with generally accepted accounting principles. Nevertheless rule 203 provides for the possibility that literal application of such a pronouncement might, in unusual circumstances, result in misleading financial statements”.

Paragraph 7of SAS 69 however refers to accounting treatment of a transaction which is not specified by a pronouncement covered by rule 203. Rule 203 requires highest-level GAAP to be followed regardless. Where lower level GAAP is relevant however, it should be applied unless the auditor can justify a conclusion that another treatment is generally accepted. If there is conflict between accounting principles relevant to the circumstances from one or more sources of lower level GAAP, the auditor should follow the treatment specified by the source in the higher category or be prepared to justify a conclusion that a treatment specified by a source in the lower category better represents the substance of the transaction in the circumstances. FIN39, to which this judgment refers later is highest-level GAAP and would, under the terms of rule 203, have to be followed if applicable.

Concept statement 2 (CON 2) at paragraph 160 reads as follow: -

“Substance over form is an idea that also has proponents, but is not included because it would be redundant. The quality of reliability and, in particular, of representational faithfulness leaves no room for accounting representations that subordinate substance to form. Substance over form is, in any case, a rather vague idea that defies precise definition”.

Representational faithfulness is defined in CON 2 as

“Correspondence or agreement between a measure or description and the phenomenon that it purports to represent (sometimes called validity). In accounting, the phenomena to be represented are economic resources and obligations and the transactions and events that change those resources and obligations.”

Paragraph 33 of CON 2 provides that “to be reliable information must have representational faithfulness and it must be verifiable and neutral”. Verifiability involves the replication of accounting treatment by independent accountants using the same methods.

The experts differed as to what was meant by the terms of CON 2 but it is clear that the concept paper (which is not authoritative GAAP) considers that “representational faithfulness” is what is required and that “substance over form” is not an appropriate criterion because of its vagueness. As Professor Ryan pointed out, the form of a transaction will almost invariably shape its substance. If a label is given to a transaction which does not represent the terms of the transaction, accounting must proceed on the basis of the terms and not the label. If however a transaction is a repurchase transaction, a leasing transaction or a sale transaction, the substance of the transaction is constituted by its form and “representational faithfulness” requires correspondence between the accounting treatment accorded to it and the rights and obligations (assets and liabilities) inherent within it. If one transaction contains different rights and obligations from another, representational faithfulness requires accounting treatment which distinguishes between the two and the concepts of comparability and verifiability which GAAP enshrines mean that transactions with real rights and liabilities of a similar nature should be accounted for in similar fashion. Whilst not all elements of a transaction may necessarily be capable of being captured in accounting treatment, that treatment must adequately reflect the substance of the transaction in question with due regard for all elements of it. This plainly involves a judgment in seeking to capture the substance of a transaction, particularly if it is a novel form of transaction or one where there is no direct accounting guidance.

FIN 39 was issued in March 1992 and was effective for periods beginning after December 15^th 1993. It is concerned with the offsetting of amounts relating to certain contracts and interprets APB Opinion No. 10 and FASB Statement No. 105. As FIN, it is highest level GAAP. In the summary of FIN 39, the following appears: -

“APB Opinion No. 10, Omnibus Opinion – 1966, paragraph 7, states that “it is a general principle of accounting that the offsetting of assets and liabilities in the balance sheet is improper except where a right of setoff exists.” This Interpretation defines right of setoff and specifies what conditions must be met to have that right. It also addresses the applicability of that general principle to forward, interest rate swap, currency swap, option, and other conditional or exchange contracts and clarifies the circumstances in which it is appropriate to offset amounts recognised for those contract in the statement of financial position. In addition, it permits offsetting of fair value amounts recognised for multiple forward, swap, option, and other conditional or exchange contracts executed with the same counter party under a master netting arrangement.”

The general principle is expressed in paragraph 5 in the following manner:-

“Opinion 10, paragraph 7, states that “it is a general principle of accounting that the offsetting of assets and liabilities in the balance sheet is improper except where a right of setoff exists.” A right of setoff is a debtor’s legal right, by contract or otherwise, to discharge all or a portion of the debt owed to another party by applying against the debt an amount that the other party owes to the debtor. 2(3). A right of setoff exists when all of the following conditions are met:

Each of two parties owes the other determinable amounts.

The reporting party has the right to set off the amount owed with the amount owed by the other party.

The reporting party intends to set off.

The right of setoff is enforceable at law.

A debtor having a valid right of setoff may offset the related asset and liability and report the net amount.”

The effect of this is clear, as Professor Ryan pointed out. If there is no right of setoff, as a matter of law, between liabilities in differing transactions, those transactions must be accounted for separately. There can be no “netting” of the liabilities in independent transactions whether there are two or three transactions involved. To treat individual transactions as composite is to engage in “synthetic accounting” which is impermissible. Three transactions cannot be collapsed into one transaction where, as a matter of law, the rights and obligations are separate and can be individually enforced. Proper accounting must reflect the individual rights and obligations in the transactions which are a matter of substance and not merely of form. The fact that, if various transactions are fully performed, they may negate one another and the fact that the transactions may have been entered into in contemplation of the others does not effect their legal substance, quite apart from their legal form. Economic substance must reflect legal substance.

Furthermore paragraph 20 of FIN 39 reads as follows:

“FASB Concepts Statement No.1, Objectives of Financial Reporting by Business Enterprises, paragraph 37, states that “…financial reporting should provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise”. The amount of credit risk exposure – the amount of accounting loss the entity would incur if the counterparties to forward, interest rate swap, currency swap, option, or other conditional or exchange contracts failed to perform in accordance with the terms of those contracts – is one indicator of the uncertainty of future cash flows from those instruments.

Con 1 Objectives of Financial Reporting by Business Enterprises also makes clear that it is a fundamental objective of financial reporting that it should provide investors with information purposes about the uncertainty of future cash flows.

The necessity of providing information which reflects the uncertainty of prospective net cash inflows, of credit risk exposure and potential failure of counterparties to perform provides an additional reason for accounting for transactions with differing parties on an individual basis.

Once it is accepted that the transactions must be reflected in the accounts on an individual basis as Mr. Turner agreed in his second report, FIN39 comes into play. It is only if the three transactions can be seen as one transaction because of rights of set off, that it is possible to look for the substance or economic substance of the three transactions compositely as opposed to the substance or economic substance of the individual transactions. It is crucial in this respect that the three transactions are independent without offsetting, netting or cross-default provisions between them. The obligations in each and the possibility of failure to perform in any one transaction should be represented in the accounting treatment of the three transactions.

When regard is had to the individual transactions themselves it can be seen that there are other individual characteristics which are inconsistent with characterisation as a loan. In a footnote in his second report Mr. Turner accepted that credit risk was borne to a greater or lesser degree by all three parties in Chase XII because the three transactions existed without any legal right of setoff between any of them. If ENAC defaulted on its obligation under the ENAC/Mahonia Swap which in turn would cause Mahonia to default on its obligations to Chase under the Chase/Mahonia Swap, and the market price of gas increased, Chase, despite the defaults which had occurred on the other two Swaps would be required to pay its net obligation to ENAC. In these circumstances, Chase would suffer an economic loss in excess of the aggregate amount which it had originally advanced to Mahonia and which Mahonia had advanced to ENAC ($350 million). Similarly, if Chase became insolvent and the price of gas went up, ENAC would have to pay a sum in excess of $350 million to Mahonia under the ENAC/Mahonia transaction whilst receiving nothing from Chase under the net settled Swap with Chase. There is no suggestion that the contracts were in any sense of the word a sham, so these rights and obligations were enforceable in accordance with the terms of the transactions with results which are very different from an ordinary loan.

Both the ENAC/Mahonia Swap and the ENAC/Chase Swap were subject to ISDA terms which gave rise to liability to provide collateral. In the case of the ENAC/Chase Swap, collateral was to be provided in respect of movements in the market price and the exposure of each party to the other as a result. There was an agreed threshold for each party which meant that Chase had to provide collateral when the market differential exceeded $50 million whilst ENAC had to provide collateral when the margin exceeded $10 million. The position of collateral was therefore not symmetrical as between the parties and the obligations were those which applied to sale transactions which would not have applied to a loan transaction. In the case of the ENAC/Mahonia Swap, ENAC had to provide collateral in respect of market movements by reference to the floating payment it had agreed to make to Mahonia. In the case of the ENAC/Chase Swap, Chase had to provide collateral for its obligations, an anomaly if Chase is seen as a lender.

The different obligations which arise as a result of structuring the transactions as three separate Swap transactions rather than as a bipartite loan transaction are matters of substance and not merely matters of form. As Professor Ryan said, the form of the transaction shapes the substance of the legal obligations and the economic substance which depends upon it. The point is illustrated by ENAC’s insolvency in this case. Whereas, if all the obligations of the parties are performed, the ultimate economic effect at the end of the day is identical or virtually identical to that of a loan with interest payable, the obligations undertaken by the parties have an altogether different effect during the six month period of the transactions and ultimately if there is default.

Mr. Turner accepted that each Swap was intended to operate in accordance with its own terms, that each was legally independent of the other with no cross default or setoff provisions and that there were default characteristics which were dissimilar from a loan and could, if Chase or ENAC became insolvent, result in payments which differed from that for a standard loan. He considered the hypothetical case of Chase’s insolvency to be so remote as not to be taken into account but the fact of ENAC’s insolvency illustrates the point as a matter of practicality. As a matter of analysis the likelihood or unlikelihood of performance does not affect the true nature of the rights and obligations agreed, but as set out earlier, the element of uncertainty of receipt is a matter which should be reflected in accounting treatment. It is the existence of distinct obligations and rights which should be represented in the accounting treatment, rather than some composite synthesised view of all the obligations, should they be fulfilled.

Whilst at one point in his evidence Mr. Turner said that there was no other legitimate view of the Three Swaps and its accounting treatment than the one he had expressed, elsewhere in cross-examination he accepted that there were matters of accounting judgment involved in characterising the transactions and selecting the facts which were significant for the purpose of that characterisation. He accepted that it was not all black and white and, because the accounting rules were not clear, that there was room for disagreement between accountants on the subject.

He maintained his view however that the three transactions had to been seen together collectively as a loan before deciding upon the accounting treatment to be granted to each swap for the purpose of journal entries and that such composite analysis was required where there was manipulation of “the accounting model to achieve a desired accounting result”.

As mentioned earlier, DIGK1 only came into force in 2001 and therefore applies only to Chase XII and not to the earlier transactions. It came in with FAS133, which also only applies to Chase XII. EITF 98-15 came into force in 1998 but both of these are low-level GAAP as compared with FIN 39 which is highest level GAAP. DIG K1 relates to specific situations in which there are two instruments which separately do not meet the definition of a derivative but, when combined, would do so. This provides for a specific instance where parties have attempted to circumvent the accounting literature for derivatives which requires fair value accounting. It sets out three specific criteria to be applied in considering whether or not the transactions should be viewed together rather than separately. This is of no direct application to the three Swap transactions, nor to the two which ENAC accounted for on a fair value basis in any event.

EITF 98-15 applies to two structured notes with exactly opposite risk characteristics that are accounted for at amortized cost on (at least) the income statement, thus providing an ability to manage earnings by subsequently selling one of the structured notes and realising a gain or loss. It requires that the two notes be accounted for on a composite basis. It too has no application to the Three Swaps, but Mr. Turner relied on it by way of analogy.

Neither of these low-level GAAP rules however sets out any general principle for general application elsewhere. Each provides for a specific situation. Neither qualifies FIN 39 in any other situation and as the highest-level standard, FIN39 remains applicable to those situations.

Nonetheless Mr. Turner relied on these provisions as looking to the intention of the transaction in situations where two transactions were entered into contemporaneously and in contemplation of one another, where they were executed by same party and/or counter party and where the desired accounting result was the only object of the structure. These, he said supported his view of EITF 98-10.

The terms of EITF98-10 are of importance in relation to classification of the ENAC/Mahonia Swap. In so far as relevant it provides as follows: -

“EITF 98-10: Accounting for Contracts Involved in Energy Trading and Risk Management Activities [Superseded by issue No. 02-3]

“2.

For purposes of this Issue, energy contracts refers to contracts entered into for (or indexed to) the purchase or sale of electricity, natural gas, natural gas liquids, crude oil, refined products, coal, and other hydrocarbons (collectively, energy). Energy contracts also includes energy-related contracts (for example, capacity contracts, requirements contracts, and transportation contracts 1(1)). Energy trading activities or energy trading contracts refers to energy contracts entered into with the objective of generating profits on or from exposure to shifts or changes in market prices. Consistent with the way in which trading activities are defined in Statement 119, trading activities also include dealing (the activity of standing ready to trade – whether buying or selling – for the dealer’s own account, thereby providing liquidity to the market).”

“6.

The issue is how energy trading contracts should be accounted for.”

EITF 98-10 DISCUSSION

“7.

At the November 18-19, 1998 meeting, the Task Force discussed the working group’s recommended approach to accounting for contracts involved in energy trading and risk management activities. The Task Force reached a consensus that energy trading contracts should be marked to market (that is, measured at fair value (2) determined as of the balance sheet date) with the gains and losses included in earnings and separately disclosed in the financial statements or footnotes thereto…….”

“8.

The Task Force reached a consensus that determining whether or when an entity is involved in energy trading activities is a matter of judgment that depends on the relevant facts and circumstances……….”

“The Task Force agreed that the framework in which such facts and circumstances are assessed should be based on an evaluation of the various activities of an entity rather than solely on the terms of the contracts. Inherent in that framework is an evaluation of the entity’s intent into an energy contract. The Task Force reached a consensus that the factors or indicators identified in Exhibit 98-10A should be considered in evaluating whether an operation’s energy contracts are entered into for trading purposes…..”

“As used in Exhibit 98-10A, operation refers to any identifiable activity of an entity (for example, a subsidiary, a division, or a unit) that enters into the types of energy contracts that are within the scope of this issue.”

“9.

The Task Force acknowledged that it is easier to evaluate the trading activities of an entity when such activities are segregated organisationally or by legal entity. However, the Task Force observed that if an operation’s trading activities are not segregated in either of those ways and an evaluation of the indicators identified in Exhibit 98-10A would conclude that a portion of the operation’s activities are trading, then only that portion of the operation’s activities would be considered trading and all energy trading contracts entered into by that portion of the operation’s activities should be marked to market. Task Force members noted that when an operation conducts both trading activities and non-trading activities and those activities are not segregated organisationally or by legal entity, it is essential that the entity analyse contracts at inception based on the factors in Exhibit 98-10A and identify each contract either as trading or non-trading.”

Exhibit 98-10A set out the factors to be considered for determining trading activities. The opening paragraph reads as follows: -

“FACTORS TO CONSIDER FOR DETERMINING TRADING ACTIVITIES

For purposes of identifying energy trading activities, the following groups of indicators should be considered for each identifiable operation (activity) of an entity that enters into energy contracts that are within the scope of this Issue. The absence of any or all of the indicators in any category, by itself, would not preclude the operation’s activities from being considered trading. 3(3) Categories A and B represent the fundamentals of the operation’s activities. Accordingly, the presence of indicators in both Categories A and B, in combination, may be a strong indication that such activities are trading. The presence of indicators in any one of the other categories (C-F), by itself, may indicate that the operation’s activities are trading. Nevertheless, all available evidence should be considered to determine whether, based on the weight of that evidence, an operation is involved in energy trading activities.”

Of the thirty factors which followed in groups A-F, twenty-six were concerned with the nature of the entity’s business whilst four (F2-F5) were concerned specifically with the energy contracts in which that entity was involved. By virtue of paragraph 9 of EITF 98-10, those factors were to be used to analyse contracts to ascertain whether or not a contract was to be considered as an energy trading contract or a non energy trading contract, where an operation’s energy trading contracts were not conducted by an organisationally segregated body.

Despite considerable argument about the necessity for a two-stage approach, upon which the experts differed, it is clear in my judgment that “energy trading activities” and “energy trading contracts” are essentially equated by paragraph 2 of EITF 98-10 and that the objective referred to in that paragraph of “generating profits on or from exposure to shifts or changes in market prices” falls to be assessed within the framework of the entity’s business as a whole. This is made clear by paragraph 8 which focuses attention upon the various activities of an entity rather than solely on the terms of its contracts and the reference to what is meant by an “operation”. It is expressly said to be a matter of judgment whether and when an entity is involved in energy trading activities and the evaluation of an entity’s intent in entering into an energy trading contract is tied up with the evaluation of its activities as a whole. Thus the factors identified in Exhibit 98-10A are to be taken into account in evaluating whether an operation’s energy contracts are entered into for trading purpose and in particular so under paragraph 9 if the trading and non-trading activities are not organisationally segregated. As Professor Ryan put it, the objective referred to in paragraph 2 is to be assessed on a portfolio or total business level rather than by reference to individual contracts per se. Energy traders enter into multiple contracts with a view to generation of profits. Some of those contracts may effectively hedge other contracts but, taken as a whole, the contracts are concluded with a view to generating profits as a result of movement in market prices.

West’s skeleton argument at paragraph 31 appears to recognise that a contract designed to protect against exposures to shifts or changes in market prices, would be an energy trading contract although Mr. Turner maintained that only a contract with a speculative element in it was a contract entered into with the objective of generating profits on or from exposure to changes in market prices.

It was common ground that the ENAC/Mahonia swap was an “energy contract” within EITF 98-10 but the question was whether or not it was an “energy trading contract” within EITF 98-10.

The ENAC/Mahonia Swap, when viewed on its own is, as Mr. Turner agreed plainly an energy trading contract within EITF 98-10. In order to escape the conclusion that it should be accounted for in this way, it is necessary to look at the objective which lies behind the two Swaps in which ENAC was involved and the third Swap between Chase and Mahonia. The objective to which Mr. Turner therefore wished to refer is the objective of the Three Swaps when taken as a composite whole, not the objective of any individual contract, despite maintaining that it was each individual contract to which regard had to be paid in assessing intent. In my judgment it does not appear to be a legitimate approach to look at a group of contracts compositely, as Professor Ryan opined, because of the terms of FIN 39 and the independence of each of the transactions from the other.

When considered as an independent contract, there is no doubt that the ENAC/Mahonia Swap has price risk in it and would qualify as an energy trading contract. Moreover, even if the Three Swaps are taken collectively, there remains a price risk in the event of default by the parties as set out by Mr. Turner himself in the footnote to his second report to which I have already referred. Whilst there was much discussion about whether default should be taken into account and the difference between credit risk and price risk, the fact is that, bound up with the credit risk in transacting business with each of the other two parties, was a price risk which would result in a greater or lesser sum being payable by reference to the price of gas at 26^th March 2002 in the event that one or other entity failed to perform in an independent transaction. Moreover there was an element of price risk in both ENAC swaps throughout their duration because of the requirement for collateral to be put up in respect of market movements, albeit that this does not per se reflect a profit objective for the individual contract. Whether or not performance risk is only to be accounted for as it becomes apparent that there may be failure as Mr. Turner maintained, there is price risk involved in the transaction, whether taken individually or as a composite, which Mr. Turner advanced as the key issue.

As paragraph 8 of EITF 98-10 makes plain, there is an element of judgment depending on the relevant facts and circumstances in determining whether or when an entity is involved in energy trading activities by reference to the factors in Exhibit 98-10A. All the available evidence has to be considered for that purpose as the Exhibit makes clear and there is clearly some room for different views on the subject. Whether or not the underlying purpose of a forward prepay is financing, if there is price risk management involved, on Mr Turner’s criterion, the contract must be an energy trading contract.

Professor Ryan pointed out that ENAC was an entity whose business was energy trading and that the objective of ENAC in Chase XII was no doubt to raise financing, but to do so in a form that was compatible with the other instruments in its trading portfolio. Many of the positions taken in a normal energy trading portfolio are not themselves speculative as the last sentence of paragraph 2 of EITF 98-10 recognises. Reference must be made to paragraphs 8 and 9 of EITF 98-10 and not merely to paragraph 2. If a contract is of a similar kind to another in the trading portfolio, why is it to be distinguished from the others because its purpose is financing, which is intended to render the portfolio as a whole profitable? Even if regard was to be had to other independent contracts, there would be no reason to draw a box round these two ENAC contracts and to treat them separately from the rest (with or without reference to the Mahonia/Chase Swap). Individual contracts in any energy trading portfolio may perform a number of roles other than directly generating profits by themselves. The question is whether or not the portfolio as a whole is aimed at profit and a financing contract which allows the portfolio to be profitable and which takes a form similar to other contracts within the portfolio should be accounted for in the same manner.

