Irreconcilable Differences:Chevron v. Galveston Bay

Chevron Corp.'s relatively small investment in a Texas biodiesel plant is turning into a public relations nightmare. The oil giant and its renewable fuels subsidiary are accused of fraud and negligent misrepresentation. But the real wounds have been inflicted outside the courtroom where Chevron stands accused of entering the biodiesel venture to "greenwash" its image.
By Sarah Smith | February 11, 2008
The lawsuit, filed in December 2007 in a Texas court, reads like a bitter divorce, rather than a contractual disagreement. Chevron is accused of abandonment during the honeymoon phase of the marriage. Plaintiff BioSelect Galveston Bay claims its reliance on Chevron's assurance of participation in several rounds of financing to build and expand its biodiesel plant led it to forego seeking other financial suitors when Chevron got cold feet. Chevron counters that participation in each round of financing was voluntary, not mandatory, and that no such reliance should have been put on a minority partner. In marital parlance, Chevron was a groomsman, not the groom, and therefore doesn't have to pay alimony.

The lawsuit centers around a venture capital strategy called "pay to play." Galveston Bay, a six-month-old biodiesel plant, claims that it shelved plans for a proposed expansion when Chevron withheld financial backing. Galveston Bay claims in the lawsuit that Chevron's initial investment and subsequent overtures lured venture capitalists into a "very attractive investment," but then Chevron balked when asked to participate in crucial rounds of recapitalization to expand the plant, "much to the surprise and detriment to the partnership."

Publicity surrounding the lawsuit nearly equals the publicity garnered in 2005 when Chevron's alternative energy subsidiary, Chevron Technology Ventures, became a minority investor in the 20 MMgy biodiesel facility that had immediate plans for expanding capacity to 100 MMgy. The lawsuit accuses Chevron of burnishing its green image through the good will generated by the "extensive media coverage." Chevron valued that publicity at $30 million. "We made significant investments to help the start-up of the [Galveston Bay]
venture," says CTV spokesman Russell Johnson. "We think the investments played a constructive and material role in the venture's launch."

Stature may be the heart of the lawsuit, aside from the dicey nature of the financing mechanism, a product of the dot-com tech wreck a decade ago.

The Lawsuit and the Litigants
Standard Renewable Energy Group LLC is a Houston-based builder, operator and investor of renewable energy companies. SREG partnered with affiliate BioSelect Fuels, a developer and operator of biodiesel plants, to erect the Galveston Bay facility. The partnership was known as Galveston Bay Biodiesel. Plans were to refine soybeans and other agricultural oilseed crops into biodiesel. Galveston Bay had an option to sell B100 or blended fuel that would serve marine, trucking, industrial and commercial markets in the Galveston and Houston areas.

In December 2005, Chevron and CTV took a 22 percent minority stake in the venture. They are named as defendants, along with R.E. Zalesky, vice president in charge of biofuels at the subsidiary. Chevron, the second-largest U.S. oil and gas company, publicized its participation extensively as part of its growing green portfolio. "This investment is another example of how Chevron takes a proactive, practical approach toward the development of emerging energy sources," Chevron Vice President and Chief Technology Officer Don Paul said in 2006. "We believe biofuels are a component of the diversification of the fuel supply to meet future energy demand."

Although they are not now parties to the suit, other investors include Contango Capital Management, Mobius Risk Group LLC, Sultex LLC, Galveston Bay Biodiesel Management LLC and Beaver Creek Fund Ltd.

Construction on the biodiesel plant was plagued by mishaps, technological issues, management changes and costly delays, necessitating subsequent rounds of financing.

Nevertheless, on May 29, 2007, all the players, politicians and other dignitaries convened at a ribbon cutting to laud the facility as the "greening of Galveston."

By Aug. 1, 2007, when another round of recapitalization was necessary to infuse more money into the plant, Chevron delayed, then declined to participate, the complaint states, adding that Chevron "never explain[ed] their misleading decision to abandon the partnership at a critical time."

An amended complaint filed in January 2008, asserts that Chevron told Galveston Bay it would "not let you fail," but that's essentially what happened.

Unpaid creditors, mostly the contractors and construction workers who built the plant, filed liens worth more than $6 million by the fall of 2007. In early 2008, Chevron received a $15 million lifeline from an unnamed financier, and was able to settle the construction liens for $2.2 million.

Chevron, invoking a clause in the partnership agreement, filed a petition for binding arbitration on Nov. 30, 2007. The lawsuit followed a week later, seeking to litigate the matter rather than resolve it through alternative dispute resolution.

Galveston Bay "is simply one element of our company's broad portfolio of alternative energy investments," Johnson says. "Chevron is committed to biofiuels as a long-term business strategy." He adds that "CTV has met all of its contractual obligations with respect to the project, and any suggestion to the contrary is inaccurate."
Most of the biodiesel Galveston Bay produced headed for Europe instead of local outlets, the lawsuit states.