Professor Ryan pointed out that if Chase and ENAC had not hedged with each other in the ENAC/Chase Swap but had hedged with other counterparties, the position would be no different economically and all the contracts would clearly be energy trading contracts because of the price risk management inherent in each, even if that risk was perfectly hedged by another similar contract. The fact that Chase and ENAC chose to hedge with each other does not have significant effect on the substance of each transaction. In energy trading portfolios there are often contracts which are fully hedged from a price risk point of view if the counterparties perform, but they all fall to be accounted for as energy trading contracts. Here there is both individual price risk in each transaction and even should a box be put round the two contracts in question and the Chase/Mahonia Swap taken into account, there was a collectively price risk linked to credit or default risk.

When Mr. Turner was asked whether Chase I - Chase V (or IV) were energy trading contracts because these were hedged out into the market and were not the subject of a net settled swap constituting a third leg between ENAC and Chase, he said he did not know the answer. Proceeding from his view that it was the elimination of price risk which prevented a contract from being an energy trading contract his answer should have been negative. Proceeding from his view that it was the circularity of the Three Swaps transactions and the requirement to treat them compositely which prevented the transactions from being energy trading contracts, his answer should have been affirmative. He insisted that it was the composite analysis of these transactions which showed that price risk was eliminated and meant that the Three Swaps together constituted a loan, so, on that basis, it was inevitable that the logical answer to the question posed in relation to Chase I – IV would be as effectively eliminated in both situations. This highlights the point that, because of the independence of the Three Swaps one from the other, it can make no difference whether ENAC and Chase hedge their risks in the market generally or with one another. It can be said that each transaction takes effect as an energy trading contract with an inbuilt price risk and profit objective, notwithstanding any underlying financing purpose which is achieved if all three independent contracts are fully performed and the profits or losses are cancelled out.

West maintained that Professor Ryan’s approach was contrived because the subjective aim of Enron and ENAC was to obtain financing by means of the Three Swaps taken together so that there was no objective of generating a profit in any individual transaction. West argued that Mahonia was introduced simply as a conduit to transfer the price risk round in a circle. ENAC had however two contracts only with Mahonia and Chase for which it had to account with price risk in each and an inbuilt profit or loss depending on market movement. Looked at individually, on an objective basis, they were speculative and clearly energy trading contracts. If they were considered as part of an overall trading portfolio, they could also be considered energy trading contracts since the objective of the portfolio was plainly to make profit and these contracts were intended to contribute thereto by providing financing.

In these circumstances, whether ENAC’s transactions are looked at individually or looked at on a collective basis by reference to the whole of its trading activity, I cannot say that Professor Ryan’s approach in treating them as energy trading contracts under EITF 98-10 was not a legitimate approach to adopt.

In my judgment it is simply not possible to focus on the “round tripping” or “circularity” of the three transactions and state that this is so much the dominant characteristic of the two ENAC transactions that nothing else matters besides, so that it is imperative to ignore the overall portfolio and the price risk characteristics of each transaction which, as is common ground, has to be accorded individual entries in the accounts.

In his second report, Mr. Turner said that the ENAC/Chase Swap was to be treated as a derivative whilst the ENAC/Mahonia Swap was to be treated as a loan host with an embedded derivative. The $350 million figure would be entered as a debt in the balance sheet whilst the derivative element relating to the floating sum would be accounted for separately. The effect of Mr. Turner’s view, as set out in his second report was that the objective, for the purposes of paragraph 2 of EITF 98-10 was to be assessed on a composite basis in respect of the Three Swaps, whilst the accounting entries were to be made on an individual basis. The effect would then be to treat the ENAC/Mahonia Swap in accounting entries, not as a single instrument but as two instruments and to treat it differently from other contracts in the portfolio of a similar kind.

Mr. Turner took the view that paragraph 12 of FAS 133 applied to the accounting entries to be made for the ENAC/Mahonia Swap. FAS 133 which is headed “Accounting for derivative instruments and hedging activities” was effective for ENAC for the 2001 year and therefore could apply to Chase XII alone, not to Chase I – XI. It was recognised as easily the most single complex standard that FASB have ever issued. Mr. Turner accepted that it was difficult to understand and implement and that paragraph 12 was entirely new in the sense that GAAP had nothing similar prior to it. Paragraph 12 was an anti-avoidance provision to stop people trading derivatives in composite instruments but accounting for them on an accrual or historic cost basis and to ensure that fair value accounting was applied instead. Thus paragraph 293 of FAS 133 refers to the Board’s view that it was important that an entity should not be able to avoid the recognition and measurement requirements merely by embedding a derivative instrument in a non-derivative financial instrument or other contract. What is envisaged is a contract with separate elements in it, one of which is a derivative and one of which is not, and a situation where the accounting entity chooses to account for the instrument as a whole on a non-derivative basis. As Professor Ryan pointed out however, the ENAC/Mahonia transaction settles as a single instrument and not as two instruments. Moreover fair value accounting was applied by ENAC to this transaction so that the objective which underlies FAS 133 paragraph 12 does not apply in any event. It would be odd to use FAS 133 to justify historic cost accounting as opposed to mark to market treatment. It is clear and common ground that the ENAC/Mahonia Swap, if treated as one instrument is not a derivative because of the substantial advance payment of $350 million, so that a characterisation as a loan and a derivative does not seem apt.

It is accepted that there is no provision in GAAP as to how to account for energy contracts which are not energy trading contracts. There was an issue between the parties as to whether or not there was a practice of accounting for such contracts as if they were energy trading contracts but the evidence on this was not sufficient for me to come to any clear conclusion about it. Suffice it to say that Mr. Turner recognises that most, if not all entities involved in energy trading activities accounted for these contracts (energy contracts) as energy trading assets and liabilities, whilst Professor Ryan’s research from studying the filings of the 15 main energy trading companies revealed that they accounted for all their energy contracts as energy trading contracts or as hedging instruments, but not in any other way. The issue summary for EITF 98-10 referred to the prior practice as “diverse”.

I found Professor Ryan’s evidence more persuasive than that of Mr. Turner, despite the latter’s experience as chief accounting officer for the SEC. The latter’s analysis of the position changed significantly and fundamentally between his first and second report and the matters relied on by him when giving evidence to the PSI were different from those upon which he relied in his evidence before me. Insofar as he sought to say that there was only one legitimate way to account for the prepays, whether Chase VI – XI or Chase XII, namely as a loan, I reject his evidence. As appears from the above discussion, in my judgment, Professor Ryan’s view that ENAC was bound to account for the ENAC/Mahonia Swap and the ENAC/Chase Swap as separate transactions (because that is what they were) on the basis of the rights and liabilities contained in each was a justifiable view. A faithful representation of those contracts required them to be treated as the contracts they were and not on some composite basis, as if they constituted a single loan, simply because the economic effect of them, if they and the Mahonia/Chase Swap were fully performed, was similar or identical to that of a loan. They contained provisions which made them swap contracts with margin obligations and obligations to make payments which depended on the market movement of gas prices. There was price risk in each both on a performance basis and on a default basis.

I also take the view that ENAC was justified in treating the ENAC/Mahonia Swap as an energy trading contract and the ENAC/Chase Swap as a derivative so that both were accounted for on ENAC’s balance sheet as price risk management assets or liabilities. Prior to the introduction of FAS 133, I do not see how this could be criticised or thought impermissible under GAAP and thereafter, although alternative accounting treatment was available, in the manner put forward by Mr Turner, it cannot be said that Prof Ryan’s approach was impermissible. Thus ENAC was justified in giving the prepays “non debt” treatment on its Balance Sheet and accounting for them as Price Risk Management Activities, both in respect of Chase I – XI and Chase XII.

It follows from this conclusion that ENAC was entitled also to account for cash flows resulting from these Swaps as “operating cash flows” rather than “financing cash flows”. Whilst ENAC was seeking to raise cash through the Three Swaps, both the form and substance of the transactions were forward swaps so that cash flows resulting from them do not constitute “investment” or “financing” cash flows and therefore fall into the remaining category of “operating” cash flows.

I am conscious of what West refers to as “the US Investigations”, namely the report of the chief investigator of the US Senate’s Permanent Subcommittee on Investigations (the PSI), the report of Mr. Batson, the Enron Bankruptcy Courts Appointed Examiner, the SEC complaint and settlement and the DA settlement. West points out that conclusions were reached about Enron’s wrongful accounting for the Mahonia prepay transactions and that Mr. Turner’s evidence played some part in this. On the 28^th July 2003 the SEC filed a complaint against Chase in respect of the Mahonia prepay transactions including Chase XII, contending that Chase had aided and abetted Enron’s breach of US Securities laws. On the same day as the SEC complaint was issued against Chase, Chase entered into the SEC settlement and consented to judgment in respect of the complaint. Chase agreed to pay a disgorgement in the sum of $65 million plus interest in the sum of $5 million, to pay a civil penalty in the sum of $65 million under S(2)(1)d of the Securities Exchange Act 1934 and to be permanently restrained and enjoined from a violation of S10(b) of that Act. Chase consented to judgment without admitting or denying the allegations in the SEC complaint but also declared that it understood and agreed to comply with the SEC’s policy “not to permit Chase to consent to a judgment or order that imposes a sanction whilst denying an allegation in the complaint or order for proceedings”. Additionally, on the same day, Chase entered into a settlement with the Manhattan District Attorneys Office pursuant to which the Manhattan DA agreed not to prosecute Chase in respect of its conduct in relation to the Mahonia prepay transactions. Pursuant to that settlement Chase agreed to pay without any reservations or denials $12.5 million to the State of New York, $12.5 million to the City of New York and $2.5 million to the Manhattan DA’s office for the costs of its investigations.

West has placed reliance upon these matters as showing that not only was Enron’s accounting obviously wrongful but that Chase recognised that it was so and that the settlements can be treated as admissions.

I have had to proceed on the evidence before me which plainly differs from that put forward to the PSI by Mr. Turner in his capacity as an expert witness called by the investigating committee. As is usual for such investigations, there was questioning by the PSI itself but no cross-examination of Mr Turner by others. Mr Turner had taken a stance before the PSI which he upheld in this Court, but on a different basis. His view appears to have evolved between the time he gave evidence to the PSI and made his first report (which accorded with one another) and the time when he made his second report, as set out earlier in this judgment. Mr. Turner’s initial view was that the prepay transactions were collapsible into loans and should have been accounted for as such. In his second report to this Court he changed his analysis, arguing that the transaction comprised a freestanding derivative and an embedded derivative and a debt host. This latter accounting treatment is one which West had described in its statement of case as “wrong and misleading”. Before the PSI and in his first report, Mr. Turner considered that the Swaps should together be reported as a loan whereas in his second report he accepted that they had to be accounted for individually under FAS 133–12, of which no mention was previously made. He also grappled with APB10, FIN 39 and EITF 98.10 for the first time in that second report, each of these having been raised in the sequential report of Prof Ryan. Equally, in his first report Mr. Turner placed great reliance upon the involvement of Mahonia and the GAAP guidance relating to SPV’s, whereas in his second report Mahonia scarcely merits a mention and under cross-examination he accepted that the accounting issues would be exactly the same whether or not Mahonia had been involved in the transaction at all or whether Mahonia had been a company of substance. Once again this ran counter to West’s pleaded case that “Chase knew that the proposed accounting treatment could not be justified not least because Chase and Mahonia were not unrelated entities”.

The change in Mr. Turner’s stance, as the former chief accountant of the SEC, is significant not only in respect of the substance of his evidence and the reliability of it but also because it shows that there is considerable room for divergence of view as to the proper accounting treatment of these prepays. Mr. Turners’ second report could only criticise the accounting for Chase XII because there he relied upon FAS 133, which was inapplicable to Chase I – XI, whereas in his first report, where he maintained that the transactions were collapsible, Chase VI – XI or possibly all twelve transactions were attacked. I am bound to say that I did not find Mr Turner’s evidence to be satisfactory, and whilst I had reservations about some of Prof Ryan’s views on rating agencies, his approach was much more considered and balanced on the accounting issues. It was suggested that Prof Ryan was partisan, but it seemed to me that Mr Turner had taken a stance before the PSI which he felt he had to justify on new and different grounds and I preferred the evidence of Professor Ryan on all the accounting points that matter where there was an issue between him and Mr Turner.

It can fairly be said that this area of accounting is not one without difficulty, in particular in the application of EITF98-10 and FAS 133. Whilst the overall structure of the prepays from Chase I – Chase XII remained essentially the same and the accounting treatment given to it by Enron, with advice from Andersens, also remained the same, not only did the standards change over the period of accounting but the difficulty in applying them is self evident.

Whilst therefore there may be other ways in which the transactions could properly be accounted, on the evidence before me, I cannot conclude that the accounting treatment actually adopted was contrary to GAAP.

For there to be a breach of US law, misaccounting would have to be material. Having decided the issue relating to breach of GAAP in the way that I have, there is no need for me to consider the question of the materiality of the prepay accounting adopted by Enron. For the purpose of the issues which arise before me, whether in relation to West’s argument about a conspiracy to injure West by unlawful means or in the context of the argument about illegality, the only illegality in question is that which relates to Chase XII. The question therefore is whether or not, if Enron’s accounting had been contrary to the principles of GAAP, it was sufficiently material. Materiality concerns the significance of an item to the users of financial statements and, on the basis of the test set out in SAB 99, a matter is material if there is a substantial likelihood that a reasonable user of the financial statements would consider it important and would regard it as significantly altering the “total mix” of information.

By accounting for Chase XII as price risk management activities rather than debt Enron understated its total reported consolidated debt by approximately 3 per cent as at 30^th September 2001 and the current portion of such debt by a little in excess of 5 per cent. Professor Ryan did not consider this material and in particular said that debt was an unimportant line item for Enron compared with other obligations, in particular trading liabilities which were huge. For a manufacturing firm, a service firm or a retailing firm, whose primary source of financing was debt, this kind of debt analysis might be appropriate but for a company engaged in the activities in which Enron was engaged, focusing on debt and percentage alterations in debt was inappropriate. The focus of Mr. Turner had been upon the debt figures for the years-ending 1999 and 2000 and the effect of the totality of the prepays which Professor Ryan considered bordered on the material. The impact on leverage rates was assessed on the basis of the debt line. Professor Ryan considered however that the figures for Chase XII were immaterial.

The burden is upon West to satisfy me that, on the balance of probabilities, the percentage alterations in the debt figures on the balance sheet attributable to Chase XII are material. It is clear from the accounting literature that, whereas 5 per cent is a rule of thumb as to materiality, it is no more than that and is really only a preliminary guide which must yield to full analysis of all relevant considerations. I am not satisfied that West has discharged the burden of proof in relation to the materiality of the debt line item in the balance sheet both because of the percentage change effected if Chase XII is accounted differently and because of Professor Ryan’s view as to the inappropriateness of any reasonable person approaching Enron on the basis that all its financing was to be found in the debt line, although on this hypothesis Chase XII should have featured there, and the classification must have some significance.

The same point as to the readers’ perception and the appropriateness of it arises in relation to cash flow but here the figures are of a different order. In the quarter ended September 30^th 2001, Enron reported cash flow from operating activities as $584 million. The net cash flow from Chase XII was $350 million out of that figure with the result that, if Enron wrongly reported this as cash flow from operating activities, the true figure of $234 million was overstated by 150 per cent. If compared with a nine-month period ending September 30^th 2001, the overstatement would amount to 46 per cent. Since Chase XII ran for a limited period of six months, a comparison over a short period is not, in my judgment, inappropriate.

Professor Ryan expressed the view that materiality was a hard question to answer in relation to cash flow statements because there was no literature which helped to decide what the proper benchmark was for the materiality assessment for cash flows. Mr. Turner’s evidence was that cash flows from, or used in, operating activities are a well established operating performance benchmark and that the distortive effect upon cash flows from operations was important for users of Enron’s financial statements. Lenders and Credit Rating Agencies would want to know how much debt an entity could service whilst satisfying its operating expenditures as they became due. Net cash flow from operating activities is one of the primary sources of cash that entities used to repay their debt and other non-operating obligations.

If the question is asked whether there is a substantial likelihood that a reasonable user of the financial statements would consider the information important or a substantial likelihood that the reasonable investor would regard this information as significantly altering the “total mix” of information available, it is clear that the short term cash flow position is altered by a significant amount if the classification as operating cash flow, as opposed to financing cash flow is important.

The question of materiality proceeds on the hypothesis that there was misaccounting and on that basis, there must be significance in the characterisation of cash flow as “operating” as opposed to “financing”. If therefore the numbers are significant in themselves, the misclassification matters. Professor Ryan’s view was that the nine-month figures were meaningless because the cash flow from operations for that period was $700 million negative. He regarded a negative percentage figure of 46 per cent, by reference to Chase XII, as an “absolutely uninterpretable number”. In my judgment however the very size of the figures in comparison with the current cash flow shows that this would be material to any reader of the accounts if the classification is significant, which on this hypothesis it is. A change of 150 per cent or 46 per cent by virtue of Chase XII is one which would impact upon a reasonable reader of the financial statements and despite any difficulties in interpreting what this means, I consider that this amounts to a significant alteration of the total mix of information available.

It follows from my finding that Enron’s accounting for the prepays was not in breach of US GAAP that its accounting for these transactions did not constitute a breach of US Securities law. It inevitably follows that West cannot show that there was any conspiracy between Enron, Mahonia and Chase to devise arrange and implement transactions in order to enable Enron to account wrongfully. It equally follows that there was no unlawful purpose behind the Three Swaps or the letter of credit.

West alleges that, as a matter of English law, Chase conspired with Enron to devise and implement the prepays for the purpose of Enron’s wrongful accounting under GAAP and to breach US Securities law. In addition to contending that Enron breached US Securities laws, West also contended that Chase committed breaches of US Securities laws itself, in case it should be said that Chase could not be liable for conspiracy under English law in circumstances where a US Federal Court would not find it liable under its law. It was said that Chase was in breach of S.20 (e) of the Securities Exchange Act of 1934 which provides that: -

“Any person that knowingly provides substantial assistance to another person in violation of a provision of this title, or of any rule or regulation issued under this chapter title, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided. ”

There was a dispute between the US law experts, whose reports were put before me, as to the meaning of “knowingly” in the section. West contended that the SEC’s view, which was entitled to “deference”, corresponded with dicta in District Courts to the effect that actual knowledge on the part of the alleged aider and abettor of the violation by the principal wrongdoer was not necessary and that recklessness was sufficient. Attention was drawn to places in the statute where the word “knowingly” was used but was specifically defined to mean actual knowledge, with the inference that, where there was no such applicable definition, actual or constructive knowledge (i.e. recklessness) would suffice, as it had prior to the decision which had led to an amending statute in which S.20 (e) was to be found. By contrast the US law evidence adduced by Chase pointed to the ordinary and natural meaning of the word “knowingly” and to the only dicta on the subject in an Appellate Court in SEC v Fehn, 97F.3d1276,1288n.11(9thCir.1996) where a distinction was drawn between actual knowledge and reckless disregard whilst stating that S20(e), by its plain terms required knowledge. Reliance was placed on the legislative history of the amendment in support of both views.

It is accepted that, whether actual knowledge or constructive knowledge is required (and by the latter is meant knowledge which a party ought to have had in all the circumstances,) what had to be known or ought to have been known was the wrongfulness of their own conduct or that of the primary violator of the 1934 Act – namely that there was to be misaccounting.

Even if there had been a breach of US GAAP by Enron in its accounting for the prepays, I would not have found that there was any aiding or abetting by Chase because of the absence of either actual knowledge or constructive knowledge that there had been wrongful accounting in respect of prior prepays or that there would be wrongful accounting in respect of future transactions, including Chase XII. Chase was not reckless in this regard. Whilst this is dealt with in more detail later in this judgment, I find that at all times the individuals at Chase who were concerned with the prepay transactions considered that Enron would account for them in accordance with responsible advice from their accountants Andersens and that, they themselves considered that the transactions had been effectively structured so as to entitle Enron to the accounting treatment envisaged.

Apart from the question of knowledge, in order to aid and abet within S.20(e), it is necessary for the person to “provide substantial assistance to another person in violation of a provision” of the Act or any rule or regulation issued there under. There was an issue between the legal experts as to whether or not Chase’s actions were capable of amounting to “substantial assistance”. It would plainly not be enough for a bank to put forward a structured transaction to a customer which provided the customer with an opportunity wrongfully to account for the transaction. Nor, in my judgment would it be enough if, in addition, the bank suspected that the customer might wrongly account for it. In order to give “substantial assistance” there must be some activity or participation in the wrongdoing by the primary violator. To provide a party with an opportunity to commit wrongdoing would not be enough because there would be no assistance given, whether in the form of encouragement or action. If however the bank entered into a scheme with its customer, as West alleged and they planned the transaction with the express object of knowingly accounting for it in a wrongful manner, the bank plainly would be guilty, even if it was not guilty as a primary violator. Thus, in my judgment the question of substantial assistance here turns almost entirely on the questions of knowledge and intent. If the acts done are an essential planned link in the course of action which leads to wrongful accounting then, if it is part of the joint scheme wrongfully to account, the bank would be liable. For the reasons I have already given, this does not apply here since the Chase personnel had no actual knowledge, nor ought to have appreciated that Enron would be guilty of wrongful accounting and had no intent that Enron should wrongly account.

So far as any question of breach of the 1934 Act by Enron is concerned, there are three relevant provisions to which West draws attention.

Violations of the Federal Securities Laws can be subject to criminal prosecutions which are the responsibility of the Department of Justice, as opposed to the SEC. In order to establish a criminal offence, the defendant must be shown, beyond reasonable doubt, to have acted wilfully and, in the context of false statements, knowingly.

There was before the court no direct evidence as to Enron’s internal books and records to which section 13(b) relates. It is however a fair inference, as West maintained, that Enron’s internal books and accounts would have reflected its public filed accounts and disclosure statements. If therefore there had been misaccounting for the prepays, no doubt these would have been wrongly accounted for in the internal books and records as well and there would have been a breach of rule 13(b).

As a public company Enron was required to provide condensed unaudited financial statements every quarter. If form 10Q for the third quarter of 2001 had been materially inaccurate that, it appears would have been a violation of Section 13(a) and rule 12B.

S.10 (b) of the Securities Exchange Act prohibits material misstatements made with intent to defraud. Actual knowledge of inaccuracy or recklessness with regard to inaccuracy will suffice.

Neither the breach of s.13 (a) nor 13 (b) would be a criminal offence unless, in accordance with S.32 (a) of the Securities Exchange Act, Enron had acted wilfully and knowingly in making the false statements in the financial statements. The word “wilfully” connotes an understanding on the part of the wrongdoer that he is involved in a wrongful act. There must be some evil purpose or guilty intent although it does not require knowledge that the Securities Exchange Act is being broken. “Knowingly” appears to add little this.

In order to establish that Enron was guilty of a criminal offence in relation to the Securities Exchange Act, whether in relation to section 13 (a), section 13 (b) or section 10 (b), or in relation to Mail and Wire Fraud to which section 10 (b) refers, it would be necessary to make a finding against Enron in relation to the state of mind of those involved in decisions about accounting and the filing of financial statements. West adduced no direct evidence from Enron but relied on various depositions from which it concluded that Enron personnel, like Chase personnel, knew that the prepays were “disguised loans” and that it was therefore obvious that accounting for them as “price risk management activities” was unlawful. West accepted that the state of mind involved knowledge of misaccounting, mischaracterisation of the transactions in accounting terms and knowledge of wrongful accounting, even if there was no full understanding of GAAP. It was said that both Enron and Chase personnel knew that a fair presentation was not being made. Alternatively, where the statute so allowed, it was said that both Enron and Chase were at the least reckless with regard to the misaccounting.

Later in this judgment I set out my findings with regard to Enron’s knowledge and understanding of the position in relation to its accounting and merely point out at this stage that to make a finding of intent to defraud, or of wilful or knowing misstatements, or of recklessness where the risk of misleading investors is so obvious that Enron must be taken to have known of it, would not be possible on the basis of the deposition evidence adduced.

If therefore I had found that the prepays and in particular Chase XII were the subject of wrongful accounting, I could not have made any finding as to a criminal or fraudulent state of mind of those involved at Enron. Given the obvious involvement of their accountants, the most logical inference to be drawn would be that Enron’s accounting was effected on the basis of advice from their accountants and was innocently wrong so far as the prepays were concerned. It is clear from the documents that Enron received advice from Andersens and there is no basis upon which it can be said that it did not follow it. Since many other entities were involved in similar transactions (involving different banks also) and accorded them similar accounting treatment, I could not find that Enron was knowingly or wilfully committing any wrongdoing.

West asserted that, as a matter of US Securities law, the L/C could not be enforced against it because of the terms of S.29 (b) of the Securities Exchange Act. This provides as follows: -

“Every contract made in violation of any provision of this title or of any rule or regulation thereunder, and every contract… heretofor or hereafter made the performance of which involves the violation of or the continuance of any relationship or practice in violation of, any provision of this title or any rule or regulation there under, shall be void

1)

as regards the rights of any person who in violation of such provision, rule or regulation, shall have made or engaged in the performance of any such contract, and

2)

as regards the rights of any person who not being a party to such contract shall have acquired any rights there under with actual knowledge of the fact by reason of which the making or performance of such contract was in violation of any such provision, rule or regulation…”

This section is not directly relevant as a defence or cause of action for West since the enforceability of the L/C is a matter of English law for this court to decide without reference to US Securities law. The point is however of significance in the context of the allegation of an English law conspiracy to commit an act which is unlawful under foreign law, namely US Federal Law.

As appears later in this judgment, I hold that as a matter of English law, it is necessary for any unlawfulness to be actionable at the suit of the victim against at least one of the co-conspirators. If therefore foreign law unlawfulness is sufficient for this form of conspiracy, known as “unlawful means conspiracy”, then the acts in question must be actionable under foreign law by the alleged victim, in this case West, as against one of the co-conspirators, alleged to be Enron, Chase or Mahonia.

The point may also be of significance in the context of allegations of unenforceability of the L/C under English law and the ground that its purpose contravened foreign law since it would be relevant in that enquiry to know what attitude the US Courts would adapt to the transaction.

Professor Farnsworth, whose evidence was adduced by Chase, took the view that section 29 was inapplicable to the Three Swaps and to the L/C. He said that the illegality alleged by West was not of a type with which the section was concerned and that the statute could only be invoked by an innocent member of a class protected by the provision that had been violated. The scope of section 29 was confined to contracts either “made in violation of” the Act or “the performance of which involves the violation of” the Act. Authority shows that “the violation to trigger the application of the section must have occurred in the making or performance of the contract sought to be rescinded”.

Professor Farnsworth opined that contracts concluded for the purpose of facilitating a violation are not within the scope of section 29(b) except where a violation actually occurs in their making or in their performance, on the basis of Court of Appeals’ decisions. The violation had to be inseparable from the performance of the contract for that contract to be avoided. Entering into the Three Swaps with the intention of using them for the purpose of facilitating an accounting fraud was a different matter from a violation in the making of the Swaps themselves. Equally the performance of the Swaps did not involve any accounting violation as such, merely the payment of money and posting of collateral.

Professor Franco, whose evidence was adduced by West took a contrary view because the allegation was that the Three Swaps and the L/C were integral to a scheme to manipulate the reported figures in Enron’s financial statements which meant, in his view that their performance involved the violation of the accounting provisions. If Chase had violated Securities laws itself by “knowingly providing substantial assistance” to Enron for the purpose of section 20 by devising arranging and implementing a scheme specifically for wrongful accounting, the Three Swaps and the L/C were connected to the Securities law violations and were an essential link in the chain of actions leading to those violations. Thus, he said that if Chase had been guilty of a section 20(e) offence and had conspired with Enron wrongfully to account for the transactions, then the performance of the Three Swaps would involve the violation of the accounting provisions.

Whatever the position with regard to the Three Swaps and their validity because of their link to the misaccounting, it is however hard to see how as a matter of logic, performance of obligations under the L/C, namely the presentation of a draw statement and payment under it could involve violation of the provisions of the 1934 Act. The accounting was not in any way tied to the L/C, only to the Three Swaps transactions. The L/C was security for Enron’s payment obligations but had no direct connection with Enron’s accounting at all. Whilst it is true that the transactions would not have gone ahead had there been no letter of credit provided, this does not provide an essential link in the chain leading to wrongful accounting in the same way that the Three Swaps do.

The word “void” in section 29 has been interpreted by the US Court to mean “voidable”. The wording of section 29 provides for those rights which may be avoided, namely the contractual rights of a party in breach of the provisions of the Act or a successor in title to such a person who has the necessary knowledge of the facts which give rise to the violation. It is clear that an offending transaction is voidable at the instance of an innocent party to that transaction but not at the instance of a party who violated the Act (this being expressly decided in Regional Properties Inc. v Financial & Real Estate Consulting Co. 678F.2d552(5^th Circuit 1982)). Moreover an innocent party seeking to rescind must be in the class of persons whose interest the Act was designed to protect. With reference to the Three Swaps, not only has there been no attempt to avoid the transaction by Chase, Mahonia or ENAC, but, on the hypothesis put forward by West, all were guilty participants in the 1934 Act violations and none would be in a position to avoid any of the Three Swaps. In these circumstances, the Three Swaps would remain in being and could not be avoided under section 29 on the application of West, which was not a party to any of the Three Swaps nor in the class of persons the Act was designed to protect and would not be in a position to challenge it.

West relied upon two District court cases where guarantors or sureties were permitted to void loans in violation of the Federal Securities Law. Since their liability depended upon the validity of the transaction for which they were guarantors or sureties, this does not assist West because the L/C transaction is not dependent upon the validity of the underlying transaction in the same way.

West however seeks to rely on section 29 in order to avoid the L/C (rather than the Three Swaps) in circumstances where it maintains that the applicant, Enron and the beneficiary, Mahonia were complicit in the conspiracy to mis-account. Self evidently if Mahonia were not complicit in this conspiracy, West could not succeed on this point. If however Mahonia had been complicit, then, in my judgment West would still not be able to avoid the L/C because it was not an essential link in the violation of the Securities Laws. West’s liability under the L/C does not depend upon the validity of the liability of ENAC to Mahonia and there is insufficient nexus between the L/C and any misaccounting for the wording of section 29 to apply to West in this situation. Performance of the L/C does not involve violation of the 1934 Act.

Furthermore, there is no suggestion that it would be open to West to bring a claim for damages against any of the co-conspirators under US Law in respect of the breach of the 1934 Act. West was not a purchaser or seller of securities so that there is no possibility of any direct claim under section 10(b) and there is no civil action available at all in respect of breaches under section 13. Similarly, section 20 gives rise to no claim in damages. In consequence, even if section 29 was to apply to enable West to obtain a declaration that the Three Swaps transactions were void, or that the L/C was void, it would still not have a cause of action for damages which, as I hold later in this judgment, is a necessary prerequisite for the English tort of conspiracy to injure by unlawful means.

It is clear that Andersens and Enron regularly discussed the accounting for the successive prepay transactions and that Andersens advised from time to time on the accounting implications of any changes which Enron introduced into the structure.

The deposition of the appropriately named Ms. Cash who worked for Andersens from 1987 onwards and became a partner in 1998 was adduced in evidence under the Civil Evidence Act. She advised Enron with regard to some of the prepays. Enron’s purpose, so far as she was concerned was “to get cash in” and notes to the file drafted by her appear in June 1999 and June 2001. These reveal consideration of tripartite transactions involving Swaps and forward sales contracts and reference to accounting literature including, in the case of the June 2001 memo, EITF 98-10 and an amended version of the June 1999 memorandum “amended by (Ms. Grutzmacher) for FAS 133”. Reference has already been made to the June 24^th 1993 memorandum which related to Chase I and II and Mahonia’s positions as an SPV. Ms. Cash described her role as being to address hypothetical transactions with certain characteristics and to give advice on them. She said there was no one set of criteria that was to fit all sizes but there were general characteristics to look for in determining whether a transaction was a trading activity or something else. Some of those factors were outlined in one of the memoranda. One of the characteristics was the issue of price risk and any forward sale of gas from Enron to a counterparty for a prepaid amount with gas to be delivered in the future was a transfer of price risk. In the hypothetical referred to in the June 1999 memorandum, the counterparty had the option to lay off the price risk through another counterparty but still retained other risks such as credit risk for each counterparty and performance risk. There were mechanisms for mitigating performance risk in some hypotheticals, such as surety bonds or performance guarantees.

Her evidence was that she had been presented with hypotheticals with respect to prepay transactions with three separate counterparties and some where legs two and three did not exist and there were just two parties. She considered it was possible that a hypothetical involved a prepay transaction between two parties and in addition a Swap of a fix for floating payment where Enron was the fixed payment payer and the purchaser was the floating payer. As far as she was concerned, if Enron sold to counterparty A, counterparty A sold to a Swap counterparty and the Swap counterparty sold back to Enron, that alone would not affect her accounting advice. There were other factors to consider such as cross-default, cross-collateralization or termination events. The fact that there were two counterparties and simultaneous contracts between the three, in and of itself, was not problematic.

Nor did she consider that if Enron entered into the prepay forward contract for the purpose of obtaining cash, that this would change the accounting treatment. She did not believe that the fact that there was not a profit involved in the particular transaction would destroy the other factors in EITF 98-10 since all the available evidence had to be weighed to determine whether it was a trading activity or not. She said that Enron was a trading company and it might be laying off risk and there might be a risk transfer inasmuch as it was entered into in contemplation with others where there was a profit motive, even though there was not a particular profit motive on that specific contract. In isolation, the absence of profit motive from the particular transaction did not destroy the accounting. She did not see that as a big factor. What mattered was whether the activity was considered a trading activity and the activities of the total portfolio of contracts had to be considered as a whole, where the intention was to generate a profit. If contracts were at market levels, there was no reason to think that there was some other element that was not being accounted for, whether or not the particular contract generated a profit. In these circumstances, the accounting treatment was for cash received on the prepay to be shown in the balance sheet as a debit to cash and a credit to liability from price risk management activities whilst the cash flow would be reflected in operating cash flow, along with the cash flow from other trading activities. The effect of the prepay would increase both assets (cash) and price risk management liabilities on the balance sheet.

When asked about substance over form, she took the view that there was accounting literature which told the accountant to follow form and not substance.

Whilst she said that she knew that Mahonia was legally distinct from Chase and Enron, she said she did not know that Mahonia was formed by Chase or that Chase was Mahonia’s exclusive banking partner. She did not know that Mahonia had no offices or employees. She must however have forgotten the 1993 memorandum which showed that Andersens knew full well that Mahonia was an SPV. She said she had never spoken to anyone at Chase or Mahonia about the topic and answering a hypothetical, said she did not know whether the accounting would be different if in fact the company in Mahonia’s position was controlled by the company in Chase’s position.

Thus it appears that Andersens took the same view on accounting treatment of these transactions as that of Professor Ryan. Whilst it was suggested in the proceedings that Chase knew that Andersens had issued “guidelines” for the accounting treatment of prepay transactions and that Andersens were misled as to the status of Mahonia by the four representations to which I have already referred, no basis for this appeared anywhere in the evidence. The guidance given by Andersens in various presentations to which West referred were found in presentations which relate to prepay transactions with municipalities which could raise cash through the issuance of tax free municipal bonds. As the documents made clear, municipalities, when raising cash through tax free municipal bonds had to comply with certain specific rules and a number of the criteria which are set out in the documents relate to tax treatment rather than anything else.

The only relevant documents appear to be the 1993, 1999 and 2001 notes to which I have already referred and although the latter two refer to physically settled transactions involving periodic settlement, it is evident that Andersens knew about each of the three legs of the transactions (as the diagrams illustrate) and that full performance resulted in effective price risk elimination at the end of the day. The key issue as set out in the notes appears to be the question of cross-default.

West sought to place reliance upon the deposition of Ms. Grutzmacher but there is nothing in that deposition which assists its position. Although she maintained that she always understood that Mahonia was not an SPV and was not related to Chase or Enron she could not recall how she came to that view and then said that this information had come from Enron. She thought that if Mahonia had been Chase’s SPV, that might have changed the accounting treatment but this would need further analysis. As already set out earlier in this judgment however it is now common ground that Enron’s accounting treatment of the transactions is not altered by the fact of Mahonia’s existence nor the fact that it is an SPV, whether it is related to Chase or not. Her evidence reveals that Andersens determined that the contracts were mark to market contracts under EITF 98-10, that FAS 133 did not apply and that it made no difference whether there was physical settlement or financial settlement. Andersens concluded that the third leg of the Swap transactions made no difference to the accounting treatment as long as the transactions were de-linked. Linkage meant a contractual term which linked one to the other but the major form of linkage was cross-default clauses in the agreements. That was not the only possible linkage but the only other linkage she identified against which Andersens warned was a linkage through the ISDA Master Agreements which gave rise to automatic cross liabilities. The fact that contracts were entered into contemporaneously did not involve linkage and Andersens concluded it was not necessary to see the contract between Mahonia and Chase to give accounting advice on the Enron prepays.

She said that FAS 133 did not change the accounting treatment when it became effective for the 2001 transaction because the first leg was not a derivative and it met the test in EITF 98-10. Andersens had a flow chart indicating the order in which various tests had to be applied. If a transaction met the test of EITF 98-10, it was not necessary to go on to consider FAS 133’s possibility of accounting on a bifurcated basis with part derivative and part debt.

In short, the deposition evidence of Ms. Cash and Ms. Grutzmacher coincided in relation to the advice given, though Ms. Grutzmacher had reservations about the effect of Mahonia as a Chase SPV, considering that there were further matters to be considered if she had known that this was the case. Since this is an accounting irrelevance, there is no basis for any allegation that Enron kept back material from Andersens deliberately or that Andersens advised on the wrong basis. The effect of Andersens’ advice is clear enough. Andersens considered prepay transactions of the kind seen in Chase I – XII as justifying the accounting treatment given to them by Enron and approved Enron’s accounts on that basis.

The only witnesses called from Enron were Mr. Crowe and Miss Martin, both of whom were called by Chase. There is no suggestion that they had any knowledge or understanding of the accounting issues and West does not seek to rely upon their state of mind in this connection.

The evidence of Enron personnel given in depositions and adduced under the Civil Evidence Act does not establish that Enron considered that its accounting was in any way contrary to GAAP or unlawful. To the contrary, it considered that it was taking advice from Andersens and following that advice in according the prepays the accounting treatment that was appropriate.

West asserts that Enron’s objectives in utilising the prepay structure were to borrow money without recording it as debt and to record the loan proceeds as cash flow from operating activities. This is scarcely an issue once it is recognised that the prime objective for Enron was to secure financing. It wished to do so in a manner that it considered advantageous to it for accounting purposes. West rightly draws attention to the fact that the prepay transactions were normally requested by Enron towards the end of a quarter or a year-end in order to get cash in for a particular reporting period. Yet the motivation which lay behind the prepays is neither here nor there if Enron was entitled to account for the transactions in the way it did. If it had the effect of improving Enron’s credit rating or enhancing Enron’s share price, that was to Enron’s advantage and is a plausible motivation to which West can point, albeit without any direct evidence. If the accounting treatment was permissible or if Enron genuinely considered it permissible, the underlying motivation is irrelevant.

Nor does it matter whether, in internal documents Enron itself referred to the prepays as “balance sheet obligations classified as non-debt liabilities” or “debt classified as non-debt liabilities”. Whether or not the prepays could be described as “tricks”, the issue still remains whether or not Enron knew that the accounting treatment it accorded the prepays ran counter to GAAP. That Enron was alive to the different ways of accounting for the prepays, including the need to apply FAS 133 to Chase XII if the contracts were not energy trading contracts, is clear from Enron’s own documentation. It is clear also that Enron appreciated that to account for a transaction as a host debt contract with an embedded derivative would negate the purpose of the prepays. None of this however establishes that Enron considered that it was mis-describing the transactions in the form of accounting which it adopted.

There were other documents which were put to various Chase witnesses which indicated that Enron always regarded its accounting as appropriate. An example appears in the transcript of a telephone call between Mr. Dellapina and Ms. Bills of Enron where she said, in relation to Chase XII: - “We think it should work and it passes our accounting”.

Additionally, as appears from the section of this judgment dealing with “what West would have done”, (had the details of the Three Swaps been spelt out to it), it is clear that Enron sought to interest West in transactions of a similar nature. If Enron had considered these transactions to be wrongful because of the accounting treatment they accorded to them, it is unlikely that it would have so brazenly sought to introduce them to West. The evidence shows that a number of other Banks were involved in prepays of a similar kind, both with Enron and other customers and the presumption must be that these were concluded for similar accounting reasons. With a widespread practice of this kind, the suggestion that the structure was obviously wrongful for accounting purposes means that all those involved should have been aware of the wrongfulness of the accounting treatment. This is not easily accepted. Although there is no evidence of the exact form of structure adopted by others, there is enough information to judge that they were sufficiently similar for the same issues to arise in accounting terms and that the rationale for concluding transactions in this form must have been identical or similar to that of Enron. Whilst the fact that such accounting was relatively commonplace does not justify it, it does suggest a perception that it was permissible.