Down Round Financing With a Pay to Play Option
When cash-starved dot coms needed an influx of money in 2000, they used bridge loans to tide them over. The alternative was going out of business. Pay to play was born. In traditional venture capital financing each successive round of financing comes at a higher valuation than the one preceding it, allowing early investors to demonstrate progress to their own backers. It also theoretically provided increasing incentives for the founding patrons to stay in the game. Dot coms deemed promising but unable to meet their financial goals hoped to benefit from the largesse of subsequent investors who provided these bridge loans.

Initially the early stage investors viewed this practice as one that legitimized and bolstered their capital investment. It gave the start-ups new life, weary investors a shot in the arm, and propelled shaky companies to the next level of development. The financing mechanism caught on, even though the dot coms died, and by 2003 it was fairly common in venture capital circles. It has become a hallmark of gold rush economic cycles when a hot ticket investment turns ice cold.

The down round is the opposite: investors purchase stock at a lower valuation. It's risky, like a high-stakes poker game, and frequently results in litigation. Poker players ante up money just to see what the other player is holding, at the risk of losing everything.

In theory with pay to play, new stock is offered in exchange for the new financing. It dilutes all of the shares just by adding to the pot, but the investors get a smaller share of a bigger pot. In practice it often operates like a Ponzi scheme in reverse. Original investors, if they chose not to participate in the later rounds of financing, face adverse consequences such as having their stock values diminished or converted to lower-value stocks. Sometimes their original investments became worthless. The new investors are brought in at a lower valuation than the value the founders placed on the company at the embryonic stages.

That is what Chevron alleges happened here. The plaintiffs' attorneys say the oil giant ponied up $100,000 for an initial 4.9 percent interest. When more financing was necessary, Chevron threw $3.5 million into the pot, giving it a 22 percent share. It also extended a loan of $5.1 million, the attorneys say. But when recapitalization was necessary later, Chevron folded. Galveston Bay looked to European financiers to arrange stopgap debt financing.

"The transaction would effectively eliminate CTV's equity position," the plaintiffs alleged Chevron indicated in its refusal to participate. As a result, the lawsuit alleges, "an opportunity to lock in lower soybean oil prices came and went because no funds were available." Third-party funding sources then declined to get into the game.

"Ongoing investment decisions are dynamic and based on many different factors," CTV's Johnson says. "Each investment decision was based on individual investment offerings or requests for funds. The parties' agreements specifically state that the partners are not obligated to make any further contributions."

Galveston Bay's dreams of becoming one of the largest biodiesel plants in the United States died. The $15 million influx will enable it to expand its capacity to 30 MMgy or 40 MMgy, but 100 MMgy is out of reach for now. The plaintiffs are seeking unspecified damages, but have also requested punitive damages because of the alleged deceptive nature of the fraud accusations.

Small Greenbacks, Big Green Headaches
Chevron's $3.6 million investment is small potatoes in the overall scheme of the company. In early 2008, Chevron announced record profits for fourth quarter 2007. Although it did not provide specifics, it earned $3.72 billion the previous quarter.

"There is increasing pressure on all companies, but especially oil companies, to go 'green,' i.e., to cultivate, encourage, and grow more environmentally friendly businesses," the amended petition states. "Chevron's investment in the biodiesel plant garnered extensive positive publicity for Chevron."

Court filings indicate that Todd Sullivan, president of BioSelect Fuels, John Berger, CEO of Contango, Standard Renewables and Sullivan family members invested $1.5 million in June 2007 relying on Chevron's assurances of staying in the game.

The amended petition stated that Chevron "never intended to do anything more for the project, aside from enjoying the favorable publicity that resulted from being associated with it." When Chevron became noncommittal in the recapitalization efforts, it knowingly undermined Galveston Bay's hopes for success, the lawsuit alleges. "Nevertheless, publicly Chevron continued to brag about its commitment to biodiesel as one of several alternative fuels, and its commitment to Galveston Bay Biodiesel in particular," the amended petition alleges.

Johnson declined to comment on whether Galveston Bay was a poor investment choice, or whether a volatile biodiesel economy has soured Chevron temporarily on future ventures. "In addition to biodiesel, Chevron is funding research into cellulosic ethanol, hydrogen, ultraclean diesel and other forms of emerging energy," Johnson says. "In all, we expect to spend more than $2.5 billion between 2007 and 2009 on alternative and renewable energy technologies as well as energy efficiency."

Chevron maintains that contractually, the parties agreed to arbitrate any disagreements. Johnson says the fraud allegations are simply a way for the plaintiffs to circumvent the arbitration provisions and air the grievances in a public forum. It's the marital equivalent of bypassing couples counseling and going on "Dr. Phil."

The saga will continue through the court system as the partners are left to wonder if this marriage of convenience was nothing more than a shotgun wedding that spawned a fatherless child.

Sarah Smith is a Biodiesel Magazine staff writer. Reach her at ssmith@bbibiofuels.com or (701) 663-5002.
 
 
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