There was no adequate basis in the material before the court upon which West could contend that Enron considered its accounting for the prepays to be wrongful. It was well known for its innovative financing arrangements but the evidence here suggests that Enron considered that it had taken proper accounting advice and, in compliance with it, was obtaining the beneficial accounting treatment that was appropriate for the structures adopted.

In paragraph 48 J of the re-amended defence and counter-claim, West alleges that because Chase VI – Chase XI were “disguised loans”, Chase knew that Enron overstated its cash flow from operating activities and understated debt on its balance sheet in respect of these transactions and that as a result it knew that third parties such as actual or potential creditors, analysts and credit agencies were being misled. In particular in paragraph 48K, West alleges that Chase knew in respect of Chase VI – XI that: -

West alleges in paragraph 108 A of its statement of case that Chase knew or ought to have known that Enron’s proposed accounting treatment for the Three Swaps would not be fairly presented or in accordance with GAAP and would be in breach of US Securities laws. Chase was thus complicit in such conduct. Since the Three Swaps were concluded on 28^th September 2001, there would be no figures filed publicly, in which this transaction fell to be included, until the quarterly filing on 16^th October 2001. West relies upon Chase’s alleged knowledge of Enron’s wrongful accounting treatment of Chase VI – XI and its knowledge that, since the Three Swaps were “in effect a loan to Enron”, Enron’s purpose in concluding the Three Swaps was to report its obligations under them as price risk management liabilities and its proceeds as cash from operating activities. Chase therefore is alleged to know that Enron would not account for the Three Swaps in accordance with the economic substance of the transaction or in accordance with GAAP, nor make proper disclosure of those transactions in its financial statements nor elsewhere, as required by law.

West also placed reliance upon Chase’s continued maintenance of “the illusion of Mahonia’s independence” but in the light of the expert accountancy evidence, which was to the effect that the presence of Mahonia had no impact upon the proper accounting treatment of the transaction, this must be based on the premise that Chase wrongly understood that there was a need for Mahonia to be involved.

In their closing submissions West maintained that Chase not only knew of Enron’s improper accounting objectives but also actively participated in enabling Enron to achieve these objectives by structuring the Mahonia prepay transactions to appear as if they were genuine trading contracts rather than in reality a loan from Chase to Enron. It is said that the inclusion of Mahonia in the transactions for no substantive business purpose was nothing more than a device to seek to enable Enron to pass these transactions off as trading contracts which could be accounted for as trading liabilities under the heading “price risk management activities”.

West contends that Chase’s knowledge and participation in Enron’s improper accounting can be established by the following: -

I have already held that the prepay transactions were financing transactions which could properly be accounted for on the balance sheet as trading liabilities or price risk management activities rather than loans or debt. I have also found that there was price risk management in the transactions even thought the intention was that, on final performance, the price risks in the individual transactions would be cancelled out. In such circumstances, what Chase personnel thought, assumed or knew is of no significance but I now set out my findings on this aspect of the matter.

I heard evidence from a number of Chase witnesses, some of whom were cross-examined about their knowledge of some of these matters. West asked the four members of the deal team, Messrs. Traband, Walker, Serice and Dellapina, as well as Mr Ballentine, about their knowledge of Enron’s accounting, but the latter’s knowledge was derived from the members of the deal team, so that the focus was on the first four individuals. Mr. Levy was scarcely questioned on this aspect but his evidence was that he knew there was a perceived accounting benefit for Enron in the prepays but did not know what it was.

Mr. Traband was, from about March 1999 onwards, the Corporate Banker or Lending Officer at Chase with responsibility for Enron. His job involved the assessment of extensions of credit to Enron and liaison with Credit in relation to this. He said that, so far as he was concerned, the prepay transactions in which he was involved, namely Chase IX – Chase XII were all concluded by Enron with a view to “monetising” Enron’s net assets in its trading book. This was an understanding he gained from Enron in particular at a meeting in May 1999 and perhaps one later meeting. The need to raise finance was what drove the transactions. He understood them to be financing, thought that there could be small losses from the transactions but that if both parties performed there would be no profit and no loss, whilst recognising risks in respect of the physical delivery of commodity where this occurred and risks associated with the individual contracts.

On May 11^th 1999 he, together with Mr. Walker who was Chase’s client relationship manager for Enron, wrote a letter to Enron about a projected meeting which, whilst planned for the 14^th May, took place a little later. The letter and the enclosure were drafted by Mr. Traband. The opening sentence of the letter read thus: -

“We appreciate your consideration in taking time to review the Enron capital structure, both on and off balance sheet with us. While we believe Chase understands the Enron corporate financing structure as well as anyone outside of your firm, we are equally sure that our understanding is incomplete. Your willingness to walk us through these issues will only help us in the process of adding value to your financing process and decisions.”

The letter went on to describe some of the key issues which they hoped to address but which no-one suggested were directly relevant to the issues before the court. The last paragraph however read as follows: -

“As you can see from the above areas of focus, an underlying theme is both the level and structure of consolidated and non-consolidated cash flows used to support the varying on and off balance sheet debt structures. Attached is our understanding of how ENE’s financial statements might be impacted by various project structures…”

Attached to the letter was a document headed “overview” which set out Enron’s capital structure including consolidated debt, unconsolidated affiliated debt, other items and prepays. In addition a consolidated income statement, a consolidated balance sheet and a consolidated statement of cash flows were included, encompassing the years ending December 31^st 1996, 1997 and 1998. In the margin of these financial statements Mr. Traband had added the types of financing arrangements alongside what he thought to be the entries in which those transactions would be included, with an arrow pointing to the relevant entry. In relation to the balance sheet, he identified prepays with “liabilities from price risk management activities”, whilst on the cash flows he identified prepays with “net assets from price risk management activities”.

The meeting was due to be attended, according to an attachment to this letter by, inter alia, Mr. Walker, Mr. Traband, Mr. Biello, the head of Credit for North America and Mr. Serice, who was in the syndications department of Chase.

Mr. Traband’s evidence was that, at the meeting, his belief in relation to the balance sheet was confirmed but that nothing was ever said to confirm his assumption with regard to the treatment of prepays in the cash flow statements. In a memorandum shortly before Chase IX, Mr. Walker told others, including Mr. Dellapina and Mr. Traband of a “business purpose” discussion in which he had been involved “a couple of times recently”. He referred to a high level meeting in late May with Enron’s treasurer Mr. McMahon in which the latter articulated the business purpose as “efficiently priced funding” and as monetization of the positive excess of assets for price risk management over liabilities for price risk management. I find that Enron made these purposes plain to Chase at the meeting. Mr. Traband’s assumption with regard to the balance sheet was expressly confirmed but not his assumption with regard to the treatment of cash flows, although it was the logical consequence of the balance sheet treatment.

Mr. Walker who was Enron’s client relationship manager at Chase from about April 1994 onwards, said that he appreciated from around November 1994 as a result of an interim review, or possibly earlier, that Enron booked the prepay transactions in its accounts as liabilities for price risk management on its balance sheet. The review referred to the background of utilisation of prepays as “a mechanism to address a number of needs including refreshment of section 29 credits and sourcing of funds (classified as liabilities from price risk management assets as opposed to long-term debt)”. That remained his understanding throughout and he had some recollection of a discussion at the meeting following Mr. Traband’s 11^th May 1999 memorandum, about prepay transactions and the benefits that Enron enjoyed from utilising them as a funding structure. At no stage did he know how Enron accounted for the matter on their cash flow statements.

Mr. Serice was a syndications officer from 1996 onwards whose job was to sell or syndicate bank business. He was involved in syndicating the performance letters of credit which were credit support for Chase V and Chase VI but played little part in Chase VII – XI because syndicated letters of credit were replaced in the transaction structure by surety bonds. He remained someone who was consulted on issues of pricing and bank market capacity for any extension of the Enron credit and was considered part of the “deal team” for the purposes of Chase XII. He had been involved in arranging the syndicated facility for Enron which Chase led in May 2001 in the amount of $500 million. He, like Mr. Traband and Mr. Walker said he knew of the accounting treatment given by Enron to prepay transactions on its balance sheet but did not know of its treatment of prepay liabilities in its cash flow statement. In an earlier deposition on which he was not cross-examined at the trial, he had said that he had been told by Mr. Traband at the time of Chase XII that the prepays appeared in the cash flow statements as cash from operations. Mr. Traband was not asked about this either.

Mr. Dellapina, after a short spell in London returned to the New York branch of Chase in the summer of 1997 and joined the global commodities division there. He became the effective coordinator of the prepays which took place from December 1997 onwards (Chase VI – Chase XII). So far as he was concerned, he said, although he did not have any specific discussions on the point, the purpose of the prepay transactions was to raise finance for Enron. His knowledge of how Enron accounted for the prepays was gleaned from internal discussions at Chase with Mr. Walker and Mr. Traband. He therefore understood that they were included on Enron’s balance sheet as liabilities from price risk management. He did not enquire nor did he know how the prepays were shown on Enron’s statement of cash flows.

Mr Ballentine, the first level credit officer involved in discussions with the “deal team” on Chase XII shared the same understanding on balance sheet treatment as the members of that team as a result of being told this by Mr Dellapina and Mr Traband.

These individuals when cross examined about their understanding of the prepay structures, gave evidence that they perceived the Swaps as having an element of price risk management.

The Chase structure summaries which were produced in respect of the prepays referred to them as meeting Enron’s objectives of (amongst others) “sourcing funds (classified as liabilities from price risk management as opposed to long term debt).” These structure summaries were widely circulated and the essential contents of them must have been known to each member of the deal team, who was aware of the balance sheet accounting treatment that Enron had given and proposed to give to prepays.

Emails and documents, in combination with evidence from the deal team members show that they were conscious of Enron’s desire to raise finance on a ‘non-debt’ basis, driven in part, so Enron personnel said, by Rating Agencies’ desire for Enron to get more cash out of its trading book. The idea was to “monetise” Enron’s assets which, after being used to refer to forward sales or Volumetric Production Payments (VPP) came ultimately to mean no more than raising cash on the basis of a surplus of net assets, which reflected perceived credit worthiness.

There are various documents on Chase’s files which show that the prepay transactions were regarded at Chase as being “balance sheet friendly” or “balance sheet advantaged”. Despite reluctance on the part of some of the Chase witnesses to accept the point, I find that each of the four members of the deal team, namely Messrs Traband, Walker, Serice and Dellapina, all shared this view. The reason why the transactions were so viewed was because these persons considered that if appropriately structured, they enabled the figures for a financing operation to be accounted for in the balance sheet as something other than debt. Whilst the liability was represented in the balance sheet, it was represented as price risk management activity which reflected trading activity. This, I find on the evidence, was considered by companies to be advantageous because, rightly or wrongly, it was thought that this improved their financial standing in the perception of some readers of their financial statements, including possibly the rating agencies. This perception was shared by the deal team and used to “sell” the prepay structure to customers.

Evidence was adduced under the Civil Evidence Act of the testimony given to the PSI by Mr. Barrone and Ms. Stumpp of the rating agencies S & P and Moodys. Both had positions to defend in relation to their analysis of Enron’s financial statements. It was said that Moodys had no knowledge of Enron’s prepaid forward and related Swap transactions whilst S & P did know of the prepays and sought to characterise them appropriately. S & P considered that Enron was engaged in prepaid forward transactions to actively manage its trading and marketing positions and cash flow and because its price risk management account was largely in balance, it considered it as operational cash flow. Both rating agencies maintained that they had been misled by Enron and its financial statements. Ms. Stumpp referred to this as “financial engineering gone a little too far” where “the disclosure element was particularly problematic”. Both agencies said that their rating of Enron would have been reduced if the prepays had been booked as loans.

Chase adduced some hearsay evidence to the contrary from Mr. De Spain of Enron who was responsible for Enron’s relationships with the rating agencies but this was not of great weight. On the evidence before me I cannot find that the rating agencies were actually misled, whether by the accounts or in meetings with Enron personnel: nor can I make any findings as to how the rating agencies made their assessments of corporations such as Enron, whether by reference to their publicly available manuals which are apparently used for the purpose of analysis or otherwise. What is however relatively clear is that the notion of “prepays” was known to many in accounting and financial circles and that a number of banks and customers had utilised financing structures to which this name was applied. Exactly what these structures were did not appear in evidence before the court, nor the accounting treatment they attracted, but plainly their attractiveness was the accounting treatment they were thought to engender. Whether or not the rating agencies did know about them or understood them or should have had such knowledge or understanding or whether they were misled are matters beyond the scope of this judgment. I find however that individuals of Chase, such as Mr. Walker, thought that they did not properly understand them.

The documents revealed that Chase developed forms of “pitch” or presentation for their customers on prepaid financing. These documentary presentations set out the structure of a prepay transaction involving Mahonia with diagrammatic illustration. Whilst the forms of presentation in the documents differed from one transaction to another, reference was made to the accounting treatment in terms such as “treated as a commercial obligation”, “non-debt treatment”, “price risk management”, “diversification of finance” “balance sheet friendly”, “rating agency friendly” and, in one case the following: -

“Accounted for as a commercial obligation. Could reduce…total consolidated financial debt and receive favourable treatment from accounting and rating viewpoints. (Should provide insight as to the impact on debt/EBITDA ratios).”

The footnote to this last entry was a disclaimer saying that

“J. P. Morgan Chase makes no representation with regard to tax or accounting treatment of the transaction.”

In an internal document “for discussion purposes only” a junior employee at Chase sent Mr. Dellapina and Mr. Serice, amongst others, what appears to be a draft of a presentation to be made to a potential prepay customer. In this document a comparison was made between prepaid forward sales, volumetric production payments and royalty trusts (in terms of improvement or reduction) with regard to “EBITDA”, “total debt”, “leverage ratios” and “Net Present Value of O & G assets/ total debt”, in the context of liquidity whilst a similar comparison was made in relation to the balance sheet treatment of these items. In dealing with a production company the latter comparison referred to “reduction of bank debt” and “Deferred Revenue Liability” (the equivalent for a production company of “price risk management activity” for a trader).

It is clear, despite the reluctance of some of the Chase witnesses to accept it, that they all had a broad understanding of the prospective advantages of “non-debt” financing, inasmuch as some readers of the financial statements of the customer concerned might make a more favourable analysis of the company by focusing on debt rather than focusing on liabilities as a whole and by using debt/assets ratios or debt/earnings ratios as a measure of the company’s well-being, instead of applying the liabilities of the company to assess leverage or earnings ratios.

Whilst it seems that Enron was renowned for off balance sheet financing and innovative financing using prepay structures and the like, it is unclear whether or not credit analysts and rating agencies were or were not sufficiently alive to these points to appreciate the extent of financing in which Enron was involved. Mr. Traband said that he understood that the level of debt was something which might affect a company’s credit rating but he thought that an increase in the trading liability on the balance sheet should have a comparable effect to an increase in debt, so far as equity analysts were concerned. It seems to me however to be clear that Chase personnel involved in the prepays knew that Enron wanted a structure that obtained non-debt treatment in accountancy terms and that this was a key reason for effecting the prepay, as opposed to other forms of financing. The desire for “non-debt financing” on the balance sheet was founded upon the supposition that avoidance of “debt” on the balance sheet would lead to a more favourable view of the company concerned. Chase personnel involved in prepays, such as Mr Dellapina used this accounting benefit as a selling point to other customers, but, it appears, subject to the reservation that it was a matter for each customer, with its own accountants, to ascertain whether or not the proposed transaction was suitable for it in accounting terms and achieved what it wanted to achieve.

Mr. Serice recognised that there was an attractiveness to Enron in recording the liability as a non-debt liability on the balance sheet, which was an option presented by a prepay and he knew of Enron’s preference prior to September 2001 of raising cash in this way, whilst saying that it was normal for Enron to have numerous transactions upon which it was working, some of which would raise cash as debt, some of which would be totally off balance sheet and some of which, like prepays were on the balance sheet but not recorded as debt.

In an e-mail in November 1998, Mr. Serice, in referring to prepays, said that:

“Enron loves these deals as they are able to hide funded debt from their equity analysts because they (at the very least) book it as deferred rev or (better yet) bury it in their trading liabilities. There are however tax attributes to the structure that can ‘freshen’ NOL’s. (Net operating losses) …sale can accelerate gains to the year in which the prepay is consummated which gains can be offset by expiring NOLs.”

In Mr. Walker’s call report referring to a meeting with Enron on 18^th December 1998, it is suggested that the Rating Agencies did not have full knowledge of all Enron’s financings and Enron might “suffer heartburn” if they did. This appears to have been primarily referable to off balance sheet financing, to which the call report refers but may also encompass prepays. Similarly, in an e-mail in October 2001 Mr. Walker expressed his belief that “agencies had not yet figured out prepays”. I am left in no doubt that all the members of the “deal team” considered that there were balance sheet advantages to be gained by Enron and other customers in effecting prepay transactions which were not recorded as debt on the balance sheet, because not only was it good for a company to have diverse means of financing, but the perceptions of others (including rating agencies) of the company’s financial standing would, might well be, or could be, improved thereby.

Historically, as already mentioned, Structure Summaries were prepared for each proposed prepay transaction. These described the transactions as “a series of commodities and interest rate Swaps which result in a known cash flow stream”. In the first draft structure summary for Chase XII, (as with previous structure summaries), the Enron credit statistics in it did not include the prepays. As a result of a conversation between Mr. Ballentine, Mr. Traband and Mr. Dellapina on 20^th September 2001, subsequent structure summaries did include the prepays in the debt figures in the credit statistics. In that telephone conversation, a transcript of which was available to the court, it was explained to Mr. Ballentine that this was a structured financing transaction and a monetization of assets from price risk management. Mr Ballentine, who was relatively new to Credit, after referring to it as “amortised debt” and being told it was “monetization”, insisted that it was nonetheless a liability and, in the same way as he had required prepays to be included as a notation in the Aquila statistics for their prepay in order to calculate leverage, he required the previous prepay liabilities to be included in the credit statistics for Enron for any consideration by Credit as to whether to grant more financing in the shape of what became Chase XII. Thereafter they were included by Mr. Traband in the debt figures in those credit statistics and the leverage figures then reflected that addition.

In a few Chase documents, there are references to Enron “hiding the debt” or burying it in other liabilities. There are also many occasions in the documents where Chase personnel referred to the transactions as “loans” or “debt”. West drew attention to all kinds of documents which took the matter no further. Correspondence with bank regulators when seeking permission to conduct prepays proceeded on the basis that they were analogous to loans and that the assessment of credit risk was the same as for loans. They are many internal references to the effect of prepays being similar to that of loans, to the result of a “known cash flow stream” and documents showing treatments of prepays in the same way as a loan for a number of different purposes including, specifically, pricing. The deal team members themselves often referred to the prepays either as loans or in loan-like terms. Occasional references appear to the economics working like a loan, to prepays counting as debt for financial covenant purposes and even to a “term loan embedded in a commodity Swap”. The calculation of the figures for use in assessing the discount on the prepayment was done by reference to interest rates also.

In this latter connection where Chase XII is concerned, there is a series of exchanges between Mr. Garberding of Enron and Mr. Sabloff of Chase in which they refer to it throughout as being a loan, for the purpose of effecting the calculations necessary to arrive at the figures for the amount of gas for the floating payment and for the purpose of calculating the fixed payments. Whilst the exchanges also relate to additional interest rate risk and whether or not Enron wanted additional interest rate management (which they did not) and some of the language used (“bullet loan” “borrowing” “no amortisation”) relate to this, there is no doubt that for those involved in calculating the figures, the prepays were treated as if they were loans.

Nonetheless when using terms appropriate for loans, these individuals were not speaking technically. There is no doubt that bank personnel regarded the prepay transactions as similar to a loan or debt, referred to it in such terms and frequently treated the transactions as if they were debt. From a banking perspective, and the judgement to be made as to whether to finance Enron or not, little depended on the form of the financing adopted- it was a matter for the lawyers to draft the appropriate structure and a matter of legal analysis to say what the transactions represented. Whether or not Chase personnel regarded the prepays as loans or referred to them in language which referred to them as such or reflected a view of them as loans is beside the point however. It has no relevance, in my judgement to the question of their knowledge of Enron’s accounting treatment, its justifiability or unjustifiability nor to their own view as to whether or not the structures devised did carry with them the accounting benefits to which they referred nor their knowledge of Andersens’ approval of Enron’s accounting treatment of them.

West drew attention to the expression “efficiently priced funding”. West said that pricing was not efficient because, as was accepted by Mr. Serice, a premium was payable in respect of prepayments as opposed to conventional “vanilla” loans. Indeed the evidence from all those involved in banking, from both sides, was that banks (including West) generally charged more for structured finance than for vanilla loans. Equally there was a premium for end of year deals when many companies were seeking financing. West drew attention to a reference in a Mr. Dellapina telephone conversation where he suggested that Chase XII was an opportunity to “charge the shit out of them” but this was said in a telephone conversation immediately following the events of September 11^th when the market was in turmoil and options for raising finance were limited. It does not appear to me that this point takes West any distance since it is plain that Enron had said at a meeting that it regarded its prepays with Chase as “efficiently priced funding” and it may be that it was indeed efficiently priced in comparison with other possible options for raising money available to Enron from other banks. The fact that it was funding is not an issue and there was no evidence to suggest that the pricing was exorbitant because there was some known unlawfulness in the transactions.

Although the accounting experts agreed that there was no significance in the presence of Mahonia in the transaction for accounting purposes, West made much in its arguments of that and of Chase’s knowledge of the lack of a substantive role for Mahonia in the transactions as a basis for imputing guilty knowledge of some kind. Attention was drawn to many of the factors set out earlier in this judgment in relation to Mahonia, its status and its activities as well as to the lack of any apparent tax or regulatory reason for its use after 1996/7. Documents show that in October 1997 consideration was certainly being given to the abandonment of Mahonia’s use but I find on the evidence that a decision was taken to retain Mahonia because Enron requested it because of the perceived benefit to Enron of dealing with an SPV which was legally independent. Chase was content to continue in the same way as the documents were essentially drafted with an available template. There was a view shared by some at Enron (and Chase) that there was benefit in having a three party transaction on a prepay where the prepayment was not made by a bank. This could be described as “optics” as it was by Mr. Serice in a deposition, on the basis that the outside world might regard a transaction with a bank as more likely to be a loan than a transaction with another company. Mr. Dellapina accepted that the need to use an SPV was driven by the treatment that Enron wanted on its balance sheet and that the question of legal independence of that entity was an important requirement so far as Enron was concerned.

Thus it seems that there was a perceived accounting benefit in making use of Mahonia, although the experts at trial indicated that there was none in reality. Moreover, Andersens who advised upon prepay transactions, appeared to have advised both on two leg and three leg transactions and had been told back in 1993 of Mahonia’s status as an SPV. Mr. Dellapina’s evidence was that prepays were done by Chase with other companies without the use of SPV’s in the years 1998 – 2000 but that he knew that Enron wanted non-debt funding and a structure which had an independent SPV which worked for Enron to accomplish this objective.

Moreover it is right to note that Chase, in its marketing of prepays to its customer, marketed them on the basis of using Mahonia as part of the structure. Whilst this did provide an additional option in facilitating syndication of the funding, it appears that it was part of the structure which was thought to achieve the accounting benefits envisaged. There was moreover some evidence that Mr. Dellapina wished to add to the “commerciality” of Mahonia’s activities by involving it in investment in speculative gas contracts which Mr. James was not prepared to countenance at the time of the suggestion. Whilst West regards all this as suspicious, if the reality was that Mahonia was an independent company but that questions might be raised, there was nothing devious about seeking to involve it in other business activity.

West refers also to the hedging strategy letters which were, it said calculated to give an impression of independence. These were exchanged between Mahonia and Enron and it is hard to see how they take the matter further since it was not suggested that Andersens was misled.

Contrary to West’s contentions, the limited recourse agreement which formed part of the transactional documents is a strong pointer to Mahonia’s independence from Chase and the autonomy of its decision making process so far as concluding any prepay transaction is concerned. Mahonia needed such an agreement to protect its own position in the event of a default by Enron and to enable it justifiably to conclude the transaction for the small fee available. The letters showing that neither party relied on the other’s advice also reinforce this point. It was in fact the limited recourse agreement which meant that it was sensible for both Mahonia and Chase to enter into the agreement of 26^th November 2001 to ensure that Mahonia’s obligation to Chase were fixed at the same level as those of ENAC to Mahonia.

Mr. James’s evidence, which I have accepted, was entirely accurate and apt in describing Mahonia as being independent in deciding whether or not to conclude any given transaction. The existence of “perfect hedging”, Agency Agreements, Security Agreements giving Chase a lien on Mahonia’s contractual rights against ENAC and the other documents and representations reflect Mahonia’s independence in that decision making process, whilst handing over control of the transactions it had concluded to Chase, as its agent and as the arranger required because of its security interests. It matters not how the point is put, it cannot be said that Chase controlled Mahonia – only that Chase, by agreement with Mahonia controlled the transactions which Mahonia had voluntarily and independently concluded with Chase, at Chase’s request, following upon Chase’s presentation of a virtually concluded deal to it for consideration.

West’s propositions which are put forward as supporting the allegation of Chase’s knowledge and participation in Enron’s improper accounting purposes do not get to the root of the real issue which is whether or not Chase understood that Enron’s past accounting and proposed accounting for prepay transactions was wrongful, that the prepays were in accounting terms “debt” and that US GAAP required a different treatment from that which Enron had given and proposed to adopt in the future. To say that Chase knew that the Mahonia prepay transactions were in reality loans/debt, that it knew that Enron was “hiding” debt and burying the liabilities in the balance sheet as trading liabilities begs the question. West accepted that it had to show that Chase knew of misaccounting, mischaracterization of the transactions in accounting terms and that the accounting was wrongful. If Chase personnel considered that prepays could properly be accounted for in the manner which Enron adopted, its knowledge of the manner in which Enron did account for them and its knowledge of the presence or absence of risk management in them are not significant. The question is whether or not Chase did know that the accounting was improper and there had been inadequate disclosure in Enron’s accounts with the result that readers or users were being misled in a manner that was wrongful.

Although the four individuals in the Chase deal team to whom I have referred all had financial experience and some had accounting qualifications, none were current practising accountants and all were entitled to take the view that Enron was taking its own accountancy advice and would properly account for the transactions in accordance with that advice, unless there was some indication to the contrary.

In July 2000, the documents show that Mr. Dellapina had a meeting with Price Waterhouse Coopers who were Chase’s auditors “to review the final rulings on VPP/prepay accounting”. An e-mail from Mr. Dellapina to Mr. Serice reveals that a “standard prepay pitch” had been given to Mr. Keehan of that firm at his request. Mr. Dellapina described his objective “to have a coherent argument to maintain deferred revenue treatment even if we must separate the embedded commodity forward”. Mr. Serice was invited to the meeting which was scheduled to take place, where Mr. Dellapina said that the VPP accounting issues had been the focus by FASB and that it was hard to imagine that this could affect the off balance sheet product. He said he did not recall any final rulings on the issues of VPP or prepays. Mr. Serice did not attend the meeting. Following the meeting Mr. Keehan sent Mr. Dellapina a copy of DIG B11 relating to volumetric production payments and embedded derivatives and a copy of FAS 138 which amounted to an amendment of FAS 133, dealing with “accounting for certain derivative instruments and certain hedging activities”. FAS 133, as already discussed in the context of the accountancy expert evidence was a document of considerable size and complexity and when Mr Dellapina says that he did not grapple with its complexities, that may not be surprising. That was presumably why he was seeing Mr. Keehan, but I find that he was taking trouble to understand the accounting issues because, if Chase was to continue to sell structured financing to its customers, he had to be aware of the general rules surrounding their accounting treatment.

Mr. Dellapina’s evidence under cross-examination was that he understood that FAS 133 was to come into effect and he was seeking to ascertain the impact on the transactions upon which the bank worked. He had a limited understanding of FAS 133, gained by being part of a large trading business at the bank but did not know whether a prepay could or could not simply be treated as a derivative obligation. It seemed that he had picked up that separating the embedded commodity forward was one of the issues raised by FAS 133 in derivatives but he did not know whether that applied specifically to prepays. Whilst this matter was not explored in any great detail in cross-examination, I conclude that Mr. Dellapina did consult Price Waterhouse on accounting questions with regard to prepays and FAS 133 and that Mr. Dellapina must have had some understanding of FAS 133 to talk in the terms in which he did in the e-mail to Mr Serice.

In a telephone conversation between Mr. Dellapina and Mr. Serice on 14^th September 2001 there is discussion about the prospective Chase XII. Part of the conversation included reference to Enron’s desire for the transaction for “accounting reasons” because “they don’t want to just keep rolling this into debt”. The conversation continued by reference to the Royal Bank of Canada who had done some pure prepayments of financial Swaps, to whom Enron might go direct. The exchange then included the following: -

DELLAPINA: “So they could go to them direct. I wouldn’t be surprised if they did. Literally, they do like an ISDA Swap and just prepay it. ”

SERICE “Uh-huh”.

DELLAPINA “Which I don’t know how the fxxx they’ve ever gotten accounting treatment, but I think the accountants are getting tougher. I think they need this. I think you should. I think you go back we could do it together”

SERICE “Uh-huh”.

It was unclear exactly to what Mr. Dellapina was referring in relation to the past accounting treatment but, far from demonstrating that Mr. Dellapina was involved in putting up schemes which were unlawful, it demonstrates that he knew that accountants were involved and deciding on the appropriate accounting treatment for Enron whether in relation to Royal Bank of Canada deal or otherwise. It does show that he had a greater understanding of accounting matters than he was prepared to concede but I have no doubt that he was not prepared to second-guess Enron’s accountants and, as with all the other witnesses, it was never suggested to him that he was in any way trying to deceive Andersens into giving advice to Enron on a wrong basis about appropriate accounting treatment for their transactions.

Whilst the evidence of the Chase witnesses was well rehearsed and some of the deal team had a propensity for avoiding questions on documents on the basis of not reading them at the time, on the fundamental points which matter, I accept their evidence. What is plain from the evidence of each of the four members of the deal team is that they considered that Enron’s own accountants, Andersens were fully involved in the issue of accounting treatment of the prepay transactions by Enron and that the structure of the transactions was vetted by Andersens in order to give it “non-debt” classification on the balance sheet.

The fact that Chase sought to interest its customers in prepay transactions by referring to the beneficial accounting treatment they were thought to receive is a clear indication that Chase did not consider that to account for them as “non debt” in the Balance Sheet was unlawful. The forms of “pitch” revealed in the documents are straightforward in their attribution of potential accounting benefits. Chase required customers to make their own enquiries of their accountants by disclaiming liability for any representation or accounting advice but if Chase had considered the accounting treatment to be in breach of GAAP it is, in my judgement, virtually inconceivable that it would have issued presentations in the form it did.

Despite reservations about some of their evidence, as set out above, I have no hesitation in finding that all the relevant Chase personnel, throughout the relevant period, not only considered that Enron had accounted for prior prepays in accordance with the advice of their well known accountants, Andersens, but that future accounting of such prepays would be vetted by those accountants also. Whilst these individuals were entitled to take the view that the manner of accounting for the prepays was a matter for Enron and Andersens, it is in my judgement clear from the attempts made by Chase to sell the structure to others that the general view amongst Chase personnel at all times was that prepays did carry with them legitimate non debt accounting treatment on the balance sheet in compliance with GAAP. Treatment as operating cash flow would follow. To the extent that the individuals involved in the Enron prepay transactions were party to such promotions, or were cross examined on the issue (as they were when asked if they considered the prepays to be loans, disguised loans or debt) I find that they considered the structure of the prepays to merit non debt accounting treatment, as Enron had told them that their accountants had advised.

Each of the members of the deal team at Chase, in their statements set out their understanding that Enron was advised by Andersens on accounting issues and their belief that Enron, as advised by Andersens and Vinson & Elkins would account for and disclose the prepays in a proper wholly lawful manner consistent with all relevant policies and regulations. There was no direct challenge to this in cross-examination, nor was any witness asked whether he regarded Enron’s accounting as unlawful.

There is no basis therefore for contending that Chase knew that Enron’s accounting for Chase VI – XI or I –XI was contrary to GAAP, constituted misaccounting or was wrongful. Indeed, Mr Turner’s final view as to the correct accounting treatment of prepays appeared to depend on FAS 133 which was not operative prior to Chase XII. How Chase personnel were meant to conclude that Andersens was wrongly advising Enron prior to that is hard to fathom. I reject any such suggestion.

With the introduction of FAS 133, which would apply to Chase XII, there was the possibility of accounting in accordance with Mr Turner’s view, but there is no evidence (other than the passing reference in Mr Dellapina’s email to Mr Serice concerning FAS 133) that the Chase personnel considered this in any detail or took the view that this, as opposed to Andersens’ and Professor Ryan’s view, constituted the correct accounting treatment.

The shape of Chase XII was the subject of some discussion between Enron and Chase following the granting of approval for the transaction by Credit. Despite approval being given for a 3 year deal, the length of the prepay was reduced initially to enable it to go through in two separate stages. In the first stage Chase was to fund the financing itself with credit support for $315 million but the idea was to replace the structure by a joint funding structure in due course. The short duration of stage one meant that there was no room for physical delivery so that the structure adopted was one involving financially settled swaps. For tax reasons connected with withholding tax, on Enron’s request, 6 months was agreed as the swaps period. In addition, Andersens specifically sought and obtained from Mahonia the four representations in writing in connection with Chase XII to which I have referred earlier in this judgment. The drafting of the documents was effected by Vinson & Elkins for Enron and agreed with Mr Levy of Chase’s legal department. It is clear therefore, and I find, that the Chase personnel knew of the involvement of Andersens (and Enron’s lawyers) in advising Enron on the form of the Three Swaps and therefore rightly considered that Enron would account for Chase XII in accordance with the advice they were given by those who had undoubted expertise in this area.

In my judgment West cannot succeed in showing that Chase knew that Enron’s accounting of Chase I – XI nor its prospective accounting for Chase XII was or would be wrongful or contrary to GAAP, nor that its financial statements had not or would not contain proper accounting treatment of the prepays or disclosure in accordance with GAAP. Whatever the “economic substance” of the prepays, a term which is best avoided in accountancy for the reasons expressed earlier, and whatever the views of the relevant Chase personnel as to that substance, none of them can be shown to have appreciated that there was or was to be any misaccounting nor any breach by Enron of GAAP, whether in relation to its financial statements or in relation to its disclosure obligations.

I have already found that Mahonia was independent in the sense that it was free to decide whether or not to enter into transactions. Having so decided, it effectively handed over complete control of each transaction to Chase by signing the Security Agreement and the Agency Agreement.

It is West’s case that, in respect of the Three Swaps, Mahonia was in reality the alter ego of Chase and that Chase and more particularly the individuals at Chase who were involved in putting together the transactions and operating them were the directing mind and will of Mahonia. West relied upon El Ajou v Dollar Land Holdings [1994] 2 AER 685 (CA). Applying the test set out in that authority requires identification of the person or persons who exercised de facto management and control of Mahonia at the relevant time in respect of the relevant transaction, so that the knowledge of that person or persons is to be attributed to Mahonia. This is in part a constitutional question in order to determine who has the responsibility on the part of the company for the relevant transaction but the test is also pragmatic in ascertaining how the company’s powers are actually exercised. (See Tesco Supermarkets v Nattrass [1972] AC 153 at 199-200.)

The knowledge in question for the purposes of the illegality argument and the conspiracy wrongly to account argument is knowledge of wrongful accounting which, on West’s case, would have to exist at the latest at the time when West issued the L/C and thus “concluded” the transaction with an unlawful purpose or suffered damage as a result of the conspiracy. West maintains that, at this point, Chase had total control over all that Mahonia did in connection with the Three Swaps and the L/C. In the context of a letter of credit, there are three points where there may be said to be a contract to which the beneficiary is a party, although the obligations under it are unilateral and rest on the issuer alone: -

I have found already that Chase had express authority from Mahonia under the Agency Agreements but no control over it as such. It had no constitutional position at all in relation to Mahonia. It proposed transactions to Mahonia and at the time when Mahonia decided to conclude those transactions I find that, the directing will and mind of Mahonia was undoubtedly Mr. James and Mr. Jeune, neither of whom are said to have had any “guilty knowledge”.

West submitted that Mr. James’s agreement to enter into Chase XII was an automatic one done at Chase’s request but I do not accept that. He exercised his own judgment as to whether or not the transaction was in the best interest of Mahonia on the basis of the criteria which I have set out earlier in this judgment. His inclination would, of course, be to enter into such a transaction to please the arranger, Chase, but he would need to be satisfied that it was a proper transaction for Mahonia to conclude, that the risks were manageable with matching contracts and the like, and that it was in the best interest of Mahonia to contract. So far as entering into Chase XII is concerned on September 28^th 2001 therefore, the directors were the true directing will and mind of the company.

Both in this context and in the context of agency, West argued that Chase did everything relating to Chase XII from negotiation of the terms through to performance. This is true so far as it goes but does not focus on the point of entry into the transaction as the basis upon which Chase was acting. As I have already found, Chase negotiated the documentation because of its security interest but always had to put the transaction documentation to Mahonia in the shape of a proposal for final agreement and execution. It had no authority actually to negotiate for, nor to conclude any transaction on behalf of Mahonia: nor did it purport to do so. When it handled the transactions following the conclusion of the contracts, it did so under the express terms of the Security Agreements and Agency Agreements.

It was suggested that Mahonia was merely a façade inasmuch as the incorporation of Mahonia was a device to conceal the true facts. It is clear however that Mahonia existed for purposes independent of what West alleges to be “wrongful accounting” by Enron. Mahonia was originally involved both because Chase considered it could not take physical possession of product and so that Enron could utilise tax credits. It was later involved because of perceived accounting benefits to Enron. It was a company properly incorporated and properly governed by its directors in Jersey. It at all times had a separate legal personality from Chase with independent governance. In my judgment there is no room for the façade argument to succeed where the alter ego argument does not. Neither provide West with any basis for attribution of knowledge on the part of Chase personnel to Mahonia at the time of concluding Chase XII or at the time of opening the L/C, when, if the Agency Agreement operated (as appears hereafter) the agents duties were to be performed subject to the overall direction of Mahonia’s directors.

West also alleged that, as a matter of agency, the knowledge which Chase personnel had should be attributed to Mahonia. West said that above and beyond the specific Agency Agreements for each of Chase I – XII, Chase acted as agents in a much more general sense in doing everything that had to be done on behalf of Mahonia. West relied on one answer given by Mr James in cross examination, as to the generality of Chases’s agency, but taken in context, I do not consider that he was assenting to the proposition that Chase was Mahonia’s agent for all purposes connected with Chase I- XII. The reality was that Chase was appointed agent for Mahonia under specific Agency Agreements which were carefully drafted in order specifically to limit the scope of the agency and the functions to be performed under them. The law will generally impute to a principal knowledge relating to the subject matter of the agency which an agent acquires whilst acting within the scope of his authority. Thus, knowledge gained by Chase personnel whilst acting as agents of Mahonia would be imputed to Mahonia. The knowledge gained by Chase personnel in the course of Chase I- XI as to the form of accounting adopted by Enron would therefore be attributable to Mahonia and would become relevant for Chase XII once Chase was constituted Mahonia’s agent for Chase XII. A problem emerges in relation to knowledge gained by Chase personnel whilst not acting as agents of Mahonia so that knowledge gained in relation to the purpose of Chase XII, prior to any Agency Agreement in relation to Chase XII, may not theoretically be attributable to Mahonia.

The specific agency for Chase XII is constituted by letter of 28^th September 2001 from Mahonia to Chase which reads as follows: -

“Dear Sirs

We have entered into or propose to enter into a prepaid commodity price swap transaction (the “Swap transaction”) with Enron North America Corp. (“ENAC”) pursuant to which we will have a Irrevocable, Transferable Standby Letter of Credit issued in our favour (the “Letter of Credit”). Under the Swap Transaction we are required to receive payments and receive or transfer cash and securities pursuant to the terms of a Credit Support Annex.

We hereby appoint you as our agent to:

(a)

monitor and arrange for the receipt of such payments and the receipt and transfer of such cash and securities:

(b)

act for and on our behalf in connection with any instrument furnished by or on behalf of ENAC in connection with the Swap Transaction and the Letter of Credit, including, without limitation, drawing under the Letter of Credit on our behalf: and

(c)

generally to perform such other functions as are reasonably incidental to the above.

We confirm that for these purposes you shall be entitled to appoint an agent or agents in order to enable you to perform your role as our agent in accordance with the terms of this letter.

Your duties shall be performed subject to the overall direction of the Directors of this Company and in accordance with their instructions.

We can confirm that, in the absence of gross negligence or wilful default on your part, we shall have no claim against you in respect of any failure by you to perform or properly to perform any of the duties set out above.”

There is argument about the construction of this document. Chase maintained that this gave an administrative authority only to Chase after the ENAC Swap and L/C transaction had been executed. West did not accept this but said that in any event, there was an agency which extended far beyond the terms of this letter. As a matter of construction, Chase is correct so far as concerns the Three Swaps inasmuch as “(a)” and “(b)” specifically refer to functions which arise following the conclusion of the Swaps and “(c)” must be construed restrictively in relation to those functions. No relevant agency therefore arises until the point of conclusion of the Three Swaps on September 28^th.

Nonetheless this letter was sent on 28^th September 2001 and whilst the timing is doubtful, it appears that it was sent prior to conclusion of the Three Swaps and it is certainly prior to the issuance of the L/C on 5^th October. Chase was authorised to act on behalf of Mahonia “in connection with any instrument furnished by or on behalf of ENAC in connection with the Swap transaction”. In my judgment although subparagraph (b) also refers to the L/C itself, this wording includes the draft L/C which was furnished “in connection with the Swap transaction” on behalf of ENAC, since the word “and” does not mean that the instrument in question must relate to both the Swap and the L/C. Chase was thus authorised to negotiate the terms of the L/C on behalf of Mahonia and Mr. Levy did so. His knowledge of any illegal purpose lying behind the L/C would therefore be attributable to Mahonia at the time when the L/C was opened, as would that of the members of the deal team of Chase, being knowledge relevant to the scope of the agency and knowledge gained in connection with prior activity as agents in relation to Chase I – XI and in connection with Chase XII. Mr. Levy was sent the draft L/C and asked to review it and direct comments to Ms. Mata of Enron. He forwarded the draft to Mr. Dellapina and Mr. Traband apparently for any comments they might have. In those circumstances, whilst acting as agent for Mahonia, their state of mind would have to be attributed to Mahonia for whom they were obtaining the L/C (as well as obtaining it for Chase’s benefit).

When a principal has a duty to make disclosure to another and engages an agent to carry out his duty, the agent’s knowledge will generally be imputed to the principal. (See Bowstead & Reynolds on Agency 17^th Edition at Article 97 and El Ajou at pages 701-704.) If West were correct in saying that there was a duty on Mahonia to disclose the underlying purpose of the Three Swaps or the existence of the Three Swaps, the knowledge of Chase personnel when securing the L/C, both of the Three Swaps themselves and the purpose would be attributable to Mahonia.

Whilst there are problems in the idea that Mahonia (or Chase on its behalf) was entering into any contract with West by virtue of the issuance of the Letter of Credit, the notification of its opening or the making of a demand under it, it appears to me that it is impossible to restrict the attribution of knowledge on the technicality in law that a beneficiary may not, as a matter of legal theory, strictly be a party to the Letter of Credit contract. Mahonia sues under the Letter of Credit and there is no doubt that, as a matter of settled law, it is entitled to do so. The theoretical basis for this has long been in doubt although the Contracts (Rights of Third Parties) Act 1999 may now provide a satisfactory statutory basis. (See also Jack “Letters of Credit” at paragraph 5.1 – 5.14.) The relevant time for attribution of knowledge must in practice be before or at the point of opening the L/C when considering knowledge of the illegality of the L/C transaction.

In the context of tort, Mahonia is alleged to be liable for conspiracy to injure by unlawful means and for this liability, it is accepted that it must have knowledge of the unlawful means, namely the misaccounting. The issue arises as to the point at which the conspiracy is alleged to have been formulated but at the latest, once again, Mahonia would have to have the relevant knowledge before West opened the L/C. Similarly, in the context of conspiracy to mislead West, the latest point for such knowledge would be the point at which West was induced to open the L/C.

In the context of the conspiracy allegations however Mahonia would not be liable for the tort of its agent unless the wrongful act was specifically instigated, authorised or ratified by it so that Mahonia could be considered to have effectively committed the tort itself. Otherwise, in circumstances where it is an agent, not a servant who commits the tort, liability does not flow to the principal for the agents’ tortious misdoings. There is no evidence of any such instigation, authorisation or ratification on the part of Mahonia and none was suggested, so that there could be no issue of Mahonia’s liability in respect of any conspiracy in which Chase was involved.

If Mr. Levy had fraudulently or negligently misrepresented the position to West, then, if he did so in the course of representing Mahonia whilst acting within the actual or apparent authority given to him by Mahonia, Mahonia would incur liability. Mahonia did not instruct Chase about the information it should give to West but it did authorise Chase to obtain the letter of credit and to act on its behalf in communicating with West in that context, as a result of the agency letter to which I have already referred. Since these matters were within the authority given to Chase, any deliberate misleading by Chase constituting deceit on its part would be attributable to Mahonia (see Bowstead and Reynolds Article 92). In fact, as I have already found, Mr. Levy did not deceive West.

West contends that the transaction involving the Three Swaps and the letter of credit was part of a conspiracy between Chase, Mahonia and Enron to devise, arrange and implement a transaction which enabled Enron wrongfully to account for the proceeds of it under GAAP and thereby commit a breach of US Securities law. It is said that a bank asked to issue the letter of credit would inevitably suffer loss by relying upon the apparent financial strength of Enron and the apparent legality of the purpose behind the ENAC/Mahonia Swap.

I have already found that Enron did not account for Chase I – XI, nor Chase XII, in breach of GAAP. There is no evidence that it ever intended wrongfully to account for Chase I – XI or Chase XII either, since both its lawyers Vinson & Elkins and its accountants Arthur Andersens were extensively involved in the structuring of the transaction and the latter would undoubtedly be involved in the accounting treatment of it. I have also found that in October 2001,Chase personnel were entitled to believe and did believe that Enron had correctly accounted for Chase I – XI and would properly account for Chase XII. Chase did not therefore have the necessary state of mind for this tort.

The conspiracy alleged by West is a conspiracy to use unlawful means with an intention to injure West. The unlawful means alleged are the violations of the US Securities laws by Enron relating to the accounting for the prepay transaction. This was a late addition to West’s case but represented a prominent part of it at trial. The allegation fails for a number of reasons. It is accepted that the ingredients of a conspiracy to use unlawful means are fourfold, namely a combination or an agreement, unlawful action taken in pursuance of the combination/agreement, an intent to injure and loss and damage suffered as a result.

For the purpose of this allegation the conspiracy must relate to the devising, arranging and implementation of Chase XII alone, since it is the obtaining of the L/C in respect of this transaction which is said to injure West and which it is refusing to pay. The devising of Chase I – Chase XI or Chase VI – Chase XI represents background only to the conspiracy alleged here but was relied on by West in relation to the known unlawfulness of the accounting which would ensue following the conclusion of Chase XII, notwithstanding the different standards which applied to Enron’s 2001 year of accounting. For the reasons already given, Chase (and Mahonia) had no knowledge of any unlawfulness in prior accounting and there was no actual unlawfulness. Equally, West cannot show that Chase (or Mahonia) conspired with Enron to put together a transaction in circumstances where they knew that Enron would account wrongfully for it. There was therefore simply no agreement or combination that Enron should take unlawful action and no unlawful action actually taken in any event. Whether the allegation is expressed as an agreement, a combination, a conspiracy, a plan, a scheme, an understanding, a joint enterprise or a common purpose to account wrongfully, there is no basis in fact for it.

Enron, with the benefit of advice from Vinson & Elkins and Andersens, doubtless intended to account for Chase XII in the way they did account for it in their 10Q form on 16^th October 2001. But Chase personnel did not have access to those advisers nor actual knowledge of the form of accounting which Enron would adopt, although the form of accounting would be exactly as Chase would have expected. Chase personnel knew in September 2001 that Enron was looking to conclude a financing transaction which gave rise to accounting benefits in the sense of non debt treatment on the Balance Sheet but left it to Enron and its advisers to effect the accounting treatment for Chase XII that they considered appropriate. Chase was content to structure a financing in the way that its customers considered advantageous from an accounting perspective, and would seek to assist its customers in putting together structures which were thought to have beneficial tax or accounting treatment, but the actual accounting of the transaction was always a matter for Enron and not a course of action which Chase personnel planned, nor one on which Chase personnel agreed, nor one in which Chase personnel participated. Chase personnel did not have any intention about the particular accounting action Enron should take although those to whom I have referred understood that the structure was put together so that Enron could obtain non debt Balance Sheet treatment, if so advised by their own advisers, as they expected to happen. Chase personnel did not consider the projected accounting to be wrongful.

Furthermore, West must establish an intent on the part of Chase and Mahonia to injure it. It is right that the intent to injure need not be the primary intent – see Lonrho v Fayed [1992] AC 448. Nonetheless, there must be some intent which involves the conspiring parties directing their minds towards West or a category of persons which would include West as a target to be harmed (see Lord Bridge in Lonrho at pages 465-468 and Lonrho v Shell [1982] AC 173 and Kuwait Oil Tanker Co. v Al Bader [2000] 2AER (Comm) 271). An intention can be inferred from the facts but there was no evidence at all of any such intent on the part of Chase or Mahonia, whether to injure West or to injure anyone who might issue a letter of credit by way of credit support. The intention of those involved at Chase in the prepays and the intention at Enron was undoubtedly to effect a financing transaction, with monetary benefit to each of them and which was perceived as attracting, or being likely to attract, beneficial accounting treatment. There was no perception of, nor any intention to, harm any provider of credit support since it would be expected that any credit provider would decide whether to offer credit support on the sole basis of its assessment of Enron’s creditworthiness. The hope and expectation was that the credit support would never be called on, because Enron was considered by Chase to be creditworthy. Since Chase itself led a syndicated letter of credit for $150 million which was used as credit support for the ENAC/Mahonia transaction, the notion that Chase targeted future issuers of letters of credit in support of that transaction, in order to harm them, is odd, unless it is postulated that Chase had no appreciation that Enron might avail itself of the May 2001 Chase facility as credit support.

The alleged conspiracy wrongfully to account for Chase XII would inevitably involve an accounting which took place after West had issued its letter of credit on the 5^th October 2001. The prepay was concluded on the 28^th September 2001 and appeared in the quarterly figures for the three months ending 30^th September (filed on 16^th October 2001), but there was no suggestion that the accounting of those figures, whenever it was expected to take place, would in itself harm West or that it did harm West. West cannot and does not claim to have issued the letter of credit on the strength of Enron’s accounting for the September 2001 prepay transaction (nor on the basis of Enron’s accounting for Chase I – XII). It is therefore not possible to see how, as a matter of logic, Enron, Mahonia and Chase could have conspired to enable Enron to manipulate its accounting on Chase XII with an intent that it should injure West or any other issuer of a letter of credit as credit support for the financing. Equally, any accounting violations relating to the earlier transactions, since they occurred long before any possible agreement or combination between Chase, Mahonia and Enron to obtain credit support for the ENAC/Mahonia Swap in Chase XII, have not been shown to be relevant to an intent to harm West or any other issuer of a letter of credit.

So far as the last ingredient of the tort is concerned, namely the causing of loss and damage, much the same can be said as for the intent to injure. Any manipulation of Enron’s accounts in respect of Chase XII would not cause West loss and damage in either concluding the letter of credit transaction or paying Mahonia in accordance with its terms. Whilst it is true to say that the letter of credit came into existence in support of the ENAC/Mahonia transaction in Chase XII, the unlawful act complained of is the wrongful accounting, not the transaction itself. Moreover, there is no evidence that West issued the L/C on the basis of any accounting by Enron for prepays at all.

Finally, the immediate cause of the loss which West will incur on payment of the letter of credit is Enron’s insolvency and inability to pay Mahonia or to reimburse West, which was caused by a multitude of other factors, and not by the form of accounting for the prepays so that, unless West can make good a case of being wrongly induced to enter into the L/C, it must fail on the issue of loss and damage.

West contended that it was sufficient for damage to be suffered by West as a result of the conspiracy and that the damage did not have to be linked to the unlawful means envisaged by the conspiracy. It was accepted that the alleged unlawful accounting did not itself cause loss to West but it was said that it was enough for there to be a conspiracy to injure by unlawful means and for damage to occur during the course of performance of that conspiracy, even if the unlawful means had not yet occurred and did not cause the damage. In this context West relied upon the decisions at first instance and in the Court of Appeal in the Mogul Steamship Company Limited v McGregor Gow & Co (1888) 20 QBD 544 and (1889) 23 QBD 598. Reliance was also placed upon the decision of the House of Lords in Crofter Hand Woven Harris Tweed Company Limited v Veitch [1942] AC 435. The facts in the Mogul case involved ship owners forming themselves into an association to protect their trading interests and causing damage to rival ship owners. There was no unlawful element in what they were then doing or planning to do. There was equally no predominant purpose to injure so that the defendants were not liable whether for conspiracy to injure or conspiracy to injure by unlawful means, which are now recognised as two distinct torts. The same position holds good for the Crofter’s case.

Reliance was nonetheless placed upon certain dicta in those decisions which do not appear to me to support the contention advanced. Lord Coleridge CJ at first instance in Mogul distinguished between a criminal conspiracy which was indictable on proof of the conspiracy, without any acts done in furtherance of it or damage caused, on the one hand, and a civil conspiracy where “it is the damage which results from the unlawful combination itself with which the civil action is concerned”. In the Court of Appeal, Fry LJ in fact specifically says at page 624 of the Report that there is a cause of action against the conspirators where there is an agreement which constitutes an indictable conspiracy and that agreement is carried into execution by the conspirators by means of an unlawful act or acts which produce private injury to the claimant. Whilst it is not necessary for all the acts to be done in furtherance of the conspiracy as Viscount Simon makes clear in the Crofter’s case at page 439, the underlying premise of these decisions is plainly that the unlawful act is the cause of the damage suffered.

It would be strange if it were otherwise. Since the essence of this form of conspiracy is the use of unlawful means (as opposed to a conspiracy to injure simpliciter which does not require unlawful means but for which a predominant intent to injure is required), it would be odd if a claimant could succeed in recovering for damages suffered for a lawful act which others may have agreed to effect at the same time as agreeing to carry out an unlawful act which does not damage the claimant. It is clear that the essence of this form of conspiracy is a conspiracy to injure by unlawful means and that the unlawful means must be the cause of the injury. If this were not the case, the requirement for unlawful means would effectively be rendered otiose and recovery would be possible for a conspiracy to injure, without unlawful means, and without a predominant purpose to injure. Furthermore, other decisions relied on by West in the context of conspiracy, albeit for different purposes, also proceed on the same premise of requiring the unlawfulness to cause the damage – see e.g. Surzur v Koros [1999] 2 LLR 616 per Waller LJ.

Here, for the reasons already set out, West cannot show that it was damaged by any unlawful means nor that it was targeted by the conspiracy to mis-account.

It was not argued by Chase/Mahonia that “unlawful means” could not include wrongdoing as a matter of foreign law although there was no concession about this. The argument before me proceeded entirely on the basis of breach of the US Securities Exchange Act 1934 in respect of misaccounting or failure to comply with other provisions of that Act in the United States. Reference was made to Grupo Torras SA v Al-Sabah [1999] CLC 1469.

There was however argument about one of the ingredients of the English law of conspiracy to injure by unlawful means. The argument arose as to whether or not it was necessary that those unlawful means should be actionable on the part of the claimant against at least one of the co-conspirators. There are a number of dicta on the subject in the English authorities which are both confusing and inconsistent.

West maintained that the requirement for actionability on the part of the claimant against at least one co-conspirator results from a mis-reading of the decision of the House of Lords in Lonrho v Shell Petroleum Co (no.2) [1982] AC 173, where the decision that Lonrho could not sue Shell in tort for breaches of the Rhodesia Sanctions Orders was, in West’s submission only a finding in relation to the actionability of the
Orders themselves and not in relation to this as an ingredient of conspiracy. What is plain from an analysis of that decision however is that Lonrho were seeking to argue that Shell and BP should be liable in conspiracy on the basis of a combination to breach criminally the Sanctions Orders, without asserting a predominant intention on their part to injure Lonrho. Argument then centred on the requirement for that predominant purpose to exist and there is not the slightest suggestion that, if the anomalous conspiracy to injure tort could not be established because of the absence of predominant purpose, the conspiracy to injure by unlawful means tort could be established in circumstances where Lonrho could not have brought an individual claim against Shell or BP in respect of the unlawfulness of their conduct. Thus, the decision that breaches of the Sanctions Orders could not give rise to a right of action in Lonrho for damage alleged to have been caused by those breaches and the absence of any predominant purpose meant that there was no tortious action available to Lonrho at all.

There are two first instance decisions where it has been decided that for the tort of conspiracy to injure by unlawful means to apply, the unlawful means must have been actionable at the suit of the claimant against one of the conspirators. The point was conceded by counsel in Credit Lyonnais v ECGD [1998] 1 LLR 19 but more importantly, in Yukong Line Limited v Rendsburg Investments Corporation of Liberia [1998] 1WLR 294, Toulson J held that, in an unlawful means conspiracy, the unlawful act relied on must be actionable at the suit of the plaintiff. This was followed by Laddie J more recently in Michaels v Taylor Woodrow Developments Limited [2001] CH 493, where he discussed the conflict between Toulson J’s decision and dicta in other decisions including Mance J in the Grupo Torras decision at page 1649-9 and Waller LJ in Surzur v Koros at pages 616-617.

Having considered the matter carefully in the light of this conflict I find myself in agreement with Laddie J whose reasoning, in relation to Lonrho v Shell and Lonrho PLC v Fayed [1992] 1 AC 448, I find persuasive.

As Laddie J says at paragraph 31, if the point being argued by West was correct, Lonrho’s case against Shell could and should have been pleaded as an unlawful act conspiracy rather than a conspiracy simpliciter where the question of predominant purpose arose. If the cause of action could have been based upon an unlawful act, without actionability on the part of the claimant against any conspirator, there was no need to argue about predominant purpose in the context of the other form of conspiracy. The point is well made by reference to the argument of Lonrho which he cites in that paragraph and in the following paragraphs, paragraphs 32-34.

I do not think that I can improve upon the reasoning of Laddie J in reference to Lonrho v Shell, Lonrho v Fayed and the succeeding cases, culminating in Surzur. I am content to accept his reasoning and to follow his conclusion in holding that, in the case of a conspiracy to injure by unlawful means, it is necessary to show that the unlawful means used are actionable at the suit of the claimant, which means that the claimant must be able to recover damages in respect of that unlawful action.

West cannot make good this allegation of conspiracy whether it is advanced by way of defence to Mahonia’s claim or cross claim against Mahonia or Chase.

West contends that Enron, Mahonia and Chase conspired to obtain a letter of credit from a bank knowing and intending that the bank issuing the letter of credit would not understand that it was in fact being asked to secure a transaction which was in effect a loan from Chase to Enron.

West alleges that Chase and Enron devised the underlying transaction as a disguised loan of $350 million and designed the transaction documents in such a way as to conceal the true nature of Chase XII as a loan. As part of that Chase and Enron structured the ENAC/Mahonia Swap to require ENAC to obtain an irrevocable standby letter of credit for $315 million but knew and intended that the letter of credit was to be security for the disguised loan. It is pleaded that Chase and Enron knew and intended that the bank which would be requested by Enron to provide the proposed letter of credit would be misled as to the true nature of the transaction and would not appreciate that it was in reality a disguised loan from Chase to ENAC.

The only direct contact between Chase and West took place on the 4th October when Mr. Goodwin of West spoke to Mr. Levy of Chase. Apart from this, all the dealings with West were effected by Enron personnel. It was therefore, subject to any agreement reached with Chase, up to Enron to decide what material and information it wished to show West.

Nowhere in West’s re-amended defence and counter-claim, save in relation to the telephone call of the 4th October, is there any allegation of a specific misrepresentation by either Enron or Chase to West about the nature of the transaction. What is pleaded is an intention to mislead West as to the true nature of the transaction and a failure to disclose that the purpose behind the transaction as a whole was to enable Enron wrongfully to manipulate its accounts.

There is no evidence to which West can point to show any agreement or combination made between Enron and Chase or Mahonia with regard to the approach to be made to West in respect of the issuance of the L/C. West relies upon the fact that there were three independent Swaps and that only the ENAC/Mahonia Swap was made known to West. It also relies on the past practice of Chase to disclose only the Swap transaction to which the letter of credit applied to any prospective writer of such an instrument, or to any prospective syndicate member who would accept liability in respect of it. That this was the practice appeared from Mr. Serice’s evidence. There was however nothing sinister in this because, as discussed later in this judgment an issuer of a letter of credit is not concerned with the underlying transaction but with the credit worthiness of its customer against whom it has recourse. Where there was a syndicated funding in a Swap transaction, the syndicate received full information about all the Swap transactions whilst where there was credit support in the shape of a letter of credit for one Swap only, it was that transaction alone which was disclosed.

The Instrument Request which was dated 4th October 2001was sent by Enron to West by fax on 5^th October. It was a simple two page document with a draft standby letter of credit attached, which in itself has an attached pro forma request for transfer of the letter of credit, in consequence of the discussions which had taken place between Ms. Mata, Mr. Levy and Mr. Goodwin on the evening of the 4th October. The two page Instrument Request asked West to issue a standby letter of credit pursuant to the Facility Agreement and set out the terms sought for the L/C in a series of box entries. It was a request for a letter of credit made by Enron Corp. on behalf of ENAC in favour of Mahonia. It asked for the L/C to be advised through Chase in New York to the beneficiary in Jersey with a faxed copy to be sent to ENAC and to Enron Corp. The draft L/C complied with the terms of the request, being payable against presentation of a straightforward draw statement signed by Mahonia stating that “an Event of Default (as defined in the ISDA Agreement as referenced in the Swap Transaction Confirmation dated September 28^th 2001 between Mahonia Limited and Enron North America Corp…) has occurred”. The letter of credit was expressly transferable solely to Chase or its successor, but provided that transfer instructions had to be sent to West on the attached form.

There is no evidence that West was told anything about the Three Swaps transaction beyond the ENAC/Mahonia Swap and the L/C required. Elsewhere in this judgment I have referred to the 4th October telephone conversation between Ms. Mata, Mr. Levy and Mr. Goodwin and the other conversations surrounding it. Nonetheless, there is no evidence of any agreement or combination between Enron and Chase (or Mahonia) as to the basis upon which West or any other issuing bank would be asked to issue the L/C which was required by the terms of the ENAC/Mahonia transaction. West points to a snippet in a telephone conversation of 14^th September 2001 in which Mr. Dellapina, Mr. Walker, Mr. Serice and Mr. Traband talked to Mr. Deffner of Enron. At this stage the proposed structure for Chase XII was undecided. A number of different possibilities were being explored. Mr. Dellapina explained to Mr. Deffner that to attempt to involve other banks in the initial funding of the prepay, as had been done by involving Fleet in Chase XI, would not be possible in the time available, if the transaction was to be concluded by the end of September which was Enron’s desire. The reason for this was that a funding transaction of this kind would require extensive legal documentation which would have to be reviewed in detail by lawyers acting for any other bank. The thinking at this stage was that Chase would fund the prepay, whatever form it took and credit support would be obtained for Enron’s performance in the shape of a syndicated letter of credit which Chase would lead and which, after one year, might be turned into a funding of the prepay itself.

This was the quickest way of putting together the transaction. In that context the following appears in the transcript of the conversation: -

DELLAPINA: “We just don’t think it’s conceivable, Joe, that even if we do a deal by month end, given the experience we’ve had and given the way that lawyers will look in these documents to try to find ways that their banks are being screwed or potentially going to have to suffer in a meltdown, we have to give them something simple to evaluate”.

DEFFNER: “Okay”

DELLAPINA: “It took Bank of Boston way too long, and I think the other banks would take longer. So just trying to say, you know, what you issue is a letter of credit, we show you the documents, we show you what the termination event is and what the drawing statement is to Enron Corp. but that is the drawing statement that goes back to you if, in fact, we meltdown. So really, at this initial phase or this circling phase, you give them something simple to approve, which is not a structure, it’s just a credit risk”.

DEFFNER: “Okay. But then you have a performance L.C. at the end of this month, and then you want to incentivise them to basically participate or, or what lend to Mahonia. [Inaudible]”.

At this stage it is plain that Mr. Dellapina was talking about a syndicated letter of credit to be led by Chase and that what was envisaged was that documents which were undefined, were to be shown to participating banks together with the termination event and the drawing statement for the letter of credit, on the basis that the banks would have something simple to approve which was not a structure but just a credit risk. The basis for this was that, in evaluating whether or not to issue a letter of credit, Mr. Dellapina took the view that the only risk with which the issuers would be concerned was Enron’s credit-worthiness. The exact nature of the underlying transaction in respect of which the letter of credit operated was neither here nor there, since the only recourse for those participating in the letter of credit would be to Enron.

To extrapolate from this an agreement that particular documents should be shown by Enron to banks which it was to approach as part of its responsibility to produce a letter of credit is far fetched. Whilst Chase personnel had good reason to think that those issuing a letter of credit or participating in it would only have regard for the credit worthiness of Enron, and would not therefore need to know anything about the underlying transaction, there is no evidence of any agreement or understanding as to what Enron would show West or any other issuer or participant in a letter of credit which was to be credit support for ENAC’s obligations, as guaranteed by its parent company. A statement by Mr. Dellapina as to what Chase would do if it arranged a syndicated letter of credit does not amount to an understanding, agreement or combination as to what Enron should do if it was to arrange a letter of credit.

West maintains that although there may be no clear express agreement, there was plainly a common intention and common purpose whereby Chase deliberately combined with Enron, however tacitly, to achieve a common end in deceiving West as to the nature of the underlying transaction. Thus it is said to be no answer for Chase to say that it was Enron’s responsibility to obtain the L/C and that whatever it said to West was a matter for it alone. I find however that there was no such common intention and no such combination and that Chase did leave it to Enron to procure the issuance of the letters of credit for the credit support required by the terms of the ISDA contract between Mahonia and ENAC. Chase pressed ENAC to comply with its obligations in this respect but did not participate in the obtaining of the L/C apart from Mr. Levy’s telephone conversation with Mr. Goodwin to which I have referred elsewhere.

West maintains that Mr. Levy’s conversation should be seen in the light of this overall conspiracy but, in the absence of any such conspiracy the conversation has no more significance than a discussion of the draft form of words in the L/C itself, although Mr. Levy was himself well aware of the structure of the Three Swaps.

There is no evidence of any intention on the part of Chase or Mahonia to mislead or injure West, as already set out in the section of this judgment relating to West’s allegation of a conspiracy to devise a transaction to enable Enron to give it accounting treatment contrary to GAAP and US law.

I heard evidence from a number of witnesses about the criteria to be applied by a bank when deciding whether or not to issue a letter of credit and the information which would be made available to it. I heard from Messrs. Traband, Serice, Walker, Dellapina, Biello, Ballentine and Mr. Levy of Chase. They had varying experience of such matters depending upon their involvement with trade, and with syndication, but the thrust of their evidence was clear inasmuch as any issuer of a letter of credit would be concerned with the credit worthiness of the customer on whose behalf the letter of credit was issued, whose failure would give rise to a call on the letter of credit and against whom the bank would seek recourse. The details of the transaction in respect of which the obligation was being incurred by the applicant and the identity of the beneficiary were of little or no import. Mr. Edey of West’s trade department essentially agreed and, with some qualifications, so did Mr. Goodwin. None of the West witnesses could seriously support the contrary argument.

In this context and in the light of my findings about the nature of the Three Swaps transaction, it would not be misleading to request a bank to issue a letter of credit in respect of the Mahonia/ENAC transaction without referring in any way to the other transactions which were entered into at the same time and in contemplation of it. There was no duty to produce any other information. The only obligation which was being secured by the L/C was ENAC’s obligation to Mahonia. No other obligation of ENAC was being secured (such as that to Chase under the ENAC/ Chase Swap) and West, absent any limit on the use of the L/C, could not complain at the absence of information about the other two Swaps.

In short, there is no evidence of any agreement or combination, no evidence of any intention by Enron, Chase or Mahonia to injure West, no evidence of any intention to deceive West and, no evidence that Chase and Mahonia had any knowledge of the terms of the Facility Agreement nor of the circumstances surrounding its conclusion or discussions as to its use. Equally Chase and Mahonia had no knowledge of the basis upon which Enron would request West to issue the L/C nor what information it would provide when doing so. West cannot make good this cause of action, whether it is advanced by way of defence or cross-claim.

In a formulaic part of their statements, many of the West witnesses stated what they would have done if Enron had asked West to issue a guarantee to cover its bank borrowing or if they had known that the ENAC/Mahonia Swap was one of Three Swaps executed contemporaneously in contemplation of one another and that the effect of the Three Swaps was that of a loan from Chase to Enron. This point arises therefore in the context of both allegations of conspiracy and that of deceit by Mr. Levy. The thrust of their evidence was that if they had known that Mahonia was a SPV set up by Chase and that Enron was obtaining financing from Chase through Mahonia, they would not have been willing to issue the letter of credit. This was the effect of the statements of Messrs Frohmaier, Sai Louie and Taylor. It appeared from the evidence of the West witnesses that the burden of taking up the point with Enron would have fallen to one or more of these three, who would have spoken to Mr. Crowe or Miss Martin, after the matter had first come to light through Mr. Goodwin.

It was submitted on behalf of Mahonia that West were obliged under the terms of the Facility Agreement to issue the L/C in any event. For the reasons I have already given, I accept this submission. It was nonetheless submitted by West that if it had known what it now knows, it would have refused to issue the letter of credit regardless and that, if the issue had surfaced, Enron would not have sought to enforce its legal rights to have the letter of credit issued. Alternatively, Enron would in any event have gone into insolvency by the time the issue was resolved.

Mr. Crowe of Enron gave evidence that, if West had refused to issue a letter of credit because Enron had said that it was really to service Chase’s lending to it, he would have accepted that West was entitled to refuse to issue. The question would not have been one for him however since the furnishing of credit support to Chase was being handled by Enron in Houston, as always occurred in relation to financing matters. If Enron had insisted that West fulfil its legal obligations, the matter would have escalated. If asked, Mr Crowe said that he would probably have told Houston that the general facility covered this sort of thing, but if West did not want to do it they should go elsewhere to get an L/C. He thought a bank could always find a reason not to issue and would have said to Houston that it would be sensible to talk to West about it. Ultimately, his view was that Enron was unlikely to threaten or take legal action against the bank. At various points in his evidence he also accepted that West was entitled to refuse to issue a letter of credit. The decision would not however have lain in his hands as the Facility was operated out of Houston, not London and Enron personnel in Houston would have been looking at the Facility Agreement wording and Enron’s contractual rights.

Mr. Crowe’s evidence was not satisfactory because the evidence given in his statement and initially under cross examination was inconsistent with an interview he gave to West’s solicitors on 30^th July 2002, when he met those solicitors in a coffee shop and told them that if West was presented with a request for a guarantee which was not trade related, he believed it had a right to refuse to issue and, if it had said so, he would have agreed. He told them that West could refuse because it was not the intention of the facility to provide Instruments to support non-trade related activities and it was never the intention that the guarantee should be used to back Enron’s lending from other banks, although the facility was broadly drafted. At that meeting he was presented with various files and asked for his immediate comments. His evidence before me was that, thereafter, on being sent a draft statement to sign, he was not comfortable with it because, although it did largely reflect the conversation in the coffee shop, he did not think it was entirely accurate. He explained in re-examination that his current statement was correct, having reviewed all the documents, including his evidence about whether the facility was or was not limited to trade related activities.

I have already found that, whilst there were general expressions of intention in the 15^th August telephone conversation, there was no commitment made by Enron which restricted the use of the facility above and beyond the express terms of the Facility Agreement. In this situation, in October 2001, had the matter arisen, I find that Enron would have taken the view that it was entitled to insist that West issue the L/C and would certainly, initially, have taken that stance. Whatever Mr. Crowe said nine months later, if he had been asked in October 2001 what the position was, the most he would have said was that there had been an expression of intention but, as he also said in evidence, he would have said that the general facility was apt on its wording to cover the L/C requested. Given Enron’s desire for the financing and the strict time limits under which it was operating, I have no doubt that Enron would have insisted on the issue of the L/C had any question been raised and pressed for this unless some good reason had been advanced by West for not doing so.

The question then arises as to whether and how the issue would have been raised, by whom and how far at West. It was wholly unclear from the evidence how any decision would have been taken to refuse to issue the L/C and who would have taken it. It was Mr. Goodwin to whom the request was made on the 4^th October and who agreed the form of wording with Mr. Levy and Ms. Mata in the manner I have already described. This was a run of the mill exercise for him or anyone else in West’s Trade Finance Department. He agreed that there was nothing in the Agency Procedures, which was the West internal document giving guidance on the Facility Agreement, to show that West was in any way interested in the underlying transactions for which any L/C was to be issued. Both he and Mr Edey accepted that, as an issuing bank, West did not look at the transaction underlying a letter of credit, save to ensure that the letter of credit corresponded to it. Mr Goodwin had noticed the provision in the L/C for transfer to Chase and had discussed that with Mr. Levy. He had been told twice before his conversation with Mr Levy that there was financing involved in the transaction. Although Mr Harrison had said inconsistent things and did not appear to know what the transaction was truly about, the fact remains that the suggestion that it was about financing did not disturb Mr. Goodwin at all. He was not interested in the purpose of the credit, as he accepted in cross- examination. Mr Edey admitted that it was obvious on the face of the L/C that there was a relationship between Mahonia and Chase and that it was obviously a structured finance transaction. Mr Goodwin recognised that there was a relationship between Chase and Mahonia.

In his statement, with regard to the hypothetical situation, he said that he believed he would have referred the matter to Mr. Edey (Head of trade finance) or Mr. Bryant (the Deputy Head). The latter said he would have referred the matter to Mr. Edey, Mr. Frohmaier and Mr. Taylor. As Mr. Edey said he would have raised the issue with Messrs Frohmaier or Taylor, the matter would then have been discussed with Enron in London who would have discussed it with Enron in Houston.

Mr. Battinelli who worked in West’s New York credit department had been the risk manager for the 1995 participation by West in the Chase syndicated L/C which provided credit support for Chase IV, the 1995 prepay. He knew the beneficiary to be an SPV, Mahonia and, as far as he was concerned, the risk to West was Enron’s credit-worthiness and it was upon that which West focused in deciding whether or not to provide support. West in New York knew that Mahonia was an SPV set up to facilitate financing and that the 1995 prepay was a structured finance for Enron. He understood monetization and the fact that Mahonia was an SPV and a beneficiary of the L/C did not raise any concerns at all. West in New York had been involved in structured finance deals with Enron including off balance sheet financing of power plants and a large monetisation project known as “Rawhide”, on which it was one of the leading banks, where one of the attractions to Enron was known to be the significant reduction of reported leverage, by accounting on the balance sheet for a minority interest rather than debt. In marketing “Project Inauguration” in January 2001 to other banks, West as leader referred to the transaction as “accounting oriented financing which is structured to achieve off balance sheet treatment for Enron…” Additionally it had several accounting orientated transactions for off balance sheet purchases of turbines and turbine related equipment for other entities. It was familiar with structured finance set-ups and was heavily involved in them. In 2001 West was named as the Structured Finance/Project Finance Bank of the year by International Financing Review.

Mr. Battinelli’s approach was that there was nothing wrong with such structures as long as they were accounted for in accordance with GAAP. He said: -

“If the financing is in accordance with GAAP and has adequate disclosure, there is nothing inherently wrong with a structured financing or with a transaction to window-dress a balance sheet, as long as it is in conformity with GAAP…if GAAP permits it you are entitled to do it…[I agree that] what you cannot say is, this is just obvious window-dressing, it must be outwith GAAP… The right approach is: is there anything in here which is offensive to GAAP”.

Mr. Newman’s statement evidence, as West’s overall relationship manager for Enron, referred to West’s development of C98 synthetic lease structures for use by Enron where West was aware of the accounting issues. He knew that West in London had not done a lot of structured finance transactions but was particularly interested in obtaining business of this kind. The 1995 L/C transaction was to support a Chase/Enron gas monetization arrangement and West knew that Mahonia was an SPV set up between Chase and Enron to facilitate the purchase of gas that Enron would repay over time. The decision to participate in the L/C was made on the basis of Enron’s credit worthiness alone. West focused on the credit risk it was taking and the underlying structure was not important to it. The focus was on the source of repayment which was viewed as Enron and the structure of the transaction in which Enron was involved was not significant.

Mr. Newman’s evidence was that West in London (and Mr Taylor in particular) wanted to lead structured finance deals for Enron and it was a key component of West’s strategy to expand the relationship with Enron in Europe. This was an interest which went beyond project financing into doing more structured deals out of London. Prepays were something that London was keen to understand because they wanted to be involved in such activity.

The focus of West on structured finance in New York had been developed in a strategic plan put forward to the main board in Dusseldorf by Manfred Knoll who was head of structured finance in New York. This plan was pursued with vigour. Because structured finance was more sophisticated, it attracted higher fees from the bank than what was referred to throughout the evidence as “vanilla” lending. In consequence West wished, and the plan required, progressive diminution of vanilla business in favour of increasing structured business. In an Enron Review document, issued by London branch in the early part of 2001, the “products strategy” included “focus on leading one project finance/advisory annually for European market (including monetisation)” and “structured commodity finance –prepayment financing structures in respect of cross border electron delivery contracts within Europe.”

The Facility Agreement, when proposed, was seen as having the potential for an enhancement of West’s relationship with Enron and an opportunity for West to position itself to offer future structured financings. West would be able to tap into European lending capacity (particularly in Germany) with syndicated transactions and to give Enron access to other European banks, where it did not already have it.

In order for West to proceed with the Facility Agreement, it was necessary to obtain the approval of the Board in Dusseldorf. Whilst the discussions with Enron took place in London between Mr. Crowe, Mr. Frohmaier, Mr. Bourke and others, as already described, because Enron Corp. was the applicant for the facility, and was a US company, the formal request for credit approval to Dusseldorf had to come from West’s New York branch. The transaction proposal was put together under the supervision and with the approval of Mr. Giles Taylor who was West’s customer relationship officer for Enron in Europe. He liaised with Mr. Newman who had overall responsibility for managing the relationship with Enron out of Houston. Mr Newman would sign off on European transactions and give Mr. Taylor the green light, but approval had to come from Dusseldorf itself. Thus the transaction proposal, originating in London, went via the US to Dusseldorf.

The transaction proposal of 25^th May 2001 which was approved by Mr. Taylor and Mr. Newman included the following: -

“This memo is to request a credit approval for West LB London to participate at a final take and hold level of $25 million in a $350 million performance letter of credit facility to be arranged by Global Loan Syndications London. The transaction is to be syndicated on a best efforts basis.

Overview of LC & guarantee Facility

This letter of credit and guarantee facility will comprise documentary L/C’s, contract bonds and guarantees and financing guarantees.

West LB Relationships:

West LB is one of Enron’s 8 Tier 1 global banks. The bank products used are Credit, Project Finance, Structured Finance, Energy Trading, Asset Securitisation, FX, Derivatives, Letters of Credit, Export Finance.

West LB Rationale for transaction:

The background to West LB pitching for lead arranger in the aforementioned facility was the provision of a $150 Mio letter of credit facility to Enron at very short notice approximately 15 months ago. Prior to this West LB had had no LC involvement with Enron Europe. The client was very impressed with the fact that West LB issued the documents so expeditiously and efficiently, and consequently we were invited to pitch for lead arranger status in this new transaction in view of Global Loans syndication further ability to access new bank investors for Enron.

The Bank’s ability to access and distribute this new facility to new bank investors is a key skill for Enron. This facility is effectively to be syndicated as a “non relationship” transaction. The ROE on the transaction is extremely attractive in view of the Bank’s lead position, delivering an ROE in excess of 14%, with up front new arrangement fee in excess of $450,000.

Furthermore, the transaction is very important to the West LB relationship, cementing our position as a leading bank to Enron in Europe and globally, by illustrating the Bank’s distribution skills.

Our increased profile with the client within its core-banking group in Europe should enable West LB to successfully pitch for further Structured Finance and Capital market Lead mandates. A key goal for West LB is to lead both a capital market and monetization financing in Europe. Another area of interest for West LB is prepayment financing structures for cross-border electron delivery contracts with Europe.”

It thus appears that the facility was attractive in its own right but was also considered important for relationship building. It is clear that West was not only interested in monetization and prepayment financing structures but had as a key goal capital market and monetization financing opportunities in Europe.

West was coy about disclosing various documents which showed the extent of the interest of West in London in being involved in such transactions. Having discovered a document relating to the SE transaction relating to delivery of cross-boarder electrons in Enron’s depository, Chase disclosed it to West and thereafter sought disclosure of West’s own documents in relation to this transaction and any other transactions of a similar nature. The document which Chase had found referred expressly to West LB in the context of a SE prepay/ neutral funds flow. In due course, under pressure and not long before trial, West disclosed documentation showing that its London branch had been involved in considering prepay proposals for SE, PSE, and Norske Skog in 2000 and 2001. The schematic diagrams produced for these transactions revealed the three Swap structure which was adopted for Chase XII with West as the party to be responsible for the advancement of funds. An Enron subsidiary was, in each case, to be the recipient of the advance and the third party in the Three Swaps was to be “bank two”, meaning an SPV created by West.

West witnesses who were cross examined on this and who had an involvement in the consideration of these transactions denied any knowledge or understanding of the financing structure set out in these diagrams. The evidence of Mr. Saint and Mr. Taylor was not credible on this point and I reject it. It is plain from the documents and from what Mr. Crowe said, that if a schematic of this kind was produced and became the subject of discussion, as Mr. Saint and Mr. Taylor accepted was the case, the whole structure would be explained and discussed, including the financing structure on the right hand side of the diagram as well as the physical deal on the left hand side. Mr. Taylor had therefore to understand the proposals and I find that he did, particularly as he reproduced diagrams of the same kind. A copy of the SE prepay document appears as Appendix 2 to this judgment along with Mr. Taylor’s own manuscript diagram of the same transaction which expressly refers to the Three Swaps and the absence of cross default provision in them. (These documents were pages 10 and 11 of the exhibit produced by Chase in its opening submissions.)

I find therefore that, prior to October 2001, there were personnel in London, including in particular Mr. Taylor, who had a clear understanding of prepay structures for financing purposes, which included the use of “circular Swaps” and SPV’s, in which West itself was considering involvement (although none of the transactions came to fruition). The indications of some off balance sheet financing required prior to the year-end when accounts were to be produced were plain and it is clear that West had no rooted objection to transactions of this kind.

The dilatory disclosure of these documents and Mr. Taylor’s anxiety to deny knowledge of the right-hand side of the diagrams which he drew or redrew are significant. His involvement in such matters gives the lie to any suggestion that West were ignorant of Enron’s financing methods or that letters of credit were utilised in financing structures such as Chase XII. It also demonstrates that West, like Chase, could see no illegality in such transactions since there is no suggestion that West refused to enter into such financing deals because they were unlawful. That was never suggested by any of the West witnesses. It is plain that West did not consider these to be obviously unlawful and that also gives the lie to any suggestion that Chase should have done so either, whether in relation to Chase VI – Chase XI or Chase XII. Doubtless West would have considered these financing structures to be different from a “loan” and the accounting benefits would have been explained to West.

It is also clear from the 1995 Chase forward transaction that West in the USA and Dusseldorf had no rooted objection to providing support for monetizations effected by other banks. If the matter is looked at objectively, as Mr. Bourke recognised, the identity of the beneficiary of a letter of credit opened on the application of Enron was a matter of indifference to West. It would not matter if the L/C was in favour of the Mongolian Basket Weavers’ Association. The fact that the L/C was in favour of Mahonia and could be transferred to Chase could not matter to West whose only right of recourse was against Enron should it be called on to pay. Whether the letter of credit operated in respect of a trade obligation or a financing obligation could not matter objectively to West who had agreed to the Facility Agreement on the basis of its assessment of Enron’s credit worthiness. In fact West had already issued a somewhat similar instrument under the Facility Agreement in the shape of a standby letter of credit and having agreed excision of a “trade related” restriction for letters of credit to be issued under the Facility Agreement, the only possible logical basis for objection to furnishing a letter of credit in respect of a financing transaction would be the pricing point raised in discussions in August 2001.

When Mr. Taylor was cross-examined about the financing agreement, he described the Facility Agreement as “vanilla lending”. He stated that West would not want to secure another bank’s vanilla lending to Enron or help any other bank satisfy Enron’s requirements for that bank to supply vanilla lending. Banks took the view that they had to supply their quota of vanilla lending to Enron in order to obtain the more highly remunerated deals in the shape of structured financing and the like. Thus a bank would not wish to find that the financing it supplied was being used by Enron to obtain a lower rate for vanilla financing from another bank on the basis of West’s high credit rating, nor would it wish another bank to gain a competitive edge by obtaining good security on its vanilla lending which might enable it to free up further capacity to engage in better paid financing transactions with Enron. Credit support for a Chase structured finance prepay would not fall into either category.

It was accepted by Mr. Edey of West that standby letters of credit are functionally similar to guarantees and frequently had the same weighting as financial guarantees under the Facility Agreement for the purpose of allocation of reserves. As head of the trade finance department he knew that the scope of the Facility Agreement was not confined to trade related instruments but covered instruments for Enron’s general corporate purposes. He accepted that West might have deduced at the outset, when the request was made for the letter of credit that Chase was providing structured financing and Mahonia was a conduit for that. The letter of credit looked as though it was covering some type of structured transaction. When he looked at the documents after Enron had encountered financial difficulty in November 2001, it was obvious that there was a relationship between Chase and Mahonia and that it was a structured finance transaction. He took the view that the letter of credit was issued correctly and in accordance with the facility notwithstanding that Mahonia was likely to be an SPV conduit in a structured finance transaction, because the credit risk for West was Enron and nothing else. The Trade Finance Department considered that the L/C should be paid.

In these circumstances it seems highly unlikely that Mr Goodwin or Mr Edey would have raised any objection had they been expressly informed of the Three Swaps and the part the L/C played in the structure. It seems unlikely that the matter would have reached Mr. Frohmaier or Mr Taylor, but if it had, it is hard to see the latter making an issue of it in circumstances where he was enthusiastic to develop business with Enron in structured finance of the same kind as was involved here.

The evidence that West in London would have done something different, if it had known the full circumstances of the Three Swaps is therefore tenuous. When Messrs Frohmaier and Taylor from London maintained in their evidence that they would have been prepared to stand their ground on issuing the L/C, if they had known the full facts, this has to be seen against the evidence that the L/C terms indicated structured finance and West wished to do this business with Enron in order to secure its own share of Enron structured financing and securitisation deals. This was not a case where Enron was obtaining vanilla lending from Chase at a lower price, on the back of financial guarantees issued by West, nor a case where Chase was satisfying Enron’s requirements for vanilla lending with West as a backstop security. This was structured financing of the same kind as Chase IV, for which West had provided L/C credit support, where it could make no difference to West whether Enron’s liability was to a trade supplier or to a bank. The key from West’s perspective was always its relationship with Enron, its assessment of Enron’s credit worthiness and its desire to do business with Enron of a vanilla type in the hope of also doing more business at more highly remunerated rates.

West’s desire to continue a relationship with Enron even when Enron’s financial troubles surfaced appeared from the steps taken by Mr. Frohmaier and Mr. Sai Louie when Enron approached it to seek a waiver of the clause 4.1(d) representation of accounting in according with GAAP in the light of Enron’s restatement of its accounts by $1.1 billion on 8^th November 2001. Both Mr. Frohmaier and Mr. Sai Louie discussed with Enron the possibility of a letter from it to explain the restatement of its accounts in order to satisfy the syndicate of banks. Mr. Taylor’s evidence was that he was looking to keep the relationship at its status quo and to support Enron even as late as 19^th November 2001. Had a request come for an instrument to be issued and West lawyers had advised that there was no basis for refusal, the evidence was that West would have issued it at that stage, regardless of the views of any syndicate bank, but was looking to “fend off” the syndicate banks and to stand by Enron in the hope it would come through its problems and reward West for its loyalty. Mr Taylor optimistically saw this as an “opportunity” and was suggesting financing Enron to Mr Frohmaier, on the basis that there was an 80% chance of Dynegy taking over Enron.

There was no evidence that the other banks, to whom the Facility Agreement had been syndicated, had been told of any restriction on the L/C’s to be issued save what they could see in the Facility Agreement itself, which was the basis of the syndication. Although it was suggested by Mr. Frohmaier in re-examination that the transaction was sold to the other syndicate banks on the basis that it did not involve securing Enron’s borrowing from other banks, who would be opposed to financing of this kind, there was no direct evidence of this at all. Whilst, after the event, West and its syndicates of banks are understandably less than pleased at the prospect of paying $165 million to alleviate Chase’s exposure to Enron, there is not enough evidence before me to establish that, if Mr. Goodwin had expressly been told the details of the Three Swaps, he would have taken any action on that or, had he consulted Mr Edey that the latter would have taken the matter up. Had he, in turn, spoken with Mr. Frohmaier, Mr. Taylor, Mr. Newman or West in Dusseldorf, I am not satisfied that West would have taken a stance against Enron.

If the matter had been referred to West in New York or Houston, it is hard to see how any objection would have been taken there in the light of West’s participation in Chase IV. It is clear that Mr. Newman who was overall relationship manager at West for Enron would not have had a problem with it and, given the terms of the request for credit approval and the absence of any binding limitation on the wording in the Facility Agreement, there would be no basis upon which West in the USA could take any point.

So far as West Dusseldorf is concerned, where it is likely that any ultimate decision would have to be taken should the argument have escalated about the issue of this letter of credit, no evidence has been adduced by West. Since the request for credit approval, endorsed by West in London and West in New York gave no intimation of any restriction in use, it is again hard to see the basis upon which West in Dusseldorf could object. There is no suggestion that West in Dusseldorf was ever told of any restriction of any kind upon the use to which a L/C could be put, beyond the terms which appeared in the Facility Agreement.

I find that if the issue had been raised it would have been handled by Enron in Houston with liaison with London, but Enron would, as always have been hard nosed in its dealings with its banks and insisted that there was no basis for refusal to open the L/C on the wording of the Facility Agreement. If West had taken legal advice on the subject it would have received advice that, under the terms of the Facility Agreement, it was not justified in refusing to issue the L/C and that, whatever the oral exchanges in the summer, they provided no defence in the light of Clause 8.7 of that Agreement. If Mr Frohmaier and Mr Taylor had stood their ground, with Mr Sai Louie’s support, the matter would surely have been taken up in the USA with Mr Newman and if necessary with Dusseldorf by him and the outcome would have been one of accommodating Enron.

In a situation where the creditworthiness of Enron was not in doubt and West’s clear desire was to do business with Enron in order to secure the type of business to which the credit approval request referred, there were good reasons for West to do that which it was bound to do, namely issue the L/C as requested. It does not seem to me at all likely that if Mr. Goodwin had received further information about the structured finance transaction and had referred the matter to others in West for a decision as to what to do, that those who had to take the decision would have taken a stance on the matter on the basis of reports from him, Mr. Frohmaier, Mr. Bourke, Mr. Taylor or Mr. Saint in London of conversations with Mr. Crowe and Miss Martin in August and September 2001 which, as I have found, did not have and were not expected to have any legal effect.

Even if each of them had said to Enron what appears in their witness statement, I am not satisfied that West would have made an issue of the matter when Enron were not only solvent but the substantial company in the power industry with whom every bank appears to have wanted to transact business.

The notion that West would have taken any point about the illegality of the Three Swaps transaction is, I find, fanciful. West itself was prepared to effect transactions of the same kind and was, it appears, keen to do so. With the time pressure to issue the L/C by 8^th October and the desirability of issuing such a large L/C from West’s standpoint the thought of illegality would not even have crossed the mind of those involved at West, let alone provided a ground for objection to issuance or exploration with lawyers or accountants.

For all the reasons set out, I cannot find that West, whether in London, New York or Dusseldorf would have been prepared to refuse to issue the L/C on Enron’s insistence.

West ultimately put forward in its closing submissions two grounds on which it argued that the L/C was unenforceable for illegality. West says that the L/C is illegal and/or is tainted by illegality and/or is unenforceable on grounds of public policy.

The first illegality defence, namely that the L/C was created for an illegal purpose under the law of a friendly foreign State or is tainted by the same unlawful purpose underlying the Three Swaps, fails on the basis of my findings that Enron’s accounting was not in breach of GAAP and did not therefore constitute any breach of US Securities law, and because Mahonia was not privy to any unlawful purpose, having no knowledge of any element of wrongful accounting.

The second ground of illegality depends on the commission of a fraud by Chase in deceiving West or conspiring to deceive West in a manner which amounts to a common law conspiracy to defraud, a conspiracy to obtain property by deception, a conspiracy to obtain a pecuniary advantage by deception or the obtaining of property or obtaining of a pecuniary advantage, contrary to s1 of the Criminal Law Act 1977 and/or ss.15 and 16 of the Theft Act 1968. As I have found that there was no fraud by Chase, this defence also fails.

The latter argument raised a novel point, inasmuch as there is no case in which an English court has previously refused to enforce a contract as illegal on the grounds that it was procured by a fraud amounting to a crime, the normal basis for resisting enforcement of such a contract being the law relating to rescission of contracts by reason of fraudulent misrepresentation inducing the conclusion of the contract. The argument as to illegality was, it would appear, intended to present a defence which did not depend upon inducement or reliance or raise the possibility of any bars to rescission.

If West had been able to establish that Enron’s accounting was in breach of GAAP and in breach of s10b of the Securities Exchange Act 1934, that this wrongful accounting was the underlying purpose of the Three Swaps transaction and that Mahonia was party to that purpose, to enforce the Three Swaps would be to enforce contracts which were entered into for the purpose of breaching the law of a friendly foreign country in that country, since that is where the accounting took place. This would bring into play the principles in Foster v Driscoll [1920] KB 287 and Regazzoni v Sethia [1958] AC 301. West submitted that in those circumstances the L/C was an integral part of the Three Swaps and suffered from the same unlawful underlying purpose or alternatively that it was so connected with those transactions that it was tainted by the illegality which affected them. West relied upon the judgment of Colman J in this very matter dated 30^th July 2003 and upon a sequence of authorities as to the effect of the illegality of a contract and considerations of public policy in relation thereto. In particular West drew attention to the authorities which showed that courts will not generally enforce security given pursuant to an illegal transaction and in support of it.

If West had established that there was an unlawful underlying purpose for the Three Swaps and in particular the ENAC/Mahonia Swap, inasmuch as the performance of the Three Swaps constituted the provision of a loan for which unlawful accounting was intended, and to which unlawful purpose Mahonia was a party, I would have accepted its contention that the L/C was directly tied to the illegal purpose since it was an important part of the scheme which was to give rise to the unlawful accounting albeit that it was not directly connected to the accounting itself, in the manner of the Three Swaps. The provision of letters of credit totalling $315 million was a term of the ENAC/Mahonia Swap and the sum of $350 million would not have been advanced by way of prepayment at all if there had not been a promise of such provision. Furthermore, had the L/C’s not been provided by October 9^th, the Swap transactions would have been terminated. Thus the L/C was brought into existence for the very purpose of being part of what was, on this hypothesis, an unlawful scheme.

Equally, the doctrine of taint could be seen to apply inasmuch as the L/C is analogous to a form of security for the performance of ENAC’s obligations and there is a stream of authority commencing with Fisher v Bridges [1853] 3 EL & BL 643 and running through Bigos v Bousted [1951] 1 AER 92 to more recent cases such as Spector v Ageda [1971] 3 WLR 498 and Mansouri v Singh [1986] 1WLR 1393, where the courts have refused to enforce security given for an illegal contract.

The ENAC/Mahonia Swap and the L/C were closely connected in that the L/C was opened in consideration of obligations contained in the ENAC/Mahonia Swap. On this hypothesis, Chase, ENAC and Mahonia would have entered into the Three Swaps contracts for the purpose of using the very existence of those contracts or their performance for an unlawful purpose, namely deliberate false accounting on a substantial scale. The wrongful accounting was, on this hypothesis intimately connected with the ENAC/Mahonia Swap and akin to a form of security for its performance, so that the L/C was part of the overall arrangements and shared the same common purpose, since without it the transaction would not have gone ahead. I cannot improve on the reasoning of Colman J in this context as to the effect of such an unlawful purpose on the Three Swaps and the L/C.

Whilst the conclusion I have reached on this differs from my conclusion in respect of section 29 of the Securities Exchange Act, the reason for this is the wording of that Act which is more restrictive than a doctrine (if it can be called that) of English law which depends significantly on public policy. I do not consider that breaches of section 13 (a) or 13 (b) would without more be likely to give rise to unenforceability because they do not involve any element of deceit or intentional wrongdoing but had a breach of section 10 (b) and 20 (e) been made good, in which Chase and Mahonia were complicit, with such planned deliberate large scale misaccounting as the underlying purpose of the L/C, West’s defence would have succeeded.

I have more doubts about West’s reliance on the argument that Mahonia cannot make out its claim under the L/C without relying upon the ENAC/Mahonia Swap. Whilst there is support for this proposition in a dictum of Staughton LJ in Group Josi v Walbrook Insurance Co. [1996] 1LLR 345 (CA), it seems to me that Mahonia would not be relying on the underlying transaction in claiming under the L/C, but on the draw statement which triggered the L/C obligation, albeit that that draw statement made reference to the ENAC/Mahonia Swap. This does not affect the central point however that the Court ought not and will not lend its aid to enforce a contract, a security or something akin to a security for a contract, where the underlying purpose of that contract is contrary to the law of a friendly foreign state where performance is to occur and the gravity of that unlawfulness is such as to engage public policy considerations.

With this reservation, I would have accepted the arguments of West as to the unenforceability of the L/C had West been able to make good Mahonia’s complicity in an illegal scheme unlawfully to account for the Three Swaps. For the reasons essentially set out by Colman J in July 2003 and those set out in West’s closing submissions, I would not have held that the “autonomy” of letters of credit required a different conclusion. If the L/C had played a part in an overall scheme of the magnitude alleged, to deliberately mislead by wrongful accounting, contrary to section 10(b) of the Exchange Act 1934, and Chase and Mahonia had been complicit therein, public policy would, in my view have required the court not to lend its aid to the enforcement of the L/C which shared the same unlawful purpose as the Three Swaps, which came into existence solely by virtue of that purpose and which was, in any event so closely connected with them as to be tainted by that purpose.

I accept also that West would be, in these circumstances entitled to resist enforcement at this stage of the proceedings without knowing of any basis for resisting the demand under the L/C at the time when it refused to pay. If Colman J is right in his views in relation to fraud, as expressed in paragraphs 39-47 of his judgment, as I consider he is, the position is stronger in relation to arguments on unlawfulness because of the public policy considerations which come into play. If they require the Court to refuse to enforce the L/C, this requirement must hold good at any stage of the proceedings, regardless of the time when the point was first known to, or raised by, the defendant.

So far as concerns the illegality argument based upon the commission of UK crimes, it is accepted that fraud is not per se a crime but it is suggested that the facts relied upon by West do constitute crimes under English law. The reliance placed on s16 of the Theft Act and the obtaining of a pecuniary advantage appears to be misplaced because the definition of a pecuniary advantage in s 16(2) does not encompass the facts alleged by West and a conspiracy to obtain such a pecuniary advantage would therefore not be actionable. There remains however common-law conspiracy to defraud, obtaining property by deception contrary to s15 and conspiracy to achieve that. I need not determine these matters however, because I have already found that there was no dishonesty on the part of Chase and no deception of West, as well as finding that there was no agreement between Enron, Chase and Mahonia to obtain property by deception or to defraud. I am bound to say that it seems to me to be contrary to principle that a contract should not be enforced because of fraud, when it is not shown that the deception was relied on at all or that the contract was actually induced by that fraud.

For the reasons set out above Mahonia succeeds on its claim under the L/C. There was no illegality which affected this transaction. Chase and Mahonia (to the extent that the state of mind of Chase personnel can be attributed to Mahonia) at all times considered that Enron’s past accounting and proposed accounting for the prepays, including Chase XII, was lawful and conducted in accordance with responsible advice from experienced and able accountants. Mahonia at no time conspired with Enron in any of the ways suggested and there was no deception practiced by Mr. Levy or anyone else at Chase for which Mahonia could in any way be liable. None of the cross-claims against Mahonia succeed.

West’s claims against Chase all fail because Chase was not party to any conspiracy with Enron, whether to devise a transaction to enable Enron wrongfully to account or to mislead West as to the nature of the underlying transaction or the true purpose of the L/C. Mr. Levy did not misrepresent the position to West and no liability devolves upon Chase in respect of any of the allegations made by West.

It is inevitable that costs should follow the event and that West should be liable to pay the costs incurred by Mahonia and Chase. I have already held that the costs relating to the allegation of misrepresentation by Mr. Levy should be paid on the indemnity basis and it appears to me that the costs in respect of the two abandoned allegations of procuring a breach of the Facility Agreement and implied representation should also be paid on the same basis. I will wait for the parties to address me on these and other issues of costs before making any final order